Chapter 3 Stock Offerings And Investor Monitoring PDF

CHAPTER 3 STOCK OFFERINGS AND INVESTOR MONITORING  1 Chapter Objectives Describe the process of initial public offerings Describe secondary offerings and stock repurchases Describe to monitoring role of investors D...

CHAPTER 3 STOCK OFFERINGS AND INVESTOR MONITORING  1 Chapter Objectives Describe the process of initial public offerings Describe secondary offerings and stock repurchases Describe to monitoring role of investors Describe the globalization of stock markets  2 Initial Public Offering (IPO) 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 venture capital (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  3 Initial Public Offering (IPO) (cont’d) Underwriter selection An investment banking firm normally serves as the lead underwriter for the IPO Process of going public 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”  4 Initial Public Offering (IPO) (cont’d) Process of going public (cont’d) Pricing The offer price is determined by the lead underwriter During the road show, the number of shares demanded at various prices is assessed Book building (upper-price and lower-price) In some countries, an auction process is used for IPOs 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.  5 Initial Public Offering (IPO) (cont’d) Examples: LinkedIn In 2011, offer price $45 per share (indicated valuation of $4.25billion). Excessive offer price (about 283 times greater than current earning per share). The offer price was about 46 times forecasted earning per share By the end of the trading day of its IPO, Stock price risen to $94.25 (indicated valuation $9 billion). Next day, the opening stock price for LinkedIn was $83 (declined about 12 percent). Snapchat In 2017, offer price of $17 per share By the end of trading day of its IPO, Stock price risen to $24 per share (44% increase and indicated valuation of $33billion).  6 Initial Public Offering (IPO) (cont’d) Examples: 99 SPEEDMART IPO 2024 IPO price RM1.65 per share. The public subscriptions for IPO remained open till 23 August 2024. The largest IPO in Malaysia since 2017. Proceeds from the IPO will be used primarily to expand the company’s network of outlets (58.9%), establish new distribution centers (15.2%), purchase delivery trucks (8.3%), upgrade existing outlets (7.2%), and repay bank loans (6.8%). Source: https://themalaysianreserve.com/2024/08/15/99-speed-mart-launches-prospectus-for- landmark-ipo-listing-set-for-september-9/  7 Initial Public Offering (IPO) (cont’d) Underwriter efforts to ensure price stability The lead underwriter’s 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 The underwriter may require Prevent flipping: buy sell in short period Overallotment: Allocate additional firm’s share for particular period Lockup provision: 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  8 Initial Public Offering (IPO) (cont’d) Timing of IPOs IPOs tend to occur more frequently during bullish stock markets Prices are typically higher In the 2000–2001 period, many firms withdrew their IPO plans Initial returns of IPOs 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  9 Initial Public Offering (IPO) (cont’d) Underwriter Selection -> Preparation and submission of prospectus to SEC -> Roadshows (after approval of SEC) -> Determining IPO price (considering transaction cost) -> Launching of IPO (timing) -> allocation of shares -> Listing shares on exchange.  10 Initial Public Offering (IPO) (cont’d) Abuses in the IPO market In 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 Distorted Financial Statements may exaggerate a firm’s revenue and earnings, investors may overs-estimate its value and pay higher price.  11 Initial Public Offering (IPO) (cont’d) Long-term performance following IPOs Google and Apple IPOs perform poorly on average over a period of a year or longer Many IPOs are overpriced at the time of issue Investors may be overly optimistic about the firm Managers may spend excessively and be less efficient with the firm’s funds than they were before the IPO  12 Initial Public Offering (IPO) (cont’d) Shares Shares $$$ $$$ Company Investor A Investor B Primary Market Secondary Market  14 Secondary Stock Offerings A secondary stock offering is: 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.  15 Secondary Stock Offerings Shelf-registration A corporation can fulfill SEC requirements up to two years before issuing new securities The registration statement contains financing plans over the upcoming two years. The securities are, in a sense, shelved until the firm needs to issue them. Allows firms quick access to funds. Potential investors/purchasers must realize that information disclosed in the registration is not continually updated.  16 Investor Monitoring 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 stock’s 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 firm’s managers  17 Investor Monitoring (cont’d) Accounting irregularities To the extent that firms can manipulate financial statements they may be able to hide information from investors e.g., Enron, Tyco, and WorldCom 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  18 Investor Monitoring (cont’d) The Sarbanes-Oxley Act: 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  19 Investor Monitoring (cont’d) The Sarbanes-Oxley Act: Requires that only outside board members of a firm be on the firm’s audit committee Prevents the members of a firm’s 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  20 Investor Monitoring (cont’d) Shareholders activism Communication with the firm Shareholders can communicate their concerns to other investors to place more pressure on managers or its board members Institutional investors commonly communicate with high-level corporate managers and offer their concerns Institutional Shareholder Serves (ISS) Inc. is a firm that organizes institutional shareholders to push for a common cause  21 Investor Monitoring (cont’d) Shareholders activism (cont’d) Proxy 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  22 Investor Monitoring (cont’d) Shareholder lawsuits Investors may sue the board if they believe that the directors are not fulfilling their responsibilities to shareholders Lawsuits are often filed when corporations prevent takeovers, pursue acquisitions, or make other restructuring decisions that shareholders believe will reduce the stock’s value When directors are sued, courts typically focus on whether the director’s decision seems reasonable, rather than on whether the decision led to higher profitability  23 Globalization of Stock Markets Barriers between countries have been removed or reduced Firms in need of funds can tap foreign markets Investors can purchase foreign stocks Foreign stock offerings in the U.S. 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) The value of global domestic equity market increased from 65.04 trillion U.S. dollars in 2013 to 98.5 trillion U.S. dollars in 2022. As of July 2023, the total market capitalization of domestic companies listed on stock exchanges worldwide recorded as 112 trillion U.S. dollars. (Source: Domestic equity market capitalization globally 2023 - Statista)  24 Globalization of Stock Markets (cont’d) International placement process Many 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 firm’s perceived financial standing Can protect the firm against hostile takeovers Entails some costs  23 Globalization of Stock Markets (cont’d) Global stock exchanges Recently, stocks outside the U.S. have been issuing stock more frequently The percentage of individual versus institutional ownership varies across countries Emerging stock markets: 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  25 Globalization of Stock Markets (cont’d) Methods used to invest in foreign stocks Direct 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  26 Globalization of Stock Markets (cont’d) Methods used to invest in foreign stocks (cont’d) International mutual funds (IMFs) are portfolios of international stocks created and managed by various financial institutions International Exchange-Traded funds (ETFs) World equity benchmark shares represent indexes that reflect composites of stocks for particular countries that can be purchased or sold  27 Chapter Summary An initial public offering (IPO) is a first-time offering of shares by a specific firm to the public. A firm that engages in an IPO must develop a prospectus that is filed with the SEC, and it typically uses a road show to promote its offering. The firm hires an underwriter to help with the prospectus and road show and to place the shares with investors. Investors that purchase stock of firms monitor performance and ensure that managers make decisions that are beneficial to the firm’s shareholders. Many U.S. firms issue shares in foreign countries as well as in the United States, so that they can spread their shares among a larger set of investors and possibly enhance the firm’s global name recognition.