Required capital for running business
Equity generation plays a significant role in the management of an establishment. Attainment of the required capital for running business enterprises is the life wire that makes such organization to tick and survive. For a sound management and the effective attainment of set objectives and goals for an organization, there need to be the presence of adequate finance and capital layout. The presence of adequate capital need the manpower to effectively utilized the available resources in the organization in meeting those immediate objectives and targets of the organization.
Organization continues to growth in experience and gain market shares when it has a sound strategy in place. Thus, the growth of an organization would reach a stage where it would want to broaden it operational base. In this instance, more capital base is needed, and the organization seeing its level of capital would want to invite the public to partake in the floating stream of capital.
Here, the organization tends to float its shares in the stock market. When an organization is going to the stock market for the first time to seek for subscribers to its shares, and be quoted in the stock market, this is referred to as Initial Public Offering (IPO). IPO is used by organization to raise capital for the organization, and thus making the organization a public company (Public Limited or Unlimited Liability Companies, as the case maybe).
According to Ritter (1998), “An Initial Public Offering (IPO) occurs when a security is sold out to the general public for the first time, with the expectation that a liquid market will develop…An IPO can be of any debt or equity security…” (Ritter, 1998). When a company publicly trade its stock, it means it can raise capital through subscribers, by the offering of its shares to be diversified to investors. In addition, this process is regarded as more cost effective than when the company operates as a privately held organization where capital can be raised from restricted few investors.
To buttress this point, Ritter (1998) has it that, enhanced liquidity allows the company to raise capital on more favourable terms than if it had to compensate investors for the lack of liquidity associated with a privately- held company; existing shareholders have the opportunity of reselling the shares in open- market transactions. In the cause of privatizing a public enterprise, a new approach adopts the IPO as a means of enforcing the implementation of privatization. Initial Public Offerings (IPO-PLUS): This is a more recent approach to privatization, which emphasizes on the combination of a case – by- case privatization.
Advantages of this method are that it generates revenues, gives shareholders control over managers, and provides access to capital and skills (Ijaiya, 1999:114). Private Placement (PP) is a method of implementing privatization of public enterprises. It involves the appointment of a private firm to manage the affairs of a public enterprise. The nominated private firm is not the owner of the managed enterprise, but in form of caretaker to see to the effective management of such enterprise.
In other words, a management contracts places a public enterprise under private management for a specific period. For the management services, the contractor is paid a fee, which may be based partly on performance. In using Private Placement in sourcing fund, it means that the organization would be restricted in sourcing for fund for few individuals in the public. These shares are not quoted in the stock market, and the company can not declare it shares for the public to subscribe. OBJECTIVES OF THE STUDY
This report tends to meet the following objectives: 1. To give an analytical difference between Initial Public Offering and Private Placement 2. To show where necessary and significant for implementing IPO or PP in the raising of equity and enforcing managerial reform measures in the organization. 3. To determine the cost risks, time frame, and economic drivers involves in implementing each of the method for equity and managerial control measures 4. To show the type of companies that embarks on each method of equity sourcing. 5.
To recommend best approach for choosing IPO and PP. THEORIES AND MODELS OF IPO As earlier stated, most research works on IPO had concentrated mostly on issues that have to do with underpricing in IPO. Hence, majority of the available theories and models are structured around underpricing in IPO. Some theories of underpricing of IPO are based on asymmetric information. Here, “several theoretical models conclude that underpricing results from asymmetric information among groups of agents taking different roles in the IPO process.
Underpricing is then an incentive used to stimulate the uninformed group to act in the interest of the informed one” (Schindelei & Perotti, 2002). Some of these models based on asymmetric information include the following: Baron (1982), proposed the principal-agent model. This model looked at the asymmetric information that may exist between a firm and its investment banker. It considers the new issue underpricing based on this type of information asymmetry. The investment bank being an agent of the firm has superior information concerning its value.
Hence, his compensation is a function of the proceeds from issue and the post-floatation price. The price discount, therefore, serves to induce the investment banker to put enough effort in advising and selling the firm’ shares. This investment banker’s monopsony power hypothesis according to Ritter (1998), occurs when “investment bankers take advantage of their superior knowledge of the market conditions to underprice offerings, which permits them to expand less marketing effort and ingratiate themselves with buy-side clients.
While there is undoubtedly some truth to this, especially with less sophisticated issuers, when investment banking firm go public, they underprice themselves by as much as other IPOs of similar size’. But this model has being refuted. Muscarella & Vetsuypens (1989), cited in Scindelei & Perotti (2002), has it that underpricing proved to be significant at IPOs by investment banks as well, even though no asymmetric information existed since issuers acted as their own agents in the going public process.
Rock (1985) ‘Winners Curse model’ is another approach to underpricing. This model focuses on differential information of investor participating in the IPO market. It is based on information asymmetric between two groups of investors; the informed and the uninformed. The informed group knows well the prospects of firms and therefore is able to avoid buying low value IPO shares. While the uninformed people have no information on the firms’ value, which results in a bias in their purchases towards les profitable equity issues.
The uninformed investors face a winner’s curse, where they stand a better chance of being allocated shares in overpriced rather than underpriced issues. If the new-issues market is dependent on the participation of uninformed investors underwriters can only create a successful issues market by purposely underpricing new issues. “…Faced with this adverse selection problem, the less informed investor will only submit purchase orders if, on average, IPOs are underpriced sufficiently to compensate them for the bias in the allocation of new issues” (Ritter, 1998).