Bookbuidling, Auctions, and the Future of the IPO Process

Auction theorists predict that bookbuilding, long the standard process for selling equity IPOs in the U.S., is about to give way to an Internet‐based IPO auction process that is both more efficient and more fair. The promise of auctions is that, by using an electronic platform that gives all investors the opportunity to bid on IPOs, the underpricing of IPOs and commissions to underwriters will be reduced, leading to an increase in net proceeds to issuers. Largely missing from such arguments, however, is an appreciation of why bookbuilding has dominated U.S. practice (and continues to supplant auctions in IPOs in most countries outside the U.S) and the role of undepricing in the IPO process. Rather than canvassing all investors, bookbuilding involves eliciting expressions of interest from institutional investors, and then allocating shares mainly according to the strength of their professed interest. In contrast to auctions, which allocate shares according to a set of explicit rules, bookbuilding involves a set of implicit “rules” that provide considerable room for judgment by the underwriter. This does not mean that the rules are arbitrary or not well understood by participants, particularly after thousands of IPOs conducted over the better part of two centuries. But to manage the exchange of information between issuers and investors, and the potential conflicts of interest in representing both groups, such rules must be administered by an intermediary with a considerable stake in protecting its reputation for fair dealing. Investment banks that deal with both issuers and the investment community on a regular basis are well positioned to perform this function. The underpricing of IPOs is best viewed not as a transfer of wealth from issuers to favored investors but rather as compensation to the large influential investors that play a major role in the price discovery process. By opening the process to all comers, auctions will discourage these large investors from bidding aggressively because less sophisticated investors will be able to “free ride” on their research and due diligence. To the extent this happens, auctions may suc ceed in reducing underpricing (in fact, they may even lead to over pricing), but they will also reduce the net proceeds for issuers. Nevertheless, recent advances in communications technology and auction theory will undoubtedly reshape current securities underwriting practices. In particular, Internet auctions are likely to replace bookbuilding in debt IPOs and less risky equity issues (say, IPOs of LBOs). But the argument that Bookbuilding will be completely cast aside in favor of largely untested alternatives fails to appreciate a successful institutional response to major market imperfections, some of which can never be wholly eliminated. Especially in the case of risky (first‐time) equity IPOs, there will continue to be an important role for managing the information exchange between issuers and investors that is critical to the IPO process.     

投资银行-机构投资者关系、“捧场”与IPO中的利益问题

投资银行是直接融资过程中最重要的中介机构,作为融资产品的“卖方”代表,其核心竞争力源于它所构建的投资者关系网络,但现有文献对于投行-投资者关系在证券发行中的作用还缺乏系统的实证研究。本文利用机构投资者在中国IPO新股发行中的完整询价记录,基于报价参与和报价水平两个维度提出了一种新的动态关系强度测算方法,并由此细致刻画了投行-机构关系对股票发行、定价的作用机制。结果发现:(1)投行可以驱动关系机构主动认购其承销的IPO新股,并引导关系机构给出与投行估值水平保持一致的高位报价,进而有效缓解了IPO拍卖制下的“投资者参与不确定性问题”。(2)关系机构的捧场报价显著提高了股票发行价格、增加了投行的承销收入;但是当新股交易价格在长期内逐渐向其内在价值水平收敛时,受到关系机构捧场支持越多的IPO新股,其长期回报率相对越低。(3)投行与机构的关系在本质上是互惠的,一旦投行被赋予新股分配权力,它明显倾向于将新股抑价发行带来的巨大利益分配给在前期捧场的关系机构,二者的关系越强,机构报价被认定为“有效报价”的概率越高,而一旦被认定为有效报价,关系机构的新股需求更是将被优先满足。     

A Theory of IPO Waves

In the IPO market, investors coordinate on acceptable IPO pricebased on the performance of past IPOs, and this generates anincentive for investment banks to produce information aboutIPO firms. In hot periods, the information produced by investmentbanks improves the quality of IPO firms, and this allows exante low quality firms to go public and increases the secondarymarket price, thus synchronizing high IPO volumes and high firstday returns. When investment banks behave asymmetrically ininformation production, the "reputations" of investment banksare interpreted as a form of market segmentation to economizeon the social cost of information production.     

