Journal of Banking and Finance 17 (1993) I I1 I-I I3 I. North-Holland The private placement of bank equity* Raj Varma University of Delaware, Department of Finance, Newark, DE 19716, USA and Finance Deparrment, The Wharton School, University of Pennsylvania, Philadelphia, PA 19104. USA Samuel H. Szewczyk Drexrl Ufliversity, Department of Finance, Philadelphia, PA 19104. USA Received February 1991, final version received August 1992 This paper investigates the role of private placements of common stock as a source of bank capital. Our results show that information asymmetry problems that typically attend new offers of bank equity are mitigated in the private placement process. Moreover buyers of privately placed common stock seem to provide a quality certification of capital deficient bank holding companies. Our evidence is also consistent with the notion that buyers of privately placed common stock provide a monitoring service that aligns the interest of the bank’s managers and shareholders. Finally, we find no evidence that private placements are predominately motivated by incumbent management’s attempts to sell equity to a friendly buyer at the expense of the bank’s current shareholders. Key words: Private placements; Bank equity; Ownership changes; Raising capital; Bank governance JEL classification: G2l: G32 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDC 1. Introduction The rising rate of bank failures and the perception of increased risk taking has focused greater attention on bank capital. In recent years, capital regulation has been strengthened and higher capital standards imposed on the banking industry. By issuing additional common stock, a bank or bank holding company (BHC) increases the size of the cushion available to absorb losses and simultaneously reduces the incentive of bank managers to increase asset risk [see Furlong and Keeley (1989) and Keeley and Furlong (1990)]. Correspondence 10: Raj Varma, Department of Finance, College of Business, University of Delaware, Newark, DE 19716, USA. *We would like to thank Don Puglisi for many stimulating discussions about private placements. This paper also beneiitted from useful comments provided by Michael Gombola, George Tsetsekos, and two anonymous reviewers and from presentations at Drexel University, University of Delaware, and the 1991 meeting of the Financial Management Association. 03784266/93/$06.00 80 1993-Elsevier Science Publishers B.V. All rights reserved