1 Raising Capital Nandita Singh Ginette Smith Judith Muturi

2 Topics of Discussion Raising Capital: Theory and Evidence A survey of US Corporate Financing Innovations Initial Public Offerings Internet Investment Banking Are Bank Loans different? Convertible Bonds Origin of Lyons Hybrid Debt Project Finance in Infrastructure Investments

3 Raising Capital: Theory and Evidence Average abnormal returns are consistently either negative or not significantly different from zero There are no examples of a significant positive result

4 Possible Explanations: EPS Dilution Price Pressure Optimal Capital Structure Insider Information Unanticipated Announcements Ownership Changes

5 Marketing Securities: Rights vs. Underwritten Offerings Negotiated vs. Competitive Bid Contracts Shelf vs. Traditional Registration IPOs: Underpricing Best Effort vs. Firm Commitment Stabilization and the “Green Shoe” Option

6 Conclusions: Table 6, pg The primary cause for the negative response to new stock issues is the potential for management to exploit its inside information by issuing overvalued equity. Management should be sensitive to the way the market is likely to react to an announcement of a new issue.

7 A Survey of US Corporate Financing Innovations: Innovative financial instruments: Tables 3, 4, 5, 6, 7 Objectives: Manage the interest rate risk faced by investors and issuers Reduce information asymmetry Increase the tradability of financial assets

8 Initial Public Offerings Why issue public equity? Lowers cost of K for the firm Liquidity for current stockholders Imp. Information in price movements Lower monitoring costs Why should you not raise public equity?

9 Risk

10 Firm selects an investment bank Decides Best Efforts or Firm Commitment Due Diligence and SEC Regulations Roadshow to estimate demand Pricing Problems The Process of issuing an IPO

11 Why are IPO’s underpriced Compensation for underwriters Compensation for investors Selection bias Litigation bias Collusion Regulatory Constraints Asymmetry of Information Hot Issues Market

12 Hot Issues Cycles in volume and initial returns to investors Initial returns lead volume by 6 to 12 months

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14 ?????? If you were the CFO of a private company how would choose an investment bank? As an investor, how might you take advantage of IPO underpricing? Do you think that IB and firms adapt completely to market conditions?

15 Internet Investment Banking Historically, IB depended on networks of institutional investors II have an incentive to understate interest in IPO’s Favored treatment was necessary Solution: to try to appeal to retail customers

16 Wit Capital: coordinates e-syndicate of customers for small firms No flipping OpenIpo: Sets Price based on highest bid from public Difference: One coordinates investor, the other offers them a voice Problems: Winners curve Innovations

17 ?????? Is it right to say that the companies function as e-distributors? Why would firms want to use OpenIpo? Goldman Sachs owns 22% of Wit Capital. Implications? Does this imply the end of relationship based banking?

18 Summary As the cost of direct communication with individual investors has decreased, the relative cost or relationship based production technology has increased Investors should be smart and invest in IPO’s in the initial period of a hot issue market. Issuers should approach a prestigious IB and disclose information.

19 Are Bank Loans Different?: Some Evidence From the Stock Market Announcements made by public firms of new bank lending agreements elicit a significant positive reaction from the stock market Inside Debt: the lender has access to information that the general public does not have

20 Inside Debt: Advantages: Solution to “information asymmetry” Inside debt holders are in better positions to monitor the firm Confidentiality Saves time and money by avoiding the registration process with the SEC

21 Market Reaction: Uses of debt Choice of maturity also sends a signal to investors Based on the research, bank loans are the most effective form of inside debt

22 LYON Liquid Yield Option Note Zero coupon, Convertible, Callable and Puttable bond introduced by Merrill Lynch

23 Origination To target retail investors Primary activity is to buy calls Risk averse to options Result: Bond is convertible, Puttable and Callable Issuer: Investment grade, volatile stock, name recognition ?

24 Structure Convertible = Long term call Put Option Call Option What happens to value when: interest rate volatility and level of stock price call price and time of call dividend put price

25 ???? Why is a LYON relatively insensitive to a change in interest rates? When would a LYON be a safe investment?