10

Stock Offerings and Investor Monitoring

2003 South-Western/Thomson Learning

1

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
2

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
3

Background on Common Stock

Ownership and Voting Rights

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
4

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

Public Placement of Stock

Initial public offerings (IPOs)

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

statement to SEC

is assisted by an investment banker

Performance of IPOs
Price

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

6

Public Placement of Stock

Secondary stock offerings

New stock issued by firm that already has shares outstanding 1982 SEC rule Allows firms to place securities without the time lag associated with registering with SEC

Shelf Registration

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

8

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 NASDAQ9

Stock Secondary Markets

Trend: Consolidation of stock exchanges Market microstructure

Specialists, floor brokers, and market-makers

Role of specialists
Market order Limit order Stop order
10

Types of orders

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

11

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
12

Regulation of Trading on Stock Exchanges

n

Securities Act Of 1933 and 1934

n
n

Securities And Exchange Commission

National Association Of Securities Dealers (NASD) Regulate minimum information for investor and broker/dealer business practices Circuit breakers
13

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

14

Exhibit 10.6
YTD % change 110.3 Year-to-date percentage change in stock price

Hi 121.88 Highest price of the stock in this year

Lo 80.06 Lowest price of the stock in this year

Stock IBM Name of stock

Sym IBM Stock Symbol

DIV .56 Annual dividend paid per year

Yld% .6 Dividend yield, which represents the annual dividend as a percentage of the prevailing stock price

PE 20 Priceearnings ratio based on the prevailing stock price

Vol 100s 71979 Trading volume during the previous trading day

Last 93.77 Closing stock price

Net Chg 1 1.06 Change in the stock price on the previous trading day from the close on the day before

15

Stock Indexes

Dow Jones Industrial Average

Price-weighted average 30 large U.S. firms Value-weighted 500 large U.S. firms

Standard and Poors (S&P) 500

New York Stock Exchange Indexes Other Stock Indexes

Amex, NASDAQ

16

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
17

Stock Market Performance

Comparing stock performance to bond performance

18

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
19

Exhibit 10.8
New Favorable Information Disclosed to Investors Increased Valuation of Security by Investors Increased Demand for Security Increase in Equilibrium (Market) Price of Security

Reduced Supply of Security for Sale

New Unfavorable Information Disclosed to Investors

Reduced Valuation of Security by Investors

Reduced Demand for Security

Increased Supply of Security for Sale

Decrease in Equilibrium (Market) Price of Security

20

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

21

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
22

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

23

Corporate Monitoring of Firms in the Stock Market

Market for corporate control

Stock price declines due to poor management Subject to possible takeover Antitakeover amendments Poison pills Golden parachutes
24

Barriers to market for corporate control

Corporate Monitoring of Their Own Stock in the Stock Market

Stock repurchases

Dividend alternative or undervalued stock Excessive cash relative to +NPV investments If managers believe the stock price undervalued, they may buy the outstanding shares with borrowed funds Signals overvalued shares

Leveraged buyouts (LBO)

Stock offerings

25

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
26

Globalization of Stock Markets

Methods used to invest in foreign shares

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

27

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

28