INTERNET INVESTMENT BANKING: THE IMPACT OF INFORMATION TECHNOLOGY ON RELATIONSHIP BANKING

The production "technology" of investment banking, particularly in the pricing and distribution of securities offerings, has long depended on the ability of bankers to build and maintain networks of relationships with institutional investors and client firms. Among other benefits, these relationships enabled banks to economize on communications with investors at a time when communicating with the investment community was quite costly. But recent advances in information technology are forcing banks to reevaluate this relationship-based technology. For example, Goldman Sachs recently purchased a stake in Wit Capital's efforts to build a retail distribution channel via the Internet. And William Hambrecht, founder of Hambrect & Quist, has gone so far as to propose that IPOs be put up for auction over the Internet.
This article offers both historical and economic perspective on these technological innovations in investment banking. In so doing, it provides a framework for thinking about how this segment of the industry is likely to evolve in the near future. It also discusses how advances in information technology coupled with the increasing codification of investment banking practices could reduce the central role of human capital and relationships elsewhere within investment banks, and how this might influence both the organization of individual banks and the industry in general.     

IPO限价发行与新股二级市场价格泡沫——论股票市场“弹簧效应”

本文通过对比2009年7月1日至2014年6月30日IPO市场化定价发行阶段与2014年7月1日至2018年6月30日IPO限价发行阶段共1950个IPO样本,发现IPO限价发行对于新股在二级市场股价表现具有“弹簧效应”:即抑制股票一级市场发行价格会造成新股在二级市场价格短期内超涨,限价发行新股的二级市场定价显著高于市场化定价发行新股的二级市场定价。限价发行引起的过高二级市场定价最终导致股票长期回报率低下。另外,创业板公司“弹簧效应”显著强于主板公司。这些实证结果都可以被本文提出的一级市场价格压抑造成二级市场非理性投资者上涨预期一致、盲目追涨的理论模型所解释。本文的研究指出抑制股票一级市场定价虽然形式上可以解决新股发行价过高问题,但是却造成二级市场更大的价格扭曲。这一发现为进一步完善我国IPO发行定价机制提供了依据。     

CORPORATE GOVERNANCE IN AN EMERGING MARKET: THE CASE OF ISRAEL

Despite significant capital-market reforms in the mid-1980s, the Israeli government and banks continue to play an unusually dominant role in Israeli financial markets. Israeli banks operate as merchant banks and, through pyramid structures of ownership, control large segments of manufacturing, construction, insurance, and services. In addition, the banks dominate all facets of the capital market, including underwriting, brokerage, investment advice, and the management of mutual and provident funds.
Because of this dominance by the banks, several important mechanisms of corporate governance are missing. There is no effective market for corporate control; institutional investors have little incentive to monitor corporate managers; and those managers in turn have little incentive to improve firm performance and increase shareholder value.
To be sure, there has been an impressive wave of IPOs on the Tel Aviv Stock Exchange (TASE) in the 1990s. But those firms' stocks have substantially underperformed the market since going public, and many "higher-quality" Israeli firms have chosen in recent years to list their securities on the NASDAQ and not at home. The main reason the most promising Israeli firms go public in the U.S. is because that is where U.S. and other foreign investors want to buy them; such investors want the assurances that come with the U.S. corporate governance system.     

INITIAL PUBLIC OFFERINGS: GOING BY THE BOOK

In the U.S., and increasingly in other countries as well, IPO securities are marketed to investors in a process known as "book-building"—one that amounts to polling institutional investors to establish a demand schedule for the issue and then allotting stock to individual investors according to the strength of their professed interest. Although book-building methods require use of discriminatory tactics that have attracted strong criticism from investors and regulators, this article defends such practices by demonstrating that book-building is more efficient than alternative methods. It effectively allows issuers to increase the net proceeds of their offerings by making better use of information about market demand conditions.
In the process of explaining the efficiency of the book-building method, this article also offers a plausible explanation for a phenomenon that has long puzzled economists: the systematic underpricing of IPOs. The key to the success of a book-building effort lies in the use of a strategic pricing and allocation policy designed to offset the investor's incentive to understate his or her interest in an IPO. By committing to favor investors who provide strong indications of interest with relatively large allocations of underpriced shares, the investment bank can limit the distortion of investor's incentives in bidding and so increase the level of proceeds the issuing firm can expect to generate from its IPO.     

