City under fire
JOHN BULL
The City is under attack from respectable academic quarters again. In Equity Issues and the London Capital Market (published by Longmans at 42s) Professor A. J. Men•ett, Mr M. Howe and Mr G. D. Newbould argue that the total cost of issuing shares as part of the procedure of obtaining a Stock Exchange quotation is inordinately high. This is a serious criticism, for it strikes at the heart of the City's operations. What then is involved in selling shares to the public for the first time?
Under the heading of conventional costs come three categories: underwriting commis- sion (the charge for guaranteeing to buy any shares which the public does not take up), re- muneration to advisers (comprising a fee to the issuing house or broker and a turn on the shares) and other administrative costs—Stock Exchange quotation fees, capital duties, printing and ad- vertising, administration of allotments, bankers' and legal fees and reporting accountants' fees. The list is already formidable. What also has to be taken into account is the accuracy with which the advisers gauge the market, whether the price they fix for the shares proves realistic or not. Indeed, it is well known that issuing houses often undervalue new shares by a ridiculous margin. Brocks Alarms, for instance, was issued two weeks ago at 13s 3d a share: today the price is 22s 9d.
On the face of it, underwriting charges are modest. The statistical analysis of Professor Merrett et al. relates to a sample covering the years 1959-63: in that period underwriting com- mission averaged 2 per cent, although the Com- panies Act places the maximum figure at 10 per cent. But in effect underwriting provides the ,company marketing the shares with an insur- ance policy against failure. It is, therefore, right to relate the receipts which the underwriters receive to their losses. In fact, assuming that un- derwriters sold out of shares they were forced to take up on the second day of dealings an un- favourable assumption—then in the period 1959-63 the Merrett sample shows that losses amounted to only 14 per cent of receipts—an excessively lucrative form of insurance business.
Taken in isolation, advisers' fees also appear modest. On offers for sale (a particular form of marketing), net remuneration varied between 1.1 per cent and 2 per cent during 1959-63. Finally, if we add in the administrative costs listed above we get an average figure for total conventional costs of some 9 per cent. It is, however, more revealing to compare total con- ventional costs to the size of the issue. The result shows how absurdly expensive the public quotation is for the small company. If the issue amounts to less than £100,000, conventional costs are likely to amount to about 25 per cent. Even in the £100.000 to £200,000 range the total will run out at some 15 per cent.
Thus far, the Merrett analysis is disturbing. It shows that as a capital market the City is expensive to the point of public scandal. Pro- viding growing companies with extra funds in the right manner at the right time is an impor- tant feature of advanced economies. It must proceed smoothly. There is, however, worse to come. The Merrett team finds that the City issu- ing houses are poor at the crucial job of fixing the price for new shares. Unrealistic pricing means that the original proprietors are out of either pocket or reputation. This is a matter which needs careful examination. How big are these errors?
Taking the price at which a new issue settles down at the end of its first month as a reason- able guide, then in the period 1959-63 offers for sale were on average 16.3 per cent underpriced and placings 20.5 per cent underpriced. It is easier to measure this deviation than to say why the discount is the sire that it is. I think that the most decisive reason is the merchant banks' pride in their names. In the loose thinking of the market place. an issue is a success if there is a cast clamour for participation and a runaway rise in the price on the first day of dealings. That, apparently, adds lustre to a merchant bank name or, at least, does it no harm. But the issue which goes slightly sour is thought to be terribly damaging. If this seems an unhealthy regard for reputation, then it is worth remembering that merchant banks live by lending their name rather than their money.
Finally, as a coup de grdec. Professor Mer- rett adds together the conventional costs of coming to the market and the discounts at which most issues are priced (here I would add that some small discount is clearly necessary to get a block of hitherto unquoted shares away). The results are astounding: in the period 1959-63 offers were costing 23.3 per cent of the proceeds and placings slightly more (27.8 per cent).
These figures are too high for anybody's com- fort. The moral is clear. The City must go back to the use of the tender method. It was tried towards the end of 1963 for a few months. The objection is the weird one that it prevents the merchant banks from giving a lead to the public. On Professor Merretes evidence, the lead they give is at best uncertain.
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