310 B.E. Eckbo et al.
Ta b l e 1 2
(Continued)Study Model specifics Model implications forAR
Eckbo and Norli (2004) Eckbo and Masulis (1992)but with
a multistage issue game. Private
placement replaces firm
commitments. If issuer is rejected
by the private placement investor
or the standby underwriter, it
moves to the next subgame
consisting of the remaining
flotation method choices
Equilibrium where issuers pool over
entire issuestrategies,butwhere
some issuers are rejected by the noisy
quality inspection. High-kfirms
prefer the issue strategy{ur}which
implies{ARur= 0 }. Intermediate-k
firms prefer the strategy{sr, pp, ur}
which implies
{ARsr> 0 ,ARpp= 0 ,ARur< 0 }.
Low-kissuers prefer{pp, s r, ur}
implying
{ARpp> 0 ,ARsr= 0 ,ARur< 0 }In all the models below, the firm knows the true value of its assets in placeawhile shareholders and outside
investors only know the probability distribution overa. The firm needs to sell equity (no debt allowed) to
raise the amountIrequired to invest in a short-lived project with net present valueb. The models differ
in their assumptions about managerial objectives and availability of flotation methods.ARdo,ARur,ARsr,
ARfc,ARppdenote the market reactions to “direct offering”, “uninsured rights”, “standby rights”, “firm
commitment”, and “private placement”, respectively. InEckbo and Norli (2004), an issue strategy such as the
one denoted{pp, s r, ur}means “try private placement first, if rejected, try standby rights, if rejected again,
do uninsured rights”.
point for understanding the effects of adverse selection per se. We then turn to models
where the firm is allowed to select from a menu of commonly used flotation methods,
either in single-stage or in multi-stage (sequential) games.
4.3.1. Models with a single flotation method
Recall that the setting ofMyers and Majluf (1984)is a direct equity sale to the public.
Current shareholders are assumed to be passive and there are no mechanism for quality
certification. In their separating equilibrium, some undervalued firms prefer not to sell
shares, which implies that the pool of issuing firms is overpriced ex ante. The market
therefore discounts issuers’ stock price in response to news of the offer (AR <0).
Alternatively, in their pooling equilibrium, the value ofbis sufficiently large for all firms
to issue, which implies that the issue announcement conveys no new information to the
market (AR=0). Ceteris paribus, in their separating equilibrium,ARis more negative
the greater the ex ante risk that the security is overvalued by the market. The latter
implication helps distinguish theMyers and Majluf (1984)adverse selection model from
a signaling model such asMiller and Rock (1985), in which external financing conveys
negative information per se, regardless of the potential for security mispricing.