Brookings-Wharton Papers on Financial Services 2002 (2002) 309-311
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Richard Lyons asked whether international evidence for initial public offerings is consistent with underpricing and money being left on the table. Ritter replied that international patterns have become increasingly integrated with those of the United States and that the Internet bubble was a worldwide phenomenon. He added that almost all large deals, no matter where they are, are lead-managed by big investment banking firms like Goldman Sachs and Credit Suisse First Boston.
David Crosen asked why competition in the form of new IPO underwriting does not return the wealth created through underpricing back to the companies. Ritter responded that this is one reason he is sympathetic to what he calls the "issuer stupidity" theory.
John Coffee pointed out that due to stock lock-up agreements that prohibit entrepreneurs from selling their shares for six months, there may be a conflict between the managers' interest in maximizing the value of their shares after the lock-up period and the company's interest in maximizing the capital it receives. There may be an implicit contract, however: if the stock is allowed to be underpriced and there is a huge first-day run-up, the momentum and the stock price six months later are maximized. An addition to the contract may be a "booster shot," a strong buy recommendation from a star analyst strategically timed on the day before the stock lock-ups expire. Ritter thought that this line of argument has some merit but was skeptical about whether the benefits are big enough to offset the dilution effect that lowers the price per share. Nonetheless, he believed that this is consistent with the issuer stupidity story, since data show that there is surprisingly little selling by insiders when the lock-up expires.
Coffee also noted that the Securities and Exchange Commission does not do much about underpricing since it does not have an effective legal [End Page 309] handle—it only has jurisdiction to punish the withholding of material information and material needs to the investors in these offerings. In these cases, the information that the underwriters are getting more than just their fees is immaterial to the investors. In fact, the average investor would be more eager to buy the offering if she learned that hedge funds were paying millions of dollars to get a stock allocation in this offering. Hence Coffee felt that, although disclosure of full compensation would be somewhat disciplining, it would not solve the problem of underpricing.
David Crosen contended that further research is necessary to see whether the underpricing mechanism is efficient because it opens up a more flexible supply of capital rather than allowing issuers to get the highest price. He felt that 7-15 percent IPO underpricing is normal, providing some amount of grease to keep the supply of capital from investors going. He added that the distinction between the issuer and other players is that the issuer is involved in a one-shot transaction, at least for the initial public offering, while a repeated game is being played by the investors and the investment banker.Ritter agreed that certain important players do need to be compensated for acquiring information in order to keep the flexible flow of capital going, but he felt that it is an issue of magnitude. He asked whether $17 million has to be left on the table to raise $78 million and noted that roughly $100 billion was left on the table in all the initial public offerings in the United States in the past twenty-two years, with $66billion of that left during 1999 and 2000.
Ritter admitted that IPO auctions worldwide have been losing market share when no one is forcing firms to hire investment banks and leave billions of dollars on the table. In addition, while analysts are important to issuers who are worried about long-term relationships, auction firms like WR Hambrecht also hire analysts. WR Hambrecht also goes out of its way to get institutional investors to participate in the auctions.
Ausubel noted that the fact...