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Unformatted text preview: Chapter 18 Initial Public Offerings, Investment Banking, and Financial Restructuring ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS 18-1 Reasons for going public include the following. Note that, generally, several of these reasons will be important at the time of the IPO. • To raise additional capital. Original investors may be tapped out, or they may not want to put additional funds into the business for diversification reasons. Thus, the company needs to bring in outside funds, and an IPO is the most efficient way of doing so. • Founding stockholders want liquidity, which a public market would provide. • Founding stockholders want to diversify. They can sell some shares during or after an IPO. • Many companies use stock options as part of their compensation plans. Employees with options, like founding stockholders, want liquidity and the opportunity to diversify their holdings. • To establish a market price, which is useful for incentive employee option programs, for mergers, for estate tax purposes, and in divorce situations. • Public ownership may help the company make sales, because public ownership may provide credibility with regard to “staying power”—no one wants to be dependent on a supplier that goes under because it was unable to raise needed capital. Also, public ownership may provide some beneficial advertising effects. Some downsides to public ownership include: Costs, disclosure requirements, harder to engage in self-dealings that benefit the controlling stockholders. Also, analysts do not follow very small stocks where trading volume is necessarily small. Therefore, if a firm is so small that an active market for its stock cannot be developed, then public ownership won’t really make it liquid, and the price will fluctuate widely and not necessarily reflect the firm’s true value. In addition, if the firm goes public, it might be easier for a raider to gain control and oust the managers. This is something that managers consider, especially if the management team will not have over 50% of the stock after the public offering. Finally, it is interesting to note that some very large companies with tens of thousands of employees like Publix, CM2Hill, and Cargill have been able to get most of the advantages listed above without actually going public. These companies have developed internal markets that work as follows: (1) The company hires an investment banking firm to operate the plan, which is set up much like a mutual fund, with each participating employee having an account. (2) The banker develops a formula for pricing the stock, Answers and Solutions: 18 - 1 taking account of book value and earnings per share, the state of the stock market as measured by an index of comparable companies’ stock plus an index such as the S&P 500, the level of interest rates, and so forth. The formula will be adjusted over time to ensure that there is a fairly good balance between buyers and sellers. (3) Several times a year, employees will be given the opportunity to buy or sell shares at the announced...
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- Spring '08
- Securities and Exchange Commission, investment banker, flotation costs