Hedge Funds as Investors of Last Resort?

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.