Financial Management – Theory and Practice 13th Ed - Chapter 20 20-3 The SEC att

Question

Financial Management – Theory and Practice 13th Ed - Chapter 20

20-3
The SEC attempts to protect investors who are purchasing newly issued securities by making sure that the information put out by a company and its investment bankers is correct and is not misleading. However, the SEC does not provide an opinion about the real value of the securities; hence, an investor might pay too much for some new stock and consequently lose heavily. Do you think the SEC should, as a part of every new stock or bond offering, render an opinion to investors on the proper value of the securities being offered? Explain.

Explanation / Answer

The old adage of “Whats a security worth? What someone's willing to pay for it.” applies here.

Security prices are determined by an investors expectation of future earnings potential and/or the cash flow they are willing to accept on an investment. Therefore a company with a higher expectation of future earnings per share or ease in providing the cash flow promised will trade at a price that is significantly higher than one with lower expectations.

The SEC cannot predict the future earnings of a company or manage anyones expectations, and it is ridiculous to think or propose that anyone could with any certainty. Attempting to apply an opinion to investors on the "proper" value of a security would be inherently just as subjective as the value that any informed and educated investor may place on the security.

A better solution would be to turn the investment bankers into facilitators of a standardized SEC supervised dutch auction form of offering. Because the broader markets and not the investment bankers and a handful of large mutual fund companies would be determining the “proper” value of the securities from the start.

Unfortunately this not likely to happen since under the current system investment bankers are a huge profit center for their firms. They also dole out shares of the securities which they are fully aware are woefully under-priced to their most favored clients and in the process short change the issuers of the full value they may have received. It may also make it more difficult for some companies access the securities markets because in the current system, investment bankers do take risk by guaranteeing a price and minimum number of securities sold on behalf of the issuers. However, who's to say that that is not the way the market should work.

Related Questions

Navigate

• Browse (All)
• Browse F
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.