Equity Issuance

A private firm becomes a public entity by issuing shares that are traded on a regulatedexchange

• Addition fund is raised by increasing equity capital.

• New Shares are perfect substitutes for existing shares

• Could be a follow on offering or existing shareholder are selling their shares

If the Demand fo stocks for the IPO is high, the underwriter can sell additional ordinary or preffered shares

• Financing Function

• Enhance visibilty and publinc awareness of company

• Enhaince attractivity for employees and Top Manager

• Transformation of iliquid non tradable equity holdings in liquid securites

• Raise Capital for new Investments

• Reducing Cost of Debt by reducing Debt-Equity Ratio

• Facilitate future capital raisings (SEO)

• Expanded range of issuing securites

• Expand the investors range

• Costs

  • Change of legal form

  • Marketing Fees and public relation fees

  • Selling fees

  • Underwriting fees

  • Opportunity Costs of underwriting

• Loss of Control

  • Major decisions need majority of votes in general meetings

• Agency Problem (adverse selection and moral hazard)

• Self Selection

  • no alternative for action

• Signaling

• Screening

  • Not appropriate in IPO due high costs

• Information of ownership stucture

• High share of mgmt ownership

• Choice of reputable underwriter

• Choice of particular market segment for listing

  • Prime Standard

  • General Standard

• Assesment, if the firm is ready for the Stock-Market

  • Company valuation with several methods

  • Recemt Stock-Market environment, valuation and trends

  • Evaluation and Summary of external company data

  • Evaluation of the Market -> Product, Competitors, Industy

• Selection of underwriter

  • Prestige of IB

  • Performance of the past IPOs from underwriter

  • Big Issues usally need a syndicate of banks

Due Diligence is a well documented and detailed assesment of the firm

Large IPOs asses various risk

• Legal due dilligence

  • Tax Risk

  • Legal disputes

  • Copyrights

• Financial due dilligence

  • Assesment of KPIs like CF, assest or liquidity

• Strategic due dilligence

  • Assesment of the operating model of the firm like competitors, market environment

Define Value drivers and success factors, and growth porential of the firm. We try to convince the market participants of the long term profitability

• Profitability and Market Share

• Historic Grotwh and product success

• Positioning of products and services

Market Participants

• Investors

• Analysts

• Customer

• Employee

• Define Price Range und issue Volume (IPO prospectus)

• Stock Market registration

• Find Issue Price

• Listing and settlement

• Post IPO Share-Price Management

• Book Building

• Fixed-Price Offer

• Interst of issuer, underwriter and investors are taken into account

• Price is determined by lead underwriter but takes demand from the Investors into the account

• Underwriter can favor certain investor and influence the sahreholder structure of the firm

  • Private vs institutional investors

  • Informed vs non informed investors

• Issue Price is fixed prior the subscribtion period

  • Market Value of comparable firms and market situation is taken into the account

• Price does not reflect demand because demand is determined after the issue price is set

• Information Asymmetries

• Influence of the underwriter

• Signaling Models

• Other Explanatory approaches

• There are Informed and uninformed investors.

• Informed investors only subscribe to undervalued IPOs, where uninformed investors subscribe to all sorts of IPOs.

• Uninformed investores receive a larger share of overvalued IPOs

  
  

Underpricing is necessary to keep the uninformed investors in the market and ensure they subscribe to future IPOs

• Underwriter needs information of demand from informed investors. But the investors wants a compesation for the information (higher fraction of shares or underpricing)

• Without information of the demand, risk of mispricing is significantly higher

We need data of supply and demand and we have to classify investors into informed and uninformed

• Underwriter has more information about the demand than issuing firm

• Banks can set a lower price and reduce the risk that they cannot sell these shares

• Banks do not have a incentive to set the highes possible price but:

  • Constant low prices could decrease the market share

    
    

    
    

A low underpricing should beassociated, but there is a sutainable underpricing for US-Banks

• Hypothesis

  • Positice Correlation between ex-ante uncertainty and underpricing

• Underpricing serves as a Risk-premium for valuation uncertainty regarding the true price

• Measurement of uncertainty via proxies

• Issuer signal their quality by choosing reputable underwriter

• Underwriter with a high reputation will reject an IPO with high risk

• Investors are willing to accept a lower underpricing by an IPI from a reputable bank

