PART 4: CAPITAL STRUCTURE AND PAYOUT POLICY
The importance of SIPs in creating new shareholders derives from the way these issues are generally
priced and allocated. Governments almost always set offer prices well below their expected open-market
value (they deliberately underprice), thereby ensuring great excess demand for shares in the offering. The
issuing governments then allocate shares in a way that ensures maximum political benefit. Invariably,
governments favour employees and other small domestic investors (who typically have never purchased
shares before) with relatively large share allocations, whereas domestic institutions and foreign investors
are allocated far less than they desire. The net result of this strategy is to guarantee that most of the
short-term capital gains of privatisation IPOs are captured by the many citizen – investors (who vote)
rather than by institutional and foreign investors (who do not vote). Furthermore, the long-run returns
to investors who purchase privatising share issues are typically quite high. In all, privatisation share
offerings have done as much as any other single factor to promote the development of international stock
markets since the mid-1990s.12-3f ADVANTAGES AND DISADVANTAGES OF AN IPO
The decision to convert from private to public ownership is not an easy one. The benefits of having
publicly traded shares are numerous, but so, too, are the costs. This section describes the costs and
benefits of IPOs that have been highlighted by the ASX^4 and accounting firm KPMG Peat Marwick.^5 As we
discussed in Section 12-3c, the motivations for going public can be significantly different for continental
European business owners than for their Australian, New Zealand, British or US counterparts.Benefits of Going Public
1 New capital for the company. An IPO gives the typical private firm access to a larger pool of equity capital
than is available from any other source. Whereas venture capitalists can provide perhaps $10–$40
million in funding throughout a company’s life as a private firm, an IPO allows the company to raise
many times that amount in one offering. An infusion of ordinary equity not only permits the firm to
pursue profitable investment opportunities but also improves the firm’s overall financial condition and
provides additional borrowing capacity. Furthermore, if the firm’s shares perform well, the company
will be able to raise additional equity capital in the future. By being listed, the company creates a
secondary market for its shares, stimulating liquidity. This can encourage investors to purchase shares
by reducing their fear that they will be unable to exit their investments if they need to.2 Publicly traded shares for use in acquisitions. Unless a firm has publicly traded shares, the only way it
can acquire another company is to pay in cash. After going public, a firm has the option of exchanging
its own shares for those of the target firm. Not only does this minimise cash outflow for the acquiring
firm, but such a payment method may be free from capital gains tax for the target firm’s owners. This
tax benefit may reduce the price that an acquirer must pay for a target company.3 Listed shares for use as a compensation vehicle. Having publicly traded shares allows the company to
attract, retain and provide incentives for talented managers and employees by offering them employee
share options and other share-based compensation. Going public also offers liquidity to employees
who were awarded options while the firm was private.4 Personal wealth and liquidity. Entrepreneurship almost always violates finance’s basic dictum about
diversification: entrepreneurs generally have most of their financial wealth and their human capital4 Details: ASX IPO brochure IPO: The Road to Growth. 2011.
5 KPMG Peat Marwick, Going Public: What the CEO Needs to Know. Chapter 2. 1998.LO 12.2