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Why include warrants in new equity issues? A theory of unit IPOs

Author: Chemmanur, Thomas J. ; Fulghieri, PaoloINSEAD Area: FinanceIn: Journal of Financial and Quantitative Analysis, vol. 32, no. 1, 1997 Language: EnglishDescription: p. 1-24.Type of document: INSEAD ArticleNote: Please ask the Library for this articleAbstract: The authors develop a theory of unit IPOs, in which the firm going public issues a package of equity with warrants. They model an equity market characterized by asymmetric information, where insiders have private information about the riskiness as well as the expected value of their firm's future cash flows. They also demonstrate that, in equilibrium, high rik firms issue "units" of equity and warrants, and the package of equity and warrants in underpriced; lower risk firms, on the other hand, issue under prices equity alone. Underpricing is used as a signal in equilibrium, in the context of a one-short equity offering. While the model is developed in the context of IPOs of equity, it is also applicable with minor modifications to the case of seasoned equity offerings packages with warrants; further, the intuition behind the model generalizes readily to provide a new rationale for packaging call option like claims with other risky securities (e.g. convertible debt, debt with warrants) as well
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The authors develop a theory of unit IPOs, in which the firm going public issues a package of equity with warrants. They model an equity market characterized by asymmetric information, where insiders have private information about the riskiness as well as the expected value of their firm's future cash flows. They also demonstrate that, in equilibrium, high rik firms issue "units" of equity and warrants, and the package of equity and warrants in underpriced; lower risk firms, on the other hand, issue under prices equity alone. Underpricing is used as a signal in equilibrium, in the context of a one-short equity offering. While the model is developed in the context of IPOs of equity, it is also applicable with minor modifications to the case of seasoned equity offerings packages with warrants; further, the intuition behind the model generalizes readily to provide a new rationale for packaging call option like claims with other risky securities (e.g. convertible debt, debt with warrants) as well

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