A Theory of Private vs. Public Placements in Public Firms

Abstract

This paper studies a public firm's investment decision and whether to raise the equity capital needed using the public market (SEO, Secondary Equity Offering) or a private channel (PIPE, Private Investment in Public Equity). Issuing a PIPE allows the firm to enjoy more financial flexibility. This is modeled in two dimensions: First, funds can be raised faster. Second, dilution costs caused by asymmetric information can be alleviated endogenously. However PIPEs are costly because new shares are temporarily illiquid. The model explains what firms use one market or the other and the optimal timing of investments to better use financial flexibility. For instance, market illiquidity makes the firm less likely to issue a PIPE, asymmetric information makes it more likely. The paper then considers private debt contracts and shows that the pecking order need not hold. The model explains empirical regularities, for instance, why do SEOs have negative abnormal returns around its announcement whereas abnormal returns for PIPEs are positive.