Correcting the Empirical Foundations of IPO-Pricing Regulation

Abstract

Recent events are replete with stories of fraudulent or opportunistic behavior in the initial public offering (IPO) process - behavior that extended to the highest-reputation investment banks. Curiously, notwithstanding this evidence, recent financial economics literature asserts investment bank conflicts of interest certify IPO issuers. This Article develops new empirical evidence that casts doubt on this certification hypothesis by examining the pre-IPO price adjustment of IPOs involving qualified independent underwriters (QIUs), particularly IPOs in which more than ten percent of the net proceeds are being directed to participating investment banks (e.g., to repay a prior extension of credit). These offerings have similar pre-IPO pricing patterns to those others interpret as involving certification. Investment bank exit, however, cannot comfortably be categorized as certification. These results, together with other recent results in the legal literature, support the view that factors other than certification account for IPO pricing phenomena in IPOs involving investment bank conflicts of interest. The SEC has finally come to consider important proposals, put forward by the NASD and the NYSE, to reform IPO marketing, albeit five years after the internet bubble in IPOs and other securities transactions burst. These results support increased disclosure-focused regulation of the IPO process.