Professional Documents
Culture Documents
Week 6
Raising
Equity Capital
References:
Berk and DeMarzo Ch. 23
Lecture Outline
• Equity Financing for Private Companies
• Initial Public Offerings
• Seasoned Equity Offerings
Equity Financing for Private Companies
800 80
700 70
600 60
400 40
300 30
200 20
100 10
0 0
IPO underwriter cost
• A typical spread is 7% of the issue price.
– By most standards this fee is large, especially
considering the additional cost to the firm
associated with underpricing.
– It is puzzling that there seems to be a lack of
sensitivity of fees to issue size.
• Possible explanation : by charging lower fees, an
underwriter may risk signaling that it is not the same
quality as its higher-priced competitors.
Long-Run Underperformance
• Although shares of IPOs generally perform
very well immediately following the public
offering, it has been shown that newly listed
firms subsequently appear to perform
relatively poorly over the following three to
five years after their IPOs.
Seasoned Equity Offerings (SEO)
• When a public company offers new shares for
sale to raise additional equity
• Market price for the stock already exists, so
the price-setting process is not necessary.
• 3 main methods :
– Public issue
– Rights issue
– Private placement
Public Issue
• Members of the public are invited to subscribe to
the issue
– Requires a prospectus
• Public issues are generally only used for IPOs in
Australia
• Is most common method in US and Japan for
raising seasoned capital
Rights issue
• Most common method in Australia, Asia and
Europe
• Existing shareholders are given the option of
purchasing the new equity on a pro-rata basis
ie in proportion to their holdings
• no dilution in the proportional shareholding of
each shareholder provided that each
shareholder subscribes to his/her full
entitlement.
• The option/right may be tradeable/sold
• renounceable issue
– The rights are listed on the stock exchange and can
either be taken up by the shareholder or traded
• non renounceable
– the rights cannot be traded and the only person
eligible to take up the right is the registered
shareholder on the ex-rights day.
• Ex rights day
– Date on which share begins trading ex rights. After
this date a share does not have the attached right to
purchase new shares
• In Australia, the issue price is set at
announcement of the issue
• In US price set just prior to the issue opening
or rights trading beginning
• Usually priced at a discount to the market (15-
20%)
• May be underwritten ie underwriter
guarantees the dollar amount raised
Private Placement
• Issue to a small number of large investors (usually
institutions)
• Usually a fixed price on a best endeavours basis (that is,
not underwritten) and without an offering document
• limited to 15% of the amount of the security class
outstanding unless firm approval is obtained at a general
meeting
• Discount limited to 15%
– small-cap companies now allowed to issue up to 25%
of their share capital at a discount of up to 25%
• Advantages : speed, price and direction.
• allow a firm to raise capital within a short time
period
• usually priced close to the market, at a small
discount to the current market price (2.5% to
7.5%)
• allows the firm board control over the choice of
new shareholder if there are control implications
• disadvantage is that the percentage ownership of
existing security holders is diluted because the
capital is increased without their participation.
Market Reactions to the
Announcement of New Issues
• Equity:
– Public issues of equity have the most negative
announcement effect
– Rights issues of equity have a smaller negative
announcement effect
– Placements generally have a positive
announcement effect
– Consistent with adverse selection
Homework
• Chapter 23: 5, 6, 8, 13