1. The Stock Market - Primary Market
Copyright 2014 Diane Scott Docking

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Learning Objectives
Identify the features and characteristics common stock and preferred stock
Examine the process by which common stock is issued in the primary stock market
Understand the role that an investment bank plays in the financial markets
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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
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Common Stock
Right to ___
Many investor assign their vote to management via a _____
____________________have two classes of common shares outstanding, with different voting rights assigned to each class
__________________ voting
the number of votes assigned to each stockholder equals the number of shares held multiplied by the number of directors to be elected
The number of shares needed to elect p directors, Np, is:
Copyright 2014 Diane Scott Docking

7. Example: Cumulative vs. Straight Voting
ABC firm has 1 million shares of common stock outstanding and 4 open directors slots. 6 people are running for the 4 open slots: Bob, Carol, Ted, Alice, Tom, and Jerry.
If the firm uses straight voting, what is the minimum number of votes needed to ensure election to the board?
If the firm uses cumulative voting, what is the minimum number of votes needed to ensure that your
1 candidate, Bob, is elected to the board?
2 candidates, Bob and Carol, are elected to the board?
Copyright 2014 Diane Scott Docking

8. Example: Cumulative vs. Straight Voting
If the firm uses straight voting, what is the minimum number of votes needed to ensure election to the board?
(50% x # share outstanding) + 1 =
(.50 x 1,000,000) + 1 = 500, = 500,001 shs.
If Mary owns 500,001 shares, she can elect the entire Board:
Suppose Mary wants Ted, Alice, Tom and Jerry on the Board, then votes are cast as follows:
Candidate
For
Against
Elected?
Bob
499,999
500,001 No
Carol
Ted
Yes
Alice
Tom
Jerry
Copyright 2014 Diane Scott Docking

9. Example: Cumulative vs. Straight Voting
If the firm uses cumulative voting, what is the minimum number of votes needed to ensure that your
1 candidate, Bob, is elected to the board?
Chart 1: Bob guaranteed: Chart 2: Mary’s voting Ted & Alice:
Candidate
For
Elected?
Bob
800,001
Yes
Carol No
Ted
800,000
Alice
Tom
Jerry
799,999
Total votes
4,000,000
Candidate
For
Elected?
Bob
800,001
Yes
Carol ?
1,199,995
Ted
800,000
Alice
Tom ? No
Jerry ?
400,004
Total votes
4,000,000
Copyright 2014 Diane Scott Docking

10. Example: Cumulative vs. Straight Voting
2 candidates, Bob and Carol, are elected to the board?
Chart 1: Bob & Carol guaranteed: Chart 2: Mary’s voting Ted & Alice:
Candidate
For
Elected?
Bob
800,001
Yes
Carol
800,000
Ted
Alice
Tom No
Jerry
799,999
Total votes
4,000,000
Candidate
For
Elected?
Bob
800,001
Yes
Carol
800,000
Ted
Alice
Tom
400,004 No
Jerry
399,995
Total votes
4,000,000
Copyright 2014 Diane Scott Docking

11. Common Stock Characteristics (cont.)
Right to ________ , but they are discretionary and are thus not guaranteed
Common stockholders have the lowest priority claim in the event of bankruptcy (i.e., a claim)
___________ implies that common stockholders can lose no more than their original investment
Par Value
No maturity
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12. Preferred Stock Characteristics
Hybrid security
Represents equity or ownership interest, but usually _________ rights
Trade voting rights for stated fixed annual dividend
Maturity
Perpetual vs. Limited life
Call provisions
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13. Preferred Stock Characteristics (cont.)
Dividends paid before common if dividends are declared by board of directors
Nonparticipating versus participating
Dividend not affected by profits
May receive special dividend if profits high
Cumulative versus noncumulative
Preferred dividend may be omitted, but if Cumulative provision, then no common dividends paid until P/S dividend in arrears are paid
Copyright 2014 Diane Scott Docking

