1. The Quality and Service of Investment Banks’ Service: Evidence from the PIPE Market Na Dai, University of New Mexico Hoje Jo, Santa Clara University John Schatzberg, University of New Mexico

2. What is a PIPE?  Private Investment in Public Equity  PIPE securities are generally issued pursuant to Section 4(2) of the Securities Act or Regulation D under the Securities Act, which provide an exemption from registration for a non-public offering by an issuer.

3. Size of the PIPE Market YearPIPE ($M)SEO($M) 1995187046327 19969068 57294 19971280063488 19981348954731 19992560975546 200059442 90746 20017955963189 20023817055744 20039286658297 20045674175243 20055289970112 20068796083217 20079847764570

4. Major Players in the PIPE Market Issuers Placement Agents Investors Hedge Funds VC Funds PE Funds Mutual Funds Broker/Dealers Banks/Insurance Companies Pension Funds Small Young Sometimes distressed High information asymmetry Traditional investment bank Specialized PIPE placement agents

5. Research Questions  We investigate the market structure and the pricing by placement agents in private investments in public equities (PIPEs). How do firms and placement agents choose each other? Do placement agents help lower transaction costs and information costs? Do placement agents with strong reputations provide higher-quality service? Does the higher quality service enable placement agents to charge higher fees?

6. Motivation  Theoretical models about investment banks (underwriters)’ general behavior in the IPO and SEO market Chemmanur and Fulghieri (1994)  In equilibrium, reputable investment banks underwrite less risky issues, obtain higher prices for the issuers, and receive higher compensation.  Issuer quality and the pricing of investment banks’ services solve the matching problem. Fernando, Gatchev, and Spindt (2005)  Model the matching between issuers and underwriters as a two-sided process  The underwriting spread is the result of a bargaining process and does not require a specific matching of issuers and underwriters Key differences between these two models  Does the fee structure determine the matching process or is it negotiated after the matching is concluded?  Do more reputable underwriters charge higher fees?

7. Motivation (cont.)  The existing empirical evidence is mixed. Fang (2005): More reputable underwriters provide higher quality services and command a fee premium in the corporate bond market. Chen and Ritter (2000): In the US market, more than 90% of IPOs raising $20-80 million have spreads of exactly seven percent. Krigman, Shaw, and Womack (2001): Their issuer survey data reveal that fee structure received the lowest ranking among all decision criteria when selecting a lead underwriter in the IPO market.

8. Motivation (cont.)  The PIPE market is an emerging market where firms raise capital when traditional financing approaches become difficult. There is very little study or evidence about investment banks’ behavior in this market.  The PIPE market is an attractive venue for testing whether financial intermediaries help lower the transaction and information costs of the financing process. The PIPE market possesses particularly high levels of information asymmetry given that most of the issuers are small, young, and with high growth potential.

9. Hypotheses  H 1 : Higher-quality PIPE firms are associated with more reputable placement agents.  H 2 : More reputable placement agents provide higher-quality services, but not necessarily charge higher fees.

10. Methodology  The endogeneity issue  Control for the endogeneity using Instrumental Variable Framework The Lee (1978) Two-Stage Approach Simultaneous Equation Analysis

11. Sample and Data  PIPE sample is provided by Sagient Research  Sample period: from 1996 to 2005  Final sample: 1,148 common stock PIPE transactions where CRSP and Compustat data one year prior to the PIPE are available.  A total of 215 placement agents with varying levels of participation in the PIPE market

12. Measures of Agent Reputation  C&M ranking  Total market share  Discounts/CAR  Market share in previous three-year period The percentage of total gross proceeds of all PIPE deals led by the placement agent over the last three years The top 15 placement agents in every three-year period as reputable placement agents. √

13. Measures of Firm Quality  Analyst coverage: the maximum number of analysts following the issuer during the 12 months prior to the issuance as reported by I\B\E\S  Delist Dummy: equal to one if the issuer is delisted within 24 months subsequent to the issuance and zero otherwise  Volatility: the standard deviation of the daily returns in the last 12 months  EBITDA/Assets  Book to market (BM) ratio  Long term debt/Assets

