Concession

Concession — Meaning, Definition & Full Explanation

A concession is the discount or commission earned by underwriters and selling agents when they distribute newly issued securities (stocks or bonds) to investors at a price higher than what they pay the issuing company. It represents the spread between the retail offering price and the net proceeds the issuer receives, compensating intermediaries for their distribution effort and risk.

What is Concession?

A concession is the markup applied to new securities during their initial public offering (IPO) or bond issuance. When a company decides to raise capital by issuing stocks or bonds, it hires an investment bank to act as an underwriter. The underwriter purchases the securities from the issuer at a negotiated price (the underwriter's cost) and then sells them to retail and institutional investors at a slightly higher price (the offering price). This difference—the concession—is the underwriter's primary revenue source for undertaking distribution risk and performing marketing, sales, and administrative work.

The concession is distinct from other fees the issuer pays. An underwriting agreement typically includes three separate compensation components: the management fee (paid to the lead underwriter for coordinating the offering), the underwriting fee (compensation for assuming the risk of unsold inventory), and the concession (the selling spread distributed among all syndicate members who place securities with investors). The concession varies depending on the size, complexity, and demand for the offering. In highly competitive or well-subscribed issues, concessions may be lower; in slower markets, they may be higher to incentivize agents to sell.

How Concession Works

A concession operates through a structured syndicate arrangement between the issuer, the lead underwriter, and selling agents:

1. Issue and Negotiation: The issuing company (say, a ₹500 crore IPO) negotiates with the lead investment bank to underwrite the offering. They agree on the offering price to the public.

2. Syndicate Formation: The lead underwriter assembles a syndicate of underwriters and selling agents (often other banks or brokerages) to distribute the securities.

3. Pricing Agreement: The underwriting agreement specifies three prices: (a) the net price to the issuer, (b) the price paid by underwriters (underwriter's discount begins here), and (c) the public offering price.

4. Concession Distribution: The concession is carved out from the spread between the public offering price and the underwriter's cost. It is allocated to selling agents based on their sales volume or as per the syndicate agreement.

5. Risk Allocation: If the underwriting is "firm commitment," underwriters buy all securities upfront and bear the risk of unsold inventory. In a "best efforts" underwriting (common in India for smaller issues), risk is lower and concessions may be smaller.

6. Settlement: Once the offering closes and securities are allocated, concessions are paid to each syndicate member proportionate to their sales.

Concession in Indian Banking

In India, the Securities and Exchange Board of India (SEBI) regulates IPOs and primary market issuances under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. The concession structure is disclosed in the Prospectus and the Underwriting Agreement filed with SEBI. Lead underwriters (typically large banks like SBI Capital Markets, ICICI Securities, or HDFC Bank) must transparently report fees and concessions to the stock exchange (NSE or BSE) and investors.

The National Stock Exchange (NSE) and BSE have specific guidelines for merchant banking and underwriting. Concessions are part of the total underwriting spread, which is typically disclosed as a percentage of the issue size. For example, a ₹100 crore IPO might have a total spread of 2.5–4%, split between management fee, underwriting fee, and concession. SEBI regulations mandate that underwriters cannot charge excessive fees, and any deviation from the agreed concession structure must be disclosed and justified.

In the context of JAIIB (Junior Associate—Indian Institute of Bankers) and CAIIB (Certified Associate—Indian Institute of Bankers) examinations, concessions appear in the Principles of Banking and Investment Banking modules. Candidates must understand the syndicate structure, fee components, and the distinction between concession and other underwriting fees.

Practical Example

Bright Tech Solutions Ltd, a Bangalore-based software firm, decides to raise ₹150 crore through an IPO. It appoints Axis Bank as the lead underwriter. Axis negotiates with the company to issue shares at a net cost of ₹480 per share. The public offering price is set at ₹500 per share. The total spread of ₹20 per share (4%) is split as: management fee ₹6 per share, underwriting fee ₹8 per share, and concession ₹6 per share.

Axis forms a syndicate with ICICI Securities, HDFC Bank, and five regional brokers. Each syndicate member is entitled to earn the ₹6 concession for every share they sell to investors. ICICI Securities sells 12 lakh shares, earning ₹72 lakh in concession. The regional brokers collectively sell 8 lakh shares, earning ₹48 lakh in concession. The concession incentivizes aggressive selling; brokers who exceed their targets may negotiate higher concessions in future issues.

Concession vs Underwriting Fee

Aspect	Concession	Underwriting Fee
Who earns it	Selling agents and underwriters who place securities	All underwriters (including non-selling underwriters)
Purpose	Compensation for direct sales effort and distribution	Compensation for assuming inventory and market risk
Payment trigger	Securities actually sold to investors	Upon acceptance of underwriting commitment
Variability	Higher when market demand is weak	Fixed, regardless of actual sales

The underwriting fee is paid upfront to all syndicate members for agreeing to support the offering, whereas the concession is earned only by those who actively sell. In a highly successful IPO with strong investor demand, concessions may be negligible because securities sell quickly; underwriting fees remain constant. In a weak market, concessions rise to motivate syndicate members to push inventory.

Key Takeaways

• A concession is the spread earned by underwriters and selling agents when distributing new securities, calculated as the difference between the offering price to the public and the net price received by the issuer.
• The concession is one component of the total underwriting spread, alongside the management fee and underwriting fee, as outlined in the underwriting agreement.
• In Indian IPOs, SEBI mandates transparency of all fee components in the Prospectus; typical concessions range from 0.5% to 2% of the issue value depending on market conditions.
• Concessions are distributed only to syndicate members who actively sell securities; non-selling underwriters receive the underwriting fee but not the concession.
• A firm commitment underwriting carries higher risk for underwriters and typically justifies higher concessions; a best-efforts underwriting carries lower risk and lower concessions.
• Concessions are disclosed in the underwriting agreement filed with NSE/BSE and are subject to SEBI's prohibition on excessive fees.
• The lead underwriter may retain a portion of the concession and distribute the remainder to other syndicate members based on their sales performance or pre-agreed allocations.

Frequently Asked Questions

Q: Is the concession taxable for the underwriter?

A: Yes. The concession earned by underwriters and brokers is treated as business income and is subject to income tax under the Income Tax Act, 1961. It must be declared as part of the firm's business revenue in the relevant financial year.

Q: Can concessions be negotiated after the underwriting agreement is signed?

A: Ordinarily, no. The concession is fixed in the underwriting agreement before the offering launches. However, in rare cases where market conditions deteriorate significantly during the offer period, syndicate members may formally request an increase in concession, subject to issuer and lead underwriter approval and SEBI disclosure requirements.

Q: How does a higher concession affect the cost of the IPO to the issuing company?

A: Higher concessions directly reduce the net proceeds the issuer receives, as they are part of the total spread deducted from the offering price. An issuer must balance the cost of higher concessions (to incentivize strong selling) against the net capital raised.