  
  

Reputable underwriter have superior pricing abilites and are incentevized to set a fair price

• Positive initial return is not from the underpricing but from the POST-IPO stock management. They dont want short-term loss to protect their reputation

  
  

  
  

• Empirical Evidence

  • IPO with small underpricing show small negative returns at first. But this fraction of IPOs accounts only 30%

  • This Theory does not explain the underpricing fully. underpricing is cheaper than price management

• Ageny Problem between decison maker (Managers and VCs) and other pre issue shareholder. Decision maker wants an underwriter with historical underpricing, but underpricing dilute the price for the pre issue shareholder

• An Underwriter with underpricing and other hot IPOs can make side payments (Spinning)

  
  

• Spinning

  • Allocate HOT IPOs to ensure the business partnership in the future

• Laddering

  • Investors who receive shares in the IPO have to purchase more shares in the secondary market to increase or stabilize the sock price

It has to be costly, therefore high underpricing and low issuer volume

• Assumption

  • Issuer has better information about the firm value

• Issue can signal via

  • deliberate underpricing

  • Shares owned by insiders

A dynamic issue strategy where a higher price is possible in the seasoned offering

• Relationship between initial return and subsequent seasnoes new issues is not strong

If an Investor does not rely only on his information but also on other investors, an informational cascade may develop. If he sees nobody wants to buy shares from the new issue, he maybe will also not buy, despite his possesion of information.

To prevent this, the issuer will underprice to increase the incentive from the investors to buy

• Deliberate underpricing

• Fads

Issuer and underwriter agree on a price below fair value to achieve over subscription.

• Institutional investors are given preferences to guarantee returns forgood customer

• Private investors are given preference ti increase liquidity in the secondary market and reduce the risk of a public takeover

• High inital returns in the first days generates additional investor interest or market revenue because of the brighter awareness

• Investors are optimistic and euphoristics and affect the price positive, but after the true information of the firm is recevied by the market, the price will drop

• Equilbrium approaches

• Behavioral finance

• Measurment problems

Good Firms use underpricing as a signal because bad firms cannot bear the same costs.

Therefore good Firms would accept higher underpricing to reduce financing costs in upcoming capital raise

The relationship between long-term performance and underpricing is weak

• Divergence of opinion hypothesis

• Window of opportunity hypothesis

• Window-dressing hyopthesis

Uncertainty regarding the true value of the issue.

• Optimistic invesotrs expect a higher price while pessimistic investors expect a lower price.

When new information becomes public price expectation converges and the price will drop

Investors are overly optimistic with the growth opportunites and IPO firms try to time the market. Issues during these times are overvalued and will show negative perfomance with an objective valuation method

Frims conduct an IPO when perfomacne is good. After the IPO, the operating performance drops and stock price will decrease.

• In semi efficient market, all public information should reflect the stock price. Long term statistcally abnomral retrun should not be observable

• Testing Market Efficiency assumes that the model for normal returns / riskadjusted expected return is correct (Joint Hypothesis Problem)

• Benchmark choice is problematic over longt time horizon, beacuse measurement erros accumulate

The Literature does not provide generally accepted Asset Pricing Model.

• Market Risk Premium

• Size

• Value-Growth

• High stock marekt returns, high demand for shares, high first day returns, followed by rising IPO volume

• IPO waves are often concentrated in certain industires

It does not affect the firm value at all. Because the value of financing decision always equals zero

• Aggregated demands of firms is dependent on business cycle

• industry specific technology innovation

• Market timing of comoany insider (window of opportunity)

• Investors optimism for IPOs also behaves in cycle (overconfidence)

• Evidence for overconfidence

  • No relationship between aggregate IPO volume and future operative peformance

• Evidence for Market timing

  • Negative relationship between aggregate IPO volume and stock returns

• Positive relationship between underpricing and future aggregated IPO volume

• Emiision price = marekt price

  • Implementaiotn of capital increase takes place after announcement -> Price fluctuation are possible

• Emission price < marekt price

  • Compesation using rights issue

In most cases, the shareholders loses value after the emission

These studies alwaysd have a bad-model problem, because all models for expected return are incomplete description of the cross sectional risk return relationship