http://boards.straightdope.com/sdmb/showthread.php?t=612216
Inspired by the other thread, and instead of hijacking my own i made this one.
How exactly does issuing more stock equal instant money…where does it come from?
When a company issues more stock, it is selling a portion of itself to new investors. The money comes from the investors who buy the stock.
Obviously, you have to convince the investors that it’s a good idea to buy a certain percentage of the company for a certain amount, or it doesn’t work. You don’t just get to say “I WANT ELEVENTY JILLION DOLLARS! SELL STOCK!!!111”
Do you mean to ask if issuing more stock equals instant money in the economy in general? Or simply to the company issuing it? From your other thread it appears the posters were answering the second question. Yes, it is instant money for the company issuing it, but it comes at a cost of not owning the entire company anymore.
But where does the money come from?
Doesn’t the company have to wait for investors to buy?
Yes, selling stock only works if someone else will buy the stock at the price offered.
So it is not instantaneous? Issue stock and two seconds later you have a million dollars…
No, it’ll take a couple days at the very least. For a large company doing an IPO, it can take months to get through all the paperwork for the SEC.
Typically, when a company issues stock it is immediately purchased by its underwriters. Underwriters are normally large Wall Street firms like Goldman Sachs, JPMorgan, Morgan Stanley, etc. They will committ to purchase the stock at $XX per share, they will in turn then sell it on the open market to buyers. After the underwriters purchase the stock, it’s price will float up or down subject to the market. This way the issuing company is assured to get the initial price agreed to with the underwriters.
That applies to companies which are doing an IPO to become publicly traded. Underwriters are not necessary to complete a private stock sale.
For an existing company with existing stock out there, say IBM or GE, they probably already have approved authoriztion to sell additional shares. So the regulatory effort is zero.
For them to “issue” new stock is to push a button on a computer at whoever is their treasury brokerage. Moments later a million new shares exist. And IBM or GE owns them. And moments later they advertise those on the market for sale. And within a few minutes somebody someplace buys each one of them.
Those somebody’s are each out a few bucks and IBM has or GE has all that new (to them) money.
The key thing is that while IBM or GE could do that today, they couldn’t do it *every *day. Because when they issued the new shares, they also took some value away from the existing shareholders. The underlying value of IBM or GE didn’t change; just the number of slices it was cut into. Cutting a 4-slice pizza into 8 slices doesn’t make more pizza; it only makes more slices.
If the change is small enough, it gets lost in the noise of the market price going up & down. In fact, for a hot-stock popular company, the additional shares just feed the feeding frenzy & can cause the price to go up. Especially if the cable TV money channel can be convinced to tout the shares while claiming to deliver “news”.
But if any company started issuing new shares every day, pretty soon folks would stop buying the new shares and / or existing shareholders would sue over the serial destruction of their ownership stake.
One thing that was never made completely clear in this or the other thread is that to issue new stock (i.e, shares of ownership in the company) the current owners have to agree.
If I and three other brilliant people got together to form a copany, with each of us owning 25% of it, and then one of us had the idea to sell a million shares to raise more cash, the others might got upset that their 1/4 of the company suddenly became 1/1,000,004. So the process requires a lot of work by the board and the underwriters to establish a value, figure out just what percentage of control they’re willing to give up, etc., etc.
ETA: Just like LSLGuy said right before I got my post up.
I understand from your post that a company (even an already publically-traded company) doesn’t need approval from its shareholders to issue new shares. Even though doing so dilutes their share. When would the shareholders have some recourse?
ETA: okay, so according to kunilou shareholder approval is required after all.
That’s not exactly true. Immediately after the company has sold those shares, the value of the company has gone up by the price that it got for those shares. So, to follow the analogy, the 8-slice pizza is bigger than the 4-slice pizza, because the new share-holders have added something to the mix. However, it may be true that the value of one slice has gone down a bit – though the company that issued the new stock hopefully did it so that the size of the pizza will grow in the future.
Actually, in this case the underlying value did indeed change by amount of the additional capital and there is no dilution (assuming that the newly-issued shares were issued at market price).
The problem with secondary offerings is the negative signal it gives to the capital markets. Assuming the additional capital is used for normal corporate operations (and not a specific acquisition or capital expenditure), current and prospective shareholders will question why the additional capital is required. The fallback assumption is that management screwed up and might screw up again. This negative signal is typically what causes pessimism about the company and usually results in a lower stock price.
But the pizza pie is indeed bigger.
ETA: Or what Giles said!
And this function is not done by GE or IBM themselves. It is performed by their underwriters.
(bolding added)
I thought underwriters provide a guarantee - they promise to buy the stock for $x only if no other buyer can be found - rather than purchase it all up front then on sell it for a profit.
Oh and for large issues the underwriting is usually split between a number of firms - a lead underwriter for say 50% and others picking up the remainder.
Normally the proceeds are issued by the underwriters prior to reselling. Let’s say the stock issuance is for the purpose of an acquisition. The issuing company is going to need the cash at close to complete the transaction, they are not going to wait until the underwriters place all of the stock. The underwriters are also going to normally pay the issuer at a discount to the offering price (99% of $xx per share), The 1% discount the underwriter will book as fee income.
And pocket any bump in the share price too? No wonder they make money hand over fist…
They also take the risk that the price may fall as well, something that most companies don’t want to do. That’s why the underwriters are in business.
Most stocks are a little strange when stop talking technically and break it down for they are. Stocks that don’t pay dividends don’t have that much to do with the original company once they are created and sold. The company gets money during the initial IPO but then they are just traded among individual investors for whatever they are deemed worth in the abstract sense after that like trading cards. Investors can bet on a stock going up or down and make money off of individual shares that may have little to do with realities of the company whose name on the stock. The company doesn’t get any money directly if your shares with its name on it go up or down. They can trade that way outside of the company indefinitely which is which most shares do. By creating new shares, they can just get the money and do what they want with it.
People will argue that stocks are always closely tied to the performance of the company itself because the company itself owns many shares and may want to buy them back at some point. That can and does happen sometimes but it doesn’t have to. It is a strange game based abstractions on top of predictions. The technical details obscure the whole game but the rules of it sound bizarre when they are broken down plainly because they really are.