7 - Initial Public Offerings Flashcards

1
Q

why do new entities seek external capital markets if internal and debt financing is considered more desirable?

A
  • debt financing not viable due to riskiness of entity and lack of financial backing
  • not enough internal funds yet to self finance
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2
Q

why would investors be willing to invest in venture capital?

A

high risk = high returns

potential for high growth

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3
Q

Describe how AUS regulates IPOs?

A
  • disclosure docs required
  • details of price, quantity and info included and can’t be changed
  • all shares must be sold, usually to an underwriter
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4
Q

List 3 share offering types?

A
  • Best Effort Basis, doesn’t guarantee that all shares will be sold, but underwriter tries to secure the best price
  • Firm Commitment, underwrite to sell all stock at offer price
  • IPO Auction, selling directly to public
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5
Q

Why do firms choose to go public? 6

A

○ allows for lower cost of capital
○ added borrowing capacity
○ more investment → higher growth opportunities
○ provide wealth and liquidity for current owners who are not diversified
○ shift monitoring costs from private lenders to ASIC
○ publicly traded stock, share price movements, renumeration, easier to make subsequent issues

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6
Q

what are the direct costs of an IPO? 4

A
  • financial costs:
  • accounting
  • legal fees
  • underwriting
  • underpricing
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7
Q

what are 3 examples of indirect costs?

A
  • management time
  • disclosure of firm private info
  • agency costs of equity, dispersing ownership
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8
Q

do larger or smaller IPOs tend to be underpriced?

A

smaller IPOs are underpriced

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9
Q

what type of relationship is there between prestigious underwriters and underpricing?

A

a positive relationship

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10
Q

What does ROCK’s 1986 MODEL explain?

A

reason for underpricing is the WINNER’s CURSE.

  • informed investors know which shares to bid for, uninformed investors receive an average fair return, they will not receive all the shares they bid if informed investor think its a good investment and will receive all shares they bid for in bad investments.
  • therefore underwriter must under prices so uninformed investors can breakeven.
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11
Q

according to ROCK’s 1986, what type of return will an uninformed investor make?

A

on average they will breakeven

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12
Q

what are six further reasons for underpricing?

A
  • Market feedback: underprice so that informed investors reveal info during resale period.
  • Bandwagon effect: herding behaviour induced by underpricing
  • Lawsuit avoidance: if stock price increases people are happy/don’t make a loss
  • Signalling hypothesis: swift price increases due to underpricing makes investors optimistic/next issue at a higher price
  • Compensation for underwriter: underpricing makes shares easier to sell
  • Compensation for owners: shareholders see the value of their shares rapidly increasing.
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13
Q

why managers don’t mind underpricing? what tactic can firms use to not leave too much money on the table?

A
  • they expect the stock price to be worth more, when they receive good news they are complacent.
  • publicity is good/ also good for underwriters
  • small IPO followed by another offering at a higher price
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14
Q

what happened to underpricing during the tech bubble?

why?

A

it increased
changing composition hypothesis
riskier IPO are more underpriced than less risky IPOs

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15
Q

what are the agency problems between issuer and underwriter? 3

A
  • underwriters find it less costly to sell underpriced securities
  • managers don’t mind receiving good news on their own wealth
  • issuers are complacent about money left on the table
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16
Q

what was different about Googles IPO?

A

cutout the underwriter, staged a dutch auction.

IPO price set naturally not underpriced

17
Q

in the long run how do IPO firms perform?

A

lower performance than non-issuers in the long run

18
Q

what are 3 possible explanations for long run low performance of IPO firms?

A
  • impresario hypothesis
    underpricing creates appearance of excess demand, high initial return low long run return
  • Windows of Opportunity Hypothesis
    Hot issues market, investors are optimistic and think firms time their IPOs
    -Divergence of opinion Hypothesis
    Optimistic investors can buy shares , pessimistic investors are unable to short-sell in IPOs
19
Q

what are 2 subsequent costs of an IPO?

A

reporting and complying with regulatory bodies

20
Q

What are the two assumptions of the ROCKs 1986 MODEL?

A
  1. the market is composed of informed investors and uninformed investors (eg. mum and dad investors)
  2. cannot rely solely on informed investors to provide capital
21
Q

What are the 3 key implications of the ROCKs 1986 MODEL?

A
  1. informed investors gain
  2. uninformed investors receive returns that is lower than the informed investors
  3. underwriter needs to price below expected fair price to attract uninformed investors
22
Q

what are the key reasons IPO underpricing has changed?

A

i. changing composition hypothesis

ii. agency problems between issuer and underwriter