Ch. 6: Security Offerings 295
information effect associated with a sophisticated institutional investors agreeing to pur-
chase shares, rather than improved monitoring of management by blockholders. Hertzel
and Smith also report that institutional investment declines in private placement firms.
Wu (2004)examines the identity of private placement investors. She reports that pri-
vate placement firms have higher asymmetric information than firms that rely on public
offerings based on issuer age, lack of venture capital backing, fewer institutional in-
vestors and wider bid–ask spreads and coverage by fewer analysts. Also, she finds that
private placement investors who engage in more intensive monitoring (i.e., venture cap-
italists and pensions funds) are not increasing their holdings in these firms after the
private placements. This result is inconsistent with increase monitoring of management
after the private placement. Finally, discounts on private placements sold to managers
are higher than those when managers are not involved. These discounts are also higher
when managers’ initial holdings are lower. These last two results are consistent with
management self-dealing. Wu also reports that private placement investors are typically
passive, which is consistent with the evidence ofBarclay, Holderness, and Sheehan
(2005).
Gomes and Phillips (2005)examine a comprehensive sample of 13,000 private and
public security issues of debt, convertibles and common stock by publicly listed firms.
They find that in the recent 2000–2003 period private issues exceed public issues.
Gomes and Phillips report that publicly listed firms with higher levels of asymmetric
information (measured by analysts’ earnings forecast errors or dispersion in earnings
forecasts) are more likely to issue debt in the public market, while they are more likely
to issue riskier equity and convertible securities in the private capital market. They also
find that smaller public firms with higher risk, lower profitability and good investment
opportunities are more likely to issue equity and convertible securities privately, while
public equity issues are more likely for firms experiencing a stock price rise in the prior
year relative to a benchmark portfolio.
More recently, a new type of private placements of equity by public companies
(PIPES) has become popular, especially with small and medium size companies. The
PIPE market originated with the SEC adoption of Regulation S in 1990, which permit-
ted U.S. issuers to sell unregistered shares to foreign investors at any price in off shore
markets without first registering them with the SEC or publicly disclosing them. In
1996, the SEC modified its rules to require issuers to report the sale of Reg S shares and
required investors to hold these shares for a year. To gain greater liquidity, issuers typi-
cally registered the PIPE shares with the SEC via a shelf registration within 30 days of
closing of the deal. The securities typically become effective 90 days after registration.
There are two major types of PIPEs. There are traditional PIPEs that are fixed num-
ber of shares or a convertible with a fixed strike price, which can be sold at a discount
through private negotiations and there is a more recent innovation called structured
PIPEs. Structured PIPEs represent convertible securities having variable strike prices
that decline if the underlying stock prices decline beyond a specified interval. A struc-
tured PIPE allows investors to convert into a larger number of shares if the stock price