Abstract
AbstractIn this paper, we consider the effect of labor market constraints on the InitialPublic Offering (IPO) activity of investment banks. We posit that identifying IPOquality requires specialized screening labor that takes time to train. Positive shocksto economy’s production frontier stimulate IPO demand. At this higher level ofdemand, screening labor costs must rise to clear the labor market. This resultsin underwriters optimally reducing screening quality, in the process encouragingfirms with sub-marginal projects to also apply, further straining the screening labormarket. In equilibrium, underpricing can be quite significant both because of lowerquality screening and because of its role in lowering the quality of the applicantpool. Our model’s predictions are consistent with empirical results such as positivecorrelation between IPO volume and underpricing, reduced information search perproject during hot markets, and the persistence of high IPO volume in the face ofincreased underpricing.
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