14. Measures of Placement Agents’ Service Quality  Discounts (closing price the day before the PIPE deal closes-offer price)/offer price  Additional benefits Analyst following Turnover Spread Volatility

15. The Matching of Placement Agents and Issuers ---- Likelihood of Having Agent Coefficientp-value Intercept-1.116**0.011 Firm Quality Ln (Analyst)-0.123*0.075 EBITDA/Assets0.0310.644 B/M-0.0520.232 Financial Leverage-0.488**0.021 Delist Dummy-0.0680.548 Ln (Volatility)0.1590.277 Other Variables Firm Size-0.217***0.000 Ln (Age)0.0830.156 Ln (Proceeds)0.655***0.000 Warrants0.557***0.000 Industry DummiesYes Year DummiesYes N1,148 Pseudo R-square (%)15.86

16. The Matching of Placement Agents and Issuers ---- Likelihood of Having Reputable Agent Coefficientp-value Intercept-1.239*0.055 Firm Quality Ln (Analyst)0.192**0.042 EBITDA/Assets0.226**0.050 B/M0.0220.792 Financial Leverage-0.0070.984 Delist Dummy-0.1300.456 Ln (Volatility)-0.0500.793 Other Variables Firm Size-0.0950.276 Ln (Age)-0.1100.180 Ln (Proceeds)0.357***0.000 Warrants-0.0560.681 IPO/Previous SEO Underwriter0.1780.656 Previous PIPE Agent0.420***0.004 Industry DummiesYes Year DummiesYes N707 Pseudo R-square (%)12.02

17. Do Placement Agents Help Reduce Discounts? IV Approach The Lee Model With AgentWithout Agent Coefficientp-valueCoefficientp-valueCoefficientp-value Intercept15.821**0.026-41.3790.1460.8090.956 Ln (Analyst)-4.342***0.004-4.143***0.003-10.108**0.016 EBITDA/Assets-0.2600.8210.3350.9161.4720.662 B/M-1.608*0.060-2.344**0.031-1.2910.332 Financial Leverage-7.8040.111-9.6280.193-18.157**0.038 Delist Dummy0.1150.9591.5020.642-4.9120.273 Ln (Volatility)9.303***0.00211.398***0.00712.437*0.077 Ln (Proceeds)9.630***0.0015.9450.11628.265***0.004 Warrants11.813***0.0016.0050.31636.595***0.001 Ln (Cash)-2.085**0.0250.1830.901-4.649**0.025 Insiders-0.3310.924-3.8810.6255.8070.477 Block Investor-0.5190.7850.2240.9136.489*0.071 Hedge Funds4.106**0.0271.4210.4894.3400.292 With Agent-61.225***0.000 Inverse Mills Ratio44.977*0.06585.074***0.001 Industry DummiesYes Year DummiesYes N1148707441 Adjusted R-square (%)6.2014.8015.46

18. Are More Reputable Placement Agents More Capable of Reducing Discounts? IV Approach The Lee Model More Reputable AgentsLess Reputable Agent Coefficientp-valueCoefficientp-valueCoefficientp-value Intercept34.457***0.000-5.2540.83823.1220.128 Ln (Analyst)0.6150.708-0.8000.7711.9260.630 EBITDA/Assets0.1980.864-2.5520.5910.6630.795 B/M-1.0790.3440.5190.763-1.2840.226 Financial Leverage1.2050.827-9.4670.2592.5710.697 Delist Dummy0.5030.848-1.0240.7780.2860.944 Ln (Volatility)5.832*0.0561.7770.6336.6380.241 Ln (Proceeds)-2.0190.242-0.7500.772-1.6730.572 Warrants-7.737***0.000-0.4950.185-8.838**0.010 Ln (Cash)1.1620.260-0.1830.8941.6110.508 Insiders-3.9880.411-11.8400.162-2.5810.791 Block Investor-2.0730.297-2.9440.285-1.8570.349 Hedge Fund1.3460.5000.8780.7490.5310.827 Reputable Agent-42.421***0.003 Inverse Mills Ratio14.1560.17938.742**0.050 Industry DummiesYes Year DummiesYes N707154553 Adjusted R-square (%)9.4431.4811.27

19. Analyst Coverage and Stock Liquidity after PIPEs BeforeAfterp-value Full sampleMeanMedianMeanMedianMeanMedian Analyst Coverage2.111.002.602.000.000*** Turnover0.180.110.190.120.3950.063* Spread2.601.901.961.270.000*** Volatility (%)6.045.595.334.830.000*** N11481086

20. Analyst Coverage and Stock Liquidity after PIPEs: With Agents vs. Without Agents Firms with AgentsFirms without Agentsp-value MeanMedianMeanMedianMeanMedian Δ Analyst Coverage0.730.000.270.000.001***0.000*** Δ Turnover0.01 0.00-0.000.7850.058* Δ Spread-0.78-0.50-0.51-0.350.063*0.009*** Δ Volatility (%)-0.92-0.71-0.53-0.470.008***0.023** N671415

21. Analyst Coverage and Stock Liquidity after PIPEs: With Agents vs. Without Agents Firms with more reputable agents Firms with less reputable agentsp-value MeanMedianMeanMedianMeanMedian Δ Analyst Coverage0.901.000.690.000.3610.112 Δ Turnover0.030.00 0.010.3900.800 Δ Spread-0.84-0.56 -0.340.038**0.068* Δ Volatility (%)-0.96-0.74-0.90-0.710.4370.406 N147524

22. The Distribution of Placement Agents’ Fees

23. Does More Reputable Placement Agent Charge a Fee Premium? IV Approach The Lee Model More Reputable AgentsLess Reputable Agent Coefficientp-valueCoefficientp-valueCoefficientp-value Intercept5.856***0.0007.2090.1087.4740.000 Ln (Analyst)-0.359**0.034-0.2010.573-0.488**0.021 EBITDA/Assets-0.0320.7930.3710.721-0.0530.825 B/M-0.0860.475-0.9340.2000.0840.486 Financial Leverage-0.1450.7992.2090.396-0.7040.298 Delist Dummy0.0410.8810.2500.7480.1650.640 Ln (Volatility)0.3150.3171.2560.315-0.0280.938 Warrants-0.0910.6730.3360.586-0.1860.470 Ln (Proceeds)-0.477**0.012-1.109**0.050-0.409*0.059 Future Business-0.3720.115-0.2290.681-0.457*0.052 Reputable Agent0.3200.855 Inverse Mills Ratio-0.3050.848-0.5350.674 Industry DummiesYes Year DummiesYes N707154553 Adjusted R-square (%)10.8241.4310.79

24. Discounts, Agent Fees, and Future Market Share Market Share at tMarket Share at t+1Market Share at t+2 Coefficientp-valueCoefficientp-valueCoefficientp-value Intercept0.008*0.0690.013***0.0020.013**0.010 Market share (t-3, t-1)0.196***0.0000.0610.1550.120**0.044 Mean discounts (t-3, t-1)-0.017**0.016-0.0110.125-0.0080.341 Mean agent fee (t-3, t-1)0.0720.2570.0030.966-0.0140.851 N20914596 Adjusted R-square (%)10.670.772.47

25. Conclusions  How do firms and placement agents choose each other? There exists a positive assortative matching of placement agents and issuing firms. Specifically, firms with more analyst coverage (less information asymmetry) and better profitability, and larger offers are associated with more reputable placement agents.  Do placement agents help lower transaction costs and information costs? Yes. Placement agents help lower PIPE discounts and improve firms’ information environment and stock liquidity after the offering.  Do placement agents with strong reputations provide higher- quality service? Yes. Firms associated with more reputable placement agents pay lower discounts to PIPE investors and obtain other benefits suggesting improved stock liquidity after the offering.

26. Conclusions (cont.)  Does the higher quality service enable placement agents to charge higher fees? No. More reputable placement agents do not appear to charge higher fees than less reputable placement agents for their higher-quality service. However, their higher-quality service enables them to increase future market share.  Overall, our results support the model of Fernando, Gatchev, and Spindt (2005). Rather than fees per se, the quality of the issuing firm and the reputational concern of the placement agent are the key factors that drive the equilibrium in the PIPE market.