The cost of fragmentation: lessons from initial public offerings*

Abstract

This paper investigates both theoretically and empirically the impact of market structure on the price discovery process at the opening of trading of IPOs. Some papers suggest that IPO value uncertainty is not fully resolved at the offering but continues into the aftermarket. Our model predicts that this ex-post uncertainty, i.e. the residual uncertainty about the firm value in the aftermarket, is related to the level of fragmentation in the aftermarket. Our model further predicts that consolidated markets are more efficient in resolving ex-post uncertainty than fragmented markets. Using the introduction of the opening IPO Cross on Nasdaq as a natural experiment, our empirical analysis provides compelling evidence that IPOs in fragmented markets exhibit larger levels of ex-post uncertainty and, consequently, larger underpricing than in consolidated markets.