article 20 ipo group 5 mohamed alrashed sahil ghai alisha hanna and duc nguyen n.
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Article #20 - IPO Group 5: Mohamed Alrashed, Sahil Ghai, Alisha Hanna and Duc Nguyen. Introduction. When a privately owned firm or capital venture is turned to publicly owned firm has the capacity to be more liquid and can raise its capital.

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  • When a privately owned firm or capital venture is turned to publicly owned firm has the capacity to be more liquid and can raise its capital.
  • However, the first offers are often risky,; especially to the issuer, investment bank and the investors.
  • The main problem is usually lack of previous operating history of the issuing company hence difficult to propose appropriate initial public offerings.
  • The unhealthy market for IPOs cause young growth companies to have limited channels of accessing public in order to raise capital.
institutional aspects
Institutional Aspects
  • When firm goes Public has the ability to raise more capital.
  • Publicly traded also enable the shareholders and the management team of a company know the firm’s value.
  • When firms go public, they seek and underwriters or their syndicates with the aim of having an added advantage over competitors in the market.
  • Therefore, IPOs are made through best efforts where the issuer and the underwriter negotiate an offering price, alternatively, they use firm commitment method where the underwriter raises all of the desired capital at the negotiated price.
In the firm commitment arrangement, the underwriter buys all the stock from the issue then sells them to the public.
  • When setting the initial public offering, the involved parties have to comply with the securities Act of 1933.
  • According to the act, potential investors should be given a true account of the issue they intent to channel their money to, else they could sue the company.
  • As per the regulations, the underwriter investigates the issuing firm and later files a report containing the required information.
findings about pricing of ipos
Findings about Pricing of IPOs
  • There is evidence, unseasoned new issues are significantly underpriced.
  • Several hypotheses have tried to unravel the reasons behind the phenomena, but none of the explanations have been backed.
  • Moreover, there an existing pattern of ‘hot’ and ‘cold’ new issue markets.
  • Hot issue markets have relatively high returns.
  • The disadvantage of the heavy issue market leads to poor initial performance with light volumes.
setting the prices
Setting the Prices
  • Setting prices of initial public offering is critical to the success of an offering.
  • The main challenge is the uncertainty of the company about the market’s view of their issue.
  • The main challenge for the above reason is the fact that IPO firms have little or no price history.
  • On the other hand, the underwriter must set a price that looks favorable to both the issuer and the investors.
If prices are too high, the issue could be withdrawn leading to the issuer raising no capital, and the banks receives no commission.
  • If prices are too low, the issuer then suffers the dilution of ownership.
  • Generally when raising the capital, the pricing should be such that the issuer realizes full potential when raising capital.
  • An IPO is a one-time-only event but of great significance to the underwriter’s reputation and to new issuers who would like to chose their underwriters.
empirical findings result
Empirical Findings Result
  • Initial public offerings are often significantly underpriced.
  • The more established an issuer, the less investor uncertainty about the firm’s real value → the lower amount of underpricing.
  • Hot and cold performances come in waves, the persistence of which is predictable.
Cold markets have average initial returns that are not necessarily positive.
  • The number of new offerings also comes in waves of heavy and light activity which are highly serially correlated.
  • Underpricing appears to lead the number of new offerings by roughly six to twelve months.
theories to explain ipo underpricing
Theories to explain IPO underpricing
  • Recent explanations:
  • The underwriter has significantly better information than the issuer.
  • New issues must be underpriced to attract not only the informed investors but also the uninformed investors.
Traditional explanations:
  • Regulations require underwriters to set the offering price below the expected value.
  • Underwriters collude to exploit in experienced issuers and to favor investors.
  • Underpriced new issues “leave a good taste” with investors so that future underwritings from the same issuer can be sold at attractive prices.
The underwriter underpriced new issues as compensation because “firm commitment” underwriting spreads do not cover all of the risks.
  • The underwriting process consists of underpricing offerings with full or partial compensation via side payments from investors to underwriters to issuers.
  • The issuer and underwriter perceive that underpricing constitutes a form of insurance against legal suits.
policy implications
Policy Implications
  • Investors’ point of view:
  • The more underpriced an issue, the harder it is to get.
  • “Outsiders” regularly participate in IPO process will only get enough underpriced issues to compensate.
  • No investor receives abnormal gains after all accounts are settled even informed investors and preferred clients.
Issuers’ point of view:
  • Issuers get the highest security prices when he market is willing to pay high multiples for unseasoned new issues.
  • The quality of the underwriter “certifies” the quality of issuer and increases the price that investors are willing to pay.
  • The less uncertainty investors have about that value of the issuing firm, the lower amount of underpricing necessary to attract them.
Advice for investors:
  • Buy new issues during a hot issue market when they are generally underpriced.
  • Buy most in the early part of the cycle when stocks are the most underpriced.
  • Pay attention to the direction of the price change in deciding whether or not to submit a purchase order.
Advice for issuers:
  • Issue in the heavy market that typically follow hot issue markets.
  • Use a firm commitment offering with a prestigious underwriter.
  • Disclose as much information as possible about the firm.