hedge strongfundsstrong as investors of last resort.pdf

Hedge Funds as Investors of Last Resort? David J. Brophy University of Michigan Paige P. Ouimet University of Michigan Clemens Sialm University of Texas at Austin and NBER Hedge funds have become important investors in public companies raising equity privately. Hedge funds tend to finance companies that have poor fundamentals and pronounced information asymmetries. To compensate for these shortcomings, hedge funds protect themselves by requiring substantial discounts, negotiating repricing rights, and entering into short positions of the underlying stocks. We find that companies that obtain financing from hedge funds significantly underperform companies that obtain financing from other investors during the following two years. We argue that hedge funds are investors of last resort and provide funding for companies that are otherwise constrained from raising equity capital. (JEL G14, G23, G32) Hedge funds have recently become an important source of funding for pub- lic companies raising equity privately. Financing young companies with severe information asymmetries is an important investment strategy for some hedge funds. Since 1995, hedge funds have participated in more than 50% of the private placements of equity securities and have contributed about one-quarter of the capital raised in such equity issuances, a total investment that has exceeded the contributions of other investor classes. This paper sheds light on the role of hedge funds in such private placements. In perfect financial markets it should be irrelevant whether a firm obtains funding from hedge funds or from other investors. To investigate whether the identity of the investors matters, we use a unique dataset that We thank Sugato Bhattacharyya, Serdar Dinc, Amy Edwards, Ken French, Radha Gopalan, Michael Hertzel, David Hsieh, Marcin Kac