Ann E. Sherman

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 see front matter r 2005 Elsevier B.V. All rights reserved. .jfineco.2004.09.005 like to thank Ravi Jagannathan, Sheridan Titman, Jay Ritter, Tim Loughran, Paul Schultz, lio, Bill Wilhelm, Alexander Ljungqvist, Don Hausch, Larry Benveniste, David Goldreich, upta, Ed Prescott, V. V. Chari, Jack Kareken, Tom Gresik, and seminar participants at the es and Exchange Commission Office of Economic Analysis, the Federal Reserve Bank of University of Minnesota, University of Notre Dame, and University of Wisconsin-Madison mments and ideas. This work began when I was at Hong Kong University of Science and the support of which is gratefully acknowledged. 74 631 3373; fax: +1 574 631 6416. dress: asherman@nd.edu.

Endogenous Entry and Partial Adjustment in IPO Auctions: Are Institutional Investors Better Informed?

Using a unique dataset of complete bid information for every IPO auction in Taiwan during 1995--2000, we examine the behaviors and returns of two groups--institutional and retail investors--in a setting in which underwriters do not have pricing or allocation discretion. We find that the bids of institutional investors are generally consistent with the predictions of IPO auction theory for informed bidders, while those of individual investors are not. Specifically, returns are higher when more institutional investors enter the auction or bid higher prices, suggesting institutional investors are informed and are also able to shave bids adequately. However, individual investors as a group exhibit return-chasing behavior, are uninformed, and systematically overbid. The Author 2009. Published by Oxford University Press [on behalf of The Society for Financial Studies]. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Why Do IPO Auctions Fail

We document a somewhat surprising regularity: of the many countries that have used IPO auctions, virtually all have abandoned them. The common explanations given for the lack of popularity of the auction method in the US, viz., issuer reluctance to try a new experimental method, and underwriter pressure towards methods that lead to higher fees, do not fit the evidence. We examine why auctions have failed and verify, to the extent possible, that they are consistent with what academic theory predicts. Both uniform price and discriminatory auctions are plagued by unexpectedly large fluctuations in the number of participants. The free rider problem and the winners curse hamper price discovery and discourage investors from participating in auctions. Calculating the optimal bids in large multi-unit common value auctions with endogenous entry imposes a huge computational burden. With IPOs taking place sporadically, and each firm being different, auctions are likely to end up being unstable.

The Long-Run Role of the Media: Evidence from Initial Public Offerings

The unique characteristics of the U.S. initial public offering IPO process, particularly the strict quiet period regulations, allow us to explore the effects of media coverage when the coverage does not contain genuine news i.e., hard information that was previously unknown. We show that a simple, objective measure of pre-IPO media coverage is positively related to the stocks long-term value, liquidity, analyst coverage, and institutional investor ownership. Our results are robust to additional controls for size, to using abnormal or excess media, and to an instrumental variable approach. We also find that pre-IPO media coverage is negatively related to future expected returns, measured by the implied cost of capital. In all, we find a long-term role for media coverage, consistent with Mertons attention or investor recognition hypothesis. This paper was accepted by Brad Barber, finance.

Underwriter Certification and the Effect of Shelf Registration on Due Diligence

Shelf registration gives underwriters greater flexibility in timing market issues and involves little or no increase in direct costs, since registration fees are exactly the same and underwriter fees seem comparable. Nevertheless, shelf equity issues are rare. I argue that erosion in the due diligence investigation of underwriters is a significant drawback to shelf registration, and this erosion explains the apparent puzzles in the data on shelf versus non-shelf issues. I compare the forecasts of my model to existing empirical evidence and conclude that shelf registration leads to both increased underwriter competition and reduced due diligence.

Come on in, the Water's Fine! An Experimental Examination of Hybrid IPO Auctions with a Public Pool

We offer experimental and theoretical evidence that the auction method for initial public offerings (IPOs) may be improved through the use of hybrid auctions with separate retail tranches or ‘public pools’. Such hybrids, which combine a price-setting tranche (an auction or book building) with a separate tranche that allows investors to place orders without specifying a price (the public pool), have been used for IPOs around the world. We develop theory, then run laboratory experiments to examine the effects of a public pool on multi-unit uniform price auction IPOs. Our experimental auction design incorporates key features of the IPO process such as endogenous bidder entry, costly information acquisition, differing capacity constraints and uncertainty with respect to the intrinsic value. Simulations are used to characterize the Symmetric Bayesian Nash Equilibria (SBNE) for both pure and hybrid auctions in a model that is calibrated to key parameters from our experimental data, generating predictions for the remaining variables. As predicted, a public pool tranche improves auction performance by increasing proceeds, lowering price volatility, reducing price error and reducing the incentive for small bidders to free ride by submitting extremely high bids. Underpricing occurs in both treatments but is less severe with the public pool. We also show that in collusive-seeming multi-unit auction equilibria, it may be optimal for informed, rational bidders to place clinching bids strictly above the expected value per unit, leading to very steep demand curves. Overall, our results imply that both IPO auctions and crowdfunding may be improved by restricting retail investors to a separate, non-price-setting tranche.Abstract. We offer experimental and theoretical evidence that the auction method for initial public offerings (IPOs) may be improved through the use of hybrid auctions with separate retail tranches or ‘public pools’. Such hybrids, which combine a price-setting tranche (an auction or book building) with a separate tranche that allows investors to place orders without specifying a price (the public pool), have been used for IPOs around the world. We develop theory, then run laboratory experiments to examine the effects of a public pool on multi-unit uniform price auction IPOs. Our experimental auction design incorporates key features of the IPO process such as endogenous bidder entry, costly information acquisition, differing capacity constraints and uncertainty with respect to the intrinsic value. Simulations are used to characterize the Symmetric Bayesian Nash Equilibria (SBNE) for both pure and hybrid auctions in a model that is calibrated to key parameters from our experimental data, generating predictions for the remaining variables. As predicted, a public pool tranche improves auction performance by increasing proceeds, lowering price volatility, reducing price error and reducing the incentive for small bidders to free ride by submitting extremely high bids. Underpricing occurs in both treatments but is less severe with the public pool. We also show that in collusive-seeming multiunit auction equilibria, it may be optimal for informed, rational bidders to place clinching bids strictly above the expected value per unit, leading to very steep demand curves. Overall, our results imply that both IPO auctions and crowdfunding may be improved by restricting retail investors to a separate, non-price-setting tranche.