11/5/2022

Chapter 3
Corporations Issuing Equity in the
Share Market

5-1

Learning Objectives
• Outline the flotation and listing (IPO) process
• Describe equity funding alternatives available to
newly listed and established corporations
• Distinguish between equity and quasi-equity
(hybrid) instruments

5-2

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3.1 Initial Public Offering

• Initial public offering (IPO) is an offer to investors
of ordinary shares in a newly listed company on a
stock exchange
– New share issuer must meet ASX listing requirements
– The promoter appoints advisers (stockbroker, merchant
bank, other specialists) and possibly underwriters

5-3

3.1 Initial Public Offering (cont.)

– Underwriters
▪ Ensure a company raises the full amount of the issue
▪ Assist with advice on the structure, price, timing and way of
the issue and allocation of securities
– Prospectus lodged with ASIC
▪ Document prepared by a company stating the terms and
conditions of an issue of securities to the public
– Out-clause
▪ Specific conditions precluding full enforcement of an
underwriting agreement
– Publicly listed corporation
▪ Has its shares listed and quoted on a stock exchange

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3.2 Listing a Business on a Stock

Exchange
• A company seeking to have its securities quoted
on a stock exchange (i.e. to join the official list)
must comply with listing rules, which are additional
to the corporations’ legislation obligations
• A non-complying listed company can be
suspended from quotation or delisted

5-5

3.2 Listing a Business on a Stock

Exchange (cont.)
• Listing rule principles embrace the interests of
listed entities, maintain investor protection, and
maintain the reputation and integrity of the market
• Main principles of a stock exchange’s listing rules
include
– Minimum standards on quality, size, operations and
disclosure
– Sufficient investor interest required to warrant listing

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3.2 Listing a Business on a Stock

Exchange (cont.)
• Main principles of a stock exchange’s listing rules
include (cont.)
– Security issues must be fair to both new and existing
holders
– Rights and obligations attached to securities must be fair
to both new and existing holders
– Prescribed information must be provided to the exchange
in a timely basis
– Material information that may affect security prices or
investment decisions must be disclosed immediately to
the exchange

5-7

3.3 Equity-funding for Listed Companies

• Different forms of equity finance are available to
established companies
– Additional ordinary shares
▪ Rights issue, placements, takeover issues, dividend
reinvestment schemes
– Preference shares
– Quasi-equity
▪ Convertible notes, options, warrants

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3.3 Equity-funding for Listed Companies

(cont.)
• Rights issue
– Issue of ordinary shares to existing shareholders
– Issued pro-rata, e.g. 5:1 or 5 for 1
– Factors influencing the issue price
▪ Company’s cash flow requirements
▪ Projected earnings flows from the new investments funded
by the rights issue
▪ Cost of alternative funding sources

5-9

3.3 Equity-funding for Listed Companies

(cont.)
• Rights issue (cont.)
– Two types
▪ Renounceable— shareholder may sell their right
▪ Non-renounceable—right may not be sold
– Rights issued at a discount to current share price

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3.3 Equity-funding for Listed Companies

(cont.)
• Placements
– Additional new ordinary shares issued directly to selected
investors (institutions and individuals) deemed to be
clients of brokers
– Not required to register a prospectus but a memorandum
of information must be prepared
– Minimum subscription $500 000 to not more than 20
participants

5-11

3.3 Equity-funding for Listed Companies

(cont.)
• Placements (cont.)
– Market price discount cannot be excessive
– Allows smaller discount and shorter time frame than
rights issue
– Dilutes holding of non-participating shareholders

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3.3 Equity-funding for Listed Companies

(cont.)
• Takeover issues
– Acquiring company issues additional ordinary shares to
owners of target company in settlement of the transaction
– Alleviates need for owners of acquiring company to inject
cash for the purchase of the company

5-13

3.3 Equity-funding for Listed Companies

(cont.)
• Dividend reinvestment schemes
– Shareholders have the option of reinvesting dividends in
additional ordinary shares
– In growth periods it allows companies to pay dividends
and pass on tax credits, while increasing equity
– Schemes may be suspended in low growth periods

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3.3 Equity-funding for Listed Companies

(cont.)
• Preference shares
– Are hybrid securities, i.e. they have characteristics of both
debt and equity
– Fixed dividend rates are set at issue date
– Rank ahead of ordinary shareholders in the payment of
dividends and liquidation

5-15

3.3 Equity-funding for Listed Companies

(cont.)
• Preference shares (cont.)
– Include combinations of the following features
▪ Cumulative or non-cumulative
▪ Redeemable or non-redeemable
▪ Convertible or non-convertible
▪ Participating or non-participating
▪ Issued with different rankings

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3.3 Equity-funding for Listed Companies

(cont.)
• Preference shares (cont.)
– Advantages of preference shares
▪ Fixed interest borrowings but they are an equity finance
instrument
▪ Assist in maintaining debt to equity ratio
▪ Widen a company’s equity base, which allows further debt
to be raised also
▪ Dividends may be deferred on cumulative shares and not
paid on non-cumulative shares, while interest on debt must
be paid

5-17

3.3 Equity-funding for Listed Companies

(cont.)
• Convertible notes
– Are a hybrid instrument, issued for a fixed term at a
stated rate of interest, either by direct placement or pro-
rata to shareholders
– Holder has right to convert the note into ordinary shares
at a specified future date and at a predetermined price
– The option to convert to equity has value
– If share price subsequently rises a gain is made

