Ch. 6: Security Offerings 265
direct costs, while commitments is a firm’s most expensive method, with standby rights
in between.
Keep in mind that when comparing the costs of alternative flotation methods, one
must control for firms’ self-selection of the issue method. For example, asHansen and
Pinkerton (1982)point out, it is possible that observed flotation costs of uninsured
rights are particularly low because this method is selected when a large blockholder
is willing to guarantee subscription (which is typically the case). It is also possible
that firms tend to select uninsured rights more generally when shareholder concen-
tration is high, and when stock return variance is low. The point is that these and
other characteristics can reduce direct flotation costs regardless of the chosen flota-
tion method. To control for this effect,Eckbo and Masulis (1992)pool all flotation
methods and use indicator variables for standbys and firm commitment issues in their
cross-sectional regressions with direct issue costs as dependent variable. Conditional
on various firm- and issue-specific factors, they conclude that the choice of an under-
written offer (standby or firm commitment) increases the flotation costs over and above
uninsured rights, and that the choice of a firm commitment offer increases these costs
further.
Lee et al. (1996)study direct flotation costs (underwriting spreads and other direct
expenses as a percentage of offer gross proceeds) of IPOs, SEOs and issues of convert-
ible and straight corporate debt over the 1990–1994 sample period. They find that the
total direct issue costs are 11 percent for IPOs, 7.1 percent for SEOs, 3.8 percent for
convertible debt and 2.2 percent for straight debt. They also document the frequency
of issues with global tranches and over-allotment options. While debt offering flota-
tion costs are low, it is important to keep in mind that debt issues, have a finite life of
generally less than 10 years duration, especially taking into account sinking funds and
callability. Thus, for a firm to have long term access to this debt capital, it is necessary
to periodically refinance these debt issues, which involves repeated rounds of future
flotation costs.
Public offering of debt can at times precede an IPO of stock, a phenomenon studied by
Datta, Iskandar-Datta, and Patel (1997)andCai, Ramchand, and Warga (2004).Firms
issuing public debt are required to meet the SEC mandated financial disclosure require-
ments of public companies.Cai, Ramchand, and Warga (2004)report that subsequent
IPOs by these firms are associated with significantly lower underpricing and lower price
revisions from the midpoint of the filing range to the offer price. However, the lower un-
derpricing is restricted to subsequent IPOs that have rated public debt, which tend to be
financially stronger issuers. Also, public debt issues can be simultaneously offered with
public equity issues, which is a financing decision studied byHovakimian, Hovakimian,
and Tehranian (2004).
3.2. Underwriter compensation
Underwriter compensation is made up of three parts: management fees paid to the syn-
dicate’s lead underwriter or book runner, underwriting fees paid to the underwriters,