Research
Litigation and Information Effects on Private Sales of Securities (with Onur Bayar, Ioannis V. Floros, and Juan Mao)
(presented at 2019 Financial Management Association meetings, 2021 Eastern Finance Association meetings, 2021 FMA Europe Conference)
We analyze the resolution of information asymmetry in transactions of private investments in public equity (PIPEs) in which the issuer has experienced class action lawsuits. We explain the associated wealth and pricing effects (information effects). We show that litigated PIPEs are associated with higher announcement wealth effects and lower levels of discounts than non-litigated PIPEs. We find that disclosure, prior investors' ownership, early registration, and intermediation have positive information effects on incumbent and new investors when issuers concurrently pursue the desired corporate actions (proxied by the auditor changes). We conclude that PIPE issuers can mitigate information effects from prior litigation.
Note: The hand collection process of allegation types and attributes of the securities class action lawsuits in our sample is described here. The dataset is password protected on the data page (available upon request).
The data fields description is available here.
How Reverse Merger Firms Raise Capital in PIPEs: Search Costs and Placement Agent Reputation (with Onur Bayar and Juan Mao)
Review of Quantitative Finance and Accounting, 56.1 (2021), 143-184.
We examine the role of placement agents in private investments in public equity (PIPE) deals of firms that went public via a reverse merger (RM). We find that reputable placement agents with greater expertise (expert agents) help RM firms to complete their PIPE deals in a smaller number of financing rounds (closings) and raise funds from a larger base of private investors. However, RM firms advised by expert agents agree to more investor-friendly contract terms and pay higher cash compensation to their placement agents. Further, RM firms are not able to negotiate more attractive pricing when they agree to more investor-friendly contract terms in PIPEs placed by expert agents. Overall, our evidence indicates that, while expert PIPE agents use their superior networking capabilities to reduce the search costs of RM firms, they also exercise more bargaining power against RM firms compared to non-expert PIPE agents. Finally, compared to the PIPE offerings of IPO firms, the PIPE offerings of RM firms are more likely to involve deals with multiple closings and substantially larger offer price discounts. This suggests that raising new capital in PIPEs entails significantly higher costs for RM firms than IPO firms.
Does innovation success reduce the cost of financing? Evidence from private investments in public equity
Finance Research Letters (2022): 103378.
This paper investigates the relation between a firm’s innovation performance and the cost of financing in private investments in public equity (PIPEs). Using patent-based metric data, I find that innovative firms issue securities in private equity placements at a 5.4% lower discount than
non-innovative firms. The negative effect of innovation performance on PIPE discounts is more pronounced for firms in R&D intensive industries and firms with higher stock market illiquidity. Channel tests show that innovative firms are more likely to be led by strategic investors who are
willing to pay a higher price to support innovative issuers. The results are robust to alternative methods that mitigate endogeneity issues.
Is Short Selling Informative about Litigation Risk? Evidence from Private Investments in Public Equity (with Onur Bayar and Juan Mao)
We examine the impact of litigation risk on short selling activity around PIPE transactions. We find that PIPE issuers that incurred securities class action lawsuits prior to the PIPE offering are shorted more heavily around the PIPE issuance date. Heterogeneity in the level of issuers’ litigation risk such as the case status at the time of security issue and the timing of the private placement after the litigation event affects the extent of short selling activity surrounding PIPEs. In addition, the effects of litigation risk on short selling are more pronounced in PIPEs where lead investors are hedge funds. Our results imply that outside investors incorporate value-relevant information about issuing firms’ litigation risk through their short selling activity around PIPE offerings.
The Role of Loan Market Access and Financial Covenants in Pricing Private Placements (with Ca Nguyen)
(presented at 2021 Financial Management Association meetings)
Our study examines the pricing of private placements in the presence of coordination frictions among existing loan creditors, incumbent shareholders, and private equity investors. Using Private Investments in Public Equity (PIPE) deals in 2001-2018, we find that issuing firms with outstanding loans offer a larger PIPE discount, and the discount increases if the loan contracts include financial covenants. Our results remain strong when we use the propensity score matching, Heckman selection model, and two-stage least squares instrumental variable analysis, to control for endogeneity. We argue that, rather than free riding on certification and monitoring provided by loan creditors, private equity investors are more concerned about the discoordination among existing equity holders and the potential of transferring control rights to debtholders when investing in firms with outstanding loans. Using different measures reflecting coordination frictions such as proposal level voting results, PIPE governance features, leverage change, covenant strictness, and covenant violations, we find supporting evidence for this argument.
The Role of Existing Shareholders in Private Equity Placements: Evidence from PIPEs in China (with Di Lu and Suhua Tian)
This paper investigates how the participation of firms’ existing shareholders affects the pricing and valuation of the private equity placements (PIPEs). Using a large sample of PIPEs issued by Chinese listed firms from 2006 to 2019, we find that the effective discount and long-term buy-and-hold abnormal stock returns of PIPEs participated by existing shareholders are significantly higher than those participated only by new investors. However, the superior post-PIPE stock performance of deals participated by existing shareholders is not driven by improved operating performance. We find that PIPEs participated by existing shareholders are more likely to use the raised funds for internal usage and be followed by tunneling activities such as frequent dividend announcements, related-party transactions, and positive earnings management following the PIPE. Our findings suggest that the effect of existing shareholders presence in private equity placements is more consistent with the “Tunneling Hypothesis” than the “Certification Hypothesis”. We document that the tunneling incentives arising after the participation of existing shareholders in PIPEs can be mitigated when the firm’s corporate governance is stronger.
