Presentation on theme: "Common Stock and the Investment Banking Process"— Presentation transcript:
1Common Stock and the Investment Banking Process Besley Chapter 16
2Balance Sheet Accounts and Definitions Common EquityThe sum of the firm’s common stock, paid in capital, and retained earnings, which equals the common stockholders’ total investment in the firm, stated at book valuePar ValueThe nominal or face value of a stock or bond
3Balance Sheet Accounts and Definitions Retained EarningsThe balance sheet account that indicates the total amount of earnings the firm has not paid out as dividends throughout its historyAdditional Paid-In CapitalFunds received in excess of par value when a firm issues new stock
4Common Equity Accounts as of December 31 (in millions of dollars, except per share data)Common Stock (40 million sh.authorized, 25 million sh. out, $1par) $25.0 $25.0Additional paid-in CapitalRetained EarningsTotal Common Stockholder EquityBook Value per Share $16.60 $15.60
5Balance Sheet Accounts and Definitions Book Value Per ShareThe accounting value of a share of common stockCommon stock + Paid-in capital + Retained earningsNumber of shares outstanding=Book Value is based on historic value and may differ greatly from market value.
6Control of the Firm Legal Rights and Privileges of Common Stockholders Stockholders elect the firm’s directors, who select the officers that manage the business.Normally, each share entitles the owner to one vote.Proxy - A document giving one person the authority to act for another, typically the power to vote shares of common stock.
7Legal Rights and Privileges of Common Stockholders Control of the FirmProxy Fight - An attempt by a person or group to gain control of a firm by getting its stockholders to grant the person or group the authority to vote their shares in order to elect a new management team.
8Control of the Firm Legal Rights and Privileges of Common Stockholders Takeover - An action whereby a person or group succeeds in ousting a firm’s management and taking control of the company.Management attempts to prevent takeovers include:Stagger Director elections – elect 1/3 of the directors each year.Shareholder approvals - Require 75% of the shareholders to approve a merger (rather than 50%).“Poison Pills” – provision that allows shareholders, during a take over, to purchase additional shares at a discounted rate (which makes the take over undesirable).
9Legal Rights and Privileges of Common Stockholders The Preemptive RightA provision in the corporate charter or bylaws that gives common stockholders the right to purchase on a pro rata basis new issues of common stock (or convertible securities).
10Types of Common StockClassified Stock - Common stock that is given a special designation, such as Class A, Class B, etc., to meet the special needs of the companyFounder’s Shares - The class of stock owned by the firm’s founders who have sole voting rights
11From the Corporation’s Viewpoint Evaluation of Common Stock as a Source of FundsFrom the Corporation’s ViewpointAdvantagesCommon stock does not obligate the firm to make payment to shareholders.Carries no fixed maturity date.Generally increases a firm’s creditworthiness, raises bond rating, lowers cost of capital.When a firm’s future appears positive, common stock can be sold for on better terms.DisadvantagesGives voting rights and perhaps control to new shareholders.Dilution of Profits (especially when compared to debt financing)Higher issuance costsWhere the firm has exceeded it optimal capital structure, the cost of capital will be higher than necessary.Non-deductability of dividends for tax purposes
12From a Social Viewpoint Evaluation of Common Stock as a Source of FundsFrom a Social ViewpointCommon stock does not require periodic fixed payments, which may add additional financial pressure during times of hardship.
13Corporations and Markets The Market for Common StockCorporations and MarketsClosely Held Corporation - One that is owned by a few individuals who are typically associated with the firm’s managementPublicly Owned Corporation - One that is owned by a relatively large number of individuals who are not involved in its managementOver-The-Counter (OTC) Market - The network of dealers that provides for trading securities not listed on the organized exchanges (these stocks are generally said to be unlisted)Organized Security Exchange - A formal organization having a tangible physical location, that facilitates trading in “listed” securities: NYSE, AMEX
14Corporations and Markets The Market for Common StockCorporations and MarketsCompanies generally first list on a regional exchange (such as the Chicago, or Midwest Exchange)As the company grows it will move up to the American Stock Exchange (AMEX) or the New York Stock Exchange (NYSE)Most Companies are traded on the OTC market (5,000 to 8,000 actively traded stocks), however, the NYSE (which lists approximately 3,000 stocks) accounts for about 60% of the daily transactions.Institutional investors (which include pension trusts; insurance companies; and mutual funds) own approximately 45 – 50% of all common stock and account for more than 75% of the trading volume.
15Types of Stock Market Transactions The Market for Common StockTypes of Stock Market TransactionsPrimary Markets:New public offerings by privately held firmsInitial Public Offering (IPO) Market - The market consisting of stocks that have just gone publicGoing Public - The act of selling stock to the public at large by a closely held corporation or its principal stockholdersAdditional shares sold by established, publicly owned companiesThe Secondary Market - Trading in the outstanding shares of established, publicly owned companies
16Types of Stock Market Transactions The Market for Common StockTypes of Stock Market TransactionsThe need for additional capital prompts companies to “go public.”A firm will look to the equity markets when its growth can no longer be financed by solely by additional debt and the existing stockholder base.The additional financing opportunities provided by the markets do require strict financial reporting and disclosure as well as adherence security regulations.