询价制度第一阶段改革有效吗

询价制度第一阶段改革后,新股定价效率明显提高,证监会取消对发行价格的管制是新股定价效率提高的前提,询价对象竞争程度的增加是定价效率提高的根本动因;改革后,机构投资者择股效应显著,将定价效率提高所引发的部分投资风险转嫁给了中小投资者。中小投资者由改革前利益分配不公平转变为改革后风险分担不公平,定价效率进一步提高很可能引发中小投资者的赢者诅咒。发行制度未来改革应在注重提高定价效率的同时,限制机构投资者向中小投资者转嫁风险的能力。     

Monitoring or colluding: the role of venture capital investors in the IPO process

We argue and provide evidence that instead of playing a monitoring role, venture capital (VC) investors collude with controlling shareholders in the IPO process of Chinese non‐state‐owned enterprises (non‐SOEs). We show that VC‐backed IPOs’ applications are more likely to be approved by regulators, especially in firms with excess control rights, but have worse post‐IPO performance. Through investing in firms with excess control rights, VC investors are able to make higher exit returns. We further document that VC investors’ role in the IPO process is stronger when they have political connections, hold higher ownership, and when they make pre‐IPO investment.     

香港市场基石投资者制度的实践与借鉴

基石投资者是香港IP O市场引导合理定价、提高发行效率的一项重要制度安排。本文对2013―2019年港股I P O进行实证分析,发现引入基石投资者可以提高IPO定价效率,帮助体量较大或估值较难的企业顺利上市,在低迷行情中起到市场稳定器的作用,但同时也存在个股流动性不足、利益输送等风险隐患。考虑到国内外形势复杂严峻,市场不确定性增强,注册制改革加速推进,新股稀缺性优势减弱,有必要借鉴香港基石投资者制度经验,进一步优化A股现行战略配售制度,合理稳定市场预期。同时,建议加强对参与战略配售投资者的信息获得、持股限售期以及信息披露等方面的监管力度。     

Conflict of Interest in Commercial Bank Equity Underwriting

This paper examines the pricing characteristics of initial public offerings underwritten by commercial banks. Assuming IPO underpricing is directly related to ex ante uncertainty, if the market rationally perceives these commercial banks to have a conflict of interest, these securities should have more underpricing than non-commercial bank underwritten initial public offerings (all else being equal). On the other hand, if the market believes that commercial bank involvement signals firm quality, less underpricing should be observed. This topic has recently gained in importance with the passage of the Financial Services Reform Act in November 1999. We find that the underpricing of commercial bank underwritten initial public offerings in which the firm had a previous banking relationship with the underwriter is significantly less than those underwritten by investment banks.     

Transparency in IPO mechanism: Retail investors’ participation,IPO pricing and returns

Using data from the transparent Indian IPO setting, the paper examines retail investors’ participation, their influence on IPO pricing and the returns they make on IPO investment. The transparency in the mechanism, which allows investors to observe prior investors’ participation, leads to demand which is concentrated at either one or two points of the offer price range. Analysis of investors’ demand during the offer period shows that the participation of retail investors is significantly influenced by the participation of institutional investors. We examine IPO pricing and find that favourable demand by retail investors is positively associated with a high IPO price even after controlling for demand by institutional investors. Further, we find that due to aggressive bidding by overconfident investors, retail investors are, on average, unlikely to make positive allocation weighted initial returns even in a setting where they do not have to compete with institutional investors. Retail investors, however, can earn significant positive allocation weighted initial returns if they limit their participation in IPOs with above average institutional investors’ demand.     

The strategic reallocation of IPO shares

In this work, we study the reallocation of shares to retail and institutional investors, measured as the difference between the allocation declared before the initial public offering (IPO) and the effective allotment decided by the underwriter after the bookbuilding process. The reallocation is disaggregated into three components, two of which are under the direct control of the underwriter: the initial allocation, and the demand satisfaction ratio. The empirical analysis is based on a sample of 193 hybrid IPOs issued in Italy between 1997 and 2012. Controlling for firm and IPO characteristics, we find that the IPO shares are typically shifted toward institutional investors when positive information is collected during the bookbuilding process. The IPO pricing and share reallocation are found to be interdependent, and reallocation is used in combination with partial adjustment to reward institutional investors.     

Commercial banks in investment banking conflict of interest or certification role?

When commercial banks make loans to firms and also underwrite securities, does this hamper or enhance their role as certifiers of firm value? This paper examines empirically the pricing of bank-underwritten securities as compared to investment-house-underwritten securities over a unique period in the U.S. (pre-Glass-Steagall) when both banks and investment houses were allowed to underwrite securities. The evidence shows that investors were willing to pay higher prices for securities underwritten by banks rather than investment houses. The results support a certification role for banks, which is more valuable for junior and information sensitive securities.     

