4. FIDUCIARY RESPONSIBILITY  LOSS OF FREEDOM BY MANAGEMENT TO SOME
INITIAL PUBLIC OFFERINGS (IPOs)
FIRST ISSUE OF COMMON STOCK BY A FIRM.
DEGREE (MONITORING BY BOARD OF DIRECTORS, LARGE OUTSIDE SHARE HOLDERS).
FIRM LIFE-CYCLE:
5. HIGHER RISK OF LOSS OF CONTROL THROUGH TAKEOVERS, ETC. (YOU HAVE TO
*PRIVATE FIRM
RETAIN > 50% EQUITY TO BE ABSOLUTELY SURE OF CONTROL).
*VENTURE CAP + BANK DEBT FINANCE EXPANSIONS
*INITIAL PUBLIC OFFERING
THE LEGAL AND REGULATORY FRAMEWORK
*SEASONED EQUITY + OTHER SECURITIES (CORPORATE BONDS) OFFERINGS.
SECURITIES ACT OF 1933 SECURITIES APPLICABLE LAWS: EXCHANGE ACT OF 1934;
- NOT ALL FIRMS GO THROUGH ALL STAGES, BUT MANY DO.
INVESTMENT COMPANY ACT OF 1940; RELATED SEC GUIDELINES; SOME STATE
ADVANTAGES AND DRAWBACKS OF BEING A PUBLIC COMPANY
SECURITIES (“BLUE SKY”) LAWS.
ADVANTAGES:
*THE UNDERWRITER, AFTER INVESTIGATING THE ISSUING FIRM, FILES THE NECESSARY
1. GET NEW CAPITAL TO SUSTAIN GROWTH/IMPROVE FINANCIAL POSITION.
INFORMATION WITH THE S.E.C.
2. GREATER LIQUIDITY FOR FIRM’S EQUITY.
*TWO-PART REGISTRATION STATEMENT:
3. POTENTIAL INCREASE IN EQUITY VALUE.
4. DIVERSIFICATION OF INITIAL SHARE HOLDERS’ PERSONAL PORTFOLIOS AND
PART-I: PRELIMINARY PROSPECTUS
EASIER TRANSFER OF OWNERSHIP.
PART-II: RELATED INFORMATION
- PRIMARY & SECONDARY OFFERINGS
TOGETHER REFERRED TO AS FORM S-1, FOR LARGE COMPANIES.
5. OPPORTUNITIES FOR FUTURE FINANCING.
6. MAKES MERGERS AND ACQUISITIONS EASIER.
*AFTER FILING, THERE IS A PERIOD OF TWENTY DAYS IN WHICH THE SEC REVIEWS THE
7. MORE EFFICIENT EMPLOYEE COMPENSATION STRATEGIES (ESPECIALLY IN HIGH-
SUBMITTED MATERIAL (COOLING-OFF PERIOD).
TECH VENTURES).
*DURING THIS COOLING-OFF PERIOD, INFORMATION IS SENT TO PROSPECTIVE
DISADVANTAGES:
INVESTORS, AND, IN A FIRM-COMMITMENT OFFERING, INVESTORS ARE ASKED TO
1. DIRECT AND INDIRECT EXPENSES OF GOING PUBLIC.
INDICATE THEIR WILLINGNESS TO PURCHASE SHARES (THIS INFORMATION USED TO
2. LOSS OF PRIVACY DUE TO INFORMATION-RELEASE DURING IPO.
PRICE OFFERING).
3. COSTS INVOLVED IN PERIODIC FINANCIAL REPORTING (E.g FILING 10-Q AND 10-K
*FINAL PRICE SET AT A PRICE MEETING THE AFTERNOON BEFORE FORMAL IPO.
FORMS; PROMPT REPORTING OF CURRENT MATERIAL EVENTS-FORM 8-K).
THE NEW ISSUES PUZZLE: UNDERPRICING
1
*THE LARGE ABNORMAL RETURN OBSERVED IN MOST COUNTRIES AND MARKETS FROM
3. SIGNALING THEORY (ALLEN AND FAULHABER, WELCH, 1989).
THE INITIAL OFFER PRICE TO THE CLOSING PRICE ON THE FIRST DAY OF TRADING IN THE
4. ISSUER-EXPLOITATION THEORIES.
SECONDARY MARKET.
GREATER THE UNDERWRITER REPUTATION, LOWER THE UNDERPRICING.
*VARYING DAYS (FIRST-WEEK RETURN IS AN ALTERNATIVE) OF MEASUREMENT-BUT
ISSUES RELATED TO CHOOSING YOUR UNDERWRITER
ESSENTIALLY SAME RESULTS.
1. UNDERWRITER REPUTATION; EXPERIENCE
EMPIRICAL FINDINGS: (See Ritter article)
2. UNDERWRITING SYNDICATES AND DISTRIBUTION CAPABILITY.
*UNDERPRICING OVER THE YEARS
- RELATIONSHIP WITH LARGE INSTITUTIONAL INVESTORS.
*UNDERPRICING VERSUS SIZE OF THE FIRM
3. UNDERWRITER COMPENSATION
*OTHER RESULTS:
UNDERWRITER WARRANTS
(I)OLDER THE FIRM, LESS UNDERPRICINGS.
THE GREEN SHOE OPTION.
(II)LARGER THE ISSUE, LESS UNDERPRICINGS.
4. AFTERMARKET SUPPORT  UNDERWRITING AS MARKET-MAKERS.
(III)MORE COSTLY IT IS TO LEARN ABOUT FIRM, MORE UNDERPRICING.
WHERE SHOULD YOU LIST YOUR COMPANY?
IN SUMMARY, WHILE IPO STOCKS ARE UNDERPRICED ON AVERAGE, ABOUT A THIRD
-NYSE
HAVE NEGATIVE INITIAL RETURNS.
-AMEX
EMPIRICAL FINDINGS:
-NASDAQ NATIONAL MARKET
BEST EFFORTS VS. FIRM-COMMITMENT OFFERINGS, AND THE COSTS OF GOING PUBLIC
-NASDAQ SMALL CAP.
*BEST EFFORTS: THE ISSUER AND UNDERWRITER NEGOTIATE AN OFFERING PRICE;
LISTING REQUIREMENTS HARSHER FOR NYSE, NASDAQ NATIONAL COMPARED TO
UNDERWRITER ONLY NEEDS TO MAKE THE BEST EFFORT POSSIBLE. IF THERE IS NO
NASDAQ SMALL CAP.
DEMAND, THE OFFERING IS WITHDRAWN.
THE TIMING OF THE GOING-PUBLIC DECISION
*FIRM-COMMITMENT OFFERING: UNDERWRITER AGREES TO GUARANTEE THAT A
1. TIMING VIS-À-VIS THE MARKET - HOT ISSUE MARKETS
CERTAIN AMOUNT OF CAPITAL WILL BE RAISED. THUS, UNDERWRITER BUYS ALL THE
2. TIMING VIS-À-VIS THE COMPANY.
STOCK IN EFFECT.
IT IS EASIER TO “TIME” THE IPO RELATIVE TO THE EARNINGS CYCLE OF YOUR FIRM THAN
TO THE MARKET (i.e., GO PUBLIC WHEN THE P/E FOR YOUR INDUSTRY IS HIGH).
THEORIES OF IPO UNDERPRICING
1. WINNER’S CURSE THEORY (ROCK, 1986).
2. INFORMATION PRODUCTION THEORY (CHEMMANUR, 1989,1993).
2