14. How Securities Are Issued
Investment banker role
Public placement
IPO
Secondary/Seasoned Offerings
Shelf Registration
Preemptive Rights Offering
Bought Deal
Auction
Private placement
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15. Role of Investment Banker in Bringing New Securities to Market
Three steps of bringing a new security issue to market include:
Origination
Underwriting
Sales and distribution
Copyright 2014 Diane Scott Docking

16. Role of Investment Banker in Bringing New Securities to Market
Three steps of bringing a new security issue to market include:
Origination
Underwriting
Sales and distribution
Copyright 2014 Diane Scott Docking

17. Role of Investment Banker in Bringing New Securities to Market
Three steps of bringing a new security issue to market include:
Origination
Underwriting
Sales and distribution
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Tombstone Ad
Syndicate members
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Tombstone Ad
Syndicate members
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20. Front Page of a Final Prospectus
IPO
IPO
Firm commitment
Syndicate members
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21. Initial Public Offerings (IPOs)
First-time offering of shares to the public
Firm must provide information to public
Firm is assisted by an investment banker
Registration statement to SEC
Red-Herring Prospectus
Road shows
Final Prospectus
Difficulty in buying IPO
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22. Google’s IPO: S-1 filing
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23. Google’s IPO: S-1 filing
Copyright 2014 Diane Scott Docking

24. Initial Public Offerings (IPOs)
First-time offering of shares to the public
Firm must provide information to public
Firm is assisted by an investment banker
Registration statement to SEC
Red-Herring Prospectus
Road shows
Final Prospectus
Difficulty in buying IPO
Copyright 2014 Diane Scott Docking

25. Image of a “Red Herring” Prospectus
Copyright 2014 Diane Scott Docking

26. Initial Public Offerings (IPOs)
First-time offering of shares to the public
Firm must provide information to public
Firm is assisted by an investment banker
Registration statement to SEC
Red-Herring Prospectus
Road shows
Final Prospectus
Difficulty in buying IPO
Copyright 2014 Diane Scott Docking

27. Google’s IPO: Final Prospectus
Copyright 2014 Diane Scott Docking

28. Initial Public Offerings (IPOs)
First-time offering of shares to the public
Firm must provide information to public
Firm is assisted by an investment banker
Registration statement to SEC
Red-Herring Prospectus
Road shows
Final Prospectus
Difficulty in buying IPO
Copyright 2014 Diane Scott Docking

29. Initial Public Offerings (IPOs)
Performance of IPOs
Price generally rises on first day
Average a 19% gain on first day of trading.
On average, the longer-term performance of IPOs is poor
Average 3-year return of IPO stocks lagged the average 3-year returns of similar non-IPO stocks by 7.2%.
Copyright 2014 Diane Scott Docking

30. Long-term Relative Performance of Initial Public Offerings
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31. Example: Best Efforts vs. Firm Commitment
Stevens Bank intends to issue 2 million shares of common stock.
The bank’s investment banker has offered two alternatives:
Plan A:
A best efforts offering at $16 per share subject to an underwriting commission of 2% of expected gross proceeds plus $300,000. The investment banking firm expects 93% of the issue will be sold.
Plan B:
A firm commitment offer at $15.50 per share plus an underwriting fee of 7% of the gross proceeds.
Which plan offers the highest net proceeds to Stevens Bank?
What other factors must Stevens consider when making their choice?
Copyright 2014 Diane Scott Docking

32. Example: Best Efforts vs. Firm Commitment
Proceeds to Firm
Proceeds to IB
Plan A:
Gross Proceeds (2 mill. shs. x $16/sh x .93)
$29,760,000
Less: Commission ($29,760,000 x .02)
- 595,200
$ ,200
Less: Fee
- 300,000
300,000
Net proceeds
$28,864,800*
$ ,200
Plan B:
Gross Proceeds (2 mill. shs. x $15.50/sh)
$31,000,000
- $31,000,000
Less: Fee ($31,000,000 x .07)
- 2,170,000
2,170,000
Proceeds from sale of shares
_________0 ?
$28,830,000
$2,170,000 + net profit from share sales**
* This amount could change since IB could sell < 93% or > 93% of the issue.
________________bears the risk.
**IB may not be able to sell the shares at a profit.
_______________ bears the risk.
Copyright 2014 Diane Scott Docking

