Ch. 6: Security Offerings 249
others who do so. There is also a filing requirement after the sale or purchase by insiders
of the firm’s securities.
2.2.2. Other major flotation methods
Table 1gives a summary of the various flotation methods available for security offer-
ings. A more detailed description of these flotation methods follows.
In a “rights offer” current shareholders are given the right to purchase a (pro rata)
portion of a new equity issue at a fixed price. A rights offer in the U.S. typically expires
after a period of typically one month. The rights offer price is initially set at a discount
from the current market price, but if the market price falls, the rights offer can end
up being at a premium, which is likely to result in offer undersubscription or offer
failure. Thus, a rights offer is like a short-lived in-the-money warrant distributed to
current shareholders in the same manner as a stock dividend. It is also similar to a
stock dividend in that the sale of new shares at a discount has the effect of diluting the
current share price. Rights may or may not be transferable and unsubscribed rights may
be reallocated among subscribing shareholders. In these non-underwritten offers, the
issuer bears a risk of offering failure, but this risk can be reduced by increasing the size
of the offering price discount.
In a “standby rights offer” the firm making the rights offer hires an underwriter to
“stand by” and guarantee to take up whatever portion of the rights offer shareholders
leave unsubscribed. The standby underwriter as a consequence bears price risk, and car-
ries out a due diligence investigation and may pursue a book building process described
above for firm commitment offerings. For these services, the underwriter charges a fixed
“standby” fee. In addition, the underwriter typically charges a “takeup” fee on each
share taken up under the guarantee. If there is a secondary market in the rights, it is
common for the underwriter to be the primary purchaser of these rights.
In a private placement, the firm places the entire issue with a single investor or con-
sortium of investors, bypassing current shareholders. As listed inTable 1and discussed
above, such issues are subject to a number of regulations primarily designed to protect
investors.
A “shelf” offering refers to an issue that has been pre-registered with the SEC. With
the introduction of SEC Rule 415 in 1983, financially strong companies are allowed to
sell up to a certain number of shares over the next two years using a list of possible
underwriters. Thus, shelf registration increases the flexibility and speed of issue over a
two-year period.
Auctions present another mechanism for selling equity. This method is only rarely
used in the U.S. (it was used recently by Google), but has been an important method
in certain international markets including France. The auction design is flexible, but the
most common is a sealed bid auction where all accepted bids pay the same price. There
are often minimum bid (reserve) price requirements (seeDasgupta and Hansen (2007)
andJagannathan and Sherman (2006)for details on IPO auction procedures).