Ch. 6: Security Offerings 313
which is counterfactual (Table 6). Moreover, there is no explicit role for current share-
holder takeup.Eckbo and Masulis (1992)offers a menu of flotation methods which
allows shareholder takeup (k) and informative but noisy quality certification by under-
writers in both standbys and firm commitment offerings. As discussed above (equa-
tion(1)), shareholder takeup reduces the size of the offering to outside investors, acting
like financial slack inMyers and Majluf (1984). In equilibrium, high-kfirms select
uninsured rights with little or no adverse selection, intermediate-kfirms select standby
rights, while low-kfirms select firm commitments. They predict thatARfc<ARsr< 0
and thatARur≈0.
Building onEckbo and Masulis (1992), Bøhren, Eckbo, and Michalsen (1997)model
two flotation methods: uninsured rights and standbys. They refine the empirical pre-
diction on announcement returns by varying the effectiveness of the underwriter in
detecting overpriced issues. As inEckbo and Masulis (1992)all high-kissuers select
uninsured rights which results inAR≈0. Moreover, in an equilibrium with “ineffec-
tive” underwriter certification, some overvalued issuers decide to risk the certification
process, leading to adverse selection in the pool of low-kfirms selecting standby rights
offerings, soARsr<0. However, in an equilibrium with “effective” underwriters some
low-kfirms prefer not to issue rather than risk being detected by the quality certification
process, so the standby pool exhibits positive selection andAR>0.
Eckbo and Norli (2004)is the first model to allow a sequential flotation method
choice. As discussed above, they prove the existence of a sequential pooling equilib-
rium in which issuers pool over entire issue strategies. Pooling results when the issue
profitsπin equation(1)is non-negative for both high-value and low-value firms. The
issue methods are private placement, standby rights and uninsured rights. Both the pri-
vate placement investor and the standby underwriter perform an informative but noisy
quality inspection and may reject the issue. Recall the definition of an issue strategy,
e.g.,{pp, s r, ur}which means “try a private placement first, if rejected try standby
rights, and if rejected again do an uninsured rights offer”. Although issuers pool over
issuestrategies, they may eventually end up using different flotation methods due to
randomness in the quality inspection process. The predictions for the market reaction
are as follows:
Eckbo and Norli (2004)—Pecking order.Supposekis known ex ante and that is-
suers follow the pecking order illustrated inFigure 3. Let “high k” meank∈[ksr,^1 ],
“medium k” meank∈[kpp,ksr]and “low k” meank∈[ 0 ,kpp].Itispartofase-
quential pooling equilibrium for high-k issuers to select the strategy{ur}, for medium-k
issuers to select the strategy{sr, pp, ur}and for low-k issuers to choose{pp, s r, ur}.
The associated market reaction AR to the issue announcement is as follows:
khigh kmedium klow
Uninsured rights: ARur= 0 ARur< 0 ARur< 0
Standby rights: off-equilibrium ARsr> 0 ARsr= 0
Private placement: off-equilibrium ARpp= 0 ARpp> 0