33. Secondary Stock Offerings
New stock issued by firm that already has shares outstanding
Quanta Services-secondary stock offering
Filed an S-3
Copyright 2014 Diane Scott Docking

34. Regulation of the Primary Market
Securities and Exchange Commission (SEC)
regulates underwriting activities
Securities Act of 1933
governs issuance of securities
Rule 415: Shelf Registration Rule
file single registration document for selling securities on a continuous basis (within 2 years)
CryoLife’s Shelf Registration: S-3 and check Rule 415
Copyright 2014 Diane Scott Docking

35. Three Variations in the Underwriting Process
___________________
Common stock only
Existing shareholders have the right to buy new common stock at a price below market value.
Elements of a rights offering:
Subscription price
Number of rights
Option to transfer rights
Right’s expiration time
_________________
Debt securities only
Investment banking firm or group of firms offers to buy an entire issue from the issuer.
Attractive features:
quick in bringing issue to market
lower risk of capital loss
Copyright 2014 Diane Scott Docking

36. Three Variations in the Underwriting Process
______________________
Applies to stocks and bonds
Mandatory for certain securities of regulated utilities and municipals
Competitive Bidding Underwriting
______________________________
All at same bid price
All at individual bid price
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37. Private Placement of Securities
Sale of securities to a limited number of institutional investors.
SEC specified conditions to be met for private placement.
Issuers usually work with investment bankers.
Rule 144A offering or non-Rule 144A offering
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Rule 144 A
SEC rule permitting large institutions to trade securities acquired in a private placement among themselves without having to register these securities with the SEC.
SEC Rule 144A improves liquidity of privately placed securities.
Encourages non-U.S. firms to issue securities in the U.S. private placement market.
Copyright 2014 Diane Scott Docking

39. Example: Preemptive Rights Offering
George owns 10,000 shares of ABC Corp. that has 10 million shares outstanding. ABC plans to sell an additional 5 million shares through a rights offering. Current share price is $50. Then new shares are offered to current stockholders at $45/sh.
How many rights will George receive?
If George exercises his rights, what is his ownership interest? If he does not, what is his ownership interest?
Assume George exercises his rights. What is the per share value of George’s investment after the rights offering?
Suppose George decides to sell his rights to another investor. What must be the minimum sales price per right, such that George loses no value in wealth?
Copyright 2014 Diane Scott Docking

40. Solution: Preemptive Rights Offering
How many rights will George receive?
Ownership before offering = 10,000/10 mill. = .001 = .1%
Rights per share to be received = New shs./Outstanding shs.
= 5 mill/10 mill = 0.5 rights / sh. owned
George will receive 10,000 x .5 = _______________________
Copyright 2014 Diane Scott Docking

41. Solution: Preemptive Rights Offering
If George exercises his rights, what is his ownership interest? If he does not, what is his ownership interest?
Ownership after exercising rights =
= (10,000 +5,000)/(10 mil. + 5 mil.)
= 15,000/15 mill. = _______________________
Ownership interest if he does not exercise rights =
= 10,000/15 mill. = = ______________________
Copyright 2014 Diane Scott Docking

42. Solution: Preemptive Rights Offering
Assume George exercises his rights. What is the per share value of George’s investment after the rights offering?
Share value before offering = 10,000 x $50/sh = $500,000
Cost of rights = 5,000 x $45/sh = $225,000
15, $725,000
Share value after = $725,000/15,000 = _________________
It is same for Total Firm:
15 mill. shs x $48.33 = $725 mill.
Copyright 2014 Diane Scott Docking

43. Solution: Preemptive Rights Offering
Suppose George decides to sell his rights to another investor. What must be the minimum sales price per right, such that George loses no value in wealth?
$ $45 = _____________________
Total wealth:
Stock value ,000 shs x $ = $483,333.33
Rights sold ,000 x $ = ,666.67
Wealth remains the same as before offering = $500,000
Copyright 2014 Diane Scott Docking