Initial Public Offerings, Investment Banking, and
ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS
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
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
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
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
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
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, taking account of book value and
Answers and Solutions:
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