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Concession

What Is Concession?

A concession in finance refers primarily to a fee paid to a securities dealer for selling a portion of a new issue of stocks or bonds, particularly during an Initial Public Offering (IPO) or secondary offering. It is a component of the underwriting spread, which is the difference between the price at which the underwriting syndicate purchases the securities from the issuer and the Public Offering Price at which they are sold to the public. This type of concession is a direct payment to compensate the broker-dealer for their role in distributing the securities to investors, falling under the broader category of Corporate Finance within financial markets.

Beyond securities offerings, "concession" also describes a long-term agreement where a private entity receives the right to operate a public service or asset, such as a toll road, airport, or utility system, in exchange for an agreed-upon share of Revenue Streams or fixed payments. These are common in Infrastructure development and public-private partnerships (PPPs), representing a grant of rights or privileges by a government or authority to a private company.

History and Origin

The concept of a concession in securities underwriting has roots in the historical evolution of investment banking and capital markets. In the early 20th century, the process of bringing new Equity or Debt Securities to market involved various "groups" and "syndicates" that collaborated to distribute the offering. The "gross spread," which encompasses the concession, was distributed among these firms as compensation for their roles in the offering. Early practices, prior to the Securities Act of 1933, sometimes involved syndicate trading accounts that could create artificial prices, leading to scrutiny and later regulation aimed at promoting transparency in the distribution process.6

The modern framework for disclosing concessions is outlined by regulatory bodies such as the Financial Industry Regulatory Authority (FINRA). For instance, FINRA Rule 5160 explicitly requires that selling syndicate agreements or selling group agreements clearly state the public offering price and the circumstances under which concessions may be allowed.5

Concessions in the context of public-private partnerships (PPPs) have a longer history, dating back centuries for projects like canals and bridges. The formalization of these arrangements accelerated in the late 20th and early 21st centuries as governments increasingly sought private sector involvement to fund and manage large infrastructure projects.

Key Takeaways

  • A concession is primarily a fee paid to a securities dealer for selling new issues, forming part of the underwriting spread.
  • In underwriting, it compensates individual selling group members for their distribution efforts.
  • Concessions also refer to long-term agreements granting private entities rights to operate public assets or services.
  • These agreements are common in public-private partnerships for infrastructure development.
  • Regulatory bodies require clear disclosure of concessions in securities offerings to ensure market transparency.

Formula and Calculation

In the context of securities underwriting, the concession is a specific portion of the total underwriting spread. The underwriting spread is the difference between the price paid by the underwriters to the issuer and the Public Offering Price to investors. This spread is typically divided into three main components:

  1. Manager's Fee: Paid to the lead Syndicate manager for originating and structuring the offering.
  2. Underwriting Fee: Paid to all syndicate members for assuming the risk of purchasing the securities from the issuer.
  3. Selling Concession: Paid to the selling group members (which can include syndicate members) for selling the securities to investors.

The formula for the concession is implicitly part of the breakdown of the gross spread. If the gross spread is denoted as (GS), the manager's fee as (MF), the underwriting fee as (UF), and the selling concession as (SC), then:

GS=MF+UF+SCGS = MF + UF + SC

The concession (selling concession) is typically the largest component of the underwriting spread, designed to incentivize broad distribution. For example, if a stock is offered to the public at $100, the underwriting syndicate might pay the issuer $97. The $3 difference is the gross spread. This $3 could be broken down, for instance, into $0.60 for the manager's fee, $0.90 for the underwriting fee, and $1.50 for the selling concession.

Interpreting the Concession

In securities offerings, the concession is a direct indicator of the compensation received by the individual Broker-Dealer or selling group member for each unit of security they successfully sell to the public. A higher concession can incentivize greater sales efforts from the distribution network, as it represents a larger profit margin for each security sold. It reflects the value placed on the distribution capabilities of the selling group in reaching a broad investor base. From an issuer's perspective, the total concession paid, as part of the overall underwriting spread, represents a significant cost of raising capital.

In public-private partnerships, the interpretation of a concession revolves around the terms of the agreement, including the duration, the responsibilities of the private entity, and the mechanisms for Revenue Streams or payments. It signifies a long-term commitment and Risk Allocation between the public and private sectors, with the private entity often assuming risks related to design, construction, financing, operation, and maintenance.

Hypothetical Example

Imagine TechInnovate Inc. is conducting an [Initial Public Offering](https://diversification.com/term/initial public-offering) (IPO) of 10 million shares, with a Public Offering Price of $20 per share. An Investment Banking syndicate agrees to purchase these shares from TechInnovate at $19.00 per share. The gross spread is thus $1.00 per share.

