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10Stock Offerings and Investor Monitoring

© 2003 South-Western/Thomson Learning

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Chapter Objectives

Describe the stock exchanges where stocks are traded

Analyze the process of the initial public offering of stock by a company

Be able to interpret a stock quote Explain the institutional use of stock markets Describe the globalization of stock markets

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Common stock = certificate representing equity or partial ownership in a corporation

Issued in primary market by corporations that

need long-term funds

Stock is then traded in the secondary market, creating liquidity for investors and company

evaluation for managers

Background on Common Stock

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Background on Common Stock

Owners of common stock vote on: Election of board of directors Authorization to issue new shares Amendments to corporate charter Other major events

Many investor assign their vote to management via a proxy

Households own about half of all common stock, the rest is owned by institutional investors

Ownership and Voting Rights

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Background on Preferred Stock Represents equity or ownership interest, but

usually no voting rights Trade voting rights for stated fixed annual

dividend Dividend paid before common if dividends are

declared by board of directors Dividend may be omitted

Cumulative provision If common dividend paid, preferred dividend fixed

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Public Placement of Stock Initial public offerings (IPOs)

First-time offering of shares to the public Firm must provide information to public

Registration statement to SEC Prospectus Firm is assisted by an investment banker

Performance of IPOs Price generally rises on first day Longer-term performance of IPOs is poor

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Public Placement of Stock Secondary stock offerings

New stock issued by firm that already has shares outstanding

Shelf Registration 1982 SEC rule Allows firms to place securities without the time

lag associated with registering with SEC

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Stock Secondary Markets

Execute secondary market transactions Examples: NYSE, AMEX, Midwest, Pacific NYSE is largest, controlling 80 percent of value

of all organized exchanges Must own a seat on exchange in order to trade Trading resembles an auction

Organized Exchanges

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Stock Secondary Markets

No trading floor or specific location Telecommunications network Nasdaq

National Association of Securities Dealers Automatic Quotations

Thousands of small firms, plus high-tech giants

Pink sheets Tiny firms that do not meet requirements for NASDAQ

Over-the-Counter Market

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Stock Secondary Markets Trend: Consolidation of stock exchanges Market microstructure

Specialists, floor brokers, and market-makers Role of specialists

Types of orders Market order Limit order Stop order

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Stock Secondary Markets Changes in technology

Online trading Real-time quotes Company information Electronic Communications Networks (ECNs)

Margin requirements Specify amount of borrowed versus amount in cash

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Stock Secondary Markets Purchasing stock on margin

Borrow a portion of the funds from broker Margin is the amount of equity an investor provide Magnifies returns (both good and bad)

Short sales Borrow stock and sell Repay stock loan, hopefully at a lower price Investor able to have potential profit from decline in

stock price

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Regulation of Trading on Stock ExchangesSecurities Act Of 1933 and 1934

Securities And Exchange Commission

National Association Of Securities Dealers (NASD)

Regulate minimum information for investor and broker/dealer business practices

Circuit breakers

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Stock Quotation Stock Quotation

52-week price range (high/low and YTD% change) Stock symbol Dividend annualized and dividend yield Price-earnings ratio Volume in round lots Previous day’s price close and net daily change Remainders in cents, not eighths

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Exhibit 10.6

YTD %change Hi Lo Stock Sym DIV Yld% PE Vol 100s Last Net Chg

110.3 121.88 80.06 IBM IBM .56 .6 20 71979 93.77 11.06

Year-to-date Highest Lowest Name Stock Annual Dividend Price- Trading Closing Change in thepercentage price price of stock Symbol dividend yield, which earnings volume stock stock pricechange in of the of the paid per represents ratio based during the price on the previ-stock price stock stock year the annual on the previous ous trading

in this in this dividend as prevailing trading day day from theyear year a percentage stock price close on the

of the pre- day beforevailing stockprice

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Stock Indexes Dow Jones Industrial Average

Price-weighted average 30 large U.S. firms

Standard and Poor’s (S&P) 500 Value-weighted 500 large U.S. firms

New York Stock Exchange Indexes Other Stock Indexes

Amex, NASDAQ

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Stock Indexes Investing in stock indexes

Indexing Has become very popular

Lower transactions costs Studies find that actively-managed funds do not

outperform stock indexes

Examples of publicly traded stock indexes SPDRs Diamonds

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Stock Market Performance Comparing stock performance to bond

performance

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Investor Trading Decisions Stock value = proportional value of total

company Investor return = dividend yield + capital

gain/loss New information translated into trading

decisions impacting supply/demand for shares New equilibrium price established until new

information appears

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Exhibit 10.8Increased

Demand for

Security

Reduced

Supply of

Security

for Sale

Increase in

Equilibrium

(Market)

Price of

Security

New

Favorable

Information

Disclosed

to Investors

New

Unfavorable

Information

Disclosed

to Investors

Increased

Valuation

of

Security

by Investors

Reduced

Valuation

of

Security

by Investors

Reduced

Demand for

Security

Increased

Supply of

Security

for Sale

Decrease in

Equilibrium

(Market)

Price of

Security

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Institutional Participation in Stock Markets

Program trading by institutions Simultaneously buying and selling of a portfolio of

at least 15 different stocks valued at more than $1 million

Most commonly used by securities firms Program refers to the use of computers Impact on stock volatility

Often blamed for rise or fall in stock market Studies show that program trading does not increase

volatility

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Investor Monitoring of Firms in the Stock Market Shareholder activism

An investor who is dissatisfied with the way managers are running a firm has three choices:

Sell

Do Nothing

Flush!

Shareholder Activism

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Investor Monitoring of Firms in the Stock Market Communication with the firm

Effort to place pressure on management Institutional investors

CALPERS TIAA

Proxy contest Shareholder lawsuits

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Corporate Monitoring of Firms in the Stock Market

Market for corporate control Stock price declines due to poor management Subject to possible takeover

Barriers to market for corporate control Antitakeover amendments Poison pills Golden parachutes

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Corporate Monitoring of Their Own Stock in the Stock Market Stock repurchases

Dividend alternative or undervalued stock Excessive cash relative to +NPV investments

Leveraged buyouts (LBO) If managers believe the stock price undervalued,

they may buy the outstanding shares with borrowed funds

Stock offerings Signals overvalued shares

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Globalization of Stock Markets Barriers to international stock trading have

decreased Reduction in information costs Reduction in exchange rate risk

Foreign stock offerings in the United States International placement process Global stock exchange characteristics Emerging stock markets

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Globalization of Stock Markets Methods used to invest in foreign shares

Direct purchases American Depository Receipts (ADRs) International mutual funds World equity benchmark shares

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Globalization of Stock Markets Global diversification and integration among stock

markets Integration of markets during the 1987 crash

All major stock markets declined, indicating the underlying cause systematically affected all markets

Integration of markets during mini-crashes Example: August 27, 1998 “Bloody Thursday” Russian financial crisis

Increased integration associated with increased financial technology, competition, and lessened government regulation