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Question
Write a short note on underwriting of shares.
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Solution
Underwriting refers to a formal agreement between a company issuing securities and an underwriter. Under this arrangement, if the public fails to subscribe to all or a specified portion of the issue, the underwriter agrees to purchase the remaining unsold securities at a pre-agreed rate of commission. In other words, it is an assurance given by the underwriter to take up the securities that the public does not subscribe to.
The primary purpose of underwriting is to provide a guarantee of funds for the issuing company. This mechanism ensures the financial stability of new ventures, as well as helps in the modernization and growth of existing businesses. Moreover, it builds public confidence in the securities market and promotes wider distribution of securities across different regions.
Sometimes, a group of financial institutions collectively undertakes the responsibility of underwriting a particular issue. This joint effort is known as consortium underwriting.
Underwriters earn a commission for their services, even if all the securities are fully subscribed by the public.
