Foundations of New Venture Finance 297- Pricing the Issue: As the company gets closer to declaring the date of the offering, nego-
tiations begin to determine the price of the issue. Many factors are involved: the current
state of the stock market, the earnings of the company, the total dollars the company is
attempting to raise, the prices and performance record of other recent IPOs, and so on.
There is a natural conflict of interest between the underwriters and the current owners of
the company. First, the underwriter typically receives 20 percent of the gross spread. The
rest of the syndicate selling the issue receives a concession for actually selling the shares.^3
The underwriters have the most to gain if the issue is slightly underpriced: If the new issue
comes to market at a discount, the underwriters’ customers will be happy because the price
will soon rise to its market level. Also, the underwriters can make additional profit, because
they often take an option (called the shoe) on as much as 10 percent of the issue. The cur-
rent owners, on the other hand, want the issue to come to market at a premium. If the issue
is slightly overpriced, they will receive more money for the shares they personally sell, and
the company will receive more money for the shares that are offered. As the time of the
offering nears, the underwriter generally assumes control.^4 - Market Timing and Closing: The last step is the actual closing of the deal. Once the date
of offering is set, the underwriters and managers closely monitor the stock market to be
ready for the date of issue. If the market starts to fall precipitously, the offering can be can-
celed up to the last minute. If the market is steady or rising, the final price is set the night
before the offering, and a financial printer works all night to produce the prospectus for the
IPO with the price on the front page.
APPENDIX NOTES
- L. Orlanski, “Positioning for the Public Offering,” Bio/technology 3, 1985: 882–885; S. Jones and B.
Cohen, The Emerging Business (New York: John Wiley, 1983). - L. Orlanski, “SEC Comments on the Offering Prospectus,” Review of Securities Regulation 17, no. 11,
1984: 887–896. - There is a good deal of evidence that new issues, on average, come to market underpriced. Quality
new issues then rise quickly and the underwriters and those favored customers who’ve been given the
option of making early purchases then sell and make a quick profit. Within 6 to 18 months the shares
are earning “normal” returns and no excess profits remain for investors. Low-quality new issues
decline even more quickly. - K. Ellis, R. Michaely, and M. O’Hara, “A Guide to the Initial Public Offering Process,” l999. Retrieved
from the Web February 27, 2007. http://forum.johnson.cornell.edu/faculty/ michaely/Guide.pdf