Variations in the Underwriting Process

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Not all deals are underwritten using the traditional syndicate process we have described. Variations in the United States and foreign markets include the bought deal for the underwriting of bonds, the auction process for both stocks and bonds, and a rights offering for underwriting common stock.

The mechanics of a bought deal are as follows. The lead manager or a group of managers offers a potential issuer of debt securities a firm bid to purchase a specified amount of the securities. The issuer is given a day or so (maybe even only a few hours) to accept or reject the bid. If the bid is accepted, the underwriting firm has bought the deal. It can, in turn, sell the securities to other investment banking firms for distribution to their clients and/or distribute the securities to its clients.

Another variation for underwriting securities is the auction process. In this method, the issuer announces the terms of the issue, and interested parties submit bids for the entire issue. The auction form is mandated for certain securities of regulated public utilities and many municipal debt obligations. It is more commonly referred to as a competitive bidding underwriting. For example, suppose that a public utility wishes to issue $300 million of bonds. Various underwriters will form syndicates and bid on the issue. The syndicate that bids the lowest cost to the issuer wins the entire $300 million bond issue and then reoffers it to the public.

A preemptive rights offering is a method for issuing new common stock directly to existing shareholders. A preemptive right grants existing shareholders the right to buy some proportion of the new shares issued at a price below market value. The price at which the new shares can be purchased is called the subscription price. A rights offering ensures that current shareholders may maintain their proportionate equity interest in the corporation. For the shares sold via a preemptive rights offering, the underwriting services of an investment banker are not needed. However, the issuing corporation may use the services of an investment banker for the distribution of common stock that is not subscribed to. A standby underwriting arrangement will be used in such instances. This arrangement calls for the underwriter to buy the unsubscribed shares. The issuing corporation pays a standby fee to the investment banking firm. In the United States, the practice of issuing common stock via a preemptive rights offering is uncommon. In other countries it is much more common; in some countries, it is the only means by which a new offering of common stock may be sold.

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