Security Issuance
(notes not complete yet!)

You should definitely know the relative Advantages/disadvantages of issuing various types of securities.  This can come in part from the definitions in the text.  You should also know the relative costs of issuing securities.  As a general rule is that the more risky (greater informational effiecicny etc), the greater the cost of issuance. Issue costs matter since they can make what would otherwise be a good investment a poor one.  This is the concept of Adjusted Present value, APV or ANPV)



Issuing Securities is tightly tied to the idea of an optimal capital structure.  There are several theories that have been used to explain the issuance process.  The most notable are the static tradeoff theory and the pecking order theory.

The tradeoff theory (also known as optimal capital structure theory) suggests that there is a target optimal capital structure and that managers want to get to this level.  The firms may take temporary movements away from the target (as market conditions and the like change) but eventually want to get back to the optimal point.  

The problem with this is that it would suggest that any issuance (which would be seen as a movement towards the optimal point) should be associated with a stock price increase.  This is NOT the case as evidenced by 3% abnormal decline surrounding a SEO.

The Pecking Order theory (generally attributed to Myers and Majluf 1984) is based on the idea that information asymmetries exist between mangers and investors.  This theory states that managers like to use internally generated cash to fund new projects.  If this cash is not available they want to issue in order of riskiness: from safe to risky.  Thus straight debt would be issued before preferred equity, which is before common equity.

Empirically this has much more support.  There is still some doubt however as this order may be merely cost driven.  (It is cheaper to issue debt than equity).  Moreover upwards of 75% of spending is funded by internal cash.  (more in some periods!  Example 1991=97% (source Federal Reserve Flow of Funds)

What are the costs of issuance? Indirect costs of issuance
market reactions!  (generally 3% down)
Time to market (managers time and window of opportunity in invetment)

Costs are large and tend to be "fixed."  Thus want to issue as much as possible when you do issue.  Spread out fixed costs.  


APV = adjusted Net Present value
    
if no costs APV=NPV
        if APV<NPV, may pass up positive NPV projects

Seasoned equity issues are quite rare.  Often used as last resort.  Investors know this and price accordingly.  Hence 3% drop.  Note this 3% drop can be an enormous percentage of the new funds raised.

IPOs difficult to assess…greater uncertainty, greater underpricing.  

We also cannot explain the waves that exist in issues.  Why do these waves exist?  It is hard to say.  
EMH says any time is as good as any other time, yet we definitely see waves.  IPOs esp. Hot market vs cold market.

More in IPO file to follow.