Assume that the bankers offer participation in the underwriting and the capitalists take it on these terms: the capitalists, in return for funds supplied the bankers, for every $100 supplied, get: — $111.10 (approximately) par value of bonds; 55.05 (approximately) par value of stock. Since the named terms of the underwriting would be bonds at 90 with a bonus of 50 per cent of common, we can state the matter ac curately. The capitalists, in return for funds supplied to the bankers, for every 900 sup plied, get: $1000 par value of bonds; 500 par value of stocks.
We are assuming that the promoters are keeping their preferred and common, either because of their confidence in the future of the company, or because it was part of their bar gain with the bankers that they should keep them for a stipulated time in order that their securities might not interfere with the bank ers' market.
If under no further obligation in the way of taking these securities off the underwriters' hands and placing them with the "ultimate consumer," — that is to say, in the hands of investors, — the bankers have made their profit and are out of it. They have made over four and a quarter (4.29) points on the bonds, which they bought at 85.71, and have disposed of at 90, and they have $2,000,000 par value of common stock, which will be worth something if the company prospers.
In the case of a genuine underwriting, the bankers have a moral obligation at least to do their utmost to take the securities off the hands of the underwriters and place them in the hands of investors. Assuming that capi talists have underwritten the securities, and the corporation has established an earning power equivalent to 10 per cent on the $3,000,000 of funds supplied, the bankers will then receive all bonds the underwriters wish to turn in for the public issue and offer them to investors at, say, 95. We will suppose the offering successful and the " public " buys all the bonds. If not, the underwriters have to take them up on their own account. The un derwriting capitalists have made five points on their bonds and have still in their hands an amount of common stock equal to half the amount of bonds they underwrote. That is, if a capitalist's participation in the syndicate had been to take up $50,000 of bonds and $25,000 of common stock, he would have put the bankers in funds to the extent of $45,000, have made a cash profit of $2500, and have $25,000 of common stock with speculative possibilities.
We have had to touch on the matter of underwriting in order to bring out the way in which water in the securities of a corporation may act as a solvent to effect divisions of risk, income, and control for results otherwise im possible to get exactly. By means of the stock
bonuses the bankers, in the first place, and the underwriters, in the second place, have been able to separate the resultant of income and control coming originally into their hands. Everyone has got what he wanted out of the transactions. Bankers and capitalists, with regard to this particular project at least, show the speculative type of mind. If they were not willing to assume the greater risk in expectation of the larger profit they would not have gone into the undeveloped enterprise. Each in turn has passed on the less risk and the limited income and kept the potentially unlimited income as a compensation for the risk he ran when embarking his funds in an enterprise while it was yet problematical whether the corporation would ever return a fair income on its capital.
During the bargaining between the bankers and the promoters, the bankers saw that they were contributing three things. In the first place, they made the enterprise possible at all; in the second place, they assumed, for a time at least, a large risk; in the third place, they undertook a definite labor of distributing se curities of the corporation to investors. Per haps without reasoning over the matter in detail their minds ran somewhat in this way : For the labor of selling these securities we want a specific sum of money. We shall add something to this sum partly to pay for the risk we run. To make the payment for the risk adequate we want some kind of an inter est in the company, in case, as a result of our assuming this risk, the company, when oper ating, proves successful; and finally (just hinted in this last statement), since the pro moters cannot get more favorable terms else where, and cannot go ahead without accept ing our terms, or their equivalent, we shall exact a still larger interest because we make the project possible at all. Watering the stock has enabled the making of a fair compensa tion for services performed. If the bankers had exacted a larger cash compensation to cover fully their estimate of the risk, they would have placed a further handicap on the corporation. By agreeing to take, for part of their compensation, their chance on the pro sperity of the corporation, they by so much give a pledge of their good faith to purchasing investors.