The thesis investigates the link between internal and external funds in financing new investment
when asymmetric information is important. In both chapter, the entrepreneur has private information
about the value of a project and, if the quality of the project is high, she tries to signal
this to outside investors. The first chapter explores the tradeoff between using internal funds and
raising external funds by issuing shares or bonds to finance a project. The entrepreneur can delay
the project to accumulate internal funds over time from existing operations. This allows an
entrepreneur with a high quality project to reduce her reliance on expensive underpriced bond or
share issues. However, accumulating funds is also costly because of discounting and the risk that
the project disappears. The more valuable the good project, the less the entrepreneur will delay
the project, risking its loss, and so the more she relies on external financing.
When external financing is sought, the entrepreneur decides to issue bonds or shares. The
greater the value of the good project, the more underpriced shares are relative to bonds. Thus
an entrepreneur with a highly valuable good project chooses equity and one with a less valuable
project chooses debt. Combining the two results shows that for a highly valuable good project,
debt is used, and for a less valuable project, internal funds are used. External equity gets squeezed
out. Aggregate data for the U.S. confirm that corporate bond issues are a more important source
of funds than new share issued. Furthermore, most small firms rely on internal funds and debt,
rather than external equity to finance their projects.
The second chapter provides a new theory for the underpricing of initial public offerings (IPOs).
As in the first chapter, underpricing is used as a signal of quality. However, the entrepreneur is risk
averse and only underprices when she cannot sell enough primary (new) shares to raise sufficient
proceeds from the IPO to cover the cost of the project without diluting her position below that
needed to signal a high project value. Underpricing allows the entrepreneur to maintain a high
stake in the firm and still make a credible signal of quality. This allows more primary shares to be
sold resulting in a net increase in proceeds.
The model predicts that underpricing should be greatest among firms that don't sell secondary
shares (shares held by insiders) at the IPO and that there should be a positive relationship between
the firm's capital requirement and the initial return among this group of firms only. A switching
regression framework is used. The probit model is first estimated where the probability of no
secondary shares is explained by proxies for a firm's capital requirements. The initial return is then
regressed on the same proxies, conditioning on whether the firm sells secondary shares or not and
accounting for possible correlation between errors in the selection and regression equations. Strong
support is found for the positive relationship between initial return and capital requirements for
only firms without secondary share sales, as predicted.
| Identifer | oai:union.ndltd.org:LACETR/oai:collectionscanada.gc.ca:BVAU.2429/10834 |
| Date | 05 1900 |
| Creators | Neumann, Mark W. |
| Source Sets | Library and Archives Canada ETDs Repository / Centre d'archives des thèses électroniques de Bibliothèque et Archives Canada |
| Language | English |
| Detected Language | English |
| Type | Electronic Thesis or Dissertation |
| Relation | UBC Retrospective Theses Digitization Project [http://www.library.ubc.ca/archives/retro_theses/] |
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