WINNER'S CURSE PROBLEM Set-up: The firm is ready to sell 1 million shares through a fixed price offering. 68 Firm managers and informed investors know the fair price; uninformed investors don't. Uninformed investors only know that fair price is either t8 or +12 with equal probability Suppose uninformed investors always bet 1 million shares. Informed investors bet 1 million only when the shares are undervalued. Suppose the firm sets the offer price at $10. Let's see what happens? Fair price = +8 Shares 0 1.000.000 Probability 0,5 0,5 Fair price = #12 Probability Shares 0,5 500.000 0,5 500.000 Gain/Loss 0 -$2.000.000 Informed Uninformed Expected Gain/Loss #500.000 -500.000 Gain/Loss +1.000.000 +1.000.000 Practice questions: [1] What is a fixed price offering? What are some alternative ways to sell equity? What are their advantages and disadvantages relative to fixed price offers? [2] Will the offer be successful at 10? Why, or why not? [3] What is the offer price that will induce uninformed investors to participate the offering and guarantee the success of the offering? [4] In real life, what strategies do issuing firms follow to avoid unsuccessful offerings? WINNER'S CURSE PROBLEM Set-up: The firm is ready to sell 1 million shares through a fixed price offering. 68 Firm managers and informed investors know the fair price; uninformed investors don't. Uninformed investors only know that fair price is either t8 or +12 with equal probability Suppose uninformed investors always bet 1 million shares. Informed investors bet 1 million only when the shares are undervalued. Suppose the firm sets the offer price at $10. Let's see what happens? Fair price = +8 Shares 0 1.000.000 Probability 0,5 0,5 Fair price = #12 Probability Shares 0,5 500.000 0,5 500.000 Gain/Loss 0 -$2.000.000 Informed Uninformed Expected Gain/Loss #500.000 -500.000 Gain/Loss +1.000.000 +1.000.000 Practice questions: [1] What is a fixed price offering? What are some alternative ways to sell equity? What are their advantages and disadvantages relative to fixed price offers? [2] Will the offer be successful at 10? Why, or why not? [3] What is the offer price that will induce uninformed investors to participate the offering and guarantee the success of the offering? [4] In real life, what strategies do issuing firms follow to avoid unsuccessful offerings