BUSF_A01.qxd

Chapter 8 • Sources of long-term finance

Issues by tender seem to be increasingly popular. There have been several of them

in recent years.

Share issues in depressed markets

It is argued by some observers that it would be unfair to sell new shares to the public

when either capital market prices generally, or the shares in a particular business,

are depressed. This is because it would allow outsiders to buy shares ‘on the cheap’

at the expense of the existing shareholders. As we shall shortly see, if a rights issue

were made under such circumstances, this advantage would go only to existing

shareholders.

This seems an illogical view in the light of the evidence on capital market efficiency,

which will be reviewed in the next chapter. Such evidence strongly supports the

hypothesis that the current market price of a share is the consensus view of its value

at the time. There is no reason to believe that because it has recently fallen in value

it is about to increase, any more than it should cause us to feel that it is about to suf-

fer a further decrease in value or to remain static.

Factors to consider in respect of equity issues to the public

Issue costs

Issue costs are very large, estimated at between 5.5 and 11 per cent of the proceeds for

a £20 million issue in the UK (London Stock Exchange 2006). Lee, Lockhead, Ritter and

Zhao (1996) estimate that the issue costs for an IPO in the USA average 11 per cent of

the funds raised, and that those for a public issue of seasoned shares average 7 per cent.

Most issue costs are fixed, irrespective of the size of the issue, so they can be pro-

portionately more costly, as a percentage of the funds raised, for a small issue.

In addition to the explicit costs of an IPO, there is a further cost. In order to attract

a sufficient number of investors for the IPO to be successful, it is usually necessary

to offer the shares at a discount to the price that they might normally be expected to

trade at. This is because the issue is likely to be quite large and so have a depressing

A business wishes to issue 10 million shares by tender. After publishing the advertisement

in the required form it receives offers as follows:

1 million shares at £5.00 each (that is, offers for 1 million shares at £5 per share)

1 million shares at £4.50 each

2 million shares at £4.00 each

2 million shares at £3.50 each

3 million shares at £3.00 each

5 million shares at £2.50 each

10 million shares at £2.00 each

The highest price at which all of the 10 million shares could be issued yet each offerer be

required to pay the same price per share is £2.50. This is known as the striking price, and is

the price at which all 10 million shares will be issued: 9 million to those who offered above

£2.50 and the other 1 million to some of those who offered £2.50 exactly. Note that all of the

10 million shares are issued at £2.50 each.

Example 8.2