WHY INCLUDE WARRANTS IN NEW EQUITY ISSUES - A THEORY OF UNIT IPOS

We develop a theory of unit IPOs in which the firm going public issues a package of equity with warrants, We model an equity market where in siders have private information about the riskiness as well as the exp ected value of their firm's future cash flows. We demonstrate that, in equilibrium, high risk firms issue underpriced ''units'' of equity an d warrants; lower risk firms, on the other hand, issue underpriced equ ity alone. In contrast to the existing literature, underpricing arises as a signal in our model in the context of a one-shot equity offering . Though developed in the context of IPOs, our model can also explain the issuance of seasoned equity offerings packaged with warrants. Furt her, the intuition behind the model generalizes readily to provide a n ew rationale for packaging call-option-like claims with risky securiti es other than equity, including convertible debt and debt with warrant s.