Stock Offerings and Investor Monitoring

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10

• Stock Offerings and Investor Monitoring

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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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Background on Common Stock

• 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

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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
5
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
Organized Exchanges

• 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

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Stock Secondary Markets
Over-the-Counter Market

• 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

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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 Exchanges

• Securities 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 days price close and net daily change
• Remainders in cents, not eighths

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Exhibit 10.6
a
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Stock Indexes

• Dow Jones Industrial Average
• Price-weighted average
• 30 large U.S. firms
• Standard and Poors (SP) 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 10.8
a
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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