Private placements and wealth constraints of owner-managers

Abstract

We present an asymmetric information model of private placements of equity to owner-managers and institutional investors. The investment-financing decision depends on the interaction between asymmetric information held by owner-managers and their wealth constraints. Our model shows that such private placements can mitigate, if not entirely eliminate, the underinvestment problem. Using a sample of 1064 preferential allotments issued in the Indian capital markets during 2001-2017, we find that announcement period returns are (1) positive, (2) higher for pure owner-manager preferential allotments, (3) unrelated to pre-announcement insider ownership, (4) negatively related to market capitalization, (5) negatively related to volatility of returns and (6) dependent on regulatory constraints that determine the issue price.