Private Benefits of Control and the Choice of Seasoned Equity Flotation Method

Abstract

Rights offers and new issues to non-existing shareholders are two major flotation methods used in seasoned equity offerings (SEOs) worldwide. Yet the existing literature has been unable to explain within the same framework: (a) why some firms choose rights offers and other firms choose new issues in a particular country; (b) why almost all firms in the U.S. are willing to choose new issues rather than rights offers; and (c) why almost all firms in most European and Pacific Basin countries do the opposite—choose rights offers rather than new issues. This paper suggests that controlling shareholders' concern about an intrusion-induced, significant loss of their private benefits of control crucially affects the choice of flotation method. We argue that control-diluting new issues provide a window opportunity for rent-seeking new blockholders to facilitate their participation in control benefits sharing; since undoing such coveted intrusion can be very costly, when coming to raise new equity, the incumbents with large control benefits may have to resort to rights offers to safeguard them. Under asymmetric information about control benefits, the choice of flotation method can convey new information about firm value. Our theory supports three important equilibriums that characterize the choice of flotation method worldwide and helps explain, in particular, the negative announcement effect of rights offers in many countries.

Keywords: Private Benefits, Control, Asymmetric information, Flotation Method, Rights Offer, SEO

JEL Classification: G14, G32, G34