1、DRAFTCONFIDENTIALCHAPTER 1Issuing Securities to the PublicExecutive SummaryThis chapter looks at how corporations issue securities to the investing public.As the basic procedure for selling debt and equity securities are essentially the same. This chapter focuses on equity.Chapter Outline19.1 Public

2、 and Private Sources of Capital19.2 The Public Issue19.3 Alternative Issue Methods19.4 The Cash Offer19.5 The Announcement of New Equity and the Value of the Firm19.6 The Cost of New Issues19.7 Rights19.8 The Rights Puzzle19.9 Shelf Registration19.10 The Private Equity Market19.11 Summary and Conclu

3、sions19.1 Public and Private Sources of CapitalFirms raise debt and equity capital from both public and private sources.Public Sources of CapitalCapital raised from public sources must be in the form of registered securities.Securities are publicly traded financial instruments. They are traded on pu

4、blic secondary markets, after issued on primary market.Most securities must be registered with the Securities and Exchange Commission (SEC).Private Sources of CapitalPrivate capital comes either in the form of bank loans or as what are know as private placements.Private placements are financial clai

5、ms exempted from the registration requirements that apply to securities.To be qualified for exemption the issue muse be restricted to a small group of sophisticated investors (fewer than 35) with minimum income or wealth requirementsPrivately placed financial instruments cannot be traded on public m

6、arkets.Rule 144A allows institutions with assets exceeding $100 million to trade these financial claims among themselves.Two differences between public and private sourcesPublic issues has to be registered with SEC, while private placed issues need not.Public issued securities can be publicly traded

7、, while privately placed instruments cannot.Public markets tend to be anonymous. Investors in public markets are legally protected against inside trading.Since investors in private markets are assumed to be sophisticated who are aware of each others identities, inside trading is not as problematic.

8、Advantages and Disadvantages of Private SourcesAdvantagesTerms of private bonds and stock can be customized for individual investors.No costly registration with SEC.No need to reveal confidential information.Easier to renegotiate.DisadvantagesLimited investor baseLess liquid19.2 The Public IssueThe

9、Basic ProcedureManagement gets the approval of the Board of Directors.The firm prepares and files a registration statement with the SEC. This document is required for all public issues of securities exceptLoans that mature within nine monthsIssues that involve less than $5.0 millionThe SEC studies t

10、he registration statement during the waiting period. The firm may distribute copies of a preliminary prospectus.The Basic ProcedureThe firm prepares and files an amended registration statement with the SEC if needed.If everything is copasetic with the SEC, a price is set and a full-fledged selling e

11、ffort gets underway. A final prospectus must accompany the delivery of securities.Marketing the issue: road shows and tombstone advertisements are used during and after the waiting period.The Process of A Public OfferingSteps in Public OfferingTime1. Pre-underwriting conferences2. Registration state

12、ments 3. Pricing the issue4. Public offering and sale 5. Market stabilization Several months 20-day waiting period Usually on the 20th day After the 20th day 30 days after offeringAn Example of a Tombstone Advertisement19.3 Alternative Issue MethodsThere are two kinds of public issues:The general ca

13、sh offerCash offers are sold to all interested investors.The rights offerRights offers are sold to existing shareholders.Classifying Equity OfferingsInitial Public Offering (IPO): the first public equity issue that is made by a company.Seasoned Offering (SEO): the new equity issue where the companys

14、 securities have been previously issued.All IPOs are cash offers.SEOs can be made by using either cash offers or rights offers Almost all debt is sold in general cash offerings.Investment BankInvestment banks are financial intermediaries that perform a wide variety of services.The business of invest

15、ment banksThe sale of securitiesFacilitating mergers and other corporate reorganizationsActing as brokers to both individual and institutional clientsTrading for their own accounts.ResearchFor corporate issuers investment banks perform the following services:Formulating the method used to issue the

16、securities.Pricing the new securities.Selling the new securities.Top Global Underwriters, 1999AdvisorsProceeds ($B)RankPercent# DealsFees ($M)Merrill Lynch412.3112.523682433Salomon Smith Barney (Citigroup)323.229.817481653Morgan Stanley Dean Witter296.339.025922618Goldman Sachs265.248.113082453Credi

