A new method for valueing underwriting agreements for rights issues (Q1117659)

The problem of valueing underwriting agreements for rights issues is addressed. In the recent literature the theory of put options has been used to find the premiums for these services. It has been a puzzle to date that the values obtained by this method have not been in agreement with observed premiums paid by the firms to the underwriters. In particular, one has concluded that firms have overpaid for underwriting. In this paper we use the theory of contingent claims analysis to find an equation on which the premium computation must be based. We derive an upper and a lower bound for the net premium, and we compare the values obtained by our method to the premiums computed by the traditional technique for 22 rights issues listed on the stock exchange in Oslo (Oslo Børs). It turns out that in many cases the discrepancies between the two methods can be substantial. In particular, from the upper bounds and from the risk-adjusted probabilities that the issues are successful, we infer that the traditional technique may sometimes undervalue these premiums. Thus we argue that the market for underwriting agreements is not inefficient after all.