This $1.00 gross spread is divided among the syndicate members:

  • Manager's Fee: $0.20 per share
  • Underwriting Fee: $0.30 per share
  • Selling Concession: $0.50 per share

A smaller Broker-Dealer that is part of the selling group, but not a full syndicate member, sells 100,000 shares to its clients. For each share sold, this broker-dealer earns the $0.50 selling concession. Therefore, for their efforts, they receive 100,000 shares * $0.50/share = $50,000. This concession directly compensates them for their role in the distribution of TechInnovate's new Equity.

Practical Applications

Concessions are fundamental in two distinct but equally vital areas of finance:

  1. Securities Underwriting: In the capital markets, concessions are the primary method by which members of a selling group are compensated for distributing new issues of Equity or Debt Securities. This ensures that a wide network of firms is incentivized to sell the securities to their client base, facilitating the successful placement of large offerings. Regulations often mandate the clear disclosure of these concessions. FINRA Rule 5160, for example, requires selling agreements to clearly state the public offering price and the circumstances under which concessions may be allowed.4

  2. Public-Private Partnerships (PPPs): Concession agreements are extensively used in the development and operation of Infrastructure projects globally. These involve a private entity receiving the right to develop, operate, and maintain public assets like toll roads, bridges, airports, or water treatment facilities for a specified period (e.g., 20-99 years). In return, the private concessionaire typically collects tolls or user fees as their primary Revenue Streams, or receives availability payments from the public authority. This model allows governments to leverage private capital and expertise for large-scale projects. The Federal Highway Administration (FHWA) provides detailed primers on how P3 concessions work for highway projects, outlining the Risk Allocation and compensation structures.3

Limitations and Criticisms

While concessions are a standard practice, particularly in underwriting, they are not without limitations and criticisms. In securities offerings, the size of the concession, as part of the overall underwriting spread, can be a point of contention for issuers, as it directly impacts the net proceeds they receive from an offering. Compensation arrangements for underwriters can sometimes go beyond simple commissions to include expense reimbursements or warrants for additional shares, which can further increase the effective cost to the issuer.2 Historically, there have been concerns about how underwriting syndicates managed offerings and the potential for practices that did not always align with optimal market efficiency or fair pricing for initial investors, as seen in pre-1933 market behaviors.1

In the context of public-private partnerships, criticisms often revolve around the long-term nature of the agreements and the potential for a lack of flexibility if economic or social conditions change significantly over the concession period. Concerns can also arise regarding the level of user fees or tolls charged by private concessionaires, especially if they become perceived as excessive. Furthermore, the complexity of these agreements requires extensive Due Diligence and robust Financial Regulation to ensure public interest is adequately protected and that fair value is achieved for taxpayers and users alike.

Concession vs. Underwriting Spread

While closely related in the context of securities offerings, "concession" and "Underwriting Spread" refer to different aspects of the compensation structure.

The underwriting spread (also known as the gross spread) is the total difference between the price at which the investment bank or syndicate buys the securities from the issuer and the Public Offering Price at which they are sold to the public. It represents the total compensation earned by the entire Syndicate for their services, including underwriting risk, management, and distribution.

A concession (specifically, a selling concession) is a portion of that total underwriting spread. It is the amount paid to individual selling group members for each share or bond they sell to investors. The concession is the incentive for the distribution network to actively market and sell the securities. In essence, the underwriting spread is the whole "pie," while the concession is one of the "slices" distributed to those directly involved in sales.

FAQs

What is the main purpose of a concession in an IPO?

In an Initial Public Offering (IPO), the main purpose of a concession is to compensate the Broker-Dealer or selling group member for successfully selling shares to investors. It acts as an incentive for a broad distribution of the new securities.

How does a concession relate to the overall cost of an offering?

A concession is a component of the larger underwriting spread, which is the total fee charged by Investment Banking firms to an issuer for bringing securities to market. The higher the concession, the less net proceeds the issuing company receives from the sale of its securities.

Are concessions always paid in cash?

Typically, concessions in securities offerings are expressed as a dollar amount per share or percentage of the offering price, which translates into cash compensation for the selling firm. However, other forms of compensation or expense reimbursements may also be part of the overall arrangement with underwriters.

What kind of assets are typically involved in a concession agreement in public-private partnerships?

In public-private partnerships, concession agreements commonly involve Infrastructure assets such as toll roads, bridges, tunnels, airports, seaports, public transportation systems, water treatment plants, and other public utilities. The private entity typically finances, builds, operates, and maintains these assets for a long period.