Corporate finance Essay Example | Topics and Well Written Essays - 3000 words - 1

Corporate finance - Essay Example In this process the underwriter sells the shares of the company at a discount to the senior executives of a third party company in exchange of some future business opportunities or some other benefits that it hopes to receive from that company. How this conflict of interest arises and how it can be solved is discussed in the following pages. When the company goes in for an IPO by using the services of an underwriter in exchange of some fees that the underwriter charges the company is in essence acting as principal and the underwriter is acting as an agent. The problem in a principal agent relationship arises when either the principal or the agent are guided by self interests. The problem is aggravated when there is information asymmetry such that the agent has more information than the principal available with it. In such cases the principal is not sure whether the agent is actually working to serve in the best interest of the Principal. In this particular case for example the agent that is underwriter of the shares, has more information available to it than the company. The investment banker has several interests over here to look into like looking into its own future interests and just to ensure that the company’s share can sell at higher price. Its primary goal is to show the company that it has sold the IPO by the company at a very high price and thus is able to command a huge price tag for its services. The second interest guiding the investment bankers is to open the doors of future business prospects. By the act of spinn ing the investment banker (acting as underwriter) is able to achieve both its objectives. A research into the field by Prof. J. R. Ritter and X. Liu in the year 2009 showed that the IPOs in which spinning was involved in by the investment bankers generated 23% higher first day returns as compared to other IPOs (Liu and Ritter, 2010). Secondly companies of the executives who were offered the shares of the IPO at discount were most likely