Effects of People's IPO on the Russian Financial Market and Corporate Governance Praxis

Effects of People's IPO on the Russian Financial Market and Corporate Governance Praxis

Dmitry Shevchenko (Southern Federal University, Russia) and Parmenas Kimani Njoroge (Southern Federal University, Russia)
DOI: 10.4018/978-1-5225-9607-3.ch005

Abstract

People's IPO is a project that aims at distribution shares of state-owned entities to members of the public. Three Russian state-owned enterprises, VTB, SBERBANK, and ROSNEFT, conducted People's IPO between 2006 and 2007. The aim of these IPOs was to offer the general public an opportunity to own shares in state-owned enterprises. Such an investment opportunity would give ordinary citizens a stake in Russia's biggest state enterprises. Authors investigated the success or otherwise of these IPOs in distributing shares of government enterprises to ordinary citizens and gave recommendations on possible ways of improving public participation in People's IPOs. The aim of this chapter is to propose People's IPO as one of the ways of ensuring proper wealth distribution and eradicating injustice in the financial system. Authors recommend adoption of offer prices that friendly to small investors, creation of credit lines that would avail funds for investing in the IPOs. Companies going public should also adherer to the world's best to ensure growth in shareholders wealth.
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Background

Initial public offering (IPO) is the sale of stock to the public for the first time. Before IPO, companies are either privately owned or owned by the state. Initial public offering is also referred to as Primary public offering (PPO). It is a way of raising capital for the company because money raised go directly to the company. If the company in the future decides to increase the number of outstanding shares by issuing more shares, this is called Secondary public offering SPO. PPO therefore refers to newly issued shares whereas SPO refers to an old issue. Both new and old issue can be offered at an IPO. At IPO both, new and old, meaning PPO+SPO, stocks can be included. IPO can offer a company an opportunity to raise additional funds for research and development, investment and growth as well as clearing debts. It is a good way of accessing foreign and domestic capital without paying interest. An IPO also creates brand awareness as investors get involved in the company’s business and its future prospects. The company issuing shares is known as the issuer, it engages the services of an investment bank or an underwriter who acts as the intermediary between the company and the investors. He advises on the offer price, the number of shares to be offered the amount of money sought to be raised and the type of securities to be issued. Information about the company is compiled in a document known as the prospectus that details the company’s growth prospects.

It is difficult to determine the offer price of IPO because shares start trading openly mostly only after IPO. Underwriters usually come up with an offer price that is lower than the market price of shares on the first day of trading. This is called underpricing. It allows traders to make a profit in the first days of trading. Many studies suggest that average IPO is underpriced (Aggarwal, Prabhala & Puri, 2002), (Loughran & Ritter, 2000).

The literature on underpricing IPO offers four basic theories of the determinants of underpricing. First, Allen and Faulhaber (1989), Grinblatt and Hwang (1989) and Welch (1989) argue that firms underprice their shares to signal their quality to the market. Later increase in price will give the firm a good name in the eyes of prospective investors. Raising prices due to previous underpricing allows the m to attract more capital in the future at more favorable rates. According to signaling theory, issuer companies, by the means of IPO with an undervalued stock, signal to investors about the financial health of their business. Informed investors are able to make a profit out of underpriced IPO because they can resell it at a higher price when the shares start trading.

Principal Agency theory of IPO underpricing also suggests that underwriters intentionally undervalue stock so that they can later get favors from informed investors.

Key Terms in this Chapter

Primary Listing: The first issue of the company's securities, conducted simultaneously with the change of its legal form in the process of reorganization: transformation, merger, accession, separation.

Price Earning Ratio: This is the amount an investor is paying for one unit of investors profit (current share price relative to its per-share earnings).

CIS Countries: A free trade area of independent countries that were formerly in the Soviet Union.

Secondary Listing: Any subsequent offer of purchase of shares that after the primary listing.

Share Split: This is when a company divides its existing shares to multiple shares to improve liquidity. For example, Sberbank split 1 share worth 89000 ruble to 1000 new shares worth 89 rubles each.

Underpricing: Placing shares in the IPO at a price that is lower than the market price.

Prospectus: A legal document issued by companies that are offering securities, describing the assets, liabilities. Risks and other material information about a company.

Buy Back: This is the re-acquisition by a company of its own stock Normally it is seen as a signal to investors that the company considers the shares to be underpriced.

Global Depositary Receipt: A bank certificate issued in multiple countries for foreign stock.

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