Conflict of Interest in Investment Banking
February 12, 2025
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Companies want to go public because it helps them raise cash, which can be used for further expansion. However, the promoters of these companies often do not want to go public since this would mean that their stakes would be diluted and that they would lose control over the company. A low promoter’s stake in a company is often considered to be a sign of weakness. This is one of the parameters which the opposition evaluates when they want to make a hostile takeover bid. This is the reason that promoters have often asked investment bankers to devise ways using which they can actually raise capital without actually diluting their stake in the company. Some of these ways have been listed in the article below.
Anyone who is already a shareholder can be allowed to buy shares in the same proportion. However, here investment bankers use timing to their advantage. They deliberately schedule the issue at the worst possible time. This is because they want the market conditions to be bad.
During a recession or a slowdown, most investors would not want to invest more in the company. Hence, a lot of the shares being issued will be left unsubscribed. This is where the promoters can come into action. They can buy leftover shares at a reasonable price. Hence, during this issue, they end up buying more shares than the other shareholders. Therefore, the proportion of their holding in the company changes during the course of the issue.
Let’s understand this with the help of an example. For instance, the company has a total of 100 shares, out of which 20 are owned by the promoters and the rest by the public. This means that promoters have 20% shares of the company. Now, if the company buys and extinguished 20 shares, the total shares outstanding will be 80. Out of 80, the promoters will still have 20 shares. Hence the shareholding of the promoter will increase to 25% (20 out of 80 shares).
This mechanism is preferred by a lot of promoters since it allows them to use the company’s funds to increase their own shareholding in the company.
In some countries, companies are allowed to issue additional shares to promoters as long as they pay the price, which is higher than the prevailing market price.
In some other countries, the concept of sweat equity also exists. This means that the company can allot more shares to promoters in lieu of their salary or any other intellectual asset that they may provide.
It is common for investment bankers to prepare a detailed strategy for the promoters. This means that only one technique is not used. Instead, a combination of several means is used, and that too is staggered over a larger period of time.
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