294 B.E. Eckbo et al.
the-money with American exercise rights over most or all of the security’s life. Many
of these securities are also callable, which is a method that allows the issuer to force the
in-the-money convertible securities and warrants to convert their securities to common
stock. Also, typical convertible securities held by venture capitalists automatically con-
vert to common stock at the time of an IPO. Lastly, many convertible securities are not
protected against cash dividends, which can again create incentives on the part of the
option holder to exercise their conversion rights early, so as to avoid the stock price fall
associated with the ex-dividend effect.Mayers (1998)argues that firms with significant
real options can benefit from issuing convertible securities that don’t have to be exer-
cised until after the real options are exercised. This is similar to staged financing in the
private equity market. Mayers finds that prior to calls of convertible bonds, firms exhibit
increases in capital expenditures and new long term debt financing, consistent with the
exercise of important real options.
There have been a variety of studies of convertible debt, convertible preferred stock
and warrant issue including:Brennan and Schwartz (1982), Stein (1992), Nyberg
(1995), Kang and Lee (1996), Mayers (1998), Lewis, Rogalski, and Seward (1998),
Byoun and Moore (2003), Korkeamaki and Moore (2004), andBrick, Palmon, and Pa-
tro (2004). Most of these studies have focused on offering methods, offering frequencies
and announcement effects. A few of these studies have also examined components of
flotation costs.
3.11.3. Private placements of equity and convertibles
Wruck (1989)was first to study private placements of equity by publicly listed firms.
She documented that these negotiated sales of equity by large NYSE listed firms had
a positive mean announcement effect of 4.5 percent on the issuer’s stock price unlike
the average negative announcement effects of public offerings of stock. She analyzes
the changes in shareholder ownership and concentration and documents that a private
placement on average increases the voting power of the dominant blockholder and re-
duces the voting power of management. She finds that the change in stock value is
strongly correlated with the change in ownership concentration. Sales that afterwards
give the blockholder under 5 percent or more than 25 percent ownership have positive
effects, while intermediate blocks result in negative effects. Moreover, sales that result
in a change in control or an increase in management shareholdings have a negative ef-
fect. She argues that increasing shareholder concentration often increases shareholder
wealth by improving firm efficiency and alignment of interests with outside sharehold-
ers, but at times can adversely effect outside shareholder wealth, when it is likely that
substantial firm resources are diverted to private benefit.
Inafollowupstudy,Herzel and Smith (1993)examine private placements by pri-
marily smaller Nasdaq listed firms. They document that private placements are sold on
average at substantial discount of 20 percent relative to public offerings. They argue
that this underpricing is to compensate private placement investors for their investiga-
tion costs prior to investing, while the positive announcement effect reflects the positive