Professional Documents
Culture Documents
Chapter Outline
Background on stock Initial public offerings Secondary stock offerings Stock exchanges Investor participation in the secondary market Monitoring by investors The corporate monitoring role Globalization of stock markets
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Background on Stocks
A stock is a certificate representing partial ownership in a corporation Stock is issued by firms to obtain long-term funds Owners of stock:
Can benefit from the growth in the value of the firm Are susceptible to large losses
Individuals and financial institutions are common purchasers of stock The primary market enables corporations to issue new stock The secondary market creates liquidity for investors who invest in stock Some corporations distribute earnings to investors in the form of dividends
Voting
is often accomplished by proxy Management typically receives the majority of the votes and can elect its own candidates as directors
Preferred stock
Preferred stock represents an equity interest in a firm that usually does not allow for significant voting rights A cumulative provision on most preferred stock prevents dividends from being paid on common stock until all preferred dividends have been paid Preferred stock is less risky because dividends on preferred stock can be omitted Preferred stock is a less desirable source of funds than bonds because:
Dividends are not tax deductible Investors must be enticed to purchase the preferred stock since dividends do not legally have to be paid
ownership feature attracts many investors who want to have an equity interest but do not necessarily want to manage their own firm A firm issuing stock for the first time engages in an IPO If a firm issues additional stock after the IPO, it engages in a secondary offering
An IPO is a first-time offering of shares by a specific firm to the public Usually, a growing firm first obtains private equity funding from VC firms An IPO is used to obtain new funding and to offer VC firms a way to cash in their investment
Many
VC firms sell their shares in the secondary market between 6 and 24 months after the IPO
An investment banking firm normally serves as the lead underwriter for the IPO Developing a prospectus
The issuing firm develops a prospectus and files it with the SEC The prospectus contains detailed information about the firm and includes financial statements and a discussion of risks The prospectus is intended to provide investors with the information they need to decide whether to invest in the firm Once approved by the SEC, the prospectus is sent to institutional investors Underwriters and managers meet with institutional investors in the form of a road show
Bookbuilding
Transaction costs The issuing firm typically pays 7 percent of the funds raised The lead underwriter typically forms a syndicate with other firms who receive a portion of the transaction costs
The lead underwriters performance can be measured by the movement in the IPO shares following the IPO
If stocks placed by a securities firm perform poorly, investors may no longer purchase shares underwritten by that firm Prevents the original owners from selling shares for a specified period Prevents downward pressure When the lockup period expires, the share price commonly declines significantly
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Timing of IPOs
Prices are typically higher In the 20002001 period, many firms withdrew their IPO plans First-day return averaged about 20 percent over the last 30 years In 1998, the mean one-day return for Internet stocks was 84 percent Most IPO shares are offered to institutional investors About 2 percent of IPO shares are offered as allotments to brokerage firms
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2003, regulators attempted to impose new guidelines that would prevent abuses
Spinning is the process in which an investment bank allocated IPO shares to executives requiring the help of an investment bank Laddering involves increasing the price above the offer price on the first day of issue in response to substantial demand Excessive commissions are sometimes charged by brokers when there is substantial demand for the IPO
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A new stock offering by a firm whose stock is already publicly traded Undertaken to raise more equity to expand operations Usually facilitated by a securities firm
In the late 1990s, the volume of publicly placed stock increased substantially From 2000 to 2002, the volume of publicly placed stock declined as a result of the weak economy Existing shareholders often have the preemptive right to purchase newly-issued stock
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Shelf-registration
A
corporation can fulfill SEC requirements up to two years before issuing new securities Allows firms quick access to funds Potential purchasers must realize that information disclosed in the registration is not continually updated
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Stock Exchanges
Stock trading between investors occurs on an organized stock exchange or on the over-thecounter (OTC) market Organized exchanges
Includes
the NYSE and AMEX The NYSE controls 80 percent of the value of all organized exchange transactions
There are 1,366 seats Floor brokers and specialists are members of the NYSE
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Trading floor
Consists of trading posts and trading booths 20 trading posts are maintained by specialists and their clerks There are 1,500 trading booths along the perimeter of the floor where brokers obtain orders NYSE requirements include number of shares outstanding, minimum level of earnings, cash flow, and revenue Minimum number of shares ensures adequate liquidity Exchanges charge a listing fee, which depends on the size of the firm
Listing requirements
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Over-the-counter market
Buy
The Nasdaq is an electronic quotation system that provides immediate price quotations Firms must meet requirements on minimum assets, capital, and number of shareholders Transaction costs as a percentage of the investment tend to be higher on Nasdaq than on the NYSE
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(contd)
More stocks are listed on Nasdaq than on NYSE The market value of stocks listed on Nasdaq is smaller than stocks listed on the NYSE
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Lists stocks that have a price below $1 per share (penny stocks) More than 3,500 stocks are listed Stocks are mostly traded by individual investors Lists stocks smaller than those listed on the OTC Bulletin Board Contains about 20,000 stocks Families and officers of the firms commonly control much of the stock
Pink sheets
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The NYSE, AMEX, and Nasdaq markets all offer extended trading sessions Late trading sessions enable investors to buy or sell stocks after the market closes An early morning session enables investors to buy or sell stock just before the market opens on the following day Total trading volume of widely traded stocks is typically about 5 percent or less of the trading volume during the day ECNs also allow for trading at any time
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The Dow Jones Industrial Average (DJIA) is a price-weighted average of stock prices of 30 large U.S. firms
Assigns a higher weight over time to those stocks that experience higher prices Does not necessarily serve as an adequate indicators of the overall market
The Standard and Poors (S&P) 500 is a value-weighted index of stock prices of 500 large U.S. firms
Does not serve as a useful indicator for stock prices of smaller firms
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stock indexes
