Building the IPO Order Book: Underpricing and Participation Limits With Costly Information

Sherman, Ann E.; Titman, Sheridan

doi:10.2139/ssrn.235926

Cited by 115 publications

(141 citation statements)

References 25 publications

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“…However, actual book building allows underwriter discretion to adjust for greater investor information costs. This finding contradicts the argument of Sherman and Titman (2002) that accuracy in the offer pricing leads to larger initial returns.…”

Section: Discussioncontrasting

confidence: 76%

A Joint Experimental Analysis of Investor Behavior in Ipo Pricing Methods

Almeida

Leal

2015

Rev. adm. empres.

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This article jointly examines the differences of laboratory versions of the Dutch clock open auction, a sealed-bid auction to represent book building, and a two-stage sealed bid auction to proxy for the "competitive IPO", a recent innovation used in a few European equity initial public offerings. We investigate pricing, seller allocation, and buyer welfare allocation efficiency and conclude that the book building emulation seems to be as price efficient as the Dutch auction, even after investor learning, whereas the competitive IPO is not price efficient, regardless of learning. The competitive IPO is the most seller allocative efficient method because it maximizes offer proceeds. The Dutch auction emerges as the most buyer welfare allocative efficient method. Underwriters are probably seeking pricing efficiency rather than seller or buyer welfare allocative efficiency and their discretionary pricing and allocation must be important since book building is prominent worldwide.KEYWORDS | Auction, book building, experiment, competitive IPO, IPO. RESUMO Este artigo examina conjuntamente as diferenças de versões experimentais do leilão holandês, um leilão de lances fechados representando o book building, e um leilão similar de dois estágios encarnando o "IPO competitivo", uma inovação usada em algumas ofertas públicas iniciais de ações (IPOs) europeias. Investigamos a eficiência no apreçamento e na alocação e concluímos que o book building simulado é tão eficiente no apreçamento quanto o leilão holandês enquanto o IPO competitivo não é eficiente no apreçamento, independentemente do aprendizado do investidor. O IPO competitivo é o método mais eficiente na alocação ao emissor porque maximiza a captação. O leilão holandês emerge como o método mais eficiente para a alocação ao comprador. Os intermediários financeiros devem preferir a eficiência no apreçamento em vez de eficiência na alocação e sua discricionariedade nestes procedimentos deve ser importante porque o book building é proeminente no mundo. PALAVRAS -CHAVE | Leilão, book building, experimento, IPO competitivo, IPO. RESUMENEl presente artículo examina de forma conjunta las diferencias entre las versiones de laboratorio de la subasta holandesa, una subasta de oferta cerrada para presentar las ofertas, y una subasta cerrada de dos fases para actuar como apoderados de la " IPO competitiva", una RAE-Revista de Administração de Empresas | FGV-EAESP

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Section: Discussioncontrasting

confidence: 76%

A Joint Experimental Analysis of Investor Behavior in Ipo Pricing Methods

Almeida

Leal

2015

Rev. adm. empres.

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“…In the case of bookbuilding, underwriters can decide to whom to allocate shares if there is excess demand. Benveniste and Wilhelm (1997) and Sherman and Titman (2002) emphasize that underwriter discretion can be used to the benefit of issuing firms. Underwriters can reduce the average amount of underpricing, thereby increasing the expected proceeds to issuers, by favoring regular investors who provide information about their demand that is useful in pricing an IPO.…”

Section: A Why Underwriters Want To Underprice Iposmentioning

confidence: 99%

Why Has IPO Underpricing Changed Over Time?

2002

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In the 1980s, the average first-day return on initial public offerings (IPOs) was 7%. The average first-day return doubled to almost 15% during 1990-1998, before What explains the severe underpricing of initial public offerings in 1999-2000, when the average first-day return of 65% exceeded any level previously seen before? In this article, we address this and the related question of why IPO underpricing doubled from 7% during 1980-1989 to almost 15% during 1990-1998 before reverting to 12% during the post-bubble period of 2001-2003. Our goal is to explain low-frequency movements in underpricing (or first-day returns) that occur less often than hot and cold issue markets.We examine three hypotheses for the change in underpricing: 1) the changing risk composition hypothesis, 2) the realignment of incentives hypothesis, and 3) a new hypothesis, the changing issuer objective function hypothesis. The changing issuer objective function hypothesis has two components, the spinning hypothesis and the analyst lust hypothesis.The changing risk composition hypothesis, introduced by Ritter (1984), assumes that riskier IPOs will be underpriced by more than less-risky IPOs. This prediction follows from models where underpricing arises as an equilibrium condition to induce investors to participate in the IPO market. If the proportion of IPOs that represent risky stocks increases, there should be greater average underpricing. Risk can reflect either technological or valuation uncertainty. Although there have been some changes in the characteristics of firms going public, these changes are found to be too minor to explain much of the variation in underpricing over time if there is a stationary risk-return relation.The realignment of incentives and the changing issuer objective function hypotheses bothWe thank Hsuan

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“…But indiscriminate allocation of underpriced shares rewards both informed (aggressive) and uninformed bidders. Although discriminatory allocation of underpriced shares diminishes the issuer's proceeds from the offering ex post, in this view, expected proceeds are maximized (Benveniste and Wilhelm, 1990;Sherman and Titman, 2000). The empirical predictions from this theory are that allocation constraints diminish information production and the issuer's expected net proceeds (as underpricing is substituted for larger institutional allocations in the 'compensation package' provided to institutional investors).…”

Section: Introductionmentioning

confidence: 98%

IPO Allocations: Discriminatory or Discretionary?

2001

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We estimate the structural links between IPO allocations, pre-market information production, and initial underpricing and find that (1) allocation policies favor institutional investors, both in the US and worldwide; (2) increasing institutional allocations results in offer prices that deviate more from the pre-marketing price range; (3) constraints on bankers' discretion reduce institutional allocations and result in smaller price revisions, indicating diminished information production; and (4) initial returns are directly related to information production and inversely related to institutional allocations. Our results indicate that discretionary allocations promote price discovery in the IPO market and reduce indirect issuance costs for IPO firms. r 2002 Elsevier Science B.V. All rights reserved.JEL classification: G32; G15; G24 Keywords: Initial public offerings; Bookbuilding; Underpricing; Intermediation; Allocation policy $ We are especially grateful to the referee for detailed comments that substantially improved the paper. We also thank Francesca Cornelli, William Greene, Michel Habib, Maureen O'Hara, Jay Ritter, G. William Schwert (the editor), and participants at the NYSE 'Global Equity Markets in Transition' conference (Hawaii, 2001), the American Finance Association meetings (Atlanta, 2002), the Third Toulouse Finance Workshop, and seminars at Cambridge University, Johann-Wolfgang-von-Goethe Universit. at Frankfurt, the University of North Carolina at Chapel Hill, Oxford University, the University of Virginia, and the University of Wisconsin-Madison for helpful comments. We wish to thank the many companies, banks, and bourses that made data available. All errors are our own.

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Building the IPO Order Book: Underpricing and Participation Limits With Costly Information

Cited by 115 publications

References 25 publications

A Joint Experimental Analysis of Investor Behavior in Ipo Pricing Methods

A Joint Experimental Analysis of Investor Behavior in Ipo Pricing Methods

Why Has IPO Underpricing Changed Over Time?

IPO Allocations: Discriminatory or Discretionary?

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