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3.3 Equity-funding for Listed Companies

(cont.)
• Convertible notes (cont.)
– If share price falls, holder may not exercise conversion
option and take the notes’ cash value
– Interest paid o notes is usually lower than straight debt
interest
– Interest payments are tax deductible to the company
– Notes are often issued for longer periods than is possible
with straight debt borrowings

5-19

3.3 Equity-funding for Listed Companies

(cont.)
• Company-issued options
– Provide the right, but not the obligation, to purchase
shares at a stated price and date
– Allow companies to raise further equity funds at planned
future dates (providing holders exercise the option)
– Typically offered in conjunction with a rights issue or
placement
– Issued free or sold at a price

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3.3 Equity-funding for Listed Companies

(cont.)
• Company-issued options (cont.)
– Generally have value and may be traded
– The option will be exercised if the exercise price is less
than the market price of the share at the exercise date

5-21

3.3 Equity-funding for Listed Companies

(cont.)
• Company-issued equity warrants
– Generally attach to corporate bond issues but may be
issued unattached
– Holder has option to convert warrant into ordinary shares
at specified price over a given period
– Warrants may be detachable from the bond and traded
separately
– No dividends but holders benefit from capital gains if
share price rises above conversion price

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3.3 Pricing of Shares

• Share price is mainly a function of supply and
demand for a share
– Supply and demand are influenced mainly by information
– Share price is considered to be the present value of
future dividend payments to shareholders
– New information that changes investors’ expectations
about future dividends will result in a change in the share
price

6-23

3.3 Pricing of Shares (cont.)

• Estimating the price of a share
– General dividend valuation model


D t

t=1
P=
(1+rs )t
0

Where P = current share price

0

D = expected dividend per share in period t

t (3.8)
r = required rate of return
s

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3.3 Pricing of Shares (cont.)

• Estimating the price of a share (cont.)
– Valuing a share with a constant dividend (D0)

D
P=
0
0
rs (3.9)

– Valuing a share with constant dividend growth (g)

1+g
 
 
 
 

P =D
 
 

r −g
0 0
 

 s




(3.12)

6-25

3.3 Pricing of Shares (cont.)

• Cum-dividend and ex-dividend
– Dividends are payments made to shareholders,
expressed as cents per share
– Dividends are declared at one date and paid at a later
specified date
– During the period between the two dates, the shares
have the future dividend entitlement attached, i.e. cum-
dividend

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3.3 Pricing of Shares (cont.)

• Cum-dividend and ex-dividend (cont.)
– Once the dividend is paid the shares are traded ex-
dividend
– Theoretically the share price will fall on the ex-dividend
date by the size of the dividend
▪ Example
Share price cum-dividend $1.00
Dividend paid 0.07
Theoretical ex-dividend price 0.93

6-27

3.3 Pricing of Shares (cont.)

• Bonus share issues
– Where a company has accumulated reserves, it may
distribute these to existing shareholders by making a
bonus issue of additional shares
– As with dividends, there will be a downward adjustment in
share price when shares go ex-bonus

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3.3 Pricing of Shares (cont.)

• Bonus share issues (cont.)
– As no new capital is raised, there is no change in the
assets or expected earnings of the company
▪ Example—if a bonus 4:1 issue is made
Cum-bonus price $5.00
Market value of 4 cum-bonus shares $20.00
Theoretical value of 5 ex-bonus shares $20.00
Theoretical value of 1 ex-bonus share $4.00

6-29

3.3 Pricing of Shares (cont.)

• Share splits
– Involves division of the number of shares on issue
– Involves no fundamental change in the structure or asset
value of the company
– Theoretically the share price will fall in the proportion of
the split
▪ Example—1:5
Pre-split share price $50.00
Theoretical ex-split share price $10.00

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3.3 Pricing of Shares (cont.)

• Pro-rata rights issue
– Involves an increase in the company’s issued capital
– Typically issued at a discount to market price
– Theoretically, the market price will fall by an amount
dependent on
▪ The number of shares issued
▪ The size of the discount

6-31

3.3 Pricing of Shares (cont.)

• Pro-rata rights issue (cont.)
– Example—market price cum-rights $1.00, with 5:1 rights
issue priced at $0.88

Cum-rights share price $1.00

Market value of 5 cum-rights shares 5.00
Plus new cash from 1:5 issue 0.88
Market value of 6 ex-rights shares 5.88
Theoretical ex-rights share price 0.98

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3.3 Pricing of Shares (cont.)

• Pro-rata rights issue (cont.)
– A renounceable right is a right that can be sold before it is
exercised
▪ The value of the right is determined by Equation 3.13

Value of right = (cum rights price - subscripti on price)

1 + 1/N

Where N is the number of shares required

to obtain the rights issue share, and the subscripti on
price is the discounted price of the additional share.

Example—market price cum-rights $1.00, with 5:1 rights issue

priced at $0.88. (3.13)

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3.4 Summary (cont.)

• Initial public offering (IPO) is an offer to investors
of ordinary shares in a newly listed company on a
stock exchange
• Additional equity can be raised through ordinary
shares, preference shares, convertible notes and
other quasi-equity

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