17、t Suisse First Boston239.357.314191489Lehman Brothers202.766.21104852Deutsche Banc139.474.2898971Chase Manhattan131.384.01158354JP Morgan131.194.0710765ABN Amro102.9103.11230640Bear Stearns94.9112.9666519Bank of America81.4122.566719319.4 The Cash OfferThere are three methods for issuing securities

18、for cash:Firm CommitmentBest EffortsDutch AuctionFirm CommitmentUnder a firm commitment the investment bank (or a group of bankers) buys the securities from the issuing firm for less than the offering price and sell them to the public investors.Obviously, they need to make a profit, so they buy at “

19、wholesale” and try to resell at “retail”.Because this function involves risk, we say that the investment bankers underwrite the securities. Or they act as underwriters. Spread (Discount), which is the difference between the underwriters buying price and the offering price is the basic compensation r

20、eceived by the underwriters.The issuer receives the full amount of the proceeds less the spread and all the risk is transferred to the underwriters.To minimize their risk, the investment bankers combine to form an underwriting syndicate to share the risk and help sell the issue to the public.The lea

21、d (principal) managers has responsibility for all aspects of the issue. Best EffortsUnder a best efforts underwriting, the underwriter does not buy the issue from the issuing firm. Instead, the underwriter acts as an agent, receiving a commission for each share sold, and using its “best efforts” to

22、sell the entire issue at the agreed-upon offering price.This is more common for initial public offerings than for seasoned new issues. Why?Dutch AuctionThe underwriters do not set a fixed price for the shares to be sold. They conduct an auction in which investors bid for shares.The offering price is

23、 determined in the auction.It is also called uniform price auction.This approach is relatively new in the IPO market though it is more common in the bond market.An Example of Dutch AuctionSuppose the Rial Company wants to sell 400 shares to the public. The company receives five bids as follows:Bidde

24、rQuantityPriceA100 Shares$ 16B100 Shares14C100 Shares12D200 Shares12E200 Shares10Determine the highest price that will result in all 400 shares being sold.In this example this price is $12 at which the demand for the shares is 500 shareholder. Successful bidders pay the same price (uniform price auc

25、tion).Allocate the shares to be issued.Compute the ratio of the shares offered to shares bid at the offer price or better, 400/500=0.8 in this case. All successful bidders receive 80 percent of the shares they bid at $12.Finally, the offering price is $12. A, B and C get 80 shares respectively, and

26、D gets 160 shares. Green Shoe ProvisionThis provision gives the members of the underwriting group the option to purchase additional shares at the offering price.It usually last for about 30 days and involve no more than 15 percent of the newly issued shares.It is a benefit to the underwriting syndic

27、ate and a cost to the issuer.LockupsLockup arrangements specify how long insiders must wait after an IPO before they can sell some of their stock.It is not unusual for the number of lock-up shares to be larger than the number of shares held by the public.The stock price will drop if these shares are

28、 sold to the market. Quiet PeriodA quiet period extends from the time a company files a registration statement with the SEC until SEC staff declare the registration statement “effective”. (U.S. Securities and Exchange Commission)All communication with the public must be limited to ordinary announcem

29、ents and other purely factual matters.The underwriters analysts are prohibited from making recommendations to the investors.Selecting the UnderwritersThere are two methods for selecting an underwriterCompetitiveNegotiatedNegotiated deals in investment banking occur with all but the largest issuing f

30、irms.IPO Under PricingThe incentives of investment banks in pricing:It is prohibitively costly or impossible sometimes for atomistic public investors to study and price the IPO firms themselves.Investment banks know the firms they underwrite much more than the public investors.Do they have the incen

31、tives to price the issue too high?In the long run their concerns on the “reputation capital” prevent them form doing so.IPO Under PricingWhat is observed in the real world?The first day return is the return an investor earns if she buys the new shares on the primary market at the offering price and

