Investment banks and investment bankers help companies issue new debt and equity securities in the primary markets and also function as brokers for the public in the secondary markets.
Leading U.S. Investment Bankers
Investment Bank 1. Merrill Lynch 2. Salomon Smith Barney 3. Morgan Stanley Dean Witter 4. Goldman Sachs 5. Credit Suisse First Boston 6. Lehman Brothers 7. Chase Manhattan 8. J.P. Morgan 9. Bear Stearns 10. Banc of America Securities
Volume $ 331.78 b 268.07 210.99 192.44 181.40 169.71 109.40 90.73 86.34 75.90
Market Share 15.4% 12.5 9.8 9.0 8.4 7.9 5.1 4.2 4.0 3.5
Usually investment banks buy the new bonds or stock from the company at one price and sell it to the public at a higher price. The difference is called the underwriter’s spread. (Debt is often sold in private placements.) Therefore, investment bankers assume the risk of not being able to sell all of the security issue and/or the risk of not being able to make a profit on the sale. This is called underwriting. Investment banks are called underwriters of securities.
Investment bankers a) give the issuing company advice on choice of security, timing, size of issue, price, etc. b) provide clerical and filing services for the new issue Investment banking can be very profitable, but it can also be very risky. Therefore investment bankers usually form underwriting syndicates to buy the issue from the company and thus distribute the risk. Additional investment bankers may be brought in to form a selling group at the retail level, i.e., to sell the shares to the public. The investment bank(s) that manages the underwriting is called the originating house. Sometimes shares are sold on a “best efforts” basis in which the issuing company retains the risk of not being able to sell all the shares to the public. The investment bank is an agent only. This is usually done either by companies that are very strong financially or, much more likely, very weak. If the sale of stock (or bonds) is the first time that a company has sold stock (or bonds) to the public, it is called an initial public offering, an IPO, “going public.” The market for IPOs can be hot and a matter of controversy because of the allocation of shares to first buyers. IPOs are often quite profitable for initial investors. Subsequent sale of additional stock to the public is called a seasoned offering. The company receives more cash. Secondary offerings are the public sale of previously issued securities held by large investors. The large investors receive the cash, not the company.
New issues of securities must be registered with the Securities and Exchange Commission, the SEC. The SEC does not pass judgment on the wisdom or investment quality of the new issue; it only checks to see that all required information has been provided and that the preliminary prospectus (called a “red herring” because of the red printing on the cover) is correct in format and content. After the registration has been approved, the company issues a final prospectus. Potential investors are supposed to read the prospectus so that they will be fully informed about the security they are considering buying. In practice few potential investors read the prospectus. A company that files a registration statement does not have to issue the new security. The approved registration statement is valid for two years, anytime during which the company can issue the new security. The company may wait until it needs the cash or until market conditions suggest the maximum price can be obtained for the stock or the lowest interest rate for the bonds. This is called a shelf registration. A private placement is the sale of the entire IPO to one or a few investors. The public does not have the opportunity to buy any of the new issue.