Determinants of Contract Choice: The Use of Warrants to Compensate Underwriters of Seasoned Equity Issues
Posted: 11 Mar 1996 Last revised: 9 Oct 2008
The issuer's dichotomous choice to include warrants as underwriting compensation is studied for a sample of 1,991 negotiated firm commitment seasoned equity issues. Using two-stage logit to adjust for self-selection, we find the issuer's decision to use or not use warrants is consistent with the objective of maximizing issue proceeds net of issuing costs, including cash spread, underpricing and the value of warrant compensation. To explain the use ofwarrant compensation, three non-mutually exclusive hypotheses are tested: certification, circumvention, and segmentation. Results suggest that the most important determinant of the choice is certification. The certification hypothesis maintains that warrants substitute for reputation in certifying the fairness of the offer price. Results also are consistent with the hypothesis that warrants can be used as means to circumvent NASD limitations on underwriting compensation. Results are inconsistent with the hypothesis that underwriting market is segmented between small and large issuers.
JEL Classification: D82, G24, L14
Suggested Citation: Suggested Citation