32、sell them on the secondary market at the closing price on the first trading day immediately. IPO typically have been offered at 11 percent below their true market price. (Ibbotson, JFE, 1975)Average IPO rose in price 17.3 percent in the first day of trading following issuance for 7600 IPOs from 1975

33、 through 2005 in United States.Possible Explanation IFact I: under pricing tends to be attributable to firms with few or no sales in the prior year.The implication for IPO Under Pricing:Young firms are riskier in general. To attract risk averse investors, young firms have to under price their issues

34、 to compensate the investors.Annual Sales of Issuing Firms# of Firms1980-1989 First-Day Average Return# of Firms1990-1998 First-Day Average Return# of Firms1999-2000 First-Day Average Return# of Firms2001-2005 First-Day Average Return0, $10m)39310.1%67117.2%32869.8%776.1%$10m, $20m)2538.737718.71397

35、9.92710.5$20m, $50m)4927.677718.715274.5709.7$50m, $100m)3456.557413.08960.47216.1$100m, $200m)2414.644411.95435.57914.7Above $200m2783.56288.78726.020910.9All20027.1%347114.8%84964.6%53411.3%Average First-Day Returns, Categorized by Sales, for IPOs: 1980-2005Possible Explanation IIFact II: when the

36、 price of a new issue is too low, the issue is often oversubscribed.The implication for IPO under pricing (Winners Curse):Though on average IPO is under-priced, some may be overpriced.Informed investors only bid for underpriced IPO, while uninformed investors bid for all IPO.In equilibrium, uninform

37、ed investors are more likely to get shares for overpriced IPO and less likely for underpriced IPO.To attract uninformed investors firms have to under-price their issues to compensate their information disadvantage.Other ExplanationsTo reduce their risk of as underwriters, investment banks have the i

38、ncentive to underprice the issues.To attract investors in later issuing, the firms are willing to underprice their IPOs at the first place.The IPO firms are overvalued at the first trading day.Investors buy the shares of IPO firms on the secondary market on the first trading day earns an average ret

39、urn of 5 percent per year over a period of 5 years (Loughran and Ritter, 1995).19.5 The Announcement of New Equity and the Value of the FirmWhat is the price effect of the existing equity if a firm announce a new seasoned equity offering?Should the price of existing equity go up because new positive

40、 NPV projects are undertaken?The market value of existing equity drops on the announcement of a new issue of common stock.Possible ExplanationsManagerial InformationSince the managers are the insiders, perhaps they are selling new stock because they think it is overpriced.Debt CapacityIf the market

41、infers that the managers are issuing new equity to reduce their debt-equity ratio due to the specter of financial distress the stock price will fall.Falling Earnings19.6 The Cost of New IssuesSpread or underwriting discountOther direct expensesIndirect expensesAbnormal returns (SEO)Underpricing (IPO

42、)Green Shoe OptionDirect CostIndirect CostProceeds ($Million)Gross SpreadOther Direct ExpenseTotal Direct Cost2-9.999.15%6.21%15.36%10-19.997.334.3011.3620-39.996.992.829.8140-59.996.962.259.2160-79.996.881.778.6580-99.996.791.558.34100-199.996.481.197.67200-499.995.910.816.72500 and up4.660.495.15T

43、otal7.17%3.22%10.39%Direct Costs as a Percentage of Gross Proceeds for IPO Offered by US Companies: 1990-2003Proceeds ($Million)Gross SpreadOther Direct ExpenseTotal Direct Cost2-9.997.56%5.32%12.88%10-19.996.322.498.8120-39.995.731.517.2440-59.995.280.926.2060-79.995.070.745.8180-99.994.950.615.561

44、00-199.994.570.435.00200-499.993.990.274.26500 and up3.480.163.64Total5.37%1.35%6.72%Direct Costs as a Percentage of Gross Proceeds for SEO Offered by US Companies: 1990-2003Proceeds ($Million)Gross SpreadOther Direct ExpenseTotal Direct Cost2-9.991.39%2.35%3.74%10-19.991.331.592.9220-39.991.220.902

