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Why Include Warrants in New Equity Issues? A Theory of Unit IPOs

Published online by Cambridge University Press:  06 April 2009

Thomas J. Chemmanur  and
Paolo Fulghieri
Thomas J. Chemmanur
Affiliation:
Graduate School of Business, Columbia University, New York, NY 10027;
Paolo Fulghieri
Affiliation:
INSEAD, Boulevard de Constance, 77305 Fontainebleau, CEDEX, France, and CEPR
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Abstract

We develop a theory of unit IPOs in which the firm going public issues a package of equity with warrants. We model an equity market where insiders have private information about the riskiness as well as the expected value of their firm's future cash flows. We demonstrate that, in equilibrium, high risk firms issue underpriced “units” of equity and warrants; lower risk firms, on the other hand, issue underpriced equity alone. In contrast to the existing literature, underpricing arises as a signal in our model in the context of a one-shot equity offering. Though developed in the context of IPOs, our model can also explain the issuance of seasoned equity offerings packaged with warrants. Further, the intuition behind the model generalizes readily to provide a new rationale for packaging call-option-like claims with risky securities other than equity, including convertible debt and debt with warrants.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 32 , Issue 1 , March 1997 , pp. 1 - 24
Copyright
Copyright © School of Business Administration, University of Washington 1997

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