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Trading Volume in the Tech Bubble
On average, IPOs appreciated by 65% on opening day, during the tech bubble of 1999 and 2000. IPO share allocation was equivalent to free money. Obviously, normal investors very rarely got such share allocations- only the favorite clients of the underwriters did. Later, this resulted in several lawsuits. One of these lawsuits revealed that VSFB (Credit Suisse First Boston) allocated IPO shares to over 100 customers, who, in return for their allocations, funneled around 33%-65% of their IPO profits back to CSFB through excessive trading of other stocks (such as Disney and Compaq) at inflated trading commissions.
What was the importance of this ‘kickback’ activity? In 1999 and 2000, underwriters left a total of around $66 billion on table for first day IPO buyers. If 20% was rebated to the underwriters by the investors, this would amount to $13 billion in profits. This would require trading of 130 billion shares at an average 10 cents commission per share, or trading of 250 million shares per day on average. These numbers indicate that kickback portfolio churning may have accounted for up to 10% of all the shares traded.
Outflows
There are various ways in which capital is flown out of the financial market. Capital distributions like share repurchase and dividends are the most important venues. Several companies pay in dividends to their investors through some of their earnings. Obviously, dividends aren’t godsends. For example, a company with $100,000 worth would only be $99,000 worth if it pays $1000 as dividends.
If your share is worth $100, roughly you would only own $1 in dividends and $99 in stock. The total would still be $100, not less or more. (It might be less if you are required to pay certain taxes on receipts of dividend.) As an alternative, outstanding shares may be reduced by firms if they pay out their earnings in repurchases of share. For instance, $1000 for share repurchases may be dedicated by the firm, and thereof you could tell them to utilize $100 for repurchasing your share. You wouldn’t have lost anything even though you decide on holding onto the share.
Before, you owned 0.1% ($100/$100,000) of the company. Now, you shall own $1.0101% ($100/$99,000) of the company. You will find out that your share’s worth is still $100. Either ways, the outstanding public equity’s value in the company has reduced to $99,000 from $100,000. Share repurchases and dividends shall be further discussed in Chapter 19.
Companies may even quit public financial markets by delisting entirely. Delisting occurs usually when either a company is bought by company firm or when the company runs into so bad financial problems that they are unable to meet the minimum requirements of listing. Such sort of financial problems lead to liquidation or bankruptcy. Certain firms even liquidate in a voluntary manner. This whey they can sell their assets and pay the shareholders by returning their money.
This happens rarely since managers are interested in continuing their work; even the company’s continuation is not good for the shareholders. It is more common for firms to make poor investments and end up in a situation being delisted and becoming bankrupt. Thankfully, investors have limited liability. This means the worst that could happen is that they lose their investments, but they don’t have to pay any further for poor management.
Solve Them!
Question 7.16 What may happen if worth of open-end fund’s holding is a lot more than what fund’s shares are trading for? What may happen in the case of a closed-end fund?
Question 7.17 Discuss the primary mechanisms through money flows into the firms from investors.
Question 7.18 What institutional mechanisms cause funds to disappear from public financial markets and return to the investors?
Question 7.19 How does share disappear from stock exchange?
Links of Previous Main Topic:-
- Introduction of corporate finance
- The time value of money and net present value
- Stock and bond valuation annuities and perpetuities
- A first encounter with capital budgeting rules
- Risk and return risk aversion in a perfect market
- Cash bonds and stocks 1970 to 2007
- Market institutions related to equity an overview
- Anecdote
Links of Next Financial Accounting Topics:-
