Research
Litigation and Information Effects on Private Sales of Securities
(with Onur Bayar, Ioannis V. Floros, and Juan Mao)
Journal of Corporate Finance (2024): 102628
We analyze PIPE (Private Investments in Public Equity) transactions in which the issuer experienced class action lawsuits. We explain the associated information effects measured by the announcement wealth effects and the discounts. Using a comprehensive, hand-gathered dataset, we show that the more severely litigated PIPEs are associated with higher announcement wealth effects and higher levels of discounts. We find that the issuer’s voluntary disclosure positively influences PIPE information effects particularly when coupled with auditor changes. We report that certain mitigation actions affect the pricing of PIPEs along with their associated wealth effects while facing ongoing litigation. We posit that confidentiality in privately negotiated securities is the key in litigated transactions as issuers efficiently share the operational details of mitigation efforts. PIPE transactions are not necessarily costlier funding venues even when securities class action lawsuits are ongoing compared to the PIPE transactions that did not experience any prior litigation action.
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.
The Role of Existing Shareholders in Private Equity Placements: Evidence from PIPEs in China
(with Di Lu and Suhua Tian)
Journal of Financial Research (2024): 12405
This paper investigates how the participation of firms’ existing shareholders affects the pricing and valuation of private investments in public equity (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, after controlling heterogeneous types of PIPE investors. However, the superior post-PIPE stock performance of deals with existing shareholders is not driven by improved operating performance but tunneling activities such as frequent dividend announcements, related-party transactions, and positive earnings management during the lock-up period. 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 are stronger when firms face greater financial constraints and can be mitigated when the firm's corporate governance is stronger.
The Role of Loan Market Access and Financial Covenants in Pricing Private Placements
(with Ca Nguyen)
Journal of Corporate Finance (2023):102466
Our study examines the pricing of private placements for issuing firms with outstanding loan covenants. Using Private Investments in Public Equity (PIPE) deals in 2001-2018, we find that issuing firms restricted by loan covenants offer a discount of 3.9% larger than those without covenants. The positive effect of financial covenants on discount is validated by channel tests regarding covenant violation history, different measures of covenant strictness, PIPE lead investor identity, and PIPE governance-related provisions. A greater likelihood of technical default and costly renegotiation in covenants potentially incentivizes borrowing firms to switch from the loan market to the PIPEs market. To minimize endogeneity concerns, we use a matched sample, Heckman selection model, and two-stage least squares instrumental variable analysis, and find consistent results. Our findings suggest that, rather than free riding on the monitoring efforts by loan creditors, PIPE investors are more concerned about the risk of transferring control rights to lenders, prompting them to demand for deeper discount at PIPE issuance.
Shareholder Litigation and Short Selling Ahead of Private Equity Placements
(with Onur Bayar and Juan Mao)
The Financial Review (2023)
We examine the impact of shareholder litigation on short selling ahead of PIPEs. We find that PIPE issuers that incurred securities class action lawsuits prior to the PIPE are shorted more heavily ahead of the PIPE issue. The case status at the PIPE date, the severity of the lawsuit, and the timing of the private placement after the litigation event also affect the extent of short selling activity ahead of PIPEs. Consistent with hedging incentives, the effects of prior shareholder litigation on short selling are more pronounced in PIPEs where lead investors are hedge funds and in traditional PIPEs.
Does innovation success reduce the cost of financing? Evidence from private investments in public equity
Finance Research Letters (2023): 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.
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.
Stock Price Informativeness and Corporate Tax Avoidance
(with Onur Bayar, Fariz Huseynov and Sabuhi Sardarli)
We demonstrate that private information incorporated by outside investors into stock prices has a meaningful and an economically significant impact on the sensitivity of corporate tax avoidance to stock price. Using an exogenous policy shock as a quasi-experiment and an instrumental variable approach to address endogeneity concerns, we find strong support for a managerial learning effect. This effect remains robust after accounting for alternative explanations, including managerial private information, various sources of public information, and firms’ financial constraints. Furthermore, the effect is more pronounced in firms with foreign operations and lower capital intensity. Overall, our findings indicate that managers actively learn from the private information in stock prices and incorporate this information into their corporate tax avoidance decisions.