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The price of a firms stock represents the value of the firm per share of stock: Value of firm Stock price Number of shares
The stock price by itself does not clearly indicate the firms value The return on the investment is determined by dividends received and the price of the stock from the time when they purchased the shares until they sell them
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buy or sell shares based on their valuation of the stock relative to the prevailing market price Investors arrive at different valuations which means there will be buyers and sellers at a given point in time As investors change their valuations of a stock, there is a shift in the demand for and supply of shares and the equilibrium price changes
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reliance on information
Favorable news increases the demand for and reduces the supply of the security Unfavorable news reduces the demand for and increases the supply of the security Investors continually respond to new information in their attempt to purchase or sell stocks
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Types of investors
Individual investors typically hold more then 50 percent of the total equity in a large corporation
Ownership is scattered
Institutional investors have large equity positions in corporations and have more voting power
Can influence corporate policies through proxy contests Insurance companies, pension funds, and stock mutual funds are common purchasers of newly issued stock in the primary market The collective sales and purchases of stocks by institutions can significantly affect stock market prices
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stock to boost their capital base in stocks for their investment portfolios stock
Issue
stock Place new issues of stock Offer advice to corporations that consider acquiring stock companies Execute buy and sell orders
Issue
Monitoring by Investors
Managers serve as agents for shareholders to maximize the stock price Managers may be tempted to serve their own interests rather than those of investors Shareholders monitor their stocks price movements to assess whether the managers are achieving their goal
When the stock price declines or does not rise as high as shareholders expected, shareholders may blame the weak performance on the firms managers
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Accounting irregularities
To
the extent that firms can manipulate financial statements they may be able to hide information from investors
The
auditors hired to audit financial statements allowed them to use unusual accounting methods
Board members on the audit committee were not always monitoring the audit
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Was implemented in 2002 to ensure more accurate disclosure of financial information to investors Attempts to force accountants of a firm to conform to regular accounting standards Attempts to force auditors to take their auditing role seriously Prevents a public accounting firm from auditing a client whose CEO, CFO, or other employees are employed by the client firm within one year prior to the audit
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Requires that only outside board members of a firm be on the firms audit committee Prevents the members of a firms audit committee from receiving consulting or advising fees from the firm Requires that the CEO and CFO of firms that are of at least a specified size level to certify that the audited financial statements are accurate Specifies major fines or imprisonment for employees who mislead investors or hide evidence Allows public accounting firms to offer non-audit consulting services to an audit client only if the client pre-approves those services
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Shareholders activism
Communication
Shareholders can communicate their concerns to other investors to place more pressure on managers or its board members Institutional investors commonly communicate with highlevel corporate managers and offer their concerns
Institutional Shareholder Serves (ISS) Inc. is a firm that organizes institutional shareholders to push for a common cause
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contest
Normally considered only if an informal request for a change in the board is ignored If dissident shareholders gain enough votes, they can elect one or more directors who share their views As a result of a more organized effort, institutional shareholders are more influential on management decisions
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If managers believe their stock is undervalued in the market, they may take actions to capitalize on this discrepancy Stock repurchases
Use
excess cash to purchase shares in the market at a low price Stock prices respond favorably to stock repurchase announcements
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A high stock price is useful to exchange acquirer shares for target shares Share prices of target firms react very positively Leveraged buyouts
LBOs are acquisitions that require substantial amounts of borrowed funds A reverse LBO is desirable when the stock can be sold at a high price
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Antitakeover amendments are designed to protect shareholders against an acquisition that will ultimately reduce the value of their investment in the firm
Poison pills are special rights awarded to shareholders or specific managers upon specified events
e.g., the right for all shareholders to be allocated an additional 30 percent of all shares without cost whenever a potential acquirer attempts to acquire the firm
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golden parachute specifies compensation to managers in the event that they lose their jobs
e.g., all managers have the right to receive 100,000 shares of the firms stock whenever the firm is acquired
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Firms in need of funds can tap foreign markets Investors can purchase foreign stocks Large privatization programs in Latin America and Europe can not be digested in local markets By issuing stock in the U.S., foreign firms diversify their shareholder base SEC regulations may prevent some firms from offering stock in the U.S. Some foreign firms use American depository receipts (ADRs)
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U.S. investment banks and commercial banks provide underwriting services in foreign countries Listing on a foreign stock exchange:
Enhances the liquidity of the stock May increase the firms perceived financial standing Can protect the firm against hostile takeovers Entails some costs
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Recently, stocks outside the U.S. have been issuing stock more frequently The percentage of individual versus institutional ownership varies across countries
Enable foreign firms to raise large amounts of capital by issuing stock Provide a means for investors from other countries to invest their funds May not be as efficient as the U.S. stock market May exhibit high returns and high risk May be volatile because of fewer shares and trading based on rumors
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purchases involves directly buying stock of foreign companies listed on the local stock exchanges American depository receipts are attractive because:
They are closely followed They are required to file financial statements with the SEC They are quoted reliably
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mutual funds are portfolios of international stocks created and managed by various financial institutions World equity benchmark shares represent indexes that reflect composites of stocks for particular countries that can be purchased or sold
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