Private Placements to Owner-Managers: Theory and Evidence

Abstract

We present an asymmetric information model to examine private placements of equity. Our main conclusion is that allowing private placements to owner-managers can mitigate, if not eliminate, the underinvestment problem. Our model predicts that announcement period returns for private placements should be: (1) positive; (2) dependent on regulatory constraints that determine the issue price; (3) positively related to volatility; (4) negatively related to insider ownership; (5) negatively related to illiquidity; and (6) inversely related to proxies of manipulation. Our model also predicts that: (7) announcements effects for private placements to private equity investors should be lower than that those of private placements to owner- managers. We empirically test our model's predictions, along with others from the literature, on a sample of private placements issued in the Indian capital markets during 2001-2009 and report empirical evidence largely consistent with the model.

Keywords: Private Placement, Preferential Allotment, Business Groups, Underinvestment

JEL Classification: G18