Question

Financial Risk Managemen

A pharmaceutical company is going through an IPO. It plans to issue 5 million shares at 12 Euro per share. The investment bank suggests that the offer price for the shares should be 10 Euro per share to ensure that all the shares should be sold easily. Explain the dilemma for the pharmaceutical company. What is the advantage of following the advice of the investment bank? What is the disadvantage? Is the investment bank incentive to place the shares aligned with the interests of the pharmaceutical company?

Answer 1

The decision to be made is confusing and difficult. Either the pharmaceutical company will raise more capital or raise less capital but be successful at selling all shares.

If the company follows the bank's advice, it will raise less money but be successful at selling all shares. Price of one share is 12 euros. 5 million shares will be offered for sale. If the company reduces the share price and sell it at 10 euros per share, all the shares are likely to be sold and a capital of 50 million euros will be raised.

If the company does not follow bank's advice and sells the share at 12 euros per share and if all the shares get sold, the company will raise a capital of 60 million euros. That means, 10 million euros more if the share price is not reduced.

No, the investment bank incentive to place the shares is not aligned with the interests of the pharmaceutical company because the investment bank will get shares at a lower price at the time of underwriting.