Electronic Thesis and Dissertation Repository

Degree

Doctor of Philosophy

Program

Business

Supervisor

Dr. Walid Y. Busaba

Abstract

This dissertation extends theory and empirical research on Initial Public Offerings (IPOs) to include the unique context faced by underwriters that have the flexibility to overprice cold offerings. First, it argues that underwriters have the incentive to deliberately overprice weakly-received offerings in order to avert potential withdrawal of the offerings and loss of underwriