1. Chapter 10: Stock Offerings and Investor Monitoring

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.

3. Background on Common Stock
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

4. 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

5. 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

6. 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 2 6

7. Types of Equity 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 4 7

8. 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 7 8

9. Process of Going Public
Initial issue (initial public offering (IPO))
Prospectus – filed with SEC
pricing
Road show
Transaction cost – about 7% 7 9

10. Process of Going Public
Other facts about IPOs
IPOs are generally underpriced
IPOs occur more frequently in bullish stock markets 7 10

11. Abuses in the IPO Market
Spinning: Spinning occurs when the underwriter allocates shares from an IPO to corporate executives who may be considering an IPO or to another business requiring the help of a securities firm. The underwriter hopes that the executives will remember the favor and hire the securities firm in the future.
Laddering. When there is substantial demand for an IPO, some brokers engage in laddering. In other words, these brokers encourage investors to place first-day bids for the shares that are above the offer price.
Excessive Commissions. Some brokers have charged excessive commissions when demand was high for an IPO. Investors were willing to pay the price because they could normally recover the cost from the return on the first day.

12. 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. 12

13. 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 13

14. 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 14

15. 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 15

16. 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. 16

17. 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 17

18. 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 18

19. 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 19

20. 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 20

21. 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 21

22. 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 22

23. 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 23

24. 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 24

25. 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 25

26. 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 26

27. 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 27

28. 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) 28

29. 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 29

30. 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 30

31. 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 31

32. End of Chapter 10