Fixed price issue

What Is Fixed Price Issue?

A fixed price issue is a method of securities issuance in which the issuer and its underwriters agree upon a set price for the shares or bonds being offered to the public, prior to the start of the public offering. This method falls under the broader category of Securities Offerings within capital markets. Once the fixed price is determined, it generally remains constant throughout the entire subscription period. Investors interested in purchasing these new securities agree to buy them at this predetermined price.

History and Origin

The concept of a fixed price issue has deep roots in the history of financial markets, particularly in initial public offerings (IPOs) and government debt issuances. Historically, many jurisdictions, including the United Kingdom, extensively used the fixed price method for floating new equity and debt instruments. For instance, the issuance of UK government bonds, known as gilts, often follows a fixed price approach through auctions, where the price is set before bidding begins, or through syndications at a pre-announced price. This practice aims to ensure certainty for both the issuer regarding the capital raised and for investors regarding the cost of acquisition. The Bank of England, for example, conducts market operations that involve the issuance and trading of government debt, influencing the financial system's stability.⁴

Key Takeaways

• A fixed price issue sets a predetermined price for securities before they are offered to investors.
• This method provides price certainty for both the issuer and the investors.
• The entire offering, regardless of demand, is sold at the established price.
• It is commonly used for government bond issuances and, historically, for some corporate offerings.

Interpreting the Fixed Price Issue

In a fixed price issue, the interpretation is straightforward: the stated price is the price at which investors will buy the security. There is no negotiation on the price per share or per bond unit during the offering period. This contrasts with other issuance methods where the final price might fluctuate based on market demand. For an issuer, the fixed price issue means a clear understanding of the capital to be raised, assuming full subscription. For investors, it means knowing the exact cost of their investment upfront, which can simplify investment decisions but also introduces the risk of overpaying if demand is lower than anticipated.

Hypothetical Example

Consider a hypothetical technology startup, "InnovateTech Inc.," planning its flotation. The company, in conjunction with its investment bank, decides on a fixed price issue for its IPO.

1. Preparation: InnovateTech and its lead underwriter determine that 10 million shares will be offered to the public. After extensive valuation analysis, they set the fixed price at $20 per share.
2. Prospectus Release: A prospectus is released detailing the offering, including the fixed price of $20 per share.
3. Subscription Period: For a specified period, investors can place orders to purchase shares at $20 each.
4. Allocation: If demand exceeds the supply of 10 million shares, the shares are typically allocated among the interested investors. If demand is less, the underwriters may be left with unsold shares.

In this scenario, every investor who acquires shares through the fixed price issue pays exactly $20 per share, regardless of how popular or unpopular the offering turns out to be during the subscription phase.

Practical Applications

The fixed price issue method finds its primary practical application in government bond sales and certain types of corporate debt or equity offerings where stability and clarity in pricing are prioritized. For example, the United States Treasury often issues new Treasury bills, notes, and bonds through an auction system that effectively sets a fixed price (or yield) for a given offering, even if competitive bids are also accepted. Similar mechanisms are used for UK gilts, which are UK government liabilities issued by HM Treasury and listed on the London Stock Exchange.³,²

Furthermore, in some regulatory frameworks, such as certain exemptions from registration with the U.S. Securities and Exchange Commission (SEC), a fixed price may be utilized. For instance, Regulation A allows for certain public offerings up to a specified monetary limit, which can sometimes employ a fixed price model, simplifying the process compared to a full registration.¹

This method is most effective in stable market conditions or when the issuer has strong investor confidence, ensuring sufficient demand at the fixed price. However, in volatile markets, setting a fixed price can expose the issuer or underwriters to significant risk if market conditions change rapidly.

Limitations and Criticisms

One of the main limitations of a fixed price issue is its inflexibility in adapting to market demand. If the demand for the securities is very high, the fixed price may result in the issuer "leaving money on the table" as they could have sold the securities at a higher price. Conversely, if demand is lower than anticipated, the underwriters responsible for the underwriting may be left with unsold securities, potentially leading to losses if they have to sell them on the secondary market at a discount.

Critics also argue that the fixed price model can lead to unequal access for investors. Large institutional investors, due to their relationship with the underwriters, may receive preferential allocation in popular offerings, while smaller investors might find it difficult to acquire shares at the fixed price. This can also create a phenomenon known as the "winner's curse" for smaller investors who do get allocations in less popular offerings.

From a broader financial market perspective, the concept of "market efficiency" suggests that asset prices should fully reflect all available information. A fixed price issue, by its nature, sets a price regardless of immediate market fluctuations during the offering period, which might lead to a temporary divergence from the market's true collective valuation if demand is not perfectly gauged. This underscores the challenge of price discovery in less flexible issuance mechanisms.

Fixed Price Issue vs. Book-Building Process

The fixed price issue stands in contrast to the book-building process, which is a more commonly used method for corporate equity offerings today. The key differences are:

In the book-building process, underwriters gauge investor demand by soliciting bids at various price points within a specified range. This allows the issuer to adjust the final offering price to maximize proceeds and ensure full subscription, making it a more adaptive mechanism for price discovery in dynamic market conditions compared to the static nature of a fixed price issue.

FAQs

Why do some issuers still use fixed price issues?

Fixed price issues offer simplicity and certainty regarding the capital to be raised. For stable entities like governments issuing bonds, where investor demand is generally predictable, this method can be efficient. It also reduces complexity for retail investors who prefer a straightforward price.

What happens if a fixed price issue is undersubscribed?

If a fixed price issue is undersubscribed, meaning not all available securities are purchased by the public at the fixed price, the underwriting syndicate may be obligated to purchase the remaining securities themselves. They then attempt to sell these on the secondary market, potentially at a lower price, which can result in losses for the underwriters.

Is a fixed price issue always an Initial Public Offering (IPO)?

No, a fixed price issue is a method of offering securities and is not exclusively used for an Initial Public Offering. While IPOs can theoretically use a fixed price model, the book-building process is far more common for equity IPOs today. Fixed price issues are frequently seen in offerings of government bonds or certain corporate debt instruments.