Continuing Auditor from the Private Company to the Merged Firm: Evidence from SPACs
(with Juan Mao, Thomas Omer, Hakjoon Song)
We investigate how and to what extent the SPAC company’s use of the auditor from the acquired private target after the de-SPAC transaction (“the continuing auditor”) and the de-SPAC expert auditor affect audit fees and audit quality. Using a sample of audit opinions as of January 2023 issued to U.S-listed merged companies after the de-SPAC transactions, we document that the continuing auditor provides lower-quality audits (greater restatements) and has more PCAOB inspection deficiencies. This result suggests that challenges in transitioning from the audits of private targets to public entities and handling complex accounting issues associated with de-SPAC transactions outweigh knowledge of private target’s accounting system and business practice. Moreover, we document that auditors with de-SPAC expertise charge higher audit fees, but those specialist auditors do not provide higher quality audits (less misstatements) relative to non-de-SPAC specialist auditors, suggesting that de-SPAC specialist auditors charge fee premiums without providing quality audits. This might be because the financial reporting quality of de-SPAC firms is poor and some of de-SPAC auditors are small with lacking audit resources and quality staff to cope with complex accounting issues and transition from private company to public company. Our study extends SPAC research and auditor specialization, particularly task-based literature, and our findings provide meaningful implications to investors and regulators.
The Role of PIPEs in SPACs
(with Kerron Joseph)
We study the role of Private Investments in Public Equities (PIPEs) at different stages in the Special Purpose Acquisition Companies (SPACs) lifecycle. PIPE investments committed before the business combination (BC) announcement differ from those made after the merger is announced. Both pre-BC and post-BC announcement PIPEs enhance the survivability of SPACs, but only post-BC announcement PIPEs reduce the time to close the deal and are compensated with more favorable pricing and contract terms. While PIPEs invest in both high quality and low quality deals, successful business combinations are attributed to the PIPE investment rather than the quality of the deal. Furthermore, later stage SPAC PIPEs receive more shareholder rights than investor matched non-SPAC PIPEs. Our findings suggest that PIPEs at the later stage of SPACs are critical to deal success and may explain why bad merger deals are completed.
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)
Journal of Corporate Finance (2024): 102628
We analyze PIPE (Private Investments in Public Equity) transactions in which the issuer experienced class action lawsuits. We explain the associated information effects measured by the announcement wealth effects and the discounts. Using a comprehensive, hand-gathered dataset, we show that the more severely litigated PIPEs are associated with higher announcement wealth effects and higher levels of discounts. We find that the issuer’s voluntary disclosure positively influences PIPE information effects particularly when coupled with auditor changes. We report that certain mitigation actions affect the pricing of PIPEs along with their associated wealth effects while facing ongoing litigation. We posit that confidentiality in privately negotiated securities is the key in litigated transactions as issuers efficiently share the operational details of mitigation efforts. PIPE transactions are not necessarily costlier funding venues even when securities class action lawsuits are ongoing compared to the PIPE transactions that did not experience any prior litigation action.
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.
The Role of Existing Shareholders in Private Equity Placements: Evidence from PIPEs in China
(with Di Lu and Suhua Tian)
Journal of Financial Research (2024): 12405
This paper investigates how the participation of firms’ existing shareholders affects the pricing and valuation of private investments in public equity (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, after controlling heterogeneous types of PIPE investors. However, the superior post-PIPE stock performance of deals with existing shareholders is not driven by improved operating performance but tunneling activities such as frequent dividend announcements, related-party transactions, and positive earnings management during the lock-up period. 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 are stronger when firms face greater financial constraints and can be mitigated when the firm's corporate governance is stronger.
The Role of Loan Market Access and Financial Covenants in Pricing Private Placements
(with Ca Nguyen)
Journal of Corporate Finance (2023):102466
Our study examines the pricing of private placements for issuing firms with outstanding loan covenants. Using Private Investments in Public Equity (PIPE) deals in 2001-2018, we find that issuing firms restricted by loan covenants offer a discount of 3.9% larger than those without covenants. The positive effect of financial covenants on discount is validated by channel tests regarding covenant violation history, different measures of covenant strictness, PIPE lead investor identity, and PIPE governance-related provisions. A greater likelihood of technical default and costly renegotiation in covenants potentially incentivizes borrowing firms to switch from the loan market to the PIPEs market. To minimize endogeneity concerns, we use a matched sample, Heckman selection model, and two-stage least squares instrumental variable analysis, and find consistent results. Our findings suggest that, rather than free riding on the monitoring efforts by loan creditors, PIPE investors are more concerned about the risk of transferring control rights to lenders, prompting them to demand for deeper discount at PIPE issuance.
