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reaction to standbys and firm commitment offerings indicate that the signal quality of
the underwriter certification technology only partially reveals the issuer’s true quality.
With perfect revelation and firm-value-maximization on the part of the issuing firms,
the market reaction would be non-negative.^40 Thus, the evidence favors models that
presume some form of imperfection in the underwriter’s quality certification.
Shareholder monitoring. A private placement offers opportunities and incentives for
communication between the issuer and the private placement investor which may alle-
viate ex ante investor nervousness with the possibility that the offer is overpriced. This
may inducepositiveselection in the pool of private placement issuers. This is consistent
with the evidence. As summarized inTable 16, the typical private placement offering of
equity generates a significantly positive market reaction, withARpp= 2 .5% in the U.S.
andARpp= 3 .1% internationally.
What is the nature of the positive information?Wruck (1989)andHerzel and Smith
(1993)suggest that the positive announcement effect reflects the fact that the firm is
willing to subject itself to increased monitoring and certification by a large, private
placement investor. A positive announcement effect if also predicted by the variant of
theMyers and Majluf (1984)model developed byCooney and Kalay (1993)andWu
and Wang (2005), where managers are allowed to select value-decreasing investment
projects.Cronqvist and Nilsson (2005)andWu and Wang (2005)argue that large share-
holders prefer a rights issue over a private placement in order to protect private benefits
of control.Cronqvist and Nilsson (2005)conclude that family-controlled firms in Swe-
den avoid issue methods that dilute control benefits.Wu, Wang, and Yao (2005)and
Wu and Wang (2006b)reach a similar conclusion after studying control-diluting place-
ments and rights issues in Hong Kong. Thus, the selection of private placement carries
a positive signal relative to a rights offer, which is also consistent with the evidence.
Do private placements in fact lead to increased monitoring? Empirically,Barclay,
Holderness, and Sheehan (2005)conclude that there is little direct evidence of moni-
toring activities by private placement investors in the U.S. If this is in fact true, then
the positive announcement effect of private placements represents positive information
about the issuer per se, perhaps due to the certification role played by the private place-
ment investor (Eckbo and Norli, 2004).
Managerial earnings expectations. Ross (1977)develops a model in which the firm’s
issue decision reflects private managerial information about the firm’s future earnings
prospects. Managers face personal bankruptcy costs and prefer to issue equity over debt
when they have private information indicating a future decline in earnings, and vice
versa for debt issues. This model implies a negative market reaction to an equity issue
and a positive market reaction to a debt issue. While the empirical evidence is consis-
tent with the first part of this prediction, the evidence contradicts the second part. The
(^40) As discussed in Section3 above, the focus of the underwriter is typically on certifying the existence and
value (b) of the investment project, the validity of the firm’s accounting statements, the firm’s strategic plans,
etc.