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Small Business and the New Issues Market for Equities

Published online by Cambridge University Press:  19 October 2009

Hans R. Stoll  and
Anthony J. Curley
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Extract

A great deal of interest has been expressed by economists and policy-makers concerning the adequacy of the financing of small and, especially, new firms. This paper presents an empirical study of the adequacy of one particular source of funds—outside equity.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 5 , Issue 3 , September 1970 , pp. 309 - 322
Copyright
Copyright © School of Business Administration, University of Washington 1970

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References

1 Relevant research is contained in Financing Small Business, Report to the Committee on Banking and Currency and the Select Committee on Small Business, U. S. Congress, 1958. Since then relevant work is contained in H. Stekler, Profitability and Size of Firm, 1963; Fink, S., Equity Financing of Small Manufacturing Companies in New Jersey, 1962Google Scholar; Finn, G., The Availability of Credit to Wisconsin Small Business, 1961.Google Scholar

2 The full report, “The Small Business Equity Gap: An Empirical Study,” submitted to the Small Business Administration, discusses in detail the relevant criteria.

3 Differences in flotation costs, after-market transaction costs (liquidity), taxes, etc., may also be cause for an equity gap, but these factors are of secondary importance and they are not considered in this paper.

4 The ex post rate of return for one period is given in the usual fashion by

5 Regulation A, applying to issues less than $300,000, permits use of abbreviated registration statements. The 643 offerings comprise all Regulation A issues in the years cited with the exception of the following: senior securities, financial corporations, theatrical production, employee stock plans, foreign offerings, rights offerings, secondaries, and those never offered.

6 These are 21.1 per cent, 45.3 per cent, and 11.4 per cent, respectively, of total offerings selected in each year, and 36.4 per cent, 63.9 per cent, and 27.9 per cent, respectively, of underwritten offerings selected in each year.

7 The price is the midpoint between bid and ask prices. Dividends, which are infrequently paid by firms in the sample, are one-half the indicated annual rate.

8 That time period averaged about 300 calendar days.

9 Standard deviations, for what they are worth in the case of these skewed distributions, are quite large, so that none of the average return relatives is significantly different from one.

10 Short-run return relatives do not differ significantly for Reg. A firms filing in the financially active New York SEC office (87 of 205 firms) from those filing in other offices (Atlanta, Boston, Chicago, Denver, Fort Worth, San Francisco, Seattle, Washington, D.C.). One might expect to find more “hot issue” price appreciation in the New York market, but this was not so.

11 The length of the offering period averaged about 145 calendar days.

12 Such values often tend to arise when the stock is selling at very low prices, and a 500 per cent return is, for example, not improbable.

13 See Friend, I. and Herman, E., “The SEC Through a Glass Darkly,” Journal of Business (October 1964)Google Scholar; Stigler, G., “Public Regulation of the Securities Markets,” Journal of Business (April 1964)Google Scholar; and Friend, I. and Longstreet, J., “Price Experience and Return on New Stock Issues,” in Friend et al. Investment Banking and the New Issues Market (New York: World Publishing, 1967).Google Scholar

14 See, e.g., Arditti, F., “Risk and Required Return on Equity,” Journal of Finance, March 1967.Google Scholar

15 See Fisher, L., “Outcomes for ‘Random’ Investments in Common Stocks Listed on the New York Stock Exchange,” Journal of Business January 1966, SupplementGoogle Scholar. He finds that, for the period 1926–1960, 5 per cent of all combinations of month-end purchases and sales of each common stock on the New York Stock Exchange yielded a compound annual rate of return between 30 per cent and 50 per cent.

16 There is other evidence on this phenomenon. See, e.g., the SEC Report of Special Study of Securities Markets (1963), Part I, pp. 621–622. The Wall Street Journal, discussing the phenomenon (August 7, 1968) reports that in a study of 48 new issues by an advisory firm, 46 appreciated (an average of 75 per cent) and only two declined (an average of 7.5 per cent). A compilation of the offering experience of 71 OTC firms as reported in Barrons between 7/15/68 and 10/07/68 revealed that only one issue declined in price immediately after offering.

17 The Wall Street Journal of August 7, 1968 reports, “In fact, the demand for most new issues is so great underwriters can't satisfy it. They ration shares in new issues among their regular customers; this means that “outsiders” normally can't buy the shares at the initial offering price, but must bid higher to persuade the favored few to part with their shares.”

18 He may be compensated with cheap stock or warrants but under SEC regulations, the stock or warrant must be held 1 year or the size of the issue going to the public is reduced by an equal amount. In the case of regulation A issues, this may reduce by a significant percentage the new capital available to the firm. At any rate, since the stock is given away or priced far below the offering price, there is no need to guarantee further market appreciation in order to compensate the underwriter. In the initial sample of 643 offerings, less than 10 per cent involved cheap stocks or warrants.

19 The existence of such “suckers born every minute” would be consistent with evidence that, in the commodity markets, “smart” speculators make money at the expense of amateur speculators. See Rockwell, C., “Normal Backwardation, Forecasting, and the Returns to Commodity Futures Traders,” Food Research Institute Studies, Vol. VII, Supplement (1967).Google Scholar

20 U.S. Securities and Exchanges Commission, Special Study of Securities Markets, Part I, p. 493.