LITERATURE REVIEWS
2.2 Understanding Seasoned Equity Offerings (SEOs)
2.2.1 Different Issue Methods
There are several evidences of seasoned equity offerings in many countries.
Each country has unique style of offering depending on the regulations and market conditions. In Japan, for example, Kang and Stulz (1996) summarized public common stock offering was accounted for almost 70% during late 1980s. In US, Gajewski and Ginglinger (2002) found out that the majority of firms choose underwriting method. On the other hand, Australia and most European countries issue right under flotation method. In France alone, approximately 80% of the firms issue rights.
Shahid et al. (2010) briefly described right issues as offering new shares to the current shareholder at a specified subscription price that is normally less than what the offering price to the public will be. This will enable shareholders to maintain their proportional ownership, preemptive right. Normally, insured rights offering is the rights offering underwritten by an underwriter who has a standby commitment to purchase any unsubscribed shares. However, a study in the European countries by Jeanneret (2003) shows that flotation method is predominant. Overall, the stock price reaction to rights offerings announcements is non-negative, but it may depend on the contractual placement agreement, whether the issue is underwritten or uninsured.
In summary, from many papers and researches, the offering methods used widely can be categorized into 7 types.
2.2.1.1 Fully Marketed Offerings
As recapitulated by Greene (2011), the fully marketed offering involves an underwriter or a syndicate of underwriters committing to purchase the offered securities at a fixed price subject to certain conditions and termination rights after marketing the public offering at various ‘road shows’ and obtaining expressions of interest by subscribers to minimize the risk of the underwriters having to purchase any unsold securities. Underwriter will buy all of the securities offered by the issuer for resale to its own investors. In this case, the transaction is firm, subject to any market out clauses contained in the underwriting agreement. Lead underwriters are selected and a syndicate of underwriters is assembled to support the offering. These transactions are common in the case of an initial public offering. Such offering enables an issuer to go to the market in a shortened time frame, thereby reducing the market risk to the underwriter.
2.2.1.2 Accelerated Book-Built Offerings
When applying for accelerated book-built offering, the investment bank does not have enough time to collect the same level of information, as when making a full market offering. Thus, underwriter must quickly evaluate the market demand before committing to an offer price. The accelerated book-built offerings, in general, take around 48 hours to complete according to Gao and Ritter (2010). Bortolotti et al. (2008) found out that underwriter may use “backstop clause”, which includes the minimum price guaranteed the issuer, the underwriting spread, and other profit sharing agreements.
2.2.1.3 Bought Deal
Investment bank buys issued shares, and then sells the shares as quickly as possible to institutional investors. To begin with, various investment banks bid on the issued shares, and the winning investment bank will be responsible for reselling the shares. This is summarized by Bortolotti et al. (2008). The auction-based setting, where banks bid for shares, is made to increase the competition among investment banks and eventually increase the proceeds to the issuer. Greene (2011) described bought deal offering as a commitment by the underwriter or a syndicate of underwriters to buy the offered securities before the prospectus being filed without marketing the securities. Ursel (2006) noted that the bought deal method was suited to
the market turbulence, when markets could move substantially in the weeks necessary to complete fully marketed deals. Gao and Ritter (2010) call this as overnight deal since the process of a bought deal is completed within 24 hours. The investment bank buys the shares without knowing how the market will react to the offering; it bears the risks more than fully marketed offering and accelerated book-built offerings. This is the same with what Ianotta (2010) summarized: investment banks carry a greater risk in a bought deal than in a fully marketed offering.
2.2.1.4 Block trades
This method is like the combination of accelerated book-built and bought deal. The block trade, nonetheless, consists exclusively of existing shares.
Thence, firms do not raise new equity through this channel. Block trade can be compared as pure secondary offerings.
2.2.1.5 Public issues
If a company raises capital by issuing stock, it has to file a formal registration statement with the Securities and Exchange Commission (SEC) that details the business's financial history, current financial situation, the proposed public issue and future projections. The company must prepare a preliminary prospectus that contains information similar to that of the registration statement for potential investors.
As per Ginglinger et al. (2010), public offerings are cheaper and improve liquidity more than standby rights whereas uninsured rights are still the best choice for low liquidity, closely held firms. Ginglinger et al. (2010) also suggested a bias in terms of which companies undertake a public offering, namely that stock liquidity seems to be an important determinant in the choice of issuance method.
2.2.1.6 Right offers
New shares are initially offered to existing shareholders, and the offering is arranged in a different way than seasoned public offering. Most of the time, Bohren et al. (1997) noticed that existing shareholders are offered a right to buy new shares on a pro rata basis at a discount, relative to the current market price. This implies that existing shareholders are offered an in the money call option on new shares. The shareholders are typically allowed to sell the option, should they not wish to participate in the offering. Bundgaard (2012) explained the idea behind the rights offer is that the value of the right should financially offset the non-subscribing shareholders for the fall
in the share price ex-post issuance, which is also known as the Theoretical Ex-Rights Price (TERP). TERP is calculated as the weighted average of the price of new and existing shares.
2.2.1.7 Best efforts offering
This involves a dealer using commercially reasonable efforts to market the securities as an agent of the issuer and the dealer not making any commitment to buy the offered securities themselves. In this offering, a dealer does not buy the securities offered as principal, but instead agrees to use its best efforts to sell the securities as agent for the issuer. Hence, the dealer incurs no financial loss in the case of an unsuccessful offering, other than the failure to receive a commission that is contingent on the success of the offering.