Tài chính doanh nghiệp - Chapter 19: The capital market

Chapter 19The Capital Market© 2001 Prentice-Hall, Inc.Fundamentals of Financial Management, 11/eCreated by: Gregory A. Kuhlemeyer, Ph.D.Carroll College, Waukesha, WIThe Capital MarketPublic IssuePrivileged SubscriptionRegulation of Security OfferingsPrivate PlacementInitial FinancingSignaling EffectsThe Secondary MarketDeja Vu All Over AgainCapital Market -- The market for relatively long-term (greater than one year original maturity) financial instruments. Primary Market -- A market where new securities are bought and sold for the first time (a “new issues” market).Secondary Market -- A market for existing (used) securities rather than new issues.Deja Vu All Over AgainINVESTMENT SECTORFINANCIALINTERMEDIARIESSAVINGS SECTORFINANCIAL BROKERSSECONDARY MARKETPublic issuePrivilegedsubscriptionPrivateplacementIndicates the possiblepresence of a “standby arrangement”Indicates the financialintermediaries’ ownsecurities flow to thesavings sectorPublic IssueSecurities are sold to hundreds, and often thousands, of investors under a formal contract overseen by federal and state regulatory authorities.When a company issues securities to the general public, it is usually uses the services of an investment banker.Public Issue -- Sale of bonds or stock to the general public.Investment BankerInvestment banker receives an underwriting spread when acting as a middleman in bringing together providers and consumers of investment capital.Underwriting spread -- the difference between the price the investment bankers pay for the security and the price at which the security is resold to the public.Investment Banker -- A financial institution that underwrites (purchases at a fixed price on a fixed date) new securities for resale.Investment BankerThus, the services can be provided at a lower cost to the firm than the firm can perform the same services internally.Three primary means companies use to offer securities to the general public:Traditional (firm commitment) underwritingBest efforts offeringShelf registrationInvestment bankers have expertise, contacts, and the sales organization to efficiently market securities to investors. Traditional UnderwritingIf the security issue does not sell well, either because of an adverse turn in the market or because it is overpriced, the underwriter, not the company, takes the loss.Underwriting -- Bearing the risk of not being able to sell a security at the established price by virtue of purchasing the security for resale to the public; also known as firm commitment underwriting.Traditional UnderwritingA. Competitive-bid The issuing company specifies the date that sealed bids will be received.Competing syndicates submit bids.The syndicate with the highest bid wins the security issue.Underwriting Syndicate -- A temporary combination of investment banking firms formed to sell a new security issue.Traditional UnderwritingThe issuing company selects an investment banking firm and works directly with the firm to determine the essential features of the issue.Together they discuss and negotiate a price for the security and the timing of the issue.Depending on the size of the issue, the investment banker may invite other firms to join in sharing the risk and selling the issue.Generally used in corporate stock and most corporate bond issues.B. Negotiated OfferingTraditional UnderwritingBest Efforts Offering -- A security offering in which the investment bankers agree to use only their best efforts to sell the issuer’s securities. The investment bankers do not commit to purchase any unsold securities.Shelf Registration -- A procedure whereby a company is permitted to register securities it plans to sell over the next two years; also called SEC Rule 415. These securities can then be sold piecemeal whenever the company chooses.Shelf Registration: Flotation Costs and Other AdvantagesThis competition reduces underwriting spreads.The total fixed costs (legal and administrative) of successive public debt issues are lower with a single shelf registration than with a series of traditional registrations.The amount of “free” advice available from underwriters is less than before shelf registration was an alternative to firms.A firm with securities sitting “on the shelf” can require that investment banking firms competitively bid for its underwriting business.Privileged SubscriptionPrivileged Subscription -- The sale of new securities in which existing shareholders are given a preference in purchasing these securities up to the proportion of common shares that they already own; also known as a rights offering.Preemptive Right -- The privilege of shareholders to maintain their proportional company ownership by purchasing a proportionate share of any new issue of common stock, or securities convertible into common stock.Terms of OfferingTerms specify: the number of rights required to subscribe for an additional share of stockthe subscription price per sharethe expiration date of the offeringRight -- A short-term option to buy a certain number (or fraction) of securities from the issuing corporation; also