Do Private Placements Turn Around Firms? Evidence from Taiwan

• Published date: 01 December 2013
• DOI: http://doi.org/10.1111/fima.12027
• Author: Hui‐Shan Wei,Cheng‐Yi Shiu
• Date: 01 December 2013

Do Private Placements Turn Around

Firms? Evidence from Taiwan

Cheng-Yi Shiu and Hui-Shan Wei∗

We analyze the stock and operating performance of firms issuing private placements in

Taiwan. Issuing firms have poor pre-issueperformance and earn signif icantlypositive returns at

announcement. Placements with an owner-manager or with nonexecutive directorsare associated

with better post-issue stock and operating performance, suggesting that an increase in insiders’

stakes leads to better alignment of managerial incentives and an increase in monitoring by in-

siders. In contrast, placements made to outside investors are unlikely to turn around the issuing

firms.

US public corporations have typically preferred to raise equity capital through public offer-

ings rather than private placements, despite the advantages of flexibility and cost savings in

private placements. However, over the past 15 years or so, private placements have experienced

extraordinary growth. Chen, Dai, and Schatzberg (2010) find that the total amount of private

investment in public equity has increased from $2 billion in 1995 to $88 billion in 2006, whereas

the total amount of seasoned equity offerings (SEOs) in 2006 was $76 billion. Outside the United

States, private placements have also gained market share. According to Sagient Research, the

total amount of capital raised in the private placement market in 2010 was US$ 17.90 billion

(involving 336 deals) in the United Kingdom and $9.55 billion (involving593 deals) in Australia.

In contrast to public offerings, which tend to be at a smaller discount and are negatively

received by the market (Corwin, 2003), a larger discount is offered to the target investors in

private placements and the market often reacts positivelyto the announcement. Why is the market

reaction to private placements higher relative to public offerings given that the discount is larger

in private placements? Earlier studies suggest that corporate insiders who participate in private

placements can increase firm value by performing a monitoring or certif ication role. Forexample,

Wruck (1989) argues that insiders increase their ownership concentration in placements, thereby

increasing the level of their monitoring activities. As a result, they enhance the value of the

issuing firm. Hertzel and Smith (1993) assert that privately selling a large block of shares to

inside investors serves as a certification of the market value of the issuing firm. However, the

monitoring and certification hypotheses have been challenged by recent studies. For example,

Barclay, Holderness, and Sheehan (2007) find that issuers tend to sell placements to passive

investors at a large discount that serves as compensation for entrenching the management team.

In this paper, weaddress this issue in a sample of 281 private placements made on the Taiwanese

stock markets from January 2002 to December 2008. We are able to determine the identities of

We are grateful to Raghu Rau (Editor), an associate editor, and an anonymous referee for their constructive comments

and suggestions. Wealso thank seminar participants at National Central University and National Chengchi University

for providingvaluable comments.

∗Cheng-Yi Shiu is an Associate Professor of Finance in the College of Management at National Central University in

Taoyuan,Taiwan, ROC. Hui-Shan Weiis an Assistant Professor of Accounting Information in the College of Business at

Southern TaiwanUniversity of Science and Technology in Tainan, Taiwan, ROC.

Financial Management •Winter 2013 •pages 875 - 899

876 Financial Management rWinter 2013

the specific investors in the private placements, allowing us to estimate the contribution of

participating investors more precisely.

We demonstrate that whencompared with public offerings, private placements are more likely

to be made after prior poor performance. Issuing firms initiate the placement process after

experiencing a significant price run-down. This is not surprising. Firms with high information

asymmetry or illiquid stock may find it difficult to raise external equity funds in public markets

and may pursue private placements to exploit valuable investment opportunities (Hertzel et al.,

2002; Brophy, Ouimet, and Sialm, 2009; Chaplinsky and Haushalter, 2010; Chen et al., 2010).

Firms with a high level of information asymmetry and weak operating performance may regard

these placements as a last resort for raising equity capital. This finding is consistent with Barclay

et al. (2007), but contrasts with the findings of price run-ups documented in other studies (Wruck,

1989; Hertzel et al., 2002; Krishnamurthy et al., 2005; Chaplinsky and Haushalter, 2010; Chen

et al., 2010).

Our sample firms earn signif icantly positivereturns at the announcement. Similar to Wu, Wang,

and Yao (2005), we find that the positive information effect is stronger for smaller firms and lower

market-to-book stocks. Because a smaller firm is likely to be associated with higher information

asymmetry regarding growth opportunities and a lower market-to-book ratio indicates that the

firm has undertaken unsuccessful projects in the past (Wu et al., 2005), the market anticipates

that these firms will be more likely to turn around following a private placement. However,

not all firms are turned around. We find that placements made to an owner-manager and to

nonexecutive directors are associated with better long-run stock and operating performance,

suggesting that placements with insiders are more likely to turn the firm around successfully.

In contrast, placements to outside investors have poor long-run performance indicating that the

turnaround effect is weak for these placements.

This study contributes to the existing literature on private placements by confirming the

turnaround in firms upon their announcement of placements as documented in Wu et al. (2005).

Wu et al. (2005) find that the market reaction is more likely to be positive for those firms with

highly uncertain growth. This is consistent with Wu and Wang (2005) and with the turnaround

hypothesis. However, Wu et al. (2005) do not examine the post-long-run performance of private

placements. In our paper, we document post-issue operating and stock performance in addition

to pre-issue and announcement returns. We provide additional evidence of a turnaround effect

following private placements beyond the findings documented in Wu et al. (2005). Our results

are also consistent with Krishnamurthy et al. (2005) and Wruck and Wu (2009), who demonstrate

the relationship between investorsand issuers in placement matters for managerial incentives and

for the monitoring of the issuing firm. Finally, our results also support the argument of Chen

et al. (2002), who demonstrate that the negativemarket reaction to private placements in Singapore

is attributable to local regulations that forbid the sale of new shares in placements to directors

and existing large shareholders.

In addition to the literature on private placements, we also contribute to the literature on

ownership and management structure. Several studies document the high level of ownership

concentration in continental European countries and emerging Asian markets. In particular,

La Porta, Lopez-de-Silanes, and Shleifer (1999), Claessens, Djankov, and Lang (2000), and

Faccio and Lang (2002) find that over half of the firms in these regions are controlled by large

shareholders, with a controlling shareholder or a controlling family member usually taking the

position of a top executive in the firm. Moreover, the second largest shareholder may serve as

a member of the board of directors to monitor the controlling shareholder. These features are

not common in public firms in the United States. We contribute to this literature by providing

evidence that a significant increase in the stake of an owner-manager and nonexecutive directors