Contemporary Issues in Finance
You are a research assistant to the Board of the FTSE100 listed company. Write a report for your Board of Directors outlining the current trends in seasoned equity issues. Explain what financing options (particularly seasoned equity issuance) the company has if it wishes to undertake the purchase of a rival.
There have been changes in the last 20 years or so in the way British listed companies issued equity, and there was only one method which was used until the late 1980s and it was the rights issue and the other methods were used such as open offers and placings, in a placing the new shared are placed by private negotiation with a number of investors, or accelerated book building. In this method an open offer combines a placing via negotiation with an offer to the existing shareholders in proportion to their existing holdings. This method is the most used for larger issues in relation to issuer size, which is worth 5% or more of the existing equity. The method of rights issues is declining because of a decline in family firms and the rise of investing institutions. Because higher proportions of new investors are required to provide equity, rights issues becoming more expensive issue method and Eckbo (2008) claims that the rights issues are mainly used by smaller firms and in smaller markets where there are only few shareholders who are willing to provide equity but in UK the rights issues are still used mainly by the largest firms.
Even though rights issues method is declining Smith (1977) claims that rights issues are cheaper than other forms of raising new equity capital. By late 70s, most US Industrial companies had abandoned rights issues and switched to firm commitment offers due to marketing and underwriting costs. Only 2.5% of US industrials used rights from 1980-2008. This has remained the dominant method in US. In most of Europe, rights issues still dominate.
There are two methods that exist in the UK for buying declined equity are the sale of rights on the market in a rights issue and the private placing of shares in an open offer of placing. Armitage proposed that placing method is more effective of facilitating the purchase of large blocks than is selling rights on the market. Open offers and placings enable informed purchases to be made of agreed amounts of shares, at a negotiated discount and these conditions are harder to achieve through purchase of rights on the market. The placing method could result in better certification of issuer value than occurs in a rights issue.
The rights Issues, the new shares are offered to the existing shareholders, as it is required under section 561 of the Companies Act 2006. The rights to new shares can be traded on the stock market during the offer period, in the same way s existing shares are traded and the offer period must be at least 21 days. Otherwise large blocks of rights can be rejected by those who are eligible to them and privately placed with investors before the offer is publicly announced. In an open offer the new shares are usually placed by private negotiation with investors before the offer is announced and this process could last from few days to two weeks (Gao and Ritter, 2009). The investment bank then communicates with potential buyers and senior executives from the issuer will visit investors who have shown interest in the issue and then investors would have the access to private information. They agree to become insiders and not to trade in the issuer’s shares until after the issue is announced. On the announcement day the investors who have agreed informally to buy shares sign purchase or underwriting agreements, and become buyers. The shares are then offered pro rata to the existing shareholders, who have a minimum of 14 days to buy them. New shares bought by the existing holders are said to be ‘clawed back’ from the buyers. The entitlements to the new shares cannot be sold, unlike in a rights...
References: Armitage, S. (2010). Block buying and choice of issue method in UK seasoned equity offers. Journal of Business Finance & Accounting, 37(3‐4), 422-448.
Balachandran, B., Faff, R., Theobald, M., & Velayutham, E. (2009). Seasoned Equity Offerings, Quality Signalling and Private Benefits of Control. Working Paper: ssrn. com/abstract= 1118180.
Eckbo, B. E. (2008). Equity issues and the disappearing rights offer phenomenon. Journal of Applied Corporate Finance, 20(4), 72-85.
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