Litigation risk, intermediation, and the underpricing of initial public offerings

We formally examine the role of litigation risk in initial publicoffering (IPO) pricing. The underwriter's pricing decision tradesoff current revenue against expected future litigation costs,both of which are increasing in the IPO price. Given a time-consistencyconstraint and rational expectations on the part of investors,however, the 'standard' litigation risk argument does not leadto equilibrium underpricing. We develop a richer model thatprovides sufficient conditions under which there is equilibriumunderpricing. The issuer's choice of employing an underwriterversus floating the IPO on its own is examined, and varioustestable implications of the model are developed.     

How Do Investment Banks Value Initial Public Offerings (IPOs)?

Abstract:  We investigate the valuation and the pricing of initial public offerings (IPOs) by investment banks for a unique dataset of 49 IPOs on Euronext Brussels in the 1993–2001 period. We find that for each IPO several valuation methods are used, of which Discounted Free Cash Flow (DFCF) is the most popular. The offer price is mainly based on DFCF valuation, to which a discount is applied. Our results suggest that DDM tends to underestimate value, while DFCF produces unbiased value estimates. When using multiples, investment banks rely mostly on future earnings and cash flows. Multiples based on post-IPO forecasted earnings and cash flows result in more accurate valuations.     

A theory of the transition to secondary market trading of IPOs

We develop a model in which investment banks and institutional investors collaborate in smoothing an initial public offering's (IPOs) transition to secondary market trading. Their intervention promotes welfare under the assumption that significant new information arrives in the market in the immediate aftermath of the IPO. Under this assumption, it is optimal to stage the offering and suboptimal to commit to selling shares at a uniform price. The optimal strategy yields an economic rationale for secondary market price stabilization for IPOs carried out via a well-coordinated network of repeat institutional investors.     

What Do Investment Banks Truly Bring to the Table?

This paper investigates the role of intermediaries in the initial public offering (IPO) process. In the U.S. market, investment banks have traditionally been involved in a firm‐commitment or best‐efforts underwriting capacity. However, in the Australian IPO market, investment banks are increasingly being named in association with new issues in diverse roles such as issue managers, sponsoring brokers and corporate advisers. Using a sample of 468 IPOs over the 1996 to mid‐2006 period, we examine the influence of investment banks across these different engagements. In support of the signalling and information production roles of intermediaries, we find that issuers choosing high intermediary involvement are typically older, retain more capital, seek to raise larger amounts of capital and are without independent expert certification. We find mixed support for the certification hypothesis when testing for the effect of intermediary reputation on IPO issuer wealth loss. Further, the impact of intermediary involvement on underpricing is not significantly different for the different levels of intermediary involvement once issue characteristics have been accounted for. This is puzzling since these different roles by definition do not provide the same level of issue quality assurance.     

Banking relationships and access to equity capital markets: Evidence from Japan’s main bank system

We study the role of banking relationships in IPO underwriting. When a firm in Japan goes public, it can engage an investment bank that is related through a common main bank, or can select an alternative investment bank. The main bank relationship can be an efficient way for the investment bank to acquire information generated by the main bank, but may give rise to conflicts of interest. We find that main bank relationships give small issuers increased access to equity capital markets, but that issuers of large IPOs often switch to non-related investment banks that are capable of managing large offerings. While investment banks seek to exploit bargaining power with related issuers, issuers respond to expected high issue cost by switching to non-related investment banks. The net result is that total issue costs through related and non-related investment banks are similar. With respect to aftermarket performance and use of proceeds, we find no evidence of conflict of interest or self-dealing for either the main bank or the investment bank.     

Global trends in IPO methods: Book building versus auctions with endogenous entry

The U.S. book-building method has become increasingly popular for initial public offerings (IPOs) worldwide over the last decade, whereas sealed-bid IPO auctions have been abandoned in nearly all of the many countries in which they have been tried. I model book building, discriminatory auctions, and uniform price auctions in an environment in which the number of investors and the accuracy of investors’ information are endogenous. Book building lets underwriters manage investor access to shares, allowing them to reduce risk for both issuers and investors and to control spending on information acquisition, thereby limiting either underpricing or aftermarket volatility. Because more control and less risk are beneficial to all issuers, the advantages of book building's allocational flexibility could explain why global patterns of issuer choice are surprisingly consistent. My models also predict that offerings with higher expected underpricing have lower expected aftermarket volatility; that an auction open to large numbers of potential bidders is vulnerable to inaccurate pricing and to fluctuations in the number of bidders; and that both book-built and auctioned IPOs will exhibit partial adjustment to both private and public information.