Incentives to Underprice
This journal written by Grame Camp, Aimee Comer and Janice C.Y. How, is an in-depth analysis of share pricing and directly relates to IPO’s (Initial Public Offerings) and how often under pricing your shares initially doesn’t detract from overall net worth and in fact can lead to greater increases in wealth due to future economic benefits gained from shareholder support and confidence as a result of the initial sale of shares at a loss. This theory is primarily supported by Rock (1986), Habib and Ljungqvist (2001) and Barry (1989) who have all got works published on this matter.
Under pricing of IPO’s is a very common practice, studies show that under pricing ranges from 4.2 per cent in France to upwards of 80.3 per cent in Malaysia. Under pricing is frequently described as ‘money left on the table ,’ with the implication that the issuer incurs a wealth loss from trading the IPO shares at a reduction. Ljungqvist suggests that the choice issuers make at the IPO are strategic as they generate a wealth benefit in the aftermarket which ratifies the wealth loss suffered from the offering. The theory as supported by Ljungqvist is that ‘higher direct issue costs associated with an issuer’s choice to book build are traded off by a lower level of under pricing. This in turn impacts on wealth through the level of ownership retention. Focusing on increased trading volume in the immediate aftermarket as a wealth benefit from the IPO, the results support the notion that the choices issuers make at the offering generate a compensatory benefit in the aftermarket. Specifically, issuers’ choices that result in higher under pricing and wealth loss also result in higher trading volume in the aftermarket .’
In its most simple form the reason a company enters into the stock market to begin with is to refinance the firm and to obtain new funds, this will lead to added liquidity in their investments and diversification in their portfolio. It is for these gains that you can see why the choices businesses make at the offering (under pricing) may seem unfounded when considered on its own, but when viewed within the multidimensional menu of options they seem rational. It really is crucial therefore to highlight the need to consider issuers’ wealth in the perspective of all the choices they make, not only in the view of one alternative such as the offer price and, therefore, under pricing.
The purpose of this paper is to provide a summary of the article called “Can We Keep Our Promises?” by Robert D. Arnott, and to help better understand the three key risks facing each investor.
Grand Metropolitan PLC is the world’s largest wine and spirits seller. It mainly operated in London, USA. In 1991, it beats market expectation with a 4.8% increase in pretax profits, and the company Chairman stated that company’s goal “to constantly improve on”. Despite the great performance in the world recession in 1991, the price of GrandMet shares was 10% below the average price/earnings ratio of the companies in the Standard & Poor’s 500 index. And more important, rumors had that GrandMet, valued at more than $14 billion in the stock market, maybe a takeover target. The management dilemma is to understand why the company’s stock is traded below of what considered being the right price and whether the company is truly being undervalued by the market or there are consistent issues with negative NPV projects and lines of businesses.
Ross, S.A., Westerfield, R.W., Jaffe, J.F., & Roberts, G.S (2001) Corporate Finance. 3 th ed.Toronto, McGraw-Hill Ryerson.
A very slim minority of firms distribute dividends. This truism has revolutionary implications. In the absence of dividends, the foundation of most - if not all - of the financial theories we employ in order to determine the value of shares, is falsified. These theories rely on a few implicit and explicit assumptions:
To first understand what a great company is, Collins used data to answer the follow question: “can a good company become a great company, and if so, how?” The data Collins used on the 1,435 companies to see if they became a great company looks at the company’s cumulative stock return for 15 years, security prices, stock splits, and reinvested dividends.1 He then compared the data to the general stock market, omitting all companies who showed patterns similar to industrial average shifts. After narrowing down the data and comparing it to companies who once had short-lived greatness, Collins found 11 companies that showed distinctive patterns that were higher then overall industrial averages. According to his research; a dollar invested into a mutual fund of a good to great company in 1965 would be worth $470 in 2000, while the same amount would only be worth $56 in the general stock market. These exceptional numbers are on of the factors that lead Collins to believe a company went from good to great.1
There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than external financing which is due to adverse selection, asymmetry of information, and agency costs (Frank & Goyal, 2003). The trade-off theory comes from the pecking order theory it is an unintentional outcome of companies following the pecking-order theory. This explains that firms strive to achieve an optimal capital structure by using a mixture debt and equity known to act as an advantage leverage. Modigliani and Miller (1958) showed that the decisions firms make when choosing between debt and equity financing has no material effects on the value of the firm or on the cost or availability of capital. They assumed perfect and frictionless capital markets, in which financial innovation would quickly extinguish any deviation from their predicted equilibrium.
The process of doing this cased the company to ask for help from other competitors about the exact price to offer in the market. Investors knew that the price might be among 22 to 24 per share. However, the JetBlue noticed that the IPO demand is anticipated to be more than 5.5 million. Thus, the management requested to increase its price to 25-26, this would make the management concerned to convince the shareholders that the higher price improve the company in the market. Furthermore, the company was scared if this strategy would hurt sales in future. They should decide if the higher price would improve company technique in stock
Is The Tyranny Of Shareholder Value Finally Ending? N.p., n.d. Web. The Web.
Investor psychology and security market under- and overreactions, Journal of Finance, 53, No. 1. 6, pp. 58-78. 1839 - 1885 - 1885. i.e. a. Burton G. Malkiel, 2003. The Efficient Market Hypothesis and Its Critics, Journal of Economic Perspectives, Vol.
Berk, J., & DeMarzo, P. (2011). Corporate finance: The core, second edition. (2nd ed.). Boston, MA: Prentice Hall.
Loos, N. (2006). Value creation in leveraged buyouts: Analysis of factors driving private equity investment performance. Wiesbaden: Deutscher Universitäts Verlag.
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
The modern theory of price discrimination began with the work of Arthur Cecil Pigou (1877- 1959) and is defined by Machlup (1955): "Price discrimination may be defined as the practice of a firm or group of firms of selling (leasing) at prices disproportionate to the marginal costs of the products sold (leased) or of buying (hiring) at prices disproportionate to the marginal productivities of the factors bought (hired)". But in simpler terms, "price discrimination is often defined as charging different customers different prices for the same or highly similar offering" (Smith, 2004). The motive behind this is to increase profit by reducing consumer surplus. If the same price is charged to all consumers, some potential revenue is lost since some of the consumers would have been prepared to pay more. But before answering the question of whether firms should price discriminate or not, we will have to distinguish between the various types of price discrimination and before that it is important to note that there are three necessary conditions for a firm to practise price discrimination, namely, the firm must be a price maker, the elasticity of demand must be different in the different markets and finally, the market must be clearly separated.
The capital structure of a firm is the way in which it decides to finance its operations from various funds, comprising debt, such as bonds and outstanding loans, and equity, including stock and retained earnings. In the long term, firms seek to find the optimal debt-equity ratio. This essay will explore the advantages and disadvantages of different capital structure mixes, and consider whether this has any relevance to firm value in theory and in reality.
Most critical to this discussion is a clear understanding of what a financial manager is and does and how his or her role aids in helping to establish the valuation of a corporate entity in today's global financial market. Quite simply, a financial manager helps to measure a company's market value and its risk, while also helping to systematically reduce its costs and the time necessary to make informed decisions regarding objective driven operations. This is quite a demanding game plan for an individual and most often financial managers, in the corporate world, working in cooperation with a team of financial experts. Each member of that team perhaps having expertise in differing areas of activity, but each however, being no less expert in his or her respective area of endeavors on behalf of the corporation. The team is assembled under the direction of the officer known in the corporation as the Chief Financial Officer who today is becoming increasingly indispensable to the CEO who directs a modern model of action driven, bottom-line oriented corporate activity (Couto, Neilson, 2004).