Coauthored Book: "Equity Markets, Valuation, and Analysis"
Chapter 14: "Private Company Valuation"
Litigation and Information Effects on Private Sales of Securities (with Onur Bayar, Ioannis V. Floros, and Juan Mao)
(presented at 2019 Financial Management Association meetings, 2021 Eastern Finance Association meetings, 2021 FMA Europe Conference)
We analyze the resolution of information asymmetry in transactions of private investments in public equity (PIPEs) in which the issuer has experienced class action lawsuits. We explain the associated wealth and pricing effects (information effects). We show that litigated PIPEs are associated with higher announcement wealth effects and lower levels of discounts than non-litigated PIPEs. We find that disclosure, prior investors' ownership, early registration, and intermediation have positive information effects on incumbent and new investors when issuers concurrently pursue the desired corporate actions (proxied by the auditor changes). We conclude that PIPE issuers can mitigate information effects from prior litigation.
Note: The hand collection process of allegation types and attributes of the securities class action lawsuits in our sample is described here. The dataset is password protected on the data page (available upon request).
The data fields description is available here.
How Reverse Merger Firms Raise Capital in PIPEs: Search Costs and Placement Agent Reputation (with Onur Bayar and Juan Mao)
Review of Quantitative Finance and Accounting, 56.1 (2021), 143-184.
We examine the role of placement agents in private investments in public equity (PIPE) deals of firms that went public via a reverse merger (RM). We find that reputable placement agents with greater expertise (expert agents) help RM firms to complete their PIPE deals in a smaller number of financing rounds (closings) and raise funds from a larger base of private investors. However, RM firms advised by expert agents agree to more investor-friendly contract terms and pay higher cash compensation to their placement agents. Further, RM firms are not able to negotiate more attractive pricing when they agree to more investor-friendly contract terms in PIPEs placed by expert agents. Overall, our evidence indicates that, while expert PIPE agents use their superior networking capabilities to reduce the search costs of RM firms, they also exercise more bargaining power against RM firms compared to non-expert PIPE agents. Finally, compared to the PIPE offerings of IPO firms, the PIPE offerings of RM firms are more likely to involve deals with multiple closings and substantially larger offer price discounts. This suggests that raising new capital in PIPEs entails significantly higher costs for RM firms than IPO firms.
Does innovation success reduce the cost of financing? Evidence from private investments in public equity
Finance Research Letters (2022): 103378.
This paper investigates the relation between a firm’s innovation performance and the cost of financing in private investments in public equity (PIPEs). Using patent-based metric data, I find that innovative firms issue securities in private equity placements at a 5.4% lower discount than
non-innovative firms. The negative effect of innovation performance on PIPE discounts is more pronounced for firms in R&D intensive industries and firms with higher stock market illiquidity. Channel tests show that innovative firms are more likely to be led by strategic investors who are
willing to pay a higher price to support innovative issuers. The results are robust to alternative methods that mitigate endogeneity issues.
Is Short Selling Informative about Litigation Risk? Evidence from Private Investments in Public Equity (with Onur Bayar and Juan Mao)
We examine the impact of litigation risk on short selling activity around PIPE transactions. We find that PIPE issuers that incurred securities class action lawsuits prior to the PIPE offering are shorted more heavily around the PIPE issuance date. Heterogeneity in the level of issuers’ litigation risk such as the case status at the time of security issue and the timing of the private placement after the litigation event affects the extent of short selling activity surrounding PIPEs. In addition, the effects of litigation risk on short selling are more pronounced in PIPEs where lead investors are hedge funds. Our results imply that outside investors incorporate value-relevant information about issuing firms’ litigation risk through their short selling activity around PIPE offerings.
The Role of Loan Market Access and Financial Covenants in Pricing Private Placements (with Ca Nguyen)
(presented at 2021 Financial Management Association meetings)
Our study examines the pricing of private placements in the presence of coordination frictions among existing loan creditors, incumbent shareholders, and private equity investors. Using Private Investments in Public Equity (PIPE) deals in 2001-2018, we find that issuing firms with outstanding loans offer a larger PIPE discount, and the discount increases if the loan contracts include financial covenants. Our results remain strong when we use the propensity score matching, Heckman selection model, and two-stage least squares instrumental variable analysis, to control for endogeneity. We argue that, rather than free riding on certification and monitoring provided by loan creditors, private equity investors are more concerned about the discoordination among existing equity holders and the potential of transferring control rights to debtholders when investing in firms with outstanding loans. Using different measures reflecting coordination frictions such as proposal level voting results, PIPE governance features, leverage change, covenant strictness, and covenant violations, we find supporting evidence for this argument.
The Role of Existing Shareholders in Private Equity Placements: Evidence from PIPEs in China (with Di Lu and Suhua Tian)
This paper investigates how the participation of firms’ existing shareholders affects the pricing and valuation of the private equity placements (PIPEs). Using a large sample of PIPEs issued by Chinese listed firms from 2006 to 2019, we find that the effective discount and long-term buy-and-hold abnormal stock returns of PIPEs participated by existing shareholders are significantly higher than those participated only by new investors. However, the superior post-PIPE stock performance of deals participated by existing shareholders is not driven by improved operating performance. We find that PIPEs participated by existing shareholders are more likely to use the raised funds for internal usage and be followed by tunneling activities such as frequent dividend announcements, related-party transactions, and positive earnings management following the PIPE. Our findings suggest that the effect of existing shareholders presence in private equity placements is more consistent with the “Tunneling Hypothesis” than the “Certification Hypothesis”. We document that the tunneling incentives arising after the participation of existing shareholders in PIPEs can be mitigated when the firm’s corporate governance is stronger.
Coauthored Book: "Equity Markets, Valuation, and Analysis"
Chapter 14: "Private Company Valuation"