Ahmet K. Karagozoglu

The Underwriting Business: Functions, Organization, and Structure

Underwriting is defined as the intermediation service in the capital raising process that takes place in the new issues markets. This chapter describes the services underwriting firms provide to issuers and the functions these firms perform in the new issues markets. The chapter discusses the competencies and skills underwriting firms must develop and possess in order to compete successfully and how investment banks develop these competencies by running multifaceted operations in the primary and secondary capital markets. The chapter also examines the complementarities and synergies as well as conflicts of interest these operations engender as underwriting firms strive to balance their own interests with those of issuers and investors. Furthermore, the chapter reviews the structure of the underwriting industry, describes the factors that impact the structure of underwriting markets and reports information that sheds light on the structure of the industry in the United States and internationally.

The Decision to Issue Securities

This chapter starts by describing the motives that drive firms to go public through an initial public offering (IPO). Next, the chapter discusses the financial and organizational consequences of the going-public decision and their implications on the valuation of the firm as a public entity. This is followed by the development and application of analytical methods that allow the financial evaluation of the decision to proceed with an IPO. The chapter concludes with a discussion of the motives to have a seasoned equity offering (SEO) or a debt offer, respectively, followed by the financial evaluation of the decision to issue seasoned equity or debt.

International Offers: Mechanics and Performance

This chapter starts by describing institutional features that are found in securities offerings in major foreign markets in Europe and Asia. This is followed by a review of empirical evidence on the initial and long-run price performance of new issues executed in markets outside the United States. The chapter also presents evidence on foreign issues completed in the United States as well as on the international offerings of US firms. The chapter concludes with an overview of equity offers conducted in privatization programs of state-owned enterprises. The chapter discusses both the theory about the structure and initial pricing of share issue privatization offers as well as the empirical evidence in regards to the initial pricing and the long-run price and operating performance of share issue privatizations.

3 – Regulation of the New Issues Market in the United States

This chapter provides an overview of the regulation of the securities markets in the United States with primary focus on the regulation of the new issues (i.e., primary) markets. The chapter describes regulations that pertain to traditional registration as well as to shelf registration and Rule 415 offerings. In addition, the chapter covers the regulation of private placement and various registration simplifications. The chapter also summarizes regulatory provisions adopted in recent laws. The chapter concludes with an overview of the regulation of new issues conducted by US issuers abroad as well as the regulation of new issues conducted by foreign firms in the United States.

2 – The New Issues Markets

This chapter provides an overview of the new issues markets for raising equity and debt in the United States and abroad. The chapter explains the different roles of public and private markets as well as those of primary and secondary markets. The chapter also describes the different types of international equity and debt instruments and their markets and presents statistics that show the growth of new issues markets. Finally, the chapter discusses trading mechanics in secondary markets and reviews the major secondary markets in the United States, Europe, and Asia.

The Price and Operating Performance of Seasoned Equity Offers, Debt Offers and Other Offerings

This chapter presents the empirical evidence on the initial pricing and long-run return performance of seasoned equity issues (SEOs), debt issues, and other special types of issues, including dual-share offers and private investments in public equity (PIPE). In addition to the general findings on initial and long-run returns of SEOs and bond issues, the chapter reviews empirical studies that offer various perspectives on the factors that affect the short- and long-run price performance of equity and debt issues. The chapter also presents and discusses the empirical findings relating to the operating performance of firms that conduct equity or debt offerings. The chapter concludes with a review of the mechanics in PIPE and the empirical findings concerning their pricing.

The Price and Operating Performance of Initial Public Offerings

This chapter presents the empirical evidence in relation to three important topics: the initial pricing of initial public offerings (IPOs); their long-run return performance; and the operating performance of firms conducting IPOs. The chapter also presents summary statistics on initial and long-run returns produced by various studies of US IPOs. The chapter reviews empirical findings that explain the influence of various market and firm characteristics as well as institutional factors on the initial and long-run returns of IPOs, respectively. The chapter also discusses the phenomenon of “hot issue” markets and whether IPOs are efficiently priced. The chapter concludes with a presentation and discussion of the findings pertaining to the long-run operating performance of firms following IPOs.

Structuring Securities Offerings

This chapter presents the choices issuers need to make with respect to various features of a new issue offering. Issuers can choose between a private and public offering; a general cash offer and a rights offering; a traditional and shelf-registration offering; a negotiated and competitive offering; a firm commitment, and “best efforts” contract. In structuring offerings, issuers also consider the composition of the postoffer ownership of equity, the price level of the firm’s shares, and the listing venue of the new securities. This chapter discusses the criteria that are important in making these decisions as well as the pertinent empirical evidence.

Alternative Offering Methods in New Issues Markets

This chapter discusses variations of the bookbuilding-offering method as well as other methods used in the offering of securities in markets around the world. The chapter describes types of accelerated-offering methods, the subscription and auction methods, as well as hybrid-offering methods. The chapter also discusses the mechanics and the experience with online offerings through the internet. The chapter concludes with a review of the theoretical arguments and empirical findings that help analyze and evaluate the relative benefits and costs of alternative offering methods with respect to expected size of proceeds, allocation across investor clienteles, issuance costs, and the pricing of new issues.

Underwriting Costs and Compensation

This chapter discusses the various components of costs incurred in the flotation of new issues and the process by which an underwriter arrives at the estimation of the underwriter compensation under a firm commitment contract. The chapter describes a four-step process that includes estimating the expected market price of the new issue; setting the offer price; determining the expected underwriting costs; and setting the bid price. The chapter examines the various factors that contribute to the cost of providing the various underwriting services and explains how the underwriting risk can be priced as an insurance service or within a contingent claims framework. The chapter also explores various relationships and tradeoffs the underwriter faces in regards to the components of underwriting costs and in determining the underwriter compensation or gross spread.