Dutch auctions are public offerings of financial instruments made directly to the public via an auction process. The purpose of Dutch auctions is to generate capital for corporate or government ventures such as an Initial Public Offering (IPO) or a government bond issue. In the case of an IPO, the Dutch auction may also include bids that determine the total number of new shares issued. In Dutch auctions, as the name indicates, the price of a financial vehicle be it bonds or stocks, is bid on by the public before a final price is determined. According to a Bloomberg Businessweek article by Mark Frankel, called “When the Tulip Bubble Burst”, Dutch auctions emerged in the seventeenth century in Holland during a period in which tulips were a highly valued and bid upon commodity.
Process:
The process by which a Dutch auction is performed is not always the same. In some cases the Dutch auction may begin at a low price and rise until the first bid comes in. In this instance the first highest bid is the issue price. However, other times groups of shares may be bid upon within a price range until a specific number of shares are bid on thereby creating an accepted bid price range. Still other times the offering price may be high, and decline until an initial bid value is reached. Even if different methods of bidding are used, the key principle in a Dutch auction is that the prices are bid upon directly by the public rather than resolutely determined. However, according to Epiq, a supply management corporation, Dutch auctions are not the same as similar auctions that don’t use the first or highest bid.
Examples:
Examples of Dutch auctions are numerous. The U.S. Department of the Treasury utilizes a Dutch auction process for bonds, treasury inflation protected securities (TIPS), notes and bills. Individuals can bid either competitively or non-competitively by opening an account at Treasury Direct then submitting bids on products at the closing auction rate, or at a pre-determined yield that may or may not fall within the bid range. Many public companies such as Google, and Fannie Mae have also used Dutch auctions. In the case of Google, the dutch auction was used for an IPO, however for Fannie Mae, the purpose was more likely to raise capital to help finance ongoing costs associated with mortgages.
Pros and cons:
The benefits of Dutch auctions and direct public offerings via Dutch Auction are they may lower underwriting costs by eliminating the expenses associated with testing and attempting to raise market demand for the new offering through marketing campaigns. However, according to an article in the Wake Forest Law Review by Peter B. Oh, the possibility for price manipulation in Dutch Auctions exists via the issuer and the bidders via bid rejection clauses and bidding behavior that contradicts the principles of equality and accuracy presumed in the Dutch Auction Process. Oh also points out Dutch Auctions may lead to an undervaluation of the auctioned financial instrument as was the case with Google’s IPO which lowered its Dutch Auctioned determined price.
Sources:
1.http://bit.ly/bJIas0 (Wake Forest Law Review)
2.http://bit.ly/bnvcHH (Georgeson Proxy Solicitation)
3.http://bit.ly/cCLK5a (Epiq Advanced Supply Management)
4.http://slate.me/cHPKIz (Slate)
5.http://reut.rs/9v07nM (Reuters)