Chapter 10: Stock Offerings and Investor Monitoring

1-2 Chapter 10: Stock Offerings and Investor Monitoring Chapter Outline: Background on Stock. Initial Public Offerings. Secondary Stock Offerings. Stock Exchanges. Investor Participation in the Secondary Market. The Corporate Monitoring Role. Globalization of Stock Markets.

–Common stock = certificate representing equity or partial ownership in a corporation Issued in primary market by corporations that need long-term funds Stock is then traded in the secondary market, creating liquidity for investors and company evaluation for managers Background on Common Stock

–Owners of common stock vote on: Election of board of directors Authorization to issue new shares Amendments to corporate charter Other major events –Many investor assign their vote to management via a proxy –Households own about half of all common stock, the rest is owned by institutional investors

Background on Preferred Stock Represents equity or ownership interest, but usually no voting rights Trade voting rights for stated fixed annual dividend Dividend paid before common if dividends are declared by board of directors Dividend may be omitted –Cumulative provision –If common dividend paid, preferred dividend fixed

Types of Equity Internal Equity: External Equity: –Common Stock-- represents ownership One vote per share Have a residual (last) claim on income and assets Limited liability Stockholder compensated by: –dividends –appreciation

External equity: –Preferred Stock -- represents ownership Dividends are relatively high and fixed Relatively expensive Dividends paid ahead of common if declared In the event of liquidation claims are honored as follows: –Bondholders –Preferred Stockholders –Common Stockholders Types of Equity

Process of Going Public –Why does a firm go public? To raise additional capital To allow VCs to cash out To raise the public profile of the firm

Process of Going Public –Initial issue (initial public offering (IPO)) Prospectus – filed with SEC Road show Bookbuilding Transaction cost – about 7%

Process of Going Public Ensuring price stability –Lockup period –What happens to stock’s price when lockup expires (or is close to expiring?) Why?

Process of Going Public Other facts about IPOs –IPOs are generally underpriced –IPOs occur more frequently in bullish stock markets –Can you and I “get in” on an IPO? –How did Google’s IPO increase the odds that individual investors can get in on an IPO?

Google’s IPO

Abuses in the IPO Market Spinning. Laddering. Excessive Commissions. Long-Term Performance Following the IPOs.

Secondary Stock Offerings What is a Secondary Stock Offering? A secondary stock offering is a new stock offering by a specific firm whose stocks is already publicly traded.

Secondary Stock Offerings What is 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

Stock Exchanges Stock trading between investors occurs on an organized stock exchange or on the over-the-counter (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

Stock Exchanges –Listing requirements: 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

Stock Exchanges Over-the-counter market: –Buy and sell orders are completed through a telecommunications network –Nasdaq: 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.

Stock Exchanges Over-the-counter market –Nasdaq Nasdaq components are: –Nasdaq National Market –Nasdaq Small Cap Market 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

Stock Exchanges Over-the-counter market –OTC Bulletin Board 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 –Pink sheets 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

Stock Exchanges Stock quotations provided by exchanges –The format varies among newspapers, but most provide similar information: 52-week price range Symbol Dividend Dividend yield Price-earnings ratio Volume Previous day’s price quotations

Stock Indices –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 indicator of the overall market –The Standard and Poor’s (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

Stock Exchanges –Wilshire 5000 Total Market Index Created in 1974 to reflect the values of 5,000 U.S. stocks Represents the broadest index of the U.S. stock market Closely monitored by the Federal Reserve –New York Stock Exchange Indexes The Composite Index represents the average of all stocks traded on the NYSE Sector indexes: –Industrial –Transportation –Utility –Financial

Investor Participation in the Secondary Market How do investor decisions affect the stock price? –Investors 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

Investor Participation in the Secondary Market How do investor decisions affect the stock price? –Investor 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

Investor Participation in the Secondary Market Types of investors –Individual investors typically hold more than 50 percent of the total equity in a large corporation Ownership is dispersed –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

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 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 manager

Monitoring by Investors 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

Monitoring by Investors 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

The Corporate Monitoring Role Market for corporate control –A firm may engage in acquisitions to increase the value of a target firm Can also create synergistic benefits –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

The Corporate Monitoring Role Barriers to changes in corporate control: –Antitakeover amendments: are designed to protect shareholders against an acquisition that will ultimately reduce the value of their investment in the firm e.g., may require at least two-thirds of shareholder votes to approve a takeover –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

The Corporate Monitoring Role Barriers to corporate control A 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 firm’s stock whenever the firm is acquired

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)

Globalization of Stock Markets 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

Globalization of Stock Markets Emerging Stock Markets: –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

Globalization of Stock Markets Methods used to invest in foreign stocks –International 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

End of Chapter 10