Corporate Financial Decision Making - Raising Capital: Equity

Flashcards covering the fundamentals of raising equity capital, including IPO processes, underpricing theories, SEO methods like rights issues and private placements, and the Australian regulatory environment.

Investment Policy

The corporate decision determining which investment projects a firm should undertake, also known as capital budgeting.

Financing Policy

The corporate decision regarding how a firm obtains funds, specifically the choice between debt and equity.

Payout Policy

The corporate decision concerning how a firm returns cash to its owners/investors.

Ordinary Shares

The most common form of equity, characterized by full voting rights and a residual claim on returns and capital during liquidation.

Angel Finance

An informal market for direct equity finance provided by a small number of high net worth individuals.

Venture Capital

An active financial intermediary that manages funds from investors to provide financing to early-stage and high-potential start-up companies, typically for 5-7 years.

Initial Public Offering (IPO)

The process by which a firm sells equity to the public for the first time.

Seasoned Equity Offering (SEO)

The sale of shares in a company that is already publicly traded.

Primary Market

The market where transactions occur directly between the issuing firm and investors.

Secondary Market

The market where transactions occur between investors, such as a stock exchange.

Underwriter

An entity that, for a fee, guarantees all issued shares in a float will be sold and is liable to purchase any remaining unsold shares.

Prospectus

A legal document detailing the IPO that is used to market the float to potential investors.

Book-building

A process where underwriters ask institutional investors to indicate the quantities and prices they would purchase, recorded in a "book" to reduce price uncertainty.

Dutch Auction

An open auction process where investors submit bids and securities are sold to successful bidders, utilized in Google’s 2004 IPO.

Underwriting Spread

A direct cost of an IPO representing the difference between the underwriters’ buying price and the offering price, usually amounting to $7\%$ of proceeds.

Underpricing

An indirect cost of an IPO where securities are issued at an offering price below the actual market value, calculated as: $\frac{\text{First-day closing price} - \text{Offer price}}{\text{Offer price}}$.

Winner’s Curse

An explanation for underpricing based on information asymmetry, where IPOs must be underpriced to keep uninformed investors in the market.

Market Feedback Hypothesis

The theory that issuers underprice shares to induce institutional investors to reveal the firm's true market value during the book-building process.

Litigation Insurance

The theory that underpricing reduces the likelihood of subscribers suing the underwriter and company if shares subsequently perform poorly.

Signaling

The use of underpricing to leave a "good taste" with investors, making it easier for the firm to raise capital at higher prices in the future.

Impresario Hypothesis

The theory suggesting that investment bankers initially underprice IPOs to create an appearance of excess demand.

Private Placement

A seasoned equity offering involving the issue of new shares to a limited number of investors, usually financial institutions, often resulting in a transfer of wealth if issued at a discount.

Rights Issue

A new share issue offered to existing shareholders on a pro-rata basis at a fixed subscription price ($S$).

Theoretical Ex-rights Price ($X$)

The weighted average share price once it begins trading without the rights, calculated as: $X = \frac{1 \times S + N \times M}{N + 1}$ where $N$ is the number of shares held for each new one and $M$ is the market price cum-rights.

Value of the Right ($R$)

The theoretical market value of the entitlement to purchase an additional share, calculated as: $R = (X - S)$ or $R = \frac{N \times (M - S)}{N + 1}$.

Renounceability

A feature of most rights issues allowing shareholders to either exercise the rights, let them lapse, or sell them to a third party on the exchange.

Dividend Reinvestment Plan (DRP)

A scheme allowing shareholders to use dividends to apply for new shares without transaction costs, usually at a $5-10\%$ discount.

ASX Listing Rule 7.1

A regulation prohibiting a company from issuing more than $15\%$ of its issued capital within a 12-month period without prior shareholder approval.

Continuous Disclosure

An ASX Listing Rule requiring companies to immediately notify the exchange of any information likely to affect the share price.