5 - IPOs (1) Flashcards
IPO underpricing theories: enticement
Underpricing occurs in order to entice investors to subscribe for “risky” issues
- trade off of a lower price for certainty of receiving funds
- high degree of uncertainty = lower price needed to ensure demand
IPO underpricing theories: Information Asymmetry
(winner’s curse)
- informed investors: due to additional information, will only apply when an IPO is underpriced
- uninformed investors get all the shares they demand
- if new issue not underpriced, uninformed investors will systematically lose money
IPO underpricing theories: bandwagon/cascade hypothesis
- investors pay attention to whether others are buying
- underpricing entices first potential investors to buy
IPO underpricing theories: signalling
Underpricing leaves a good taste with investors, allowing for future offerings (e.g. Telstra - SEOs)
What is money left on the table and in what situation would original owners not mind?
- The difference between the IPO purchase price and the closing price at the end of first day’s trading (what theoretically could have been raised)
- Original owners generally don’t get upset by MLOT as they gain a great deal of individual wealth anyway
Risks of underwriting vs book building
UWR: fixed pricing, some shares don’t get sold, high commission fees, longer time period for which investors are exposed
BB: off-market collation only known by IB; no placement risk; flexibility of promotion; price set AFTER roadshow; minimises time between pricing of issue and trading on secondary market
Three types bookbuilding: 1 - Tender Offer
Tenders made above min price;
- If oversubscribed, priority given to the highest tenderer;
- Two types: (1) pure tender (highest bid wins - winner’s curse), and (2) common strike price: investors submit competitive bids for different amounts, common strike price determined based on price for which there is most demand, encourages higher bids to secure allocation
Does bookbuilding contribute to market efficiency?
Through strategic allocation; whereby bids thought to contain more information (e.g. revised bids) are given preference
Cornelli and Goldreich:
-3 types of bids, strike (just want shares regardless of price), limit bid (maximum price willing to pay), step bids (bidder submits a demand schedule)
-found that allocations favour investors who submit limit and step bids over strike bids (provides info)
Discuss the mechanism and effects of a green shoe option.
Aim is to protect open market price of security from downward pressures once trading commences. It provides a 15% over-allotment option to investment banks
- Strategy: if IB expects strong demand: pre-sell 15% of issue, to be met from exercise of allotment. If after market demand is weak, provide market support
- Dual intentions: financial reward to IB, benefits of price stability
Underwriting vs Bookbuilding
Underwriting: fixed pricing; no direct soliciting of market to determine investors’ interest. The IB takes on the responsibility and the risk of the new issue.
BB: the underwriter attempts to determine at what price to offer an IPO based on demand from investors (non-binding expressions of interest)
Three types of bookbuilding: (2) Open Price
- Final price set at the end of offering period
- More accurate pricing level because of indicative price range (provides guide as to value of shares)
- Prices set by lead managers and issuing firms: lower end at sufficiently attractive level to firm; higher end at price which exceeds issuing firm’s price objective
Open price bookbuilding: demand
- If strong demand indicated, final price can be above upper limit
- If low demand, offering can be withdrawn, or price range reduced
- If underwritten, risk will relate to default risk, not distribution risk
Three types of bookbuilding: (3) Constrained pricing
- Dual pricing basis
- Retail investors apply at a capped price
- Institutional investors and foreign investors pay strike price
- E.g. medibank: $2.10 retail, $2.15 institutional
Criticisms of bookbuilding
- More discretion on allocation: IB can allocate to favourite clients, only domestically, size of order/investor
- Can be both quantitative and qualitative