45、.1240-59.990.720.631.3560-79.991.520.762.2880-99.991.390.561.95100-199.991.600.521.80200-499.991.430.370.82500 and up0.620.200.82Total1.36%0.61%1.97%Direct Costs as a Percentage of Gross Proceeds for Straight Bonds Offered by US Companies: 1990-2003Some Features of Direct CostEconomy of Scale: the c

46、osts for both equity offerings and debt offerings decline as the gross proceeds of the offering increase.Direct costs are higher for equity offers than for debt offers. Why?The direct costs (gross spread plus underpricing) of going public for the first time is substantially high. So it is a weighty

47、decision for firms.19.7 RightsAn issue of common stock to existing stockholders is called a rights offering.Each shareholder is issued an option to buy a specified number of new shares from the firm at a specified price within a specified time.The rights are often traded on securities exchanges or o

48、ver the counter.This allows shareholders to maintain their percentage ownership if they so desire.Mechanics of Rights OfferingsThe management of the firm must decide:The price existing shareholders must pay for new shares.How many rights will be required to purchase one new share of stock.What effec

49、t will the rights offering have on the existing price of the stock.Rights Offering ExampleNational Power earns $2 million after taxes and has 1 million shares outstanding. Earnings per share are $2, and the stock sells at 10 times earnings (PE ratio is 10). The market price of each share is therefor

50、e $20. The market value of the firm is then $20 million. The company plans to raise $5 million of new equity funds by a rights offering. Subscription PriceSubscription Price (exercise price) is the price that existing shareholder are allowed to pay for a share of stock.A rational shareholder will su

51、bscribe to the rights offering only if the subscription price is below the market price of the stock on the offers expiration date.To attract shareholders to exercise the rights and obtain the funds in general the subscription price is set below the current market price of the stock.Assume in this e

52、xample National Power choose a price of $10, which is far below the market price, $20.Number of Rights Needed to Purchase a ShareShareholders typically get one right for each share of stock they own, 1 million rights will be issued by National Power.Funds to be raisedSubscription price5,000,00010Num

53、ber of new shares = = = 500,000 shares “Old” shares“New” shares1,000,000500,0002 rights Number of rights needed to buy a share of stock = = = Shareholders must give up two rights plus $10 to receive a share of new stock.Effect of Rights Offering on Price of StockWhen stock price of National Power is

54、 $20 on the expiration day, all investors will exercise the rights and buy new shares of the company at $10 per share.After rights offering the value of the firm is $25 million and the shares outstanding is 1.5 million. The ex-rights stock price is then $25/1.5=$16.67 per share.Value of RightsAny in

55、vestor with 2 rights can buy 1 share of National Power which is worth $16.67 per share after rights offering at a price of $10.The value of 2 rights is clearly $16.67-$10=$6.67, which means $3.33 for 1 right.Effects on Shareholders WealthWhat can an investor do with National Powers rights offering i

56、f she owns 2 shares of the company?Exercise the rights and buy 1 new share of the company.Do not exercise and sell the rights.Do not exercise and let the rights expire.StrategyWealth before Rights OfferingWealth after Rights OfferingControl Rights(1)20*2+10=5016.67*3=50No Changes(2)20*2=4016.67*2+6.

57、67=40Diluted(3)20*2=4016.67*2=33.33DilutedIf (1) occurs, the investor owns 3 shares. The total wealth of the investor is $16.67 * 3 = $50, which equals $20 * 2 + $10.If (2) occurs, the investor owns 2 shares. The total wealth of the investor is $16.67 * 2 + 6.67 = 40, which equals $20 * 2.If (3) occ

58、urs, the investor owns 2 shares. The total wealth of the investor is $16.67 * 2 = $33.33, which is less than $40The Underwriting ArrangementUndersubscription can occur if the stock price falls below the subscription price.Rights offerings are typically arranged by standby underwriting.The underwrite

59、r makes a firm commitment to purchase the unsubscribed portion of the issue at the subscription price less a take-up fee.19.8 The Rights PuzzleOver 90% of new issues are underwritten, even though rights offerings are much cheaper.A few explanations:Underwriters increase the stock price. There is not much evidence for this, but it sounds good