Financing Under Extreme Uncertainty: Evidence from Private Investments in Public Equities

Abstract

We investigate the motivations and the returns to the firms and investors using Private Investments in Public Equities (PIPE) financing, an increasingly common form of equity-based financing. From 1995-2000, 1,466 firms raised more than $29 billion through 2,626 PIPE issues. We find that PIPE issuers are poorly performing firms, urgently in need of cash that, as a consequence, are without access to traditional forms of financing. The contract terms and embedded options in PIPEs allow investors to alter their exposure to post-issue movements in the value of the issuer's equity. As a result, the returns earned by investors substantially exceed those of shareholders. Hence PIPEs provide incentives for investors to make investments in firms with substantial operating uncertainties, enabling companies barred from traditional capital markets to obtain much needed financing.

Access to private equity and real firm activity: Evidence from PIPEs

“…Martos-Vila (2011) shows theoretically that private equity financing can be optimal for companies plagued by information asymmetries. Chaplinsky and Haushalter (2010) find that PIPE issuers perform poorly before and after the PIPE offering, suggesting that PIPEs enable these firms to obtain financing that would otherwise be unavailable to them. Similarly, Brophy et al (2009) examine the performance of PIPEs invested by hedge funds versus all other investor types over 1995-2002 and argue that hedge funds provide funding for companies that are otherwise constrained from raising equity capital.…”

“…5 Several studies emphasize that private placements are concentrated in the kinds of firms especially likely to face high costs of raising external funds: smaller, younger firms with little or no internally generated cash flow and potentially severe information problems (e.g., Brophy et al, 2009;Gomes and Phillips, 2007;and Wu, 2004). However, although a number of studies following Wruck (1989) examine the stock price performance of firms issuing private placements (e.g., Brophy et al, 2009;Chaplinsky and Haushalter, 2010;Dai, 2007;Hertzel et al, 2002;and Krishnamurthy et al, 2005), this literature has generally not focused on the real effects of PIPEs. 6 Furthermore, following an early precedent, almost all studies of PIPEs ignore offerings after the first transaction by a PIPE issuer (e.g., Freund et al, 2006 andHuson et al, 2010).…”

Hedge Funds as Investors of Last Resort?

“…They also find evidence that these structured securities are a source of last resort financing. In a contemporaneous paper, Chaplinsky and Haushalter (2005) investigate the motivations and the returns to firms and investors using both priceprotected and unprotected PIPE securities. They argue that PIPE securities enable companies barred from traditional capital markets to obtain much needed financing.…”

The influence of investor identity and contract terms on firm value: Evidence from PIPEs

“…To see to what degree this influences market reactions, we next explore announcement reactions to the subsample of PIPE contracts when there are no contract terms reported in the S-1, S-2, S-3, SB-2 documents. 14 Brophy et al (2009), Chaplinsky andHaushalter (2010), and Bengtsson et al (2014) provide a thorough institutional framework describing the timeline of events around the PIPE closing date and the disclosure of publicly-available documents that are associated with the dissemination of information in PIPE transactions.…”

“…We repeat our analysis focusing only on PIPE transactions strictly involving common stock, given that Chaplinsky and Haushalter (2010) show that contingent claims imbedded in PIPE contracts associate with issuer risk. We find similar results and reach the same conclusions for this subsample of PIPE transactions.…”