298 B.E. Eckbo et al.
Masulis (2006)examining situations where lenders are also debt or equity underwriters.
The basic concern is that underwriters who are also lenders have incentives to under-
write weak security issues to strengthen the financial condition of borrowers. These
studies generally find no evidence supporting a significant conflict of interest effect.
Another potential underwriter conflict of interest with IPO investors occurs when
IPO underwriters are also venture investors since venture investors realize substantial
financial benefits when their portfolio firms complete IPOs. Several recent studies by
Li and Masulis (2005, 2006)examine whether underwriters alter their underwriting
and pricing decisions when they have venture investments in these issuers. However,
they find no evidence to support underwriters weakening their underwriting standards
to improve the returns on their venture investments.
- The flotation method choice
In this section, we examine the firm’s choice of issue method. We start with the so-
called rights offer paradox first observed bySmith (1977). The paradox highlights the
fact that a focus ondirectissue costs alone fails to adequately explain the near disap-
pearance of the rights offer method for large, publicly traded corporations in the U.S.
We then examine how observed flotation method choices may minimize issue costs un-
der asymmetric information and survey the empirical evidence on announcement effects
of security offerings as a function of the flotation method.
4.1. The paradoxical decline in the use of rights
With symmetric information between corporate insiders and outside investors, standard
economic theory predicts a preference for the relatively inexpensive uninsured rights
offer method for floating seasoned equity. Nevertheless,Table 10shows that as of the
mid-1970s, publicly listed companies in the U.S. have virtually abandoned the rights is-
sue method in favor of firm commitment underwritten offerings.^22 Furthermore, this
phenomenon is not restricted to U.S. offerings.Ursel and Trepanier (2001)show a
strong trend towards declining use of rights and increasing use of public offerings in
Canada 1970–1985. The trend away from rights is also evident in Japan:Table 11
shows a dramatic decline in rights offerings after the mid-1990s.Slovin, Sushka, and Lai
(2000)report that uninsured rights represents a small fraction of total SEOs by British
firms listed on the London Stock Exchange. In Hong Kong, rights are also now in a
minority (Wu, Wang, and Yao, 2005). Bøhren, Eckbo, and Michalsen (1997)present
evidence that issuers on the Oslo Stock Exchange have moved from uninsured rights
(^22) A corporation’s charter originally stipulates that shareholders have the first right of refusal (preemptive
right) to purchase new equity issues. Thus, abandoning the rights method requires a shareholder vote in favor
of eliminating the preemptive right. Such charter amendments became popular among U.S. publicly traded
firms in the early 1970s, preceding the move towards firm commitment offerings. See alsoBhagat (1983).