IS SIGNALING BY LOCK-UP AND DISCOUNT RATES IN PRIVATE EQUITY OFFERINGS COSTLY? EVIDENCE FROM KOREA

G. Hwan Shin
The University of Texas at Tyler

ABSTRACTA

Using a sample of firms that announce their first SEOs from January 2000 to December
2010 in Korea, this study empirically examines the relationship between the announcement effects
of equity private placements and the signals (lock-up and discount rate) sent by the issuing firms.
Without a signal that only undervalued firms can send at affordable cost, overvalued firms can
benefit by placing shares with investors who resell prior to revelation of the true state of nature,
resulting in the issuance of both overvalued and undervalued shares in the private placement
market. Unlike results from previous research, this study finds support for costly signaling in the
private equity market. From the mean test of the cumulative abnormal returns (CAR) of the
sample firms, this study finds a significantly positive market reaction to only the private
placements of firms not in financial distress. In the cross-sectional, the study shows consistently
positive abnormal announcement-period returns for firms with lock-up. The negative and
significant coefficient on the interaction term between the lock-up dummy and the financial
distress dummy indicates that distressed firms cannot successfully falsify their lock-up signal and
thereby confirming the costly signaling hypothesis.

Keywords: private placement, costly signaling, lock-up, discount rate