Transcript
Outline
What is an investment bank?Role in financial markets Investment banks and new securities
IPO mechanics
What is an Investment Bank?
Not a bank!Help firms sell securities to public
Stocks/Equity Bonds/Debt
Transfers funds from public to firms Savings -> Investments
Example: Goldman/Sachs
Initial Public Offering (IPO)
First sale of stock by firmOriginating investment bank
Key player in bringing the shares to market “Originating house” Handles most administrative details Reputation
Underwriting
A form of price guarantee Agree to purchase shares from firm for
a given amountThen sell to the publicExample:
Purchase stock from Yahoo ($10/share) Sell on the market ($11/share)
Risk of Underwriting
Market may not be willing to pay the price paid by investment bank ($10)
It would lose money Investment banks often spread this risk
over several investment banks “Underwriting Syndicate”
Also, try to reach more sellers “Selling group”
IPO Scandals
Most involve investment banks giving special deals to some favored customers (low prices)
Best Efforts Agreement
Risk shifted to issuing firm It receives whatever price the market
paysNo underwriting function by investment
bank
IPO Timing
Private firm Negotiations between shareholders and other initial
investors (Venture Capital) Find investment bank to handle IPO
Prospectus filed with Securities and Exchange Commission
“Registration” Red Herring : Version of prospectus for initial
investors Quiet period: filing to 1 month after IPO
Restrictions on public information releases
IPO Pricing
How does the initial price get set by investment banks?
Difficult problem Set price too high
Can’t sell stock at this price Lose money now, or wait and see
Set price too low (more common) Bad for issuing firm Raises lower money than it could have Investment bank looks bad (reputation)
Dutch Auction IPO’s:Another Price Mechanism
The “Dutch auction” is another mechanism for an IPO
Not many do thisMost famous: Google, August 2004
Dutch Auction
Seller announces total shares to be auctioned (Qshares)
Potential buyers submit bids for (Shares, Price)
Auction moves price down until Shares demanded above this price =
Qshares
Dutch Auction Example
Qhares = 10 Bids
2 at $10 1 at $9 3 at $8 4 at $7 2 at $6 4 at $5
Sell 10 to first 4 bidders at price = $7
Dutch Auction Analysis Benefits
More transparent No need to guess price
Price is uncertain though
Why isn’t it used more often? Google price increases
Did they get a high enough price? Confusing mechanism
Not well designed Qshares not specified Many investment banks
Patent (Hambrecht) Most firms not big enough to dictate these terms
Later Stock Offerings
“Seasoned equity” Stock issued after IPO Registered with SEC Sold at current market prices Firm often stores these shares
“Shelf registration” Google again: How to estimate shelf shares
from web (public float and shares outstanding)
Private Placements
Shares sold to private investment groups Venture capital firms Private equity hedge funds
Usually, smaller, younger, riskier firms
Regulation
Securities and Exchange Commission Set up in the early 1930’s to oversee
securities markets Oversees publicly traded firms Public investment companies (mutual
funds)
SEC: Information and Regulation
Require timely release of information to public
10-K report: Annual information on firmFirms required to report major
information events to public
Insider Trading
Trading on private information Illegal (why?) Who’s an insider?
Employees Associated
Lawyers Investment bankers
Enforcement Trade reporting
Securities Investor Protection Corporation (SIPC)
Insures investors against failure in brokerage firms
Not insurance against price dropsLimited amounts
$500,000 total $100,000 cash balances
Sarbanes-Oxley (2002)
Scandals of the 1990’s Accounting information shaky and
deceptive (Enron, Worldcom,..)Government responseProtect investors from fraud
Sarbanes-Oxley
Basic provisions Creates Public Company Accounting
Oversight Board Strengthen the independence of auditors
(accountants) Firm directors take responsibility for
numbers
Conflict of Interest Problems
Many investment banks have brokerage sides
They will recommend stocks to investors: Analyst recommendations
What if same firm is doing IPO and writing recommendations?
There is supposed to be a “firewall”
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