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The role of financial covenants in pricing private investments in public equity

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  • Liu, Yini
  • Nguyen, Ca

Abstract

Our study examines the pricing of private placements for issuing firms subject to outstanding loan covenants. Using Private Investments in Public Equity (PIPE) deals from 2001 to 2018, we find that issuing firms restricted by loan covenants offer a discount of 3.9% larger than those without covenants. We corroborate the positive impact of financial covenants on discounts through channel tests that assess covenant violation history, covenant strictness, and the identities of lead PIPE investors. The increased probability of technical default and costly renegotiation in covenants potentially incentivizes borrowing firms to transition from the loan market to the PIPE market. To minimize endogeneity concerns, we use a matched sample, a Heckman selection model, and a two-stage least squares instrumental variable analysis, all of which present consistent results. Based on our findings, we conjecture that PIPE investors are concerned about the transfer of control rights to lenders and, as a result, demand deeper discounts in PIPE offerings.

Suggested Citation

  • Liu, Yini & Nguyen, Ca, 2023. "The role of financial covenants in pricing private investments in public equity," Journal of Corporate Finance, Elsevier, vol. 82(C).
    • Handle: RePEc:eee:corfin:v:82:y:2023:i:c:s0929119923001153
    DOI: 10.1016/j.jcorpfin.2023.102466
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    References listed on IDEAS

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    1. Susan Chaplinsky, 2010. "Financing under Extreme Risk: Contract Terms and Returns to Private Investments in Public Equity," The Review of Financial Studies, Society for Financial Studies, vol. 23(7), pages 2789-2820, July.
    2. Demerjian, Peter R. & Owens, Edward L., 2016. "Measuring the probability of financial covenant violation in private debt contracts," Journal of Accounting and Economics, Elsevier, vol. 61(2), pages 433-447.
    3. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    4. Michael Bradley & Michael R. Roberts, 2015. "The Structure and Pricing of Corporate Debt Covenants," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-37.
    5. Cem Demiroglu & Christopher M. James, 2010. "The Information Content of Bank Loan Covenants," The Review of Financial Studies, Society for Financial Studies, vol. 23(10), pages 3700-3737, October.
    6. Greg Nini & David C. Smith & Amir Sufi, 2012. "Creditor Control Rights, Corporate Governance, and Firm Value," The Review of Financial Studies, Society for Financial Studies, vol. 25(6), pages 1713-1761.
    7. Charles J. Hadlock & Joshua R. Pierce, 2010. "New Evidence on Measuring Financial Constraints: Moving Beyond the KZ Index," The Review of Financial Studies, Society for Financial Studies, vol. 23(5), pages 1909-1940.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Syndicated loans; Creditor rights; Covenants; Private placements; Private investment in public equity (PIPE);
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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