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Unformatted text preview: e underwriter. This is a firm-com mitm ent
underwriting. | v v 125 | e-Text Main Menu | Textbook Table of Contents | Study Guide Table of Contents In a best-efforts offering, the underwriter simply acts as an agent and receives a com mission for each share sold.
The investmen t bank mu st mak e its 'best effort' to sell the shares at the agreed upon offering price, and the issuing
firm bears the risk that the securities cannot be sold at that price.
Th e Afterm arket (p. 454) The time period imm ediately after the sale is called the afterm arket, during which the
principal underwriter is allowed to buy shares to 'support' or stabilize the price.
Th e Gr een Sho e Prov ision (p. 455) Underwriting contracts often contain a Gr een Sho e prov ision allowing
the syndicate to purchase additional shares at the offering price.
V. IPO s AND UNDERPRICING (p. 455)
New issues are typically "underpriced" (i.e., the market price quickly rises above the offering price) which is
beneficial to new shareholders but detrimental to existing shareholders; existing shareholders are, in effect, selling a
portion of the firm they own at a price below its market value. The degree of underpricing varies considerably, but
the tendency toward underpricing is greater for smaller issues.
Evid ence on Un derpricing (p. 457) Underpricing has been observed in varying degrees for nearly four decades.
There are pronoun ced cycles in the amo unt of underpricing.
Why does Un derpricing Exist? (p. 457) Althoug h there is no universally accepted reason for the persistence of
underpricing, the evidence suggests that the following factors are associated with it:
3. Risk of the issuing firm–underpricing is mo re prevalent in smaller, speculative issues;
Dem and for the issue–underpriced issues tend to be allocated by brokers to larger custom ers;
Insurance–underp ricing may help to ensure that fewer custom ers will suffer losses after buying
new issues, reducing the likelihood of lawsuits against the investmen t bankers. VI. NE W EQ UITY SALES AND TH E VALUE OF TH E FIRM (p. 461)
The announ cement of a new issue is often regarded as a negative signal to securities markets participants because (1)
superior information in the hands of man agement may result in the issuing of new shares at a time when the firm's
stock is overvalued, and (2) firms needing new equity may have excess debt.
VII. TH E CO STS OF ISSUING SE CURIT IES (p. 462)
Issuers incur flotation costs which include the spread, other direct expenses (such as legal fees), indirect costs (such
as man agement time), abnorm al returns (the decrease in value of existing shares), costs to existing shareholders of
underpricing, and the Green Shoe option. Based on actual issuer experience, five conclusions about flotation costs
can be drawn: (1) as a percentage of proceeds, flotation costs are smaller for larger issues; (2) flotation costs are
higher for best-efforts underwriting; (3) costs of underpricing can be substantial, especially for smaller issues and
best-efforts underwriting; (4) underpricing for best-efforts offers is mu ch greater than for firm-com mitment offers; and
(5) flotation costs are higher for IPOs than for...
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