Investment Banking

Public offerings of both stocks and bonds typically are marketed by investment bankers who in this role are called underwriters. More than one investment banker usually markets the securities. A lead firm forms an underwriting syndicate of other investment bankers to share the responsibility for the stock issue.

Investment bankers advise the firm regarding the terms on which it should attempt to sell the securities. A preliminary registration statement must be filed with the Securities and Exchange Commission (SEC), describing the issue and the prospects of the company. This preliminary prospectus is known as a red herring because it includes a statement printed in red, stating that the company is not attempting to sell the security before the registration is approved. When the statement is in final form, and approved by the SEC, it is called the prospectus. At this point, the price at which the securities will be offered to the public is announced.

In a typical underwriting arrangement, the investment bankers purchase the securities from the issuing company and then resell them to the public. The issuing firm sells the securities to the underwriting syndicate for the public offering price less a spread that serves as compensation to the underwriters. This procedure is called a firm commitment; the underwriters receive the issue and assume the risk that the shares cannot be sold to the public at the stipulated offering price. Figure 3.1 depicts the relationships among the firm issuing the security, the lead underwriter, the underwriting syndicate, and the public.

An alternative to the firm commitment is the best-efforts agreement. In this case, the investment banker does not actually purchase the securities but agrees to help the firm sell the issue to the public. The banker simply acts as an intermediary between the public and the firm and does not bear the risk of not being able to resell purchased securities at the offering price. The best-efforts procedure is more common for initial public offerings of common stock, where the appropriate share price is less certain.

Corporations engage investment bankers either by negotiation or competitive bidding, although negotiation is far more common. In addition to the compensation resulting from the spread between the purchase price and the public offering price, an investment banker may receive shares of common stock or other securities of the firm.

As part of its marketing of the firm's securities, the underwriting syndicate typically takes out advertisements in the financial press to announce the prospective sale. An example of

Underwriting Syndicate Figure

these so-called tombstone advertisements is given in Figure 3.2. The underwriters plan to sell 115 million shares of stock at a price of $18.50 each, to raise $2,127.5 million for the Principal Financial Group. The four lead underwriters are presented in larger type; the firms taking a smaller role in marketing the securities are presented below in smaller type. Most of the shares will be sold in the U.S., but 15% of the issue will be sold abroad. Notice that the underwriters for the non-U.S. portion of the issue have far greater international representation.

Shelf Registration

An important innovation in the issuing of securities was introduced in 1982 when the SEC approved Rule 415, which allows firms to register securities and gradually sell them to the public for two years following the initial registration. Because the securities are already registered, they can be sold on short notice, with little additional paperwork. Moreover, they can be sold in small amounts without incurring substantial flotation costs. The securities are "on the shelf," ready to be issued, which has given rise to the term shelf registration.

1. Why does it make sense for shelf registration to be limited in time?

Private Placements

Primary offerings also can be sold in a private placement rather than a public offering. In this case, the firm (using an investment banker) sells shares directly to a small group of institutional or wealthy investors. Private placements can be far cheaper than public offerings. This is because Rule 144A of the SEC allows corporations to make these placements without preparing the extensive and costly registration statements required of a public offering. On the other hand, because private placements are not made available to the general public, they generally will be less suited for very large offerings. Moreover, private placements do not trade in secondary markets like stock exchanges. This greatly reduces their liquidity and presumably reduces the prices that investors will pay for the issue.


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  • edwin
    Why does it make sense for shelf registration to be limited in time?
    7 years ago

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