International Finance Management - Lecture 10

Companies may want to sell equity to the public to raise capital. Simultaneously, companies switch from being privately owned to publicly owned.

Firms achieve this by going through an initial public offering.

There are two ways to issue new securities:

Private Issue a.k.a. Placement/Placing: sold to a few number of institutions (no need to register)

Public Issue: shares traded on a stock exchange (needs to register with stock exchange)

Two types of PI:

- General cash offer: equity sold to all interested investors and it is the first time a company issues public equity, i.e. Inital Public Offering/ Unseasoned New Issue

- Rights Issue: equity sold to exisitng shareholders and it is a new offering, but firm already issued securities previously, i.e. Seasoned New Issue

5 Stages of PI:

1) Pathfinder prospectus: draft of prospectus released that showcases IPO [months before issuing]

2) Pre-underwriting conferences: Negotiations about target capital (setting issue price) and type of security + appointment of underwriter (investment bank) and adviser [4 weeks before full prospectus]

3) Full prospectus: all relevant financial and business information [weeks before issuing]

4) Public offering and sale: Here a firm-commitment contract is set. It is an agreement by the underwriter to purchase all securities/amount of equity for an IPO directly from issuers (the company) for public sale. The investment bank sells it at a higher price to make a margin for its services [shortly after last day of registration period)

5) Market stabilization: Underwriter is ready to place orders to buy at a specified price on the market [within 30 days of the offering]

Usually, (investment) banks are the financial intermediaries, provide advice, put a estimated price on securities and sign a firm-commitment with the issuer (company). 
Banks are responsible for setting a fair price because buyers (having little info) rely on the good judgment of bank.

The underwriter buys the number of shares and sells them at a higher unitary price. This price difference/spread is the commission that the bank receives and is called syndicate's fee. The name syndicate comes from bankers that get together to create a underwriting group to minimize the risk. 

The risk is that the underwritet accepts the risk of not being able to sell the securities.

Often firm-commitment contracts have a Green Shoe provision. Gives the syndicate the option to buy additional shares at offering price. It works as an insurance in case there is an excess demand for the issued equity.

Issuers may use 2 methods to choose a issuer:

- Competitive offer: highest bidder gets the contract

- Negociated offer: works with 1 underwriter.

Negative points: Issuing costs higher than competitive costs; suffer from lack of cometition; does not attract large issuing firms bc cost too much time and effort

Underwriters may set prices of issues too high (overpricing) or below the true market price (underpricing).

There are 2 explanations:

1) The underpricing happens in smaller issues. These young firms tend to be viewed by investors as having uncertain/risky future results. Hence, risk-averse investors commit with them only if underpricing exists.

2) Oversubscribed offering: When the issue price is too low, issue will likely be oversubscribed, meaning that investors may not be able to buy as many shares as they would like to. So, underwriter will distribute shares among investors as there're not enough shares for everyone. 

Yes, the market value of existing equity drops on the announcement of new public issue of equity.

Reasons:

- Managerial info: Draws from principal-agent problem. Managers may have exclusive information about the overvaluation of firm. They might issue new shares when market value > correct value. Even though it is beneficial to shareholders, new shareholders will bid down the price of shares on announcement as they conclude on overvaluation.

- Debt capacity: Firms with probable financial distress are more likely to raise capital through equity instead of debt. If market figures this out, share price will drop on announcement day. 

- Falling earnings: Managers may raise unexpected large amounts of capital. If investors correctly assess the firm's future investments and dividents, they may anticipate that this surprising financing will not match future earnings.

- Spread & underwriting discount: Spread = Price the issuer (company) receives - Price offered to public

- Other direct expenses: Company has to pay these costs. Includes filing fees, legal fees and taxes and not part of underwriter's compensation (in prospectus)

- Indirect expenses: Management time spent on new issue and not in prospectus

- Abnormal returns: In rigths issue (seasoned issue), price drops on announcement day of issue. This decrease protects new shareholders of buying overpriced equity of company.

- Underpricing: After issue date, equity tends to rise greatly for IPOs. Represents a cost for company as shares are sold under the efficient price in aftermarket (=day after IPO is launched publicly)

- Green Shoe option: Underwriter can buy additional shares at offer price in case of oversubscription. Cost to company as underwriter will buy additional shares only when offer price is underpriced/below price in aftermarket

'Old' shareholders have the option to assure shares of the new issue before they are traded publicly. This issue of equity is called rights issue/rights offering and the terms of issue are certified by, what's called, rights or share warrants.

Each shareholder is given an option to buy a determined number of new shares at a specified price within a fixed expiry date. 

Typically, rights issues are cheaper than cash offers (underpricing problem avoided, c.f. second card). Shareholders have the possibility to acquire one right for each share of equity they already own. The number of rights to turn into one new share will be stipulated by the company. 

3 choices for shareholders:

1) Subscribe/send payment for full amount of entitled shares

2) Order all rights sold

3) Do nothing and let rights expire

The subscription price is the price that existing shareholders may pay for a new share of equity/right offering. In general, a shareholder will subscribe to the rights offering if the price of subscription is below the market price on the offer's expiration date.