Introduction to Financial Management

Introduction to Financial Management 2006 Introduction to Financial Management

I . Introduction

To finance the day-to-day activities and to afford business expansion , a company as they grow will need lots money . The company needs additional capital in to finance technological invention , network expansion and so many other things that help them to strengthen their presence and position in the markets . In to raise the capital , interestingly the company has many options that fall into one of two broad categories internal or external financing

Internal financing as the name suggests means companies

will use their own money that come from the collected profit years after years before or from their shareholders injection . On the other hand , external financing is the financing method that raises capital from external resources such as bonds , stocks , and many other options . However basically , the two kinds of financing method are building a company 's capital structure

When a company relies on the external financing , it will deal with financial institutions that compose of several institutions such as banks , credit unions , insurance companies , mutual funds , and other financial intermediaries ( Financial Intermediation . The existence of the institutions aimed at providing bridge of or channeling funds from those people /organizations who have surplus funds to those with shortage ones

Accounting Scandal at Enron also represents the criminal way to raise capital . In the scandals , there are at least three actors : the first is Enron , the company that has a pile of debt that was off balance sheet The second actors are auditors they acted as consultants that helped the Enron to write a fake figure of the company 's profit in the book The third casts are bankers , acted as underwriter , which intentionally issued good analyst reports at Enron financial reports . By doing such bogus report , Enron aims at raising much money to pay their loans Amazingly , within three years , the fake report gives Enron over 10 billion of investors ' money

Concerning the issue of raising capital , this will analyze recent breakthrough in initial public offering (IPO ) method cast by Google , a company that operates the most widely used search engine at Internet that also operates free e-mail services ( HYPERLINK "http /www .gmail .com " www .gmail .com . The unusual method of Google 's IPO is the so-called Dutch auction method instead of usual IPO that we see at Wall Street and other stock exchange in the world . The discussion of the Google 's Dutch auction includes potential advantages and disadvantages , and pros and cons about the need of a corporation follow Google 's model of raising capital through online auctions

II . Initial Public Offering (IPO ) of Google

II .1 Challenge : Attracting Investors

Under such fear of having fooled , investors tend to put their money at low-risk instrument like savings . However , there are still many home savers view direct investment in corporate securities unattractive and too risky relative to holding cash ( Financial Intermediation

Under such fear of having fooled , investors tend to put their money at low-risk instrument like savings . Under such circumstances , Financial Institutions need to issue financial claims that are more attractive to households

During the Initial Public Offering (IPO , for example , there lies significant role that financial institutions take part where they can decide what kind of IPO mechanism is appropriate for a company and so on

II .2 Case of Google : Pros and Cons of Dutch auction

II .2 .1 Advantages of Google 's Dutch auction

Concerning the Google 's Dutch auction in 2004 , Nayantara Hensel , an IPO expert says that like other controversial method , Dutch auction also has advantages and disadvantages from the perspective of the issuing company . Delaney (2005 ) says that at that time , Google 's Dutch auction was considered as an assault on Wall Street practices

First , Hensel (2005 ) reveals that the obvious advantage of Dutch auction is that the method has ability to improve the ability of small investors to participate in the IPO process in which the investors are able to minimize the unquestioned domination of large institutional investors who become the lucrative clients of the underwriting investment bank . In this Dutch auction practice , the determination of the final price of the IPO is based on the lowest price at which all of the shares are sold

Second , the Dutch auction also offer benefits for a company since the company like Google can minimize the gap between the offer price and the opening price of the offering . Although this benefit does not happen in the case of Google , the management and venture capital firms undoubtedly take benefit of the high valuation that the markets put on the Google stocks (Hensel , 2005

Third , Dutch auction also minimize the role of the investment bank as the middleman in which the value of the IPO will go to the company that perform the IPO rather than giving benefits to the favored clients of the investment bank

This practice is definitely different from traditional IPO method . In the traditional method , it is common to find out that the investment banks , which is responsible of the company 's IPO , do some road show abroad to visit and present the attractiveness of the offered stocks to various possible investors (usually large mutual funds or clients of the investment bank ) to determine the suitable price for the IPO . This practice , in turn , will give the investors the initial allotments of IPO shares and benefit from the price appreciation imbued in the increase between the offer price and the open price (Hensel 2005

II .2 .2 Cons of Google 's Dutch auction

In addition to the advantages of the Dutch auction method for IPO , the method also has drawbacks or disadvantages since some analysts see that the high price of Google stocks does not represents the pricing mechanism of the online auction

In addition , the drawback of Google 's Dutch auction is that the method does not favor small investors since they may have no enough information to determine the right price for the IPO . This unfavorable gap might happen when the small investors do not have access to the sources , which describe the nature of the company that institutional investors have (Hensel , 2005

Another drawback is the Dutch auction is prone to lead to mispricing that is unwanted for investors , especially small investors . The mispricing is the result of several actions . First , the investors do not have sufficient information about the company , less scrutiny by investment banks , and the fact that some investors find out that only few well-known companies that have used this Dutch auction method so there is no well-informed trick

In addition , Jon Anda , a Morgan Stanley capital-markets executive reveals that auctions method is still unproven since very few companies do IPO by using this method . Moreover , Anda says that this auction method also provide the `adverse outcome` risk (Smith , 2005

II .2 .3 Should Corporations Follow Google 's Dutch auction

The Google 's brave move to adopt Dutch auction has driven many companies to pore over whether the Dutch auction becomes the best method for IPO . This is because the success of Google to achieve high price near 200 as of April 2005 and 374 as of May 30 , 2006 , makes other companies trembling to consider the option

However , the analysis of advantages and disadvantage of the Dutch auction provide a balance view about the possibility to reach unquestioned IPO success . Hensen (2005 , for example , saw that the success of Google 's Dutch auction was a special case . He sees that the global brand of Google contribute to the success of the company Dutch auction-method IPO . It means that to succeed in IPO , the company should become the leader in a market and has competitive advantage to sustain in the business for long term . Whatever the IPO method is , the investors seem to pick prospective shares

Works Cited

Allen , Franklin Anthony M . Santomero . The Theory of Financial Intermediation . Retrieved May 31 , 2006 from HYPERLINK "http /66 .102 .7 .104 /search ?q cache :KAGOlKr-ehoJ :fic .wharton .upenn .edu /f ic /s /96 /9632 .pdf understanding financial intermediation hl id http /66 .102 .7 .104 /search ?q cache :KAGOlKr-ehoJ :fic .wharton .upenn .edu /fi c /s /96 /9632 .pdf understanding financial intermediation hl id

Delaney , Kevin J (2005 . Google IPO Revisited : Insiders Got Choice Other Sellers Didn`t . Wall Street Journal (Eastern edition . New York N .Y . pg . A .1

Hensel , Nayantara (2005 . Are Dutch Auctions Right for Your IPO Harvard Business School Working Knowledge

Smith , Randall (2005 . Why IPOs Still Use the Old Way .Wall Street Journal (Eastern edition . New York , N .Y : Jul 6 , 2005 . pg . C .1

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