Legal Definitions - Dutch-auction tender method

The Dutch-auction tender method is a specific type of auction process, predominantly used in financial markets for transactions involving large quantities of securities, such as initial public offerings (IPOs), corporate share buybacks, or government bond issuances. In this method, instead of a price rising or falling in real-time, potential buyers (or sellers, in the case of a buyback) submit sealed bids indicating both the quantity of securities they wish to transact and the price they are willing to pay (or accept). The issuer or company then compiles all these bids.

A single "clearing price" is determined, which is the highest price at which all the available securities can be sold (or the lowest price at which all the desired securities can be bought). All successful bidders, regardless of their original bid price (as long as it was at or above the clearing price for buyers, or at or below for sellers), transact at this single clearing price. This approach aims to achieve a broad distribution of securities and a market-driven price.

• Example 1: Initial Public Offering (IPO)

  A rapidly growing software company, "CloudNine Solutions," decides to go public by offering 15 million shares to investors using a Dutch-auction tender. Various institutional and individual investors submit bids, specifying how many shares they want and the maximum price they are willing to pay. For instance, some bid for shares at $32, others at $31, and more at $30, and so on. CloudNine Solutions compiles all these bids, starting from the highest price offered downwards. They determine that to sell all 15 million shares, the highest price they can set is $30 per share, as this is the point where the total demand from investors willing to pay $30 or more meets or exceeds the 15 million shares offered. All investors whose bids were at $30 or higher will receive shares, and everyone pays the same single clearing price of $30 per share, even if they originally bid $32.

  This illustrates the Dutch-auction tender method because investors submit diverse bids, but a single, uniform clearing price is established, and all successful buyers pay that same price, ensuring a broad market-driven valuation for the IPO.

• Example 2: Corporate Share Buyback

  "Evergreen Holdings," a well-established manufacturing firm, announces a plan to buy back 5 million of its own shares from existing shareholders to increase shareholder value. They use a Dutch-auction tender, inviting shareholders to offer their shares for sale, specifying the quantity and the minimum price they are willing to accept. Some shareholders offer to sell at $75, others at $76, and more at $77. Evergreen Holdings reviews all the offers, starting from the lowest price upwards. They find that to acquire their target of 5 million shares, the lowest price they must pay is $77 per share, as this is the point where enough shares are offered. All shareholders who offered to sell at $77 or below will have their shares purchased, and everyone receives the same single clearing price of $77 per share, even if they originally offered to sell for $75.

  This demonstrates the Dutch-auction tender method in a buyback scenario, where the company determines the lowest single price at which it can acquire its desired quantity of shares, and all successful sellers receive that uniform price.

• Example 3: Government Bond Issuance

  The national treasury of "Republica" decides to issue $20 billion in new 5-year government bonds to fund public projects. They utilize a Dutch-auction tender to determine the interest rate (yield) at which these bonds will be sold. Banks and large financial institutions submit bids, indicating the amount of bonds they wish to purchase and the yield (interest rate) they are willing to accept. For example, some bid for a 2.5% yield, others for 2.6%, and more for 2.7%. The treasury compiles these bids, accepting those with the lowest yields first (as lower yields mean lower borrowing costs for the government). They determine that to sell all $20 billion in bonds, the highest yield they must offer is 2.7%. All successful bidders, regardless of whether they bid 2.5%, 2.6%, or 2.7%, will receive bonds priced to yield 2.7%.

  This example illustrates the Dutch-auction tender method as the government uses it to find the market-clearing interest rate for its debt, ensuring all successful buyers of the bonds receive the same effective yield.