Determinants of Contract Choice: The Use of Warrants to Compensate Underwriters of Seasoned Equity Issues


  • CHEE K. NG,


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    • Ng is from Mississippi State University, and Smith is from Claremont Graduate School. This paper is based in part on the Arizona State University Ph.D. dissertation of Chee Ng (1992). We thank Jeff Armstrong, Jim Booth, Jerry Bowman, Dave Butz, Graeme Camp, J. B. Choy, Jeff Coles, Harold Demsetz, Andrew Dick, Craig Dunbar, Mike Hertzel, Ron Hoffmeister, Chuan-Yang Hwang, Mike Joehnk, Ken Lehn, Gershon Mandelker, Wayne Mikkelson, Janet Smith, Mike Vetsuypens, Darrell Williams, Jeffrey Wilson, participants of the DuPont Finance Workshop at ASU, finance workshops at University of Auckland and the University of Pittsburgh, and the Business Organizations and Regulation Workshop at UCLA. Partial support was provided by the Center for Financial System Research at ASU.


The issuer's decision to include warrants as compensation to underwriters is studied for a sample of 1,991 negotiated firm commitment issues of seasoned equity. Using a two-stage logit model to correct for self-selection bias, we find direct evidence that warrant compensation functions as a bond, substituting for reputational capital and enabling the underwriter to certify the issue price. To a lesser degree, the decision also is affected by regulations on underwriter compensation and on the use of underwriter warrants. Issuers' decisions are consistent with an objective of minimizing total underwriting cost, including cash compensation, warrants, and underpricing.