Rights versus Underwritten Offerings: An Asymmetric Information Approach

Authors

  • ROBERT HEINKEL,

  • EDUARDO S. SCHWARTZ

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    • Both authors are from the Faculty of Commerce, University of British Columbia. Robert Heinkel gratefully acknowledges the support of the Financial Research Foundation. We appreciate the helpful comments made by our colleagues at Massachusetts Institute of Technology, University of British Columbia, and University of Southern California where this paper was presented. We also thank Anjan Thakor for his comments.

ABSTRACT

By assuming asymmetric information between investors and firms seeking new equity, we derive a rational expectations, partially revealing information equilibrium in which three forms of equity financing are observed. The highest quality firms employ a standby rights offers, intermediate quality firms signal their true value in the choice of a subscription price in an uninsured rights offer, while low-quality firms remain indistinguishable to investors by making fully underwritten issues. The model offers justification for many firms using apparently more costly underwritten offers, provides a reason why firms using uninsured rights offers do not set arbitrarily low subscription prices to ensure the success of the issue, and explains the simultaneous existence of the three financing vehicles.

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