Dutch auction definition
/What is a Dutch Auction?
A Dutch auction involves a public offering of shares, where the price is based on the highest price at which all shares can be sold. This price is derived from a bid-taking session, where investors can state the price at which they are willing to purchase a certain number of shares.
Example of a Dutch Auction
An investor could place a bid to buy 10,000 shares at $15 per share, while another investor offers to pay $14 for 8,000 shares. Once all bids have been received, the issuer allots shares to bidders based on the highest bid price first, going down until all offered shares can be sold. The price at which the last shares are sold is the amount charged to all investors to whom shares have been allotted. To return to our example, if the issuer wants to sell 15,000 shares, then the investor willing to pay $15 per share will be allotted 10,000 shares at a price of $14 per share, while the second investor will be allotted 5,000 shares at a price of $14 per share.
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Advantages of Dutch Auctions
An advantage of a Dutch auction is that it tends to result in higher payments being made to an issuer than what is derived from the more traditional initial public offering approach. It also tends to shift share purchases away from investment banks and toward smaller investors. However, the smaller investors who place bids may not conduct sufficient due diligence on the issuer, and so are at risk of paying an excessively high price.
Disadvantages of Dutch Auctions
The main concern with Dutch auctions is that they are open to all investors, of which some may be less sophisticated. If a less sophisticated party bids too high based on an incorrect analysis, that party might then sell off the shares at once in order to limit its losses, resulting in an immediate decline in the issuer’s share price.