What Is a New Issue Concession and How Is It Calculated?

Investment banks and underwriters play a key role in bringing new securities to market, earning compensation for their efforts. One component of this compensation is the new issue concession, the portion of the underwriting spread allocated to selling group members who distribute the securities to investors.

Understanding how this concession is calculated and distributed provides insight into the economics of underwriting and the incentives that drive market participants.

Components of Underwriter Compensation

Underwriters generate revenue through a structured fee arrangement that reflects the risks and responsibilities they assume in a securities offering. The underwriting spread, the difference between the price paid by investors and the amount received by the issuer, is divided among syndicate members based on their roles. This spread consists of three primary components: the management fee, the underwriting fee, and the selling concession.

The management fee goes to the lead underwriter or book-running manager, covering the costs of structuring the deal, conducting due diligence, and coordinating the offering. While typically the smallest portion of the spread, it helps offset administrative and regulatory expenses. The lead underwriter ensures compliance with SEC regulations, including the Securities Act of 1933, and prepares the necessary disclosures in the offering prospectus.

The underwriting fee compensates syndicate members for assuming financial risk by purchasing securities from the issuer before selling them to investors. This fee is especially significant in firm commitment offerings, where underwriters buy the securities outright, exposing them to market fluctuations and unsold inventory.

Calculating a New Issue Concession

The selling concession, a percentage of the total underwriting spread, incentivizes selling group members to place securities with investors. Its calculation depends on factors such as the size of the offering, the issuer’s credit profile, and market conditions. For equity offerings, the concession is typically a fixed percentage of the public offering price, while for debt issuances, it may vary based on the bond’s maturity and credit rating.

For example, in an initial public offering (IPO) priced at $50 per share with a total underwriting spread of $3 per share, the selling concession might be set at $1.50 per share. Selling group members retain this amount per share sold, while the remaining $1.50 is divided between the underwriting and management fees. The percentage allocated to the concession can fluctuate based on the issuer’s bargaining power and investor demand.

In fixed-income offerings, the new issue concession is often expressed in basis points relative to the bond’s face value. A corporate bond issuance with a $1,000 par value might have a total underwriting spread of 80 basis points, with 50 basis points allocated to the selling concession. This structure ensures dealers have a financial incentive to distribute bonds effectively, particularly in less liquid segments of the market.

Distribution Within the Syndicate

The allocation of securities within an underwriting syndicate balances market demand with the financial commitments of participating firms. The lead underwriter, or book-running manager, plays a central role in distributing shares or bonds among syndicate members. This allocation is influenced by each firm’s capital contribution, past performance in similar offerings, and investor relationships. Firms with a strong track record of placing securities efficiently often receive a larger share of the offering.

Syndicate members distribute securities through their sales channels, which may include institutional investors, high-net-worth individuals, or retail brokerage clients. Institutional investors, such as mutual funds, pension funds, and hedge funds, often receive priority allocations due to their ability to purchase large blocks of securities. Retail investors may receive a smaller portion, particularly in high-demand offerings where institutional participation dominates. This tiered approach helps underwriters manage pricing stability and aftermarket performance, reducing excessive volatility upon listing or issuance.

Syndicate members may engage in stabilization activities to support the security’s price in the secondary market. This often involves overallotment options, or greenshoe provisions, which allow underwriters to sell additional securities beyond the initial offering size. If demand remains strong, these additional shares can be permanently issued. If prices decline, underwriters may repurchase them to prevent disorderly trading. These mechanisms help ensure a smoother transition from the primary to the secondary market, reinforcing investor confidence.

Regulatory Disclosure of Fees

Transparency in underwriting fees ensures investors understand the costs embedded in the issuance process. Regulatory bodies such as the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) mandate detailed disclosure of underwriting compensation in offering documents, including IPO prospectuses and registration statements for debt and equity issuances. These disclosures help mitigate conflicts of interest by providing visibility into how much underwriters and selling group members receive.

FINRA Rule 5110, known as the Corporate Financing Rule, regulates underwriting compensation. Underwriters must file compensation arrangements with FINRA for review before a public offering is approved. The rule generally caps total underwriting compensation at 7% of gross proceeds for equity offerings, though lower limits often apply for larger transactions or those involving well-established issuers. Any additional compensation, such as warrants, advisory fees, or expense reimbursements, must be disclosed to investors to prevent excessive underwriter remuneration that could dilute shareholder value.