Adverse Selection and the Rights Offer Paradox

Eckbo, B. Espen; Masulis, Ronald W.

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Adverse Selection and the Rights Offer Paradox

Journal of Financial Economics (JFE), Vol. 32, No. 3, pp. 293-332, 1992

49 Pages Posted: 19 Jun 2006

See all articles by B. Espen Eckbo

B. Espen Eckbo

Tuck School of Business at Dartmouth; European Corporate Governance Institute (ECGI)

University of New South Wales, Sydney; European Corporate Governance Institute (ECGI); Financial Research Network (FIRN); National University of Singapore (NUS) - Asian Bureau of Finance and Economic Research (ABFER)

Abstract

We develop an analytical framework to explain a firm's choice of equity flotation method and the near disappearance of rights offers by U.S. exchange-listed firms. The choice between uninsured rights, rights with standby underwriting, and firm-commitment underwriting depends on information asymmetries, shareholder characteristics, and direct flotation costs. Underwriter certification and current shareholder takeup of issues are viewed as substitute mechanisms for minimizing wealth transfers between shareholders and outside investors. Uninsured rights create adverse selction effects when shareholder takeup is low. Implications for stock price behavior around issue announcements, shareholder subscription precommitments, and relative issue frequencies are supported by large sample evidence.

Keywords: Flotation method, seasoned common stock, SEO, stock offer, rights offer, adverse selection

JEL Classification: G24

Suggested Citation: Suggested Citation

Eckbo, B. Espen and Masulis, Ronald W., Adverse Selection and the Rights Offer Paradox. Journal of Financial Economics (JFE), Vol. 32, No. 3, pp. 293-332, 1992, Available at SSRN: https://ssrn.com/abstract=908963