7 - Initial Public Offerings Flashcards
why do new entities seek external capital markets if internal and debt financing is considered more desirable?
- debt financing not viable due to riskiness of entity and lack of financial backing
- not enough internal funds yet to self finance
why would investors be willing to invest in venture capital?
high risk = high returns
potential for high growth
Describe how AUS regulates IPOs?
- disclosure docs required
- details of price, quantity and info included and can’t be changed
- all shares must be sold, usually to an underwriter
List 3 share offering types?
- 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
Why do firms choose to go public? 6
○ 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
what are the direct costs of an IPO? 4
- financial costs:
- accounting
- legal fees
- underwriting
- underpricing
what are 3 examples of indirect costs?
- management time
- disclosure of firm private info
- agency costs of equity, dispersing ownership
do larger or smaller IPOs tend to be underpriced?
smaller IPOs are underpriced
what type of relationship is there between prestigious underwriters and underpricing?
a positive relationship
What does ROCK’s 1986 MODEL explain?
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.
according to ROCK’s 1986, what type of return will an uninformed investor make?
on average they will breakeven
what are six further reasons for underpricing?
- 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.
why managers don’t mind underpricing? what tactic can firms use to not leave too much money on the table?
- 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
what happened to underpricing during the tech bubble?
why?
it increased
changing composition hypothesis
riskier IPO are more underpriced than less risky IPOs
what are the agency problems between issuer and underwriter? 3
- 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
what was different about Googles IPO?
cutout the underwriter, staged a dutch auction.
IPO price set naturally not underpriced
in the long run how do IPO firms perform?
lower performance than non-issuers in the long run
what are 3 possible explanations for long run low performance of IPO firms?
- 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
what are 2 subsequent costs of an IPO?
reporting and complying with regulatory bodies
What are the two assumptions of the ROCKs 1986 MODEL?
- the market is composed of informed investors and uninformed investors (eg. mum and dad investors)
- cannot rely solely on informed investors to provide capital
What are the 3 key implications of the ROCKs 1986 MODEL?
- informed investors gain
- uninformed investors receive returns that is lower than the informed investors
- underwriter needs to price below expected fair price to attract uninformed investors
what are the key reasons IPO underpricing has changed?
i. changing composition hypothesis
ii. agency problems between issuer and underwriter
