Chapter 19: Issuing Equity Securities to the Public
Answers to suggested problems
19.1 a. A general cash offer is a public issue of a security that is sold to all interested investors. A general cash offer is not restricted to current stockholders.
b. A rights offer is an issuance that gives the current stockholders the opportunity to maintain a proportionate ownership of the company. The shares are offered to the current shareholders before they are offered to the general public.
c. A registration statement is the filing with the SEC, which discloses all pertinent information concerning the corporation that wants to make a public offering.
d. A prospectus is the legal document that must be given to every investor who contemplates purchasing registered securities in a public offering. The prospectus describes the details of the company and the particular issue.
e. An initial public offering (IPO) is the original sale of a company’s securities to the public. An IPO is also called an unseasoned issue.
f. A seasoned new issue is a new issue of stock after the company’s securities have previously been publicly traded.
g. Shelf registration is an SEC procedure, which allows a firm to file a master registration statement summarizing the planned financing for a two year period. The firm files short forms whenever it wishes to sell any of the approved master registration securities during the two year period.
19.2 a. The Securities Exchange Act of 1933 regulates the trading of new, unseasoned securities.
b. The Securities Exchange Act of 1934 regulates the trading of seasoned securities. This act regulates trading in what is called the secondary market.
19.3 Competitive offer and negotiated offer are two methods to select investment bankers for underwriting. Under the competitive offers, the issuing firm can award its securities to the underwriter with the highest bid, which in turn implies the lowest cost. On the other hand, in negotiated deals, underwriter gains much information about the issuing firm through negotiation, which helps increase the possibility of a successful offering.
19.4 a. Firm commitment underwriting is an underwriting in which an investment banking firm commits to buy the entire issue. It will then sell the shares to the public. The investment banking firm assumes all financial responsibility for any unsold shares.
b. A syndicate is a group of investment banking companies that agree to cooperate in a joint venture to underwrite an offering of securities.
c. The spread is the difference between the underwriter’s buying price and the offering price. The spread is a fee for the services of the underwriting syndicate.
d. Best efforts underwriting is an offering in which the underwriter agrees to distribute as much of the offering as possible. Any unsold portions of the offering are returned to the issuing firm.
19.5 a. The risk in a firm commitment underwriting is borne by the underwriter(s). The syndicate agrees to purchase all of an offering. Then they sell as much of it as possible. Any unsold shares remain the responsibility of the underwriter(s). The risk that the security’s price may become unfavorable also lies with the underwriter(s).
b. The issuing firm bears the risk in a best efforts underwriting. The underwriter(s) agrees to make its best effort to sell the securities for the firm. Any unsold securities are the responsibility of the firm.
19.8 There are two possible reasons for stock price drops on the announcement of a new equity issue:
i. Management may attempt to issue new shares of stock when the stock is over-valued, that is, the intrinsic value is lower than the market price. The price drop is the result of the downward adjustment of the overvaluation.
ii. With the increase of financial distress possibility, the firm is more likely to raise capital through equity than debt. The market price drops because it interprets the equity issue announcement as bad news.
19.9 The costs of new issues include underwriter’s spread, direct and indirect expenses, negative abnormal returns associated with the equity offer announcement, under-pricing, and green-shoe option.