Valuation of Underwriting Agreements for UK Rights Issues.

UK companies raise virtually all of their new equity capital via the fights issue method. Companies can guarantee the subscription of their issues by having them underwritten (the equivalent of standby arrangements in the USA), and in recent years, this procedure has been adopted for over 90% of UK rights issues. Underwriting is usually carried out on a fixed fee basis representing at least 1¼% of the money raised, and hence it is clear that quite substantial sums of money are involved. Since underwriting is simply a put option giving the company the right to put a failed issue onto the underwriter, we can use option valuation models to determine whether this money is well spent. In this paper, we describe an application of the Black and Scholes model to the valuation of rights issue underwriting agreements over the period 1962–1975. Model prices are compared with the fees charged in order to assess whether the latter represent competitive prices. In fact, over this period, companies appear to have overpaid for underwriting. We cannot conclude from this alone, however, that the underwriting market is inefficient, since there may well be hidden ‘side payments’ between participants in the market. This issue is addressed, at least in a qualitative sense, in the final section of this paper. [ABSTRACT FROM AUTHOR]