called a subscription right.Subscription RightsGenerally, the subscription period is three weeks or less.Options available to the holder of rights:Exercise the rights and subscribe for additional sharesSell the rights (they are transferable)Do nothing and let the rights expireSubscription RightsThe shareholder can then purchase 7 shares (use 70 rights) and still retain the 7 remaining rights. Thus, the shareholder needs to purchase an additional 3 rights.A shareholder who owns 77 shares and just received 77 rights would like to purchase 8 new shares. It takes 10 rights for each new share. What action should the shareholder take?Value of RightsA right allows you to buy new stock at a discount that typically ranges between 10 to 20 percent from the current market price.The market value of a right is a function of:the market price of the stockthe subscription pricethe number of rights required to purchase an additional share of stockWhat gives a right its value?P0 - R0 = [ (R0)(N) + S ], thereforeR0 = P0 - [ (R0)(N) + S ]R0 = the market price of one right when the stock is selling “rights-on”P0 = the market price of a share of stock selling “rights-on”S = the subscription price per shareN = the number of rights required to purchase one share of stockHow is the Value of a Right Determined? Solving for R0.How is the Value of a Right Determined?P0 - SN + 1R0 =PX = P0 - R0 = [ (R0)(N) + S ]By substitution for R0, we can solve the “ex-rights” value of one share of stock, PX. (P0 )(N) + SN + 1PX =Example of the Valuation of a RightAssume the following information:The current market price of a stock “rights-on” is $50.The subscription price is $40.It takes nine rights to buy an additional share of stock.What is the value of a right when the stock is selling “rights-on”? What is the value of one share of stock when it goes “ex-rights”? Solving for R0. Solving for PX.How is the Value of a Right Determined?$50 - $409 + 1R0 =R0 = $1($50 )(9) + $409 + 1PX =PX = $49Theoretical versus Actual Value of RightsTransaction costsSpeculationIrregular exercise and sale of rights over the subscription periodArbitrage acts to limit the deviation of the actual right value from the theoretical value.Why might the actual value of a right differ from its theoretical value?Standby ArrangementFee often composed of a flat fee and an additional fee for each unsold share of stock.The greater the risk of an unsuccessful rights offering, the more desirable a standby arrangement.Standby Arrangement -- A measure taken to ensure the complete success of a rights offering in which an investment banker or group of investment bankers agrees to “stand by” to underwrite any unsubscribed (unsold) portion of the issue.Oversubscription PrivilegeFor example, shareholders subscribe for 450,000 shares of a 500,000-share rights offering. Let us assume that some shareholders would like more shares and oversubscribe by 80,000 shares. As a result, each shareholder oversubscribing receives 5/8ths (50,000 / 80,000) of a share for each share oversubscribed.Oversubscription Privilege -- The right to purchase, on a pro rata basis, any unsubscribed shares in a rights offering.Privileged Subscription versus Underwritten IssueInvestors are familiar with the firm’s operations when using a rights offering.The principal sales tool is a discounted price (rights offering) and the investment banking organization (underwriting).A disadvantage of a rights offering is that the shares will be sold at a lower price.There is greater dilution with a rights offering which many firms attempt to avoid.There is a wider distribution of shares with a public offering.Regulation of Security Offerings -- FederalSecurities Exchange Act of 1934 -- Regulates the secondary market for long-term securities -- the securities exchanges and the over-the-counter market.Securities Act of 1933 -- Generally requires that public offerings be registered with the federal government before they may be sold; also known as Truth in Securities Act. Securities and Exchange Commission (SEC) enforces both of these acts.Regulation of Security Offerings -- FederalPart 1: Prospectus -- Discloses information about the issuing company and its new offering and is distributed to investors.Part 2: Additional information required by the SEC that is not part of the printed prospectus.Registration Statement -- The disclosure document filed with the SEC in order to register a new securities issue. Red HerringSEC reviews the registration statement to see that all the required information is presented and that it is not misleading.Deficiencies are communicated in a comment letter.Once the SEC is satisfied, it approves the registration. If not, it issues a stop order.Red Herring -- The preliminary prospectus. It includes a legend in red ink on the cover stating that the registration statement has not yet become effective. Regulation of Security Offerings -- FederalRegistration statements become effective on the 20th day after filing (or on the 20th day after filing the last amendment).The SEC, at its discretion, can advance the date. Typical time from filing to approval is 40 