Equity Issues and the Disappearing Rights Offer Phenomenon
This article presents a theoretical model based on the Myers-Majluf framework that attempts to explain the choice of public companies among alternative methods for issuing seasoned equity primarily in terms of differences in "information-asymmetry" and "adverse selection" costs. The key insight is that a "pure" (or uninsured) rights offering is likely to be the lowest-cost flotation method only in cases where a large fraction of current shareholders are expected to subscribe to the offering (i.e., only when expected shareholder takeup is high). In such cases, direct flotation costs are much lower than those associated with book-built underwritten offerings to (mainly) new investors. Even more important, because heavily subscribed rights offerings also involve minimal potential for transfer of wealth between existing and new shareholders (since they are mostly the same people), adverse selection costs are not a concern. But as the expected shareholder takeup falls-say, because increases in corporate size cause risk-averse, wealth-constrained shareholders to diversify their investments-the potential for costly wealth transfers from issuing mis-priced equity leads companies to consider underwriter certification of the new issue. This is evidenced in the data by a systematic move from pure rights offerings first towards rights with standby underwriting as shareholder takeup falls and-for sufficiently low shareholder takeup-to fully marketed firm commitment offerings. Copyright (c) 2008 Morgan Stanley.
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Volume (Year): 20 (2008)
Issue (Month): 4 ()
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