Walid Y. Busaba

Price Stabilization as a Bonding Mechanism in New Equity Issues

Examines the use of price stabilization and penalty bid provisions in primary equity markets. The model created in this analysis is based on the assumption that an underwriter represents the firm, the firm is issuing a fixed claim on its future cash flows, and there are two distinct pools of investors: regular and retail investors. Regular investors are likely to understate their interest in an investment, as they know that the underwriter bases the offer price on this interest. The underwriter must try to balance the somewhat conflicting goals of maximizing expected proceeds with gaining truthful indications of interest. This analysis begins by deriving the optimal price and allocation schedule while assuming that potential investors can obtain credible pre-market information. The analysis then moves to the situation in which investors cannot obtain information on the pre-market conditions. An overstatement of pre-market interest by an issuing firm increases investor expectations and, in turn, the offer price. Underwriters who agree to price stabilization are unlikely to overstate investor interest prior to fixing the offer price for a new issue. Allowing underwriters to utilize penalty bid systems provides for further efficiency gains. The primary equity market is made more efficient when underwriters utilize price stabilization as a bonding mechanism. (SRD)

Bookbuilding vs. Fixed Price: An Analysis of Competing Strategies for Marketing IPOs

We compare two mechanisms for selling IPOs, the fixed price method and American book-building, when investors have correlated information and can observe each others subscription decisions. In this environment, the fixed price method is a strategy that can create cascading demand. Alternatively, an underwriter building a book aggregates investor information into the offer price. We find that bookbuilding generates higher expected proceeds but exposes the issuer to greater uncertainty, and that it provides the option to sell additional shares that are not underpriced on the margin.

The Dark Side of Cross-Listing: A New Perspective from China

The overwhelming majority of Chinese firms that list their stock both in China and abroad had gone public, and listed, abroad first. We find that when companies listed abroad return to China to issue stock and list, they experience poorer post-issuance stock and operating performance in comparison to purely domestic issuers. Also, they raise more funds relative to their sales, leave less money on the table for investors, and incur lower direct flotation costs. Among returning firms, those which raise higher proceeds relative to sales experience poorer long-run stock performance and lower Tobin’s q post issuance. Our results offer a new perspective on cross-listing, which we term ‘dressing-up-for-premium’. Firms from less-developed markets take advantage of the enhanced visibility and prestige associated with the foreign listing to issue shares domestically at inflated prices and favorable terms, and to raise greater proceeds than they can efficiently use.

Do Underwriters Price-Up IPOs to Prevent Withdrawal?

We examine whether underwriters price up weakly demanded initial public offerings (IPOs) to prevent withdrawal. Our empirical strategy exploits a discontinuity in the distribution of IPO prices around the low boundary of the filing range. Offerings with a high ex ante withdrawal probability that are priced at this boundary are likely priced up to meet issuers’ reservation prices. We compare the aftermarket returns of these IPOs to the returns of other weakly demanded offerings where issuers’ reservation prices were likely not binding, and we identify a negative 8.4-percentage-point differential attributable to the aggressive pricing inherent in setting the price at the low boundary when withdrawal risk is high.

Market Volatility and IPO Filing Activity

The initial public offering (IPO) filing volume is positively related to changes in market volatility, especially when market returns are at ‘normal’ levels. This is consistent with the view that filing with the Securities and Exchange Commission (SEC) gives would-be issuers an ‘option’ on market valuations. Creating this option is attractive not only when market valuations rise but also when volatility increases, and the effect of volatility is more pronounced when market returns are neither high nor low. We therefore identify a distinct type of ‘window of opportunity’ for firms attempting to go public, characterized not particularly by strong stock valuations but by increased volatility in valuations.