PUBLIC EQUITY

 When a firm goes public, it issues stock in the

primary market in exchange for cash.
 EFFECTS OF GOING PUBLIC

• It changes the firm’s ownership structure by increasing

the number of owners.
• It changes the firm’s capital structure by increasing the
equity investment in the firm, which allows the firm to pay
off some of its debt, expand its operations, or both.
 OWNERSHIP AND VOTING RIGHTS
• The ownership of common stock entitles shareholders to
a number of rights not available to other individuals
• Normally, only the owners of common stock are are
permitted to vote on certain key matters concerning the
firm, such as the election of of the board of directors,
authorization to issue new shares of common stock,
approval of amendments to the corporate charter, and
adoption of bylaws.
 PARTICIPATION IN STOCK MARKETS
• Investors can be classified as individual or institutional.
The investments by individuals in a large corporation
commonly exceeds 50 percent of the total equity. Each
individual’s investment is typically small, however, which
means that ownership is scattered among numerous
individual shareholders.
How Investor Decisions Affect Stock Prices
• Investors make decisions to buy a stock when its market
price is below their valuation, which means they believe
the stock is undervalued. They may sell their holdings of a
stock when the market price is above their valuation,
which means they believe the stock is overvalued.
 INVESTORS RELIANCE IN INFORMATION
• Investors respond to the release of new information that
affects their opinions about a firm’s future performance. In
general, favorable news about a firm’s performance will
make investors believe that the firm’s stock is
undervalued at its prevailing price.
 INITIAL PUBLIC OFFERINGS
• A corporation first decides to issue stock to the public in
order to raise funds. It engages in an initial public offering
(IPO) which is a first-time offering of shares by a specific
firm to the public. An IPO is commonly used not only to
obtain new funding but also to offer some founders and
VC funds a way to cash out their investment.
 Process of GOING PUBLIC
• Since firms that engage in an IPO are not well known to
investors, they must provide detailed information about
their operations and their financial conditions. A firm
planning on going public normally hires a securities firm
that serves as the lead underwriter for the IPO. The lead
underwriter is involved in the development of the
prospectus and the pricing and placement of the shares.
 DEVELOPING A PROSPECTUS
• A few months before the IPO, the issuing firm develops a
prospectus and files it with the Securities and Exchange
Commission (SEC).
• Within about 30 days, the SEC will assess their prospectus and
determine whether it contains all the necessary information.
• Once the SEC approves the prospectus, it is sent to institutional
investors who may want to invest in the IPO.
• In addition, the firm’s management and the underwriters of the
IPO meet with institutional investors.
 PRICING
• The lead underwriter must determine the so-called offer
price at which the shares will be offered at the time of the
IPO.
• The price that investors are willing to pay per share is
influenced by prevailing market and industry conditions
 ALLOCATION OF IPO SHARES
• the lead underwriter may rely on a group (called a syndicate) of
other securities firms to participate in the underwriting process
and share the fees to be received for the underwriting.
• most of the shares are sold to institutional investors, as it is more
convenient for the underwriting syndicate to sell shares in large
chunks.
 TRANSACTION COST
• The transaction cost to the issuing firm is usually 7
percent of the funds raised. For example, an IPO of $50
million would result in a transaction cost of $3.5 million
(0.07 x $50 million)
• It also incurs fees from hiring legal or financial advisers
during this process. Thus, the total cost of engaging in an
IPO may be close 10 percent of the total offering.
UNDERWRITER EFFORTS ENSURE PRICE
STABILITY
• the lead underwriter’s performance can be partially
measured by the movement in the IPO firm’s share price
following the IPO.
• If investors quickly sell the stock that they purchased
during the IPO in the secondary market
 LOCKUP
• the lead underwriter attempts to ensure stability in the
stock’s price after the offering by requiring a lockup
provision, which prevents the original owners of the firm
and the VC firms from selling their shares for a specified
period (usually six months from the date of the IPO)
 TIMING OF IPOs
• Initial public offering tend to occur more frequently during
bullish stock markets, when potential investors are more
interested in purchasing new stocks. Prices of stocks tend
to be higher in these periods, and issuing firms attempt to
capitalize on such prices.
 INITIAL RETURN OF IPOs
• the initial (first-day) return of IPOs in the United States
has averaged 20 percent over in the last 30 years. Such a
return is unusual for a single day and exceeds the typical
return earned on stocks over an entire year.
 FLIPPING SHARES
• Some investors who know about the unusually high initial
returns on IPOs attempt to purchase the stock at its offer
price and sell the stock shortly afterward.