Lecture 2: Raising Capital - Equity Flashcards
1.) Equity: Characteristics 2.) Floating Process 3.) Short-run and long-run performance of IPOs 4.) SEO - Rights issues vs Placements 5.) Process of Underwriting
What are the 5 rights of Shareholders
- ) An ordinary share gives the shareholder ownership of equity in the company
- ) Shareholders are allowed to vote on matters such as election of board of directors
- ) Shareholders are allowed to sell their shares
- ) Shareholders are entitled to a PROPORTIONAL share of dividends
5) Shareholders have a SUBORDINATED right to return of their capital upon liquidation of the company
What is subordinated right of shareholders?
It means that debt holders are paid first before shareholders
What is an IPO
Initial Public Offering
What are the 3 steps of Floating
- ) Engage an Investment Banker/Underwriter
- ) Conduct a roadshow
- ) Set the price and list
What does an Investment Banker do?
- ) Prepare the prospectus
2. ) Underwrite Service (Maybe)
What is a prospectus?
Legal document detailing the IPO.
What does the underwriter do?
For a fee, it guarantees that all issued shares will be sold. He is liable to purchase any unsold shares
Why and How does an underwriter provide the service?
Why: They USUALLY have a clear incentive to have shares sold
How: It conducts a marketing roadshow
What are the 2 main methods of deciding the subscription pricing of an IPO
- ) Fixed Pricing
2. ) Bookbuilding
What is fixed pricing
Price is set, prospectus is sent out and offers are received
What are the 2 kinds of bookbuilding
Competitive bidding by INSTITUTIONAL INVESTORS (NOTE)
- ) Open Pricing: Bids are taken the final price which clears the market
- ) Constrained Open Pricing: Indicative range and bids within the range are provided
What are key differences between fixed pricing and bookbuilding
- ) Price: Fixed = known to investors; Bookbuilding = Not known to investors
- ) Demand: Fixed = known only after issue closes; Bookbuilding = known daily as book is built
- ) Investors: Fixed = no discretion over investor quality; Bookbuilding = can decide the investors
What if the subscription price is too high or too low
Too high = No one will buy the shares.
Too low = Owners of firm will suffer opportunity cost in which shares could’ve been sold higher.
What price are the shares that are initially issued by the issuing firm
Subscription prices. This is the primary market
What is the market for trading in the market and when does it take place for an IPO
Secondary market - within share holders and buyers in the stock exchange
Formula for underpricing
Underpricing = (Closing price first day of trading - Subscription Price)/ Subscription Price
Define underpricing
Underprice is defined when the subscription price is below the “true” value of the firm
What are the 7 Reasons for Underpricing (Acronym)
II LL MBS
Reason for Underpricing and Explanation (1st I)
Information Asymmetry & Winner’s Curse
Underpricing will keep uninformed investors in the market.
Overprice - All shares go to uninformed
Underprice - Majority go to informed
Reason for Underpricing and Explanation (2nd I)
IPO Spinning
Investment bankers have ulterior motives
- ) Lower the cost of underwriting
- ) Maintain good relationship with other potential clients
Reason for Underpricing and Explanation (1st L)
Liquidity
Encourage more investors > dispersed ownership > More secure management and liquidity in secondary market
Reason for Underpricing and Explanation (2nd L)
Lawsuit Avoidance
Underpricing is a form of expensvie insurance. Reduce the severity of lawsuit (esp. in cases where people don’t read prospectus, lose money, and file a suit)
Reason for Underpricing and Explanation (M)
Market Feedback
Issuer uncertain of firm’s true value. Initial bookbuilding process allows issues to find out from the market its’ firm’s true value
Reason for Underpricing and Explanation (B)
Bandwagon/Cascade
Investors are more likely to subscribe to floats perceived as popular. Induce first wave of popularity
Reason for Underpricing and Explanation (S)
Signalling
Leave good taste with investors for future expansion such as SEO
Reasons for Long-Run Under performance of IPOs (Acronym)
DIW
Reasons for Long-Run Under performance of IPOs (D)
Divergence of Opinion
IPO = Optimistic investors
Information available over time > Less divergence of opinion between optimistic and pessimistic investors
Reasons for Long-Run Under performance of IPOs (I)
Impresario
Initially hype/marketting by investment bankers died down.
Reasons for Long-Run Under performance of IPOs (W)
Windows of Opportunity
Decline in demand for IPOs correlated with a market-wide reduction in equity values. Hence, relative to the entire market