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Agenda
Underwriter Profits
Commission from the spread between the issue
price (P) investors pay and the amount paid to
the firm, P(1-C).
Over-Allotment Option or Green Shoe
provision.
Option granted to an underwriter for a period of 15 to
45 days (usually 30) after the issue date to purchase
additional shares.
Typically, up to 15% of the shares being sold.
Best Efforts
The investment bank only markets the issue.
The prospectus states an offer price (P), the
minimum number of shares that must be sold for
the issue to go through (Qmin) and the greatest
number of shares that will be sold (Qmax)
If Qmin is not reached in 90 days (this can vary) the
investors get their money back from an escrow
account.
Once again the company gives a call option to
investors.
General Facts
The majority of IPOs take place via firm
Commitment offers.
Only 35% of IPOs are Best Effort and they
account for only 13% of the total money raised.
This implies that best effort IPOs are generally from
small firms.
One rationale is that otherwise the investment banker
would force the company to go public at very low
price. In the best efforts issue the company can
choose the price itself.
U.K. Method #2
Fixed-price Offer for sale
The issuing company and the investment bank decide
on the price well in advance of the selling period.
A prospectus is printed and the investment bank
advertises the issue to general public (and to
institutions).
From the option point of view this method give rise to
same options as the firm commitment method. Now
the both options just have longer maturity.
U.K. Method #3
Auction-rate Offer for sale
No underwriting is needed as the market
decides the correct price.
Losing popularity in the UK.
But remains popular in Denmark, France and the
Netherlands.
IPO Costs
The total costs of going public are a big
percentage of the possible issue proceeds (on
average, from 15 % to 30%). The costs can be
divided into four parts:
Direct costs.
These include the underwriter commission (3% to 8%), legal
fees, auditor fees, printing fees, advertising costs,
Direct costs are on average 11% of the money raised (as
usual being mostly fixed, they range form 6% for larger firms
to 17%(!) for smaller firms)
IPO Underpricing
Underpricing is defined as the difference
in price between the closing price on the
first day of trading and the offer price.
In the US:
Firm commitment contract: about 15%;
Best effort contracts: about 48%.
Underpricing
Data Years
UK
8.6%
1985-88
France
4.2%
1983-86
Netherlands
5.1%
1982-87
Switzerland
35.8%
1983-89
Germany
21.5%
1977-87
Spain
22.3%
1986-90
Finland
9.5%
1984-89
Uninformed
PV
Do not bid.
Bid.
P<V
Bid
Bid
Implications
Uninformed investors will 100% of the shares in
an overpriced offer since they are the only
bidders.
Uninformed investors receive just a fraction of
the underpriced offers as they must compete
with the informed investors.
Uninformed investors realize that:
When they are allocated more shares, they will get a
bad deal (winners curse).
When they are allocated fewer shares it is because
the deal is good.
Spanish data:
Both over and underpriced issues tend to be
oversubscribed.
When institutional investors do not bid on an issue it
still tends to be underpriced. Under the model these
issues should be overpriced.
Underpricing: Solutions?
Auction
Problem: will investors to gather the necessary information?
France: underpricing is much lower for those firms that use
auction methods to go public!
Unit IPOs
The company sells units of securities instead of shares.
IPO evidence relies on the fact that only stocks are issued at the
IPO stage. Perhaps stocks are not the best way to go public.
Puttable Common Stocks: a combination of stocks and Put options.
The put options can be seen as a money-back warranty that
enable investors to sell back the stock to the firm if the stock does
not perform.