days.Registration Statement Effective DateRegulation of Security Offerings -- FederalA shelf registration allows a company to register with the SEC “in advance” of a security offering.The company can sell “off the shelf” by filing a simple amendment and having the SEC accelerate the “normal” 20-day waiting period accorded amendments.Typically, the waiting period following this simple amendment is only a day or two.Impact with shelf registration:Regulation of Security Offerings -- FederalThe term reflects the stark, black-bordered look of the ad (see Slide 19-32).Includes the company’s name, a brief description of the security, the offering price, and the names of the investment bankers in the underwriting syndicate.Tombstone Advertisement -- An announcement placed in newspapers and magazines giving just the most basic details of a security offering. Regulation of Security Offerings -- StateIndividual states have security commissions that regulate securities in their states.These laws are particularly important when a security issue is sold entirely to people within the state and may not be subject to SEC regulation.Important if the SEC provides only limited review.States vary on the strictness of their regulation.Blue Sky Laws -- State laws regulating the offering and sale of securities. Private PlacementEliminates the underwriting function of the investment banker.The dominant private placement lender in this group is the life-insurance category (pension funds and bank trust departments are very active as well).Private (or Direct) Placement -- The sale of an entire issue of unregistered securities (usually bonds) directly to one purchaser or a group of purchasers (usually financial intermediaries). Private Placement FeaturesAllows the firm to raise funds more quickly.Eliminates risks with respect to timing.Eliminates SEC regulation of the security.Terms can be tailored to meet the needs of the borrower.Flexibility in borrowing smaller amounts more frequently rather than a single large amount.Private Placement and Other DevelopmentsQualified Institutional Buyers (QIBs) -- Eligible purchasers, by SEC Rule 144a, of previous securities from a private placement without having to go through a public market registration.Event Risk -- The risk that existing debt will suffer a decline in creditworthiness because of the issuance of additional debt securities, usually in connection with corporate restructuring. Private Placement and Other DevelopmentsUnderwritten Rule 144a Private Placement – The issuer sells its securities initially to an investment bank that resells them to the same institutional buyers that are candidates for a regular private placement. Often includes registration rights.Private Placement with Registration Rights – It combines a standard private placement with a contract requiring the issuer to register the securities with the SEC for possible resale in the public market. Initial Financing -- Venture CapitalWealthy investors and financial institutions are the primary providers of funds for a new enterprise (usually common stock).Rule 144 and the 1933 Act require privately placed securities to be held for at least two years or be registered before they can be resold. Letter stock * -- Privately placed common stock that cannot be immediately resold.* Note: Under SEC Rule 144a, however, letter stock could be sold to qualified institutional buyers (QIBs) without a waiting period.Initial Public Offering (IPO) -- A company’s first offering of common stock to the general public. Initial Financing -- Initial Public OfferingsOften prompted by venture capitalists who wish to realize a cash return on their investment.Founders of the firm may wish to go through an IPO to establish a value for their company.There exists greater price uncertainty with an IPO than with other new public stock issues.Signaling EffectsNegative stock price reaction to common stock or convertible issues.Straight debt and preferred stock do not tend to show statistically significant effects. -10 -8 -6 -4 -2 0 2 4 6 80-1-2-3-4321Cumulative Average Abnormal Return (%)Time Around Announcement (in days)Relative AbnormalStock Returns for aNew Equity IssuePossible Explanations for Price ReactionsAsymmetric (Unequal) InformationPotential investors have less information than management (particularly for common stock).Exchanges of different types of securities show that increases (decreases) in financial leverage are associated with positive (negative) abnormal returns.Expectations of Future Cash FlowsThe unexpected sale of securities may be associated with lower than expected operating cash flows and interpreted as bad news. Hence, the stock price might suffer accordingly.The Secondary MarketPurchases and sales of existing stocks and bonds occur in the secondary market.Transactions in the secondary market do not provide additional funds to the firm.The secondary market increases the liquidity of securities outstanding and lowers the required returns of investors.Composed of organized exchanges like the New York Stock Exchange and American Stock Exchange plus the over-the-counter (OTC) market.