Concession

Concession — Meaning, Definition & Full Explanation

A concession is the discount or spread that a securities underwriter receives when selling new bonds or stocks to investors on behalf of an issuing company. It represents the difference between the price investors pay for the security and the lower net proceeds the issuer receives after the underwriter deducts its selling concession. Concessions are a form of underwriter compensation, negotiated as part of the underwriting agreement, and are expressed as a percentage of the offering price or as a fixed amount per unit sold.

What is Concession?

A concession arises when a company issues new securities—bonds, stocks, or other instruments—to raise capital. The issuing company engages an investment bank as the underwriter to distribute these securities to the market. The underwriter, in turn, sells the securities to institutional and retail investors. The concession is the margin the underwriter keeps from each sale; it does not go to the issuer.

For example, if a company issues shares at ₹100 per share but the underwriter sells them to investors at ₹100, the issuer receives ₹95 per share (assuming a 5% concession). That ₹5 per share is the selling concession earned by the underwriter for arranging distribution and managing the sale process. The underwriting agreement—the legal contract between the issuer and the underwriter—clearly specifies the concession percentage, management fees, and other compensation terms. Without this agreed-upon concession, the underwriter has no financial incentive to actively market and place the securities. Concessions vary based on market conditions, the creditworthiness of the issuer, the complexity of the offering, and the demand for the security.

How Concession Works

Step 1: Issuance Decision A company decides to raise capital through a securities offering. It selects an investment bank to act as the lead underwriter and primary distributor.

Step 2: Underwriting Agreement Negotiation The issuer and the underwriter negotiate and sign an underwriting agreement. This contract specifies the offering size, security price, concession rate, management fee, underwriting fee, and risk allocation (firm commitment vs. best-efforts basis).

Step 3: Concession Rate Setting The concession is typically expressed as a percentage of the offering price. For instance, a ₹100 bond may have a concession of 2%, meaning the underwriter retains ₹2 per bond sold.

Step 4: Distribution to Investors The underwriter distributes the securities to investors at the agreed public offering price. The underwriter may use a syndicate of dealers and brokers to expand reach; these selling agents also earn a portion of the concession.

Step 5: Settlement and Payment After the offering closes, the issuer receives its net proceeds (offering price minus concession and fees). The underwriter retains the concession for its distribution work.

Variants:

• Firm commitment underwriting: The underwriter guarantees to buy all unsold securities; concession compensates this risk.
• Best-efforts underwriting: The underwriter does not commit to purchase unsold securities; concession is lower.
• Competitive bidding: Multiple underwriter groups bid on concession rates; the lowest concession wins the mandate.

Concession in Indian Banking

The Securities and Exchange Board of India (SEBI) regulates equity offerings in India. Under SEBI's issue of Capital Issue Prospectus (CIP) guidelines and the SEBI (Depositories and Participants) Regulations, underwriting terms, including concessions, must be disclosed in the prospectus and red herring prospectus filed with SEBI.

For bond offerings, the RBI (Reserve Bank of India) may oversee corporate debt securities if they fall under banking regulations. Bond underwriting concessions in India are market-driven and typically range from 0.5% to 2%, depending on issuer rating and market depth. Leading underwriters in India include investment banking divisions of SBI, HDFC Bank, ICICI Bank, and independent firms like Kotak Mahindra Bank and Goldman Sachs India.

Concession agreements in India must comply with the Indian Contract Act, 1872, and SEBI's regulations on transparency and disclosure. JAIIB and CAIIB exam syllabi cover underwriting mechanisms, including concessions, as part of securities market and capital market modules. The National Stock Exchange (NSE) and BSE list detailed rules on offerings and underwriting arrangements. For debt securities issued to institutional investors, concession rates and fee structures are often negotiated privately and must be documented in the underwriting agreement filed with SEBI's debt listing department.

Practical Example

Priya Technologies Limited, a mid-cap software firm based in Bangalore, decides to raise ₹50 crore through an Initial Public Offering (IPO). It appoints HDFC Bank's investment banking arm as the lead underwriter. The underwriting agreement stipulates an offering price of ₹500 per share and a concession of 2.5%.

Under this arrangement, HDFC Bank sells each share to investors at ₹500. However, Priya Technologies receives only ₹487.50 per share (₹500 minus ₹12.50 concession per share, which is 2.5%). HDFC Bank earns ₹12.50 per share sold as its concession—for this IPO, that totals ₹12.50 × 10 million shares (assuming the offering is fully subscribed) = ₹1.25 crore. This compensation covers HDFC's marketing costs, broker commissions paid to the distribution syndicate, and its profit margin. The underwriting agreement also specifies that if the IPO is oversubscribed, HDFC may add an oversubscription facility at the same concession rate.

Concession vs Underwriting Fee

Aspect	Concession	Underwriting Fee
What it is	Discount per unit sold; portion of offering price retained by underwriter	Fixed or percentage-based charge for underwriter's guarantee/commitment to place securities
Basis	Per-unit sales volume; borne from investor purchase price	Flat amount or percentage of total offering; separate from concession
When paid	Upon sale of each security to investor	At offering launch or completion, regardless of sales success
Purpose	Compensation for distribution and selling effort	Compensation for underwriter's risk assumption and structuring

The underwriting fee compels the underwriter to work; the concession rewards successful placement. Together, they form the total underwriter compensation in an offering. In many Indian IPOs, total underwriter compensation (concession + management fee + underwriting fee) ranges from 3% to 5% of the offering size. Concession alone typically accounts for 1.5% to 3% of this total.

Key Takeaways

• A concession is the discount per unit that an underwriter retains when selling new securities on behalf of an issuer; it is the spread between the investor purchase price and the issuer's net proceeds.
• Concessions are negotiated in the underwriting agreement and are expressed as a percentage of the offering price or a fixed amount per security.
• In India, equity offering concessions are disclosed in SEBI-filed prospectuses; debt offering concessions are regulated under RBI guidelines and SEBI debt market rules.
• Typical Indian concession rates range from 0.5% to 2.5% for equities and 0.25% to 1.5% for high-grade corporate bonds, varying with issuer credit quality and market conditions.
• Concession differs from underwriting fee: concession is paid only when securities are sold, while underwriting fee is a fixed upfront charge for the underwriter's commitment or guarantee.
• In firm commitment underwriting, the underwriter bears inventory risk and justifies a higher concession; in best-efforts offerings, concessions are lower.
• Concessions are shared among the lead underwriter, co-managers, and the selling syndicate (brokers and dealers) based on their distribution contribution.
• The concession is a cost to the issuer but not a direct cash outlay; it reduces the net capital raised by the issuing company.

Frequently Asked Questions

Q: Is the concession paid by the issuer or the investor? A: The concession is effectively borne by the issuer. The investor pays the public offering price set in the prospectus; the underwriter deducts the concession from this price before remitting net proceeds to the issuer. From an economic standpoint, the issuer's capital raised is reduced by the concession amount.

Q: How is concession different from the management fee in an offering? A: Concession is the per-unit selling spread, while the management fee is a flat or percentage-based charge paid to the lead underwriter for structuring, pricing, and overseeing the offering. Both are part of total underwriter