PRIVATE PLACEMENT

Private Placements

Introduction1

Advantages of Private Placements1

Disadvantages of Private Placements2

Reasons for Private Placements3

Hypothesis3

Literature Review4

Financial Theories relating to Private Placements4

Asymmetric Information theory4

Signaling Theory4

Agency Theory5

Window of Opportunity Hypothesis6

Selection between Private and Public Equity Offerings6

Positive announcement effect6

Monitoring Hypothesis7

Certification Hypothesis7

Underreaction Hypothesis7

Negative Post-Issue Stock Price Performance7

Entrenchment Hypothesis8

Insider Trading Hypothesis8

Market review8

Listing rules8

Issuance regulations9

Private Placements9

Methodological Issues and Analysis10

Data Source10

Method Used10

CAR Analysis11

Response of Market to Announcement of Private Placement13

Conclusion13

References15

Private Placements

Introduction

Private placements are defined as the selling of securities in a comparatively smaller quantity to limited investors to raise capital. The investors that are involved in the private placements are mostly banks, mutual funds, pension funds and insurance companies. The private placement is the opposite of public issuance of securities in which they are made available for selling in the open market. As these private placements are made to selected individuals, they do not require the registration with the Securities and Exchange Commission. In most of the cases, detailed financial information is not provided and the requirement to make a prospectus is also waived. As these placements are made privately and not publically, an average investor is made known of the private placement after it has been done (www.investopedia.com). The private placements are considered as a cost effective way to raise capital without having to offer to the general public. There are many advantages and disadvantages of private placements. These are as:

Advantages of Private Placements

The small businesses can benefit from private placements without having to go through the initial price offerings. These private placements are cost effective and less time consuming because the assistance of underwriters and brokers is not required in private placements.

The private placements also allow the owners to select investors that have compatible interests and goals. These investors can assist the company in making confidential and complex transactions.

Disadvantages of Private Placements

For the purpose of private placements, it might be difficult to locate suitable investors and they may have limited funds for investment purpose.

The private placement securities are sold at a price lower than the market value.

The companies that issue private placement of equity might have to give up more of their equity for taking large amount of risk and assuming a position of illiquidity (www.inc.com).

Large amount of capital is raised through the private placement of equity around the world. These private placements take place in the form of bulk deals that are issued by the organization to private equity players, financial institutions, banks and managers. The reaction of the market towards the announcement of private placement is positive. The market considers the announcement of private placement equity as a positive signal.

As long as the managers are not constrained through risk aversion or capital, the announcement of private placement can resolve the issue of underinvestment. Some researchers have eliminated the option that allows the managers to buy or subscribe to the equity issues of the firm. This is true for markets where there is a lack of managerial risk aversion and wealth put a constraint on the managers from participating or subscribing to equity ...