Finance · level 3
Issuing undervalued equity
Selling shares below their true value hands part of the firm to newcomers. That wealth transfer is why announcements of equity issues move prices down and why managers prefer debt.
Worked example: Managers know the equity is worth $1.7B (113M shares) but the market prices it 10% lower. They issue $100M of new stock at the market price. How much value transfers from old to new shareholders?
Step by step
- 1
True vs market price
$15.04 vs $13.54
- 2
New shares issued
$100M / $13.54 = 7.4M
- 3
Price once the truth is out
($1.7B + $100M) / 120.4M = $14.95
- 4
Transfer
($15.04 − $14.95) × 113M = $10.43M
- 5
Akerlof in finance
Because undervalued firms lose by issuing, only overvalued firms issue eagerly — so the market marks every issuer down. Pecking order: internal cash, then debt, equity last.
Managers know the equity is worth $1.7B (113M shares) but the market prices it 10% lower. They issue $100M of new stock at the market price. How much value transfers from old to new shareholders? = 10,429,448
The theory behind it
Intuition
Finance is time and risk applied to cash: move every cash flow to the same date at a rate that reflects its risk, then compare.
Common pitfalls
- ×Discounting a nominal flow at a real rate (or vice versa).
- ×Mixing enterprise-value and equity-value numbers in the same ratio.
In the interview
Valuation, WACC, LBO and accretion rounds — where a wrong bridge is a wrong answer.