What is Underwriting Spread
The underwriting spread is the spread between the dollar amount that underwriters pay an issuing company for its securities and the dollar amount that underwriters receive from selling the securities in the public offering. The underwriting spread is the underwriter's gross profit margin, usually expressed in points per unit of sale.
BREAKING DOWN Underwriting Spread
Underwriting spreads may vary widely and are influenced by the underwriter's expectation of market demand for the securities offered for sale, interest rates and other factors. The size of the underwriting spread depends on the negotiations and competitive bidding among members of an underwriter syndicate and the issuing company itself. The spread increases as the risks involved with the issuance increase.
The underwriting spread in an initial public offering (IPO) typically includes the following components: the manager's fee, the underwriting fee (earned by members of the underwriter syndicate), and the concession, which is earned by the broker-dealer selling the shares. The manager is entitled to the entire underwriting spread. Each member of the underwriting syndicate gets a (not necessarily equal) share of the underwriting fee and the concession. A broker-dealer, who is not a member of the underwriter syndicate, but sells shares, receives only a share of the concession. The member of the underwriter syndicate that provides the shares to that broker dealer would retain the underwriting fee.
Proportionately, the concession increases as total underwriting fees rise. Meanwhile, the management and underwriting fees decrease with gross underwriting fees. The effect of size on the division of fees is usually due to differential economies of scale. The extent of investment banker work, for example, in writing the prospectus and preparing the roadshow is somewhat fixed, while the amount of sales work is not. Larger deals will not involve exponentially more investment banker work, but it might involve much more sales effort, requiring an increase in the proportion of the selling concession. Alternatively, junior banks may join a syndicate, even if they receive a smaller share of the fees in the form of a lower selling concession.
Example of Underwriting Spread
To illustrate an underwriting spread, consider a company that receives $36 per share from the underwriter for its shares. If the underwriters turn around and sell the stock to the public at $38 per share, the underwriting spread would be $2 per share. The value of the underwriting spread can be influenced by variables such as the size of the issue, risk and volatility.