The Wealth Effects of Reducing Private Placement Resale Restrictions

Abstract

Recently, the U.S. Securities and Exchange Commission reduced resale restrictions on Rule 144 private placements from 12 months to 6 months with the intention of lowering the cost of equity capital for issuing firms. In Canada, similar regulatory changes were adopted several years ago, providing a unique opportunity to test the wealth effects of reducing private placement resale restrictions. We find that shortening resale restrictions reduces the liquidity portion of offer price discounts, and thus lowers the cost of equity capital for issuing firms, but has no significant effect on announcement-period abnormal returns after controlling for issuer type. However, there is a fundamental shift in the types of firms making private placements of common stock after the legislation-induced easing of resale restrictions. Specifically, we find that smaller firms and firms with greater information asymmetry are less likely to issue privately placed common stock after the legislative change, suggesting that the easing of resale restrictions reduces the costly signal that helps to overcome the Myers and Majluf (1984) underinvestment problem.

Keywords: Private Placements, Special Warrants, Offer Price Discount, Announcement Effects

JEL Classification: G32, G28, G14