IPO Pricing and Dealers’ Interaction: A Stochastic Frontier Approach

Marco Cucculelli,Camilla Mazzoli,Sabrina Severini,Manuela Geranio

doi:10.5539/ibr.v14n1p1

Abstract

This study investigates the impact of ongoing relationships between underwriters and institutional investors on Initial Public Offerings (IPO) pricing. Differently from previous studies that are focused on allocations of underpriced shares we propose a model of primary market pricing in which the incomplete adjustment of the offer price to its maximum achievable level depends on the intensity of interactions that occurred between players in the years before the IPO. Using a stochastic frontier approach on a sample of 1 677 US IPOs between 2000 and 2016 the paper shows that the more investment banks and investors regularly work together the more the IPO offer price is set closer to the fair value of the issuing firm. This analysis helps to disentangle the ambiguous effects of underwriters&rsquo; discretion on IPO primary market pricing when bookbuilding is used. We then support the idea that banks can maximize value to issuers by fostering a regular clientele of investors.

Highlights

1.1 Motivation for the StudyAn initial public offering (IPO) is launched when a firm goes public for the first time
This study investigates the impact of ongoing relationships between underwriters and institutional investors on Initial Public Offerings (IPO) pricing
From previous studies that are focused on allocations of underpriced shares we propose a model of primary market pricing in which the incomplete adjustment of the offer price to its maximum achievable level depends on the intensity of interactions that occurred between players in the years before the IPO

Summary

Introduction

1.1 Motivation for the StudyAn initial public offering (IPO) is launched when a firm goes public for the first time. Underwriters might not raise the price to full market value for several reasons: adverse selection and moral hazard problems (Baron, 1982; Rock, 1986) the burden of market making (Benveniste, Busaba & Wilhelm, 1996; Chowdhry & Nanda, 1996) the risk of lawsuits (Lowry & Shu, 2002) reputation concerns (Beatty & Ritter, 1986; Carter & Manaster, 1990) institutional and country-specific issues (Engelen & van Essen, 2010) or the efforts required for limiting aftermarket stabilization of transactions (Beatty & Ritter, 1986; Ibbotston, Sindelar & Ritter, 1988; Aggarwal, 2003) At this stage underwriters and institutional investors who repeatedly work together during different IPOs might collude deliberately tuning the offer price according to their prevailing interests (Ljungqvist & Wilhelm, 2002)

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