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Part 4 Financing Decisions and Market Efficiency

I

n Chapter 11 we encountered Marvin Enterprises, one of

the most remarkable growth companies of the twenty-first

century. It was founded by George and Mildred Marvin, two

high-school dropouts, together with their chum Charles P.

(Chip) Norton. To get the company off the ground the three

entrepreneurs relied on their own savings together with

personal loans from a bank. However, the company’s rapid

growth meant that they had soon borrowed to the hilt and

needed more equity capital. Equity investment in young

private companies is generally known as venture capital. Such

venture capital may be provided by investment institutions or

by wealthy individuals who are prepared to back an untried

company in return for a piece of the action. In the first part

of this chapter we will explain how companies like Marvin go

about raising venture capital.

Venture capital organizations aim to help growing firms

over that awkward adolescent period before they are large

enough to go public. For a successful firm such as Marvin,

there is likely to come a time when it needs to tap a wider

source of capital and therefore decides to make its first pub-

lic issue of common stock. The next section of the chapter

describes what is involved in such an issue in the United

States. We explain the process for registering the offering

with the Securities and Exchange Commission and we intro-

duce you to the underwriters who buy the issue and resell it

to the public. We also see that new issues are generally sold

below the price at which they subsequently trade. To under-

stand why that is so, we need to make a brief sortie into the

field of auction procedures.

A company’s first issue of stock is seldom its last. In

Chapter 14 we saw that corporations face a persistent

financial deficit, which they meet by selling securities. We

therefore look at how established corporations go about

raising more capital. In the process we encounter another

puzzle: When companies announce a new issue of stock,

the stock price generally falls. We suggest that the expla-

nation lies in the information that investors read into the

announcement.

If a stock or bond is sold publicly, it can then be traded

on the securities markets. But sometimes investors intend

to hold on to their securities and are not concerned about

whether they can sell them. In these cases there is little

advantage to a public issue, and the firm may prefer to place

the securities directly with one or two financial institutions. At

the end of this chapter we explain how companies arrange a

private placement.

How Corporations Issue Securities

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CHAPTER

On April 1, 2028, George and Mildred Marvin met with Chip Norton in their research lab

(which also doubled as a bicycle shed) to celebrate the incorporation of Marvin Enter-

prises. The three entrepreneurs had raised $100,000 from savings and personal bank loans

and had purchased one million shares in the new company. At this zero-stage investment,

15-1 Venture Capital