OF FINANCIAL AND QUANTITATIVE ANALYSIS June 1975 UNSEASONED EQUITY FINANCING

Abstract

New stock financing is assuming increasing significance as a source of funds for private firms. The problem of management of external financing has grown as well. As a practical matter, financial managers must depend on the assistance of underwriters with respect to pricing and distribution of new corporate stock. But recent changes, some set in the context of the capital asset pricing model, imply systematic underpricing of new securities 2 by underwriters. If these charges are true, the financial manager is faced with the dilemma of paying monopsony profits, or accepting the cost and risk involved in taking the issue to market without the investment banker, or seeking an alternative source of funds. In any event, the process of marketing new equity depends on the relationship among the many characteristics unique to the firm and that firm's cost of equity capital. This paper discussed these interrelated issues. The next section presents a model of new issue pricing under the assumption that the issue is underwritten. The question of underwriter monopsony profit is considered with respect to underwriter risk. Determinants of net