Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

P1: TIX/XYZ P2: ABC

JWBT436-bm JWBT436-Baker February 24, 2011 17:26 Printer Name: Hamilton

ANSWERS TO CHAPTER DISCUSSION QUESTIONS 473

to cease operations due to a lack of funds, at which point its stock would be

worthless.

3. An issuer has to sell PIPE shares at a discount to attract investors. The hedge fund

strategy only works if the fund can buy shares at a price below which it can short

the shares in the market. Thus, the hedge fund will only invest and provide the

issuer with the needed funds if the issuer adequately discounts the shares. The

discount also needs to reflect the unwinding risk assumed by the hedge fund.

With PIPE deals by larger companies, the discount reflects illiquidity because an

investor cannot immediately resell the shares as it could if the shares were sold

in a registered offering or purchased in the open market. The investor has to

wait until the resale registration statement is declared effective and thus assume

the risk of delay. Also, the discount probably reflects a volume discount as PIPE

deals typically involve a larger block of stock.

4. A partial answer appears in a quote included in the chapter from the SEC

v. Lyon complaint (see SEC PIPE Enforcement Actions/Insider Trading): “the

announcement typically precipitates a decline in the price of a PIPE issuer’s

securities due to the dilutive effect of the offering and the PIPE shares being

issued at a discount to the then prevailing market price of the issuer’s stock.”

For PIPEs by smaller companies, the drop in ...