Question

Researchers document significant first trading day share price increases in a large sample of initial public offerings (IPOs) of equity but also find share prices tend to decline when companies make announcements on season equity offerings (SEOs). Please use appropriate finance theories to explain why share price behaves differently in IPOs and SEOs.

Answer 1

Share price will be behaving differently in case of initial public offering and in case of subsequent offering, because when initial public offerings are being made it will mean that investors are not aware about complete functioning of the company and they are trying to invest upon a certain rosy image of the company and the company is trying to garner a lot of interest from these investors in order to maximize its market capitalisation and attract a lot of subscribers but once the company is settled into the market and market participants are aware about the functioning of the company and the business performance of the company, then when the additional shares are being issued, it will mean that these shares are going to dissolve the control of existing shareholders of the company and the shares will also mean that the company will be losing its own control over the organisation because of addition of new equity shareholders so it can be summarised that when new share holders are being added through subsequent issue of equity shares, it will have negative impact due to dilution of existing equity and it will also mean that the company is not able to fund itself through profits and the company is also losing the control over the organisation and hence in a subsequent issue of equity shares, generally the prices tends to decrease.