IPO Pricing and Share Allocation: The Importance of Being Ignorant

  • Author(s): CÉLINE GONDAT‐LARRALDE, KEVIN R. JAMES
  • Published: Jan 10, 2008
  • Pages: 449-478
  • DOI: 10.1111/j.1540-6261.2008.01321.x

ABSTRACT

Since an underwriter sets an IPO's offer price without knowing its market value, investors can acquire information about its value and avoid overpriced deals (“lemon‐dodge”). To mitigate this well‐known risk, the bank enters into a repeat game with a coalition of investors who do not lemon‐dodge in exchange for on‐average underpriced shares. We (i) derive and test a quantitative IPO pricing rule (showing that tech IPOs were not excessively underpriced during the boom of the 1990s); and (ii) analyzing a unique multibank data set, find strong support for the conjecture that a bank preferentially allocates shares to its coalition.

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