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Investment commitment and the valuation of underwriting agreements for rights issues

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  • Anjos, Fernando

Abstract

I extend the option pricing framework for the underwriting of rights issues, by considering that the funds received at maturity may already have been committed to a project at the time of signing of the underwriting agreement (investment commitment). The model yields valuations that are up to several times the amount implied by no investment commitment, and this is most pronounced for large issues. An upper bound for the model's explanatory power is obtained by assuming that all issues exhibit full investment commitment; under this assumption, the model explains 40-65% of the overpricing of underwriting agreements in the United Kingdom.

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Bibliographic Info

Article provided by Elsevier in its journal Finance Research Letters.

Volume (Year): 7 (2010)
Issue (Month): 4 (December)
Pages: 202-213

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Handle: RePEc:eee:finlet:v:7:y:2010:i:4:p:202-213

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Web page: http://www.elsevier.com/locate/frl

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Keywords: Underwriting Rights issues;

References

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  1. B. Espen Eckbo, 2008. "Equity Issues and the Disappearing Rights Offer Phenomenon," Journal of Applied Corporate Finance, Morgan Stanley, vol. 20(4), pages 72-85.
  2. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
  3. Cronqvist, Henrik & Nilsson, Mattias, 2005. "The choice between rights offerings and private equity placements," Journal of Financial Economics, Elsevier, vol. 78(2), pages 375-407, November.
  4. Marsh, Paul, 1980. " Valuation of Underwriting Agreements for UK Rights Issues," Journal of Finance, American Finance Association, vol. 35(3), pages 693-716, June.
  5. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
  6. John C. Handley, 1995. "The Pricing of Underwriting Risk in Relation to Australian Rights Issues," Australian Journal of Management, Australian School of Business, vol. 20(1), pages 43-74, June.
  7. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
  8. Kunimura, Michio & Iihara, Yoshio, 1985. "Valuation of Underwriting Agreements for Raising Capital in the Japanese Capital Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(02), pages 231-241, June.
  9. B[oslash]hren, [Oslash]yvind & Eckbo, B. Espen & Michalsen, Dag, 1997. "Why underwrite rights offerings? Some new evidence," Journal of Financial Economics, Elsevier, vol. 46(2), pages 223-261, November.
  10. Seth Armitage, 2000. "The direct costs of UK rights issues and open offers," European Financial Management, European Financial Management Association, vol. 6(1), pages 57-68.
  11. Heinkel, Robert L & Schwartz, Eduardo S, 1986. " Rights versus Underwritten Offerings: An Asymmetric Information Approach," Journal of Finance, American Finance Association, vol. 41(1), pages 1-18, March.
  12. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  13. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  14. Eckbo, B. Espen & Masulis, Ronald W., 1992. "Adverse selection and the rights offer paradox," Journal of Financial Economics, Elsevier, vol. 32(3), pages 293-332, December.
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