1. Decentralized Investment Banking
The Case of Discount Dividend-Reinvestment and Stock-Purchase Plans

2. Objectives

3. Objectives
Test the degree to which investors can profit from discount plans by investing $3 million in discount plans, to determine if the discount plan can be a substitute for conventional capital raising methods, and the possibility of the subsequent decentralization of investment banking

4. Process

5. Step 1
Identify 74 companies with discount plans concentrated in banking, real estate and public utility industries, and split the 3.6m investment in them. Most of the plans have mostly 5% discount.
Source of information: S&P Cumulative Dividends. Telephoned or wrote to the administrators of each plan

6. Step 2
Purchased a single share in each plan, and then invested in each discount plan in batches
Increased average actual discount to 5.26% by avoiding the averaging period in which share price declines
Negotiated a favorable commission fee with a broker, and sell the shares immediately after buying them at discounts

7. Step 3
Purchased insurance against price decline on positions, and opened line of credit to finance
Reasons for not using traditional hedging
1. Long in the money put options
2. Short sell
3. Macro hedge

8. Results

9. Results
As a result, the income of this strategy is $74,600 above bench mark return (Salomon bro 35 bank stock index), and the excess return is 12% per year.
Poor stock performance of sponsoring firm doesn’t wipe out the discount income

10. Findings

11. Findings from experiment
Eight firms with 5% discount raised 98% of the common/ preferred share they paid, while seven firms with similar financials but no discount only raised 12%
Firms with lower discounts, their stocks are traded less actively, making execution costs higher
Discount plans doesn’t necessarily reduce company’s stock price

12. Conclusions

13. Conclusions
Offering shareholders shares at a discount makes them better off than they would under conventional underwritings
Discount stock slows down the rate at which the fund was raised, thus mitigating the adverse selection that might harm the company
Offering shareholders shares at a discount also enables companies to raise capital at low cost

14. Drawbacks

15. Drawbacks
Shareholders who purchase small ownership interest in secondary market and then buy disproportionate amount of discounted shares
Hard to achieve economies of scale
Hard to achieve the same level of discount Hard to negotiate as favorable a commission fee with brokers
Regulations and taxations have changed