When a company wants to offer a debt or equity security to the public, it first chooses an investment firm or multiple investment firms to which it will offer an underwriting arrangement. Once the investment company agrees to the offer, it becomes the underwriter of the security. The gross spread is how the security issuer compensates the investment firm for underwriting the security. The selling concession is a component of the gross spread.
When a company chooses an investment firm to underwrite its securities offering, it will enter into either a firm commitment underwriting arrangement or a best offer underwriting arrangement. A firm commitment arrangement is the most common. In this arrangement, the underwriter makes a commitment to the securities issue to purchase some or all of the securities from the issuer to resell it to investors. In the best offer arrangement, the underwriting firm makes the commitment to attempt to sell the security but does not make any guarantees that it will sell the securities and does not make a commitment to purchase any unsold securities from the issuer.
When the underwriting firm purchases the securities from the issuer, it does so at a discount. The gross spread is the difference between the price at which the underwriting firm purchased the security at a discounted rate from the issuer and the price at which the underwriter sells the security to investors. The underwriting firm then splits the gross between the firm, the lead underwriter and the selling agents or broker/dealers.
Splitting the Gross Spread
The lead underwriter receives a percentage of the gross spread, typically around 20 percent. The underwriting firm receives around 20 percent for various costs such as legal, marketing and promotional costs associated with the underwriting securities and preparing it for public sale. Both the selling agents and the underwriting firm receive a percentage of the gross spread depending upon how many securities they sell to public investors. This is called the selling concession.
Underwriting firms often choose to allow additional investment firms to sell the security that they are underwriting. These firms are referred to as the selling group. Members of the selling group purchase the securities from the underwriting firm at a discount. The selling group then sells the security to the public. The selling concession is the difference between the discount price at which members of the selling group purchased the security from the underwriting firm and the price at which they sold the security to the public.
- Cornell University Johnson Graduate School of Management; A Guide to Initial Public Offerings; Katrina Ellis, et al.; January 1999
- The Financial Dictionary: Gross Spread
- Duke University; Hypertextual Finance Glossary; Campbell Harvey
- University of Alabama Department of Economics, Finance and Legal Studies; Does the Gross Spread Split Compensate Lead Underwriters for Analyst Coverage?; Douglas Cook, et al.; September 2007