Chapter 19
Issuing Securities
®2002 Prentice Hall Publishing
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Public Offering of Securities
• Traditional underwriting
– SEC registration takes several weeks
• Shelf registration
– Quicker and more efficient than
traditional security offerings
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Traditional Underwriting
• Underwriting syndicate is formed to spread
risk and obtain better distribution
– Underwriters guarantee payment to the security
issuer, regardless of the success of the offering
– Lead investment banker works directly with the
firm in determining the essential features of the
issue
• Compensation to investment bankers
– Gross underwriting profit
– Selling concession
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Best Efforts Offering
• Investment bankers agree only to sell as
many securities as they can at an established
price
– Have no responsibility for securities that
are unsold
– Bear no risk
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Making a Market
• Important to investors of IPOs
• Underwriter maintains a position in the
stock
• Underwriter maintains a secondary market
for the stock
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Shelf Registrations
• Shortcut registration process under Rule 415
• Company files a form with the SEC
describing itself, its financing needs, and the
securities it is likely to issue over the next 2
years
• Flexibility to time issues to market
conditions, and the issues need not be large
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Flotation Costs
• Cost for a large common stock issue, using
a traditional underwriting, might run 3 to 4
percent of the gross proceeds
• For smaller issues, it will run upward to 8
percent
• With a shelf registration, costs run about 2
percent
– Legal and administration costs are lower
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Government Regulations
• Securities Act of 1933 dealt with the sale of
new securities and required the full
disclosure of information to investors
• Securities Exchange Act of 1934 dealt with
the regulation of securities already
outstanding and created the SEC to enforce
the two acts
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Registration Process
• Purpose is to protect the investor through
proper disclosure of financial and legal
information about the issuing corporation
• Exemption if security is sold to a limited
number of financially sophisticated
investors (private placement)
• Corporation must file a copy of the
prospectus
– Summary of the essential information in
the registration statement
– Must be available to prospective
investors and others who request it
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Info in Registration Statement
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Nature and history of the company
Use of the proceeds
Financial statements
Management and directors and their
security holdings
• Competitive conditions and risks
• Legal opinions
• Description of the security
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SEC Review
• See that all the required information is
presented and that it is not misleading
• Only concerned with the presentation of
complete and accurate information on all
material facts regarding the security
• Not concerned with the investment value
• Minimum period required is 20 days
• Usual time lapse is around 40 days
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Streamlining Registration
Procedures
• Less scrutiny by SEC
• Larger companies(> $250 million market
capitalization) no longer will be required to
go through the lengthy review process
• Companies of all sizes will face fewer
restrictions in how they market and
communicate with potential investors
• Provide more timely and accurate
information to investors
• Underwriters will be required to undertake
more due diligence in ferreting out fraud
and deception
®2002 Prentice Hall Publishing
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SEC Regulations in the
Secondary Market
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Activities of the security exchanges
Over-the-counter market
Investment bankers and brokers
National Association of Security Dealers
Investment companies
Requires monthly reports on insider stock
transactions
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Selling Common Stock
Through a Rights Issue
• Preemptive right
– Existing common stockholders have the right to
preserve their proportionate ownership in the
corporation
• Offering through rights
– Rights issues are to existing shareholders, with
a subscription price below existing share price
– The holder of rights has three choices: exercise
them, sell them, or do nothing
– Stock sells rights-on through date of record
– Stock sells ex-rights after date of record
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Value of Rights
• Function of the present market price of the
stock, the subscription price, and the
number of rights required to purchase an
additional share of stock
• Theoretical market value, stock selling
P0  S
rights-on R0 
N 1
• Theoretical value of one share of stock
( P0  N )  S
P

selling ex-rights X
N 1
• Theoretical value of a right, stock selling
PX  S
R

ex-rights X
N
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Success of the Offering
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Setting the subscription price
Amount of discount
Size of the capital outlay
Mix of existing stockholders
Balance between institutional and
individual investors
• Current trend and tone of the stock market
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Standby Underwriting
• Standby arrangements guarantee to the
issuer that the funds will be raised
• Underwriter charges a fee that varies with
the risk involved in the offering
– Flat fee
– Additional fee for each unsold share of stock
• Underwriter sells a put option to the firm
and its shareholders
• Standby fees are significant and increase
with the volatility of the stock
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Oversubscriptions
• Awarded on a pro rata basis relative to the
number of unsold shares
• Increases the chances that the issue will be
entirely sold
• Still possible to fall short
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Rights Issue Versus Offering
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Rights Issue
Principal sales tool is
the discount from the
current market price
Lower flotation cost
Stock sold at lower
price
More dilution
Less distribution
®2002 Prentice Hall Publishing
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Public Offering
Major selling tool is
the investment
banking organization
Higher flotation cost
Stock sold at higher
price
Less dilution
Wider distribution
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Green Shoe Provision
• Option to purchase additional securities at
the offering price
• Lasts several weeks after the offering
• Benefits the holder
®2002 Prentice Hall Publishing
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Financing a Fledgling
• Founders and angels get the idea
formulated, initially survey the potential
market, and develop a business plan
• Venture capitalists provide early stage
financing to new enterprises
• Stages of VC financing
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Seed money
Start-up
First-round
Second-round
Third-round
Bridge
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Financing Structure
• Preferred stock with equity link
• Letter stock
• Staged financing
– Pre-offer market price
• Syndicate
• Venture capital portfolio
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Initial Public Offerings
• Conform to SEC requirements
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Board of directors
Disclosing sensitive information
Employ certain accounting conventions
Incurring expenses as a public company
Investor fixation on quarterly earnings
• Underpricing of IPO
– Typically have a “pop” in price on the first day of
trading
– Lure uninformed investors into the market
– Price of admission to the public market
• Long-run underperformance attributable to
IPOs that are not venture capitalist-backed
®2002 Prentice Hall Publishing
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Information Effects of
Announcing a Security Issue
• Negative stock price reaction (or abnormal
return) to a common stock or convertible
security issue
• Expectations of future cash flows
• Asymmetric information between investor
and management is the foundation for an
information effect
– Managers are more likely to issue debt when
they believe the common stock is underpriced
in the market and to issue common stock when
it is believed to be overpriced
• Seasoned equity offerings (non-IPOs)
underperform nonissuing public
corporations on average
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