The Puzzling Persistence of the Fixed Price Offering: Implicit Price Discrimination in IPOs

Abstract

This chapter for a book on the regulation of primary securities markets investigates the persistence of the fixed price offering in the United States. Fixed price offerings present a puzzle because economic theory suggests that sellers would maximize returns by offering IPO shares for sale at different prices depending upon characteristics of the buyer or the buyer's order. Contrary to this expectation, however, American companies uniformly sell IPO shares at a single fixed offering price. Moreover, this is true regardless of whether the shares are sold through the traditional book-building process or at auction. This phenomenon is not a function of the legal or regulatory structure governing public offerings in the United States, which neither mandates fixed price offerings nor bars price discrimination in IPOs. Instead, it appears to be a result of the market power of underwriters. A close examination of the offering process reveals a form of implicit price discrimination in which underwriters clearly engage - that is, the selective allocation of shares with resale restrictions. The chapter argues that underwriters favor implicit price discrimination over explicit price discrimination because the benefits of implicit price discrimination redound to the underwriter while explicit price discrimination would benefit issuers and eliminate an important (but hidden) component of underwriter compensation.