Shareholder Litigation and Short Selling Ahead of Private Equity Placements
(with Onur Bayar and Juan Mao)
The Financial Review (2023)
We examine the impact of shareholder litigation on short selling ahead of PIPEs. We find that PIPE issuers that incurred securities class action lawsuits prior to the PIPE are shorted more heavily ahead of the PIPE issue. The case status at the PIPE date, the severity of the lawsuit, and the timing of the private placement after the litigation event also affect the extent of short selling activity ahead of PIPEs. Consistent with hedging incentives, the effects of prior shareholder litigation on short selling are more pronounced in PIPEs where lead investors are hedge funds and in traditional PIPEs.
Does innovation success reduce the cost of financing? Evidence from private investments in public equity
Finance Research Letters (2023): 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.
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.
Stock Price Informativeness and Corporate Tax Avoidance
(with Onur Bayar, Fariz Huseynov and Sabuhi Sardarli)
We demonstrate that private information incorporated by outside investors into stock prices has a meaningful and an economically significant impact on the sensitivity of corporate tax avoidance to stock price. Using an exogenous policy shock as a quasi-experiment and an instrumental variable approach to address endogeneity concerns, we find strong support for a managerial learning effect. This effect remains robust after accounting for alternative explanations, including managerial private information, various sources of public information, and firms’ financial constraints. Furthermore, the effect is more pronounced in firms with foreign operations and lower capital intensity. Overall, our findings indicate that managers actively learn from the private information in stock prices and incorporate this information into their corporate tax avoidance decisions.
Continuing Auditor from the Private Company to the Merged Firm: Evidence from SPACs
(with Juan Mao, Thomas Omer, Hakjoon Song)
We investigate how and to what extent the SPAC company’s use of the auditor from the acquired private target after the de-SPAC transaction (“the continuing auditor”) and the de-SPAC expert auditor affect audit fees and audit quality. Using a sample of audit opinions as of January 2023 issued to U.S-listed merged companies after the de-SPAC transactions, we document that the continuing auditor provides lower-quality audits (greater restatements) and has more PCAOB inspection deficiencies. This result suggests that challenges in transitioning from the audits of private targets to public entities and handling complex accounting issues associated with de-SPAC transactions outweigh knowledge of private target’s accounting system and business practice. Moreover, we document that auditors with de-SPAC expertise charge higher audit fees, but those specialist auditors do not provide higher quality audits (less misstatements) relative to non-de-SPAC specialist auditors, suggesting that de-SPAC specialist auditors charge fee premiums without providing quality audits. This might be because the financial reporting quality of de-SPAC firms is poor and some of de-SPAC auditors are small with lacking audit resources and quality staff to cope with complex accounting issues and transition from private company to public company. Our study extends SPAC research and auditor specialization, particularly task-based literature, and our findings provide meaningful implications to investors and regulators.
The Role of PIPEs in SPACs
(with Kerron Joseph)
We study the role of Private Investments in Public Equities (PIPEs) at different stages in the Special Purpose Acquisition Companies (SPACs) lifecycle. PIPE investments committed before the business combination (BC) announcement differ from those made after the merger is announced. Both pre-BC and post-BC announcement PIPEs enhance the survivability of SPACs, but only post-BC announcement PIPEs reduce the time to close the deal and are compensated with more favorable pricing and contract terms. While PIPEs invest in both high quality and low quality deals, successful business combinations are attributed to the PIPE investment rather than the quality of the deal. Furthermore, later stage SPAC PIPEs receive more shareholder rights than investor matched non-SPAC PIPEs. Our findings suggest that PIPEs at the later stage of SPACs are critical to deal success and may explain why bad merger deals are completed.
Coauthored Book: "Equity Markets, Valuation, and Analysis"
Chapter 14: "Private Company Valuation"