Academic journal article The International Journal of Business and Finance Research

Why Do Insiders Sometimes Pay More and Sometimes Pay Less in Private Placements?

Academic journal article The International Journal of Business and Finance Research

Why Do Insiders Sometimes Pay More and Sometimes Pay Less in Private Placements?

Article excerpt


This paper explores private placement pricing sold to insiders by considering changes in the control power of the largest shareholders in private placement. We use the Banzhaf power index to reflect the largest shareholder's relative power of influence. The results indicate that, if existing insiders maintain their leading control status, in cases where insiders are the main investors, private placements are issued at deep discounts that benefit themselves. However, in cases where outsiders/new insiders are the main investors, outsiders and new insiders will pay relatively more when existing insiders dominate. Contrarily if existing insiders fail to retain their leading position and become less powerful after private placement, outsiders and new insiders buy at lower prices. In more than 65% of the sample, the largest shareholders lost their leading control status, and the issuer's ownership structure becomes more concentrated following private placements. Finally, the findings suggest that motivations of private placement issues have a greater influence on pricing than investor types in private placements.


KEYWORDS: Private placement discount, power index, control right, self-dealing, ownership structure

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Over the last few decades, there has been a dramatic increase in the number of equity private placements. From 1995 to 2006, the number of private placements issued by U.S. corporations increased from 127 to 2,720. The total amount of capital raised via private placement also has increased from $1.87 billion in 1995 to $88.0 billion in 2006. In Taiwan, from October 2001, publicly listed firms have been able to raise equity capital via private placements. The number of private offerings has been increasing annually, while numbers of public offerings have been decreasing. Some firms even conduct multiple private offerings during a single year in Taiwan. The private placement market has emerged as an important choice among corporations for the issuance of follow-on equity financing. Although extant research has focused primarily on public offerings, private placements have recently attracted considerable attention.

Equity private placements are in general sold at a discount. Empirical research shows the average discount of U.S. private equity issues is -11.3%~-20.14%.The average discount of Taiwanese private offerings is about -20%. Why private placements are issued at relatively large discount to the market price? Past literature on the causes of private placement discount mainly focused on the impact of monitoring, illiquidity, management entrenchment and information asymmetry. However, existing studies have ignored the fact that changes in large shareholders' control over the firm may be a key consideration in determining prices.

Prior studies provide some evidence of the association between private placement discount and investor type. For example, Hertzel and Smith (1993) and Barclay, Holderness and Sheehan (2001, 2007), among others, suggested that there is a larger discount for private placement sold to outsiders. The reason for this large discount is to compensate the investors for agency cost or information cost. However, there is no consensus on the discount for private placement sold to insiders. Some studies provide empirical evidence of the self-dealing hypothesis where discounts for private placements sold to insiders are higher than discounts for private placements in which insiders do not participate (see Wruck and Wu (2009), Wu (2004), and Hertzel et al. (1993)). Insiders can issue private placements at a greater discount to benefit themselves because private placements tend to draw less attention from investors and regulatory agencies, and therefore, the incentive for insiders to tunnel tends to be strong in private placements. On the other hand, the control premium hypothesis provides a contrasting view of the pricing of issues sold to insiders. …

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