The role of expertise in syndicate formation

Abstract

AbstractIn most initial public offerings around the world, an underwriter selects syndicate members and uses their information to set the offering price. The objective of this paper is to develop a model of the “book building” process in which the formation of the syndicate is an endogenous decision variable. I analyze when it may benefit the lead underwriter to select syndicate members with different expertise and to acquire all available information about the value of the shares. I show that the underwriter faces a tradeoff between the cost of extracting information and valuation accuracy. Specifically, when the issuer is a low‐risk firm, the costs of acquiring information are higher than the benefits in terms of price accuracy and forming a specialized syndicate is optimal. However, when retail investors' participation is high enough and when the issuer is a high‐risk and transparent firm, the lead underwriter' optimal strategy is to form a diversified syndicate.