A Theory of Negotiated Equity Financing

Abstract

We examine the sale of equity within the context of a model of negotiation between a firm and a less well informed purchaser. We introduce a simple form of negotiation by allowing the firm to set the price of the issue and by assuming that the purchase is a financier-underwriter who acts strategically. This transaction is analyzed as a noncooperative game, and we identify sequential equilibria that are consistent with observed behavior: namely that negotiations occasionally fail, that market reactions to equity offers are not uniformly negative, and that equity placements are often underpriced.