Brookings-Wharton Papers on Financial Services 2002 (2002) 293-312
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The Future of the New Issues Market
Jay R. Ritter
EVERY MBA PROGRAM that I have taught in has some Asian students, and in some Asian societies, such as Korea, it is common for a student to give a gift to a teacher at the end of the year. Some Korean students continue this practice when they are studying in the United States, and over the years I have received a number of gifts from students. Most of these fall into the category of trinkets and knick-knacks, and the average value of these gifts has been about twenty dollars. I typically accept these gifts when offered, and sometimes I even remember the student's name. I do not think that many people would consider my acceptance of these gifts after the end of a semester as unethical behavior.
I have not been faced with the decision, but what would I do if I were offered a gift of a work of art, a gift worth $200? And what if I could sell this gift (I would wait until after the student graduated and left town, of course) and pocket the $200? Would accepting this gift be unethical? Would it change my behavior? What if the work of art was worth $10,000, but the Korean student let me know in advance of the final exam that he or she only gave gifts to professors in classes where an A was received? Would this affect the grade I gave this student, especially if it turned out that the student was right on the borderline between an A and a B when I [End Page 293] was making up the grade distribution? What if the student did not tell me this in advance, but I had learned from experience that I would receive much more valuable gifts from Korean students if they received high grades? Would it be okay for me to accept significant gifts from students who received high grades if other professors were doing so? In other words, if it were standard industry practice?
Because this paper is about the new issues market, I will not discuss further the ethical problems associated with professors who give high grades to students and receive gifts in return. This article focuses mainly on the initial public offerings (IPOs) of equity securities. I focus on equity IPOs mainly because this is where almost all of the controversy lies. In particular, controversies are associated with underwriters who allocate hot IPOs to hedge funds and receive commission business in return. After presenting some statistics concerning IPOs and discussing controversies, the paper ends with some policy recommendations.
The Allocation of IPOs
Economists use the term rents to refer to compensation in excess of normal competitive levels. In the 1980s, when the average first-day return on IPOs with an offer price of $5.00 per share or higher was 7 percent, rent-seeking behavior by buyers was minimal, because there were few rents to collect. The mean amount of money left on the table was $1.6 million, and the median was only $0.2 million.
In 1990-98, when the average amount of money left on the table increased to $8 million, rent seeking became more common. Many investors, both individuals and institutions, began to seek out IPOs. Frequently the goal was not to be a buy-and-hold investor, but instead to make a quick profit by buying at the offer price and selling at a higher price a short time later. During 1999-2000—the Internet bubble years—the situation got completely out of hand, with an average of $78 million being left on the table. In 2001 the average amount left on the table reverted to $37million (see figure 1 and table 1).
IPOs with an offer price below $5.00 per share, unit offers, real estate investment trusts (REITs), closed-end funds, banks, savings and loans (S&Ls), American depository receipts (ADRs), and IPOs not...