5.1 Initial Public Offerings (IPOs)

An IPO is the first sale of a company’s shares to the public, transforming a private company into a public one :

Why Companies Go Public

  • Access to public equity capital

  • Liquidity for existing shareholders

  • Enhanced profile and credibility

  • Acquisition currency

  • Employee incentive alignment

The IPO Process

  1. Preparation: Audited financials, corporate governance

  2. Selection of Advisors: Investment banks, legal counsel, auditors

  3. Due Diligence: Comprehensive review

  4. Prospectus: Registration with securities regulators

  5. Roadshow: Marketing to institutional investors

  6. Pricing: Setting offer price based on demand

  7. Allocation: Distribution to investors

  8. Listing: Trading on stock exchange 

5.2 Underwriting and Distribution

Underwriting Models

  • Firm Commitment: Underwriter buys entire issue; bears market risk

  • Best Efforts: Underwriter sells what it can; no guarantee

  • Bought Deal: Underwriter commits to purchase without prior marketing

  • Dutch Auction: Price determined by investor bids

The Syndicate

  • Lead manager(s) coordinate the deal

  • Co-managers assist with distribution

  • Selling group members distribute to retail investors

Regulation and Disclosure

U.S. SEC regulations (Securities Act of 1933) require:

  • Registration statement (Form S-1)

  • Prospectus with full disclosure

  • Quiet period restrictions 

5.3 IPO Pricing and Performance

IPO Underpricing Anomaly

IPOs tend to be underpriced—the offer price is below the first-day closing price . Explanations include:

  • Information asymmetry: Investors must be compensated for due diligence

  • Signaling: Underpricing signals quality

  • Market feedback: Underwriters learn demand through bookbuilding

Average first-day returns typically range 10-20% in developed markets, often higher in emerging markets.

Long-run Performance

Studies show IPOs underperform relative to the broader market over 3-5 years, potentially due to :

  • Optimistic initial projections

  • Timing of offerings at market peaks

  • Reduction of incentives as founders cash out

5.4 Seasoned Equity Offerings (SEOs)

Follow-on offerings by already-public companies :

  • Primary SEOs: New shares issued, proceeds to company

  • Secondary SEOs: Existing shareholders sell shares

  • Rights Issues: Shares offered to existing shareholders first

SEOs typically have negative price impact due to signaling concerns and increased supply.

PreviousNext