17The Decision to List the Stock The Market for Common StockThe Decision to List the StockTo have its stock listed, a company must:Apply to the exchangePay a relatively small feeMeet the exchange’s minimum requirementsNet Income# of shares outstanding and held by outsidersBenefits of listing:Listed companies receive free advertising and publicityStatus as a listed company enhances their prestige
18The Decision to List the Stock The Market for Common StockThe Decision to List the Stock
19Regulation of Securities Markets The Market for Common StockRegulation of Securities MarketsSecurities Exchange CommissionThe U.S. Government agency that regulates the issuance and trading of stocks and bondsRegistration StatementA statement of facts filed with the SEC about a company that plans to issue securitiesProspectusA document describing a new security issue and the issuing companySEC lawyers and accountants analyze both the registration statement and the prospectus; if the information is inadequate or misleading, the SEC will delay or stop the public offering.
20Regulation of Securities Markets The Market for Common StockRegulation of Securities MarketsSecurities Exchange Commission Regulations:Ensure investors receive fair financial disclosure from publicly traded companiesDiscourage fraudulent and misleading behavior by the firm’s investors, owners, and employees with the intent of manipulating the stock’s price
21Regulation of Securities Markets The Market for Common StockRegulation of Securities MarketsElements of SEC regulation:Jurisdiction over all interstate offerings of new securities to the general public in amounts of $1.5 million or more.Regulates all national securities exchanges, and companies whose securities are listed on an exchange must file annual reports similar to the registration statement with both the SEC and the exchange.
22Regulation of Securities Markets The Market for Common StockRegulation of Securities MarketsElements of SEC regulation:Reviews stock trades by corporate insiders.Insiders must file monthly reports of changes in their holdings of the firm’s stock.Insiders: Officers, directors, major shareholders, or others who might have inside, or privileged information on a company’s operations.Power to prohibit manipulationControl over the form of the proxy and the way the company uses it to solicit votes.
23Regulation of Securities Markets The Market for Common StockRegulation of Securities MarketsThe Board of Governors of the Federal Reserve System controls the flow of credit into securities transactions through:Margin Requirements - The percentage of a security’s purchase price that must be deposited by investors (currently 50%)Margin Call - a call from a broker asking for more money to support a stock purchase loanBlue Sky Laws - State laws that prevent the sale of securities that have little or no asset backing
24Regulation of Securities Markets The Market for Common StockRegulation of Securities MarketsThe Board of Governors of the Federal Reserve System controls the flow of credit into securities transactions through:Margin Requirements - The percentage of a security’s purchase price that must be deposited by investors (currently 50%)Margin Call - a call from a broker asking for more money to support a stock purchase loanBlue Sky Laws - State laws that prevent the sale of securities that have little or no asset backing
25American Depository Receipts (ADRs) Financial Instruments in International MarketsAmerican Depository Receipts (ADRs)Certificates presenting ownership in stocks of foreign companies; held in trust by a bank in the country in which the stock is traded, and traded on U.S. marketsForeign Equity InstrumentsEuro Stock - a stock that is traded in countries other than the home country of the companyYankee Stock - stock issued by foreign companies that is traded in the United States
26Investment Banker The Investment Banking Process An organization that underwrites and distributes new issues of securitiesHelps businesses and other entities obtain needed financing
27Raising Capital: Stage I Decisions The Investment Banking ProcessRaising Capital: Stage I DecisionsDollars to be raised2. Type of securities used3. Competitive bid versus negotiated deal4. Selection of an investment banker
28Raising Capital: Stage II Decisions The Investment Banking ProcessRaising Capital: Stage II DecisionsReevaluating the initial decisionsBest efforts or underwritten issuesUnderwritten Arrangement - agreement for the sale of securities in which the investment bank guarantees the sale by purchasing the securities from the issuerBest Effort Arrangement - investment bank handling the transaction gives no guarantee that the securities will be soldIssuance CostsUnderwriter’s Spread - The difference between the price at which the investment banking firm buys an issue from the company and the price at which the securities are sold in the primary marketFlotation Costs - The costs associated with issuing new stocks or bondsSetting the offering priceOffering Price - The price at which common stock is sold to the public
29Selling Procedures The Investment Banking Process Underwriting SyndicateA syndicate of investment firms formed to spread the risk associated with the purchase and distribution of a new issuance of securitiesLead or Managing UnderwriterThe member of an underwriting syndicate who actually manages the distribution and sale of a new security offeringSelling GroupA group (network) of brokerage firms formed for the purpose of distributing a new issuance of securities
30Shelf Registrations The Investment Banking Process Securities are registered with the SEC for sale at a later dateThey are held “on the shelf” until the sale
31Maintenance of the Secondary Market The Investment Banking ProcessMaintenance of the Secondary MarketWhen a company is going public for the first time the investment banker is obligated to maintain a market for the shares after the issue has been completedThe lead underwriter agrees to “make a market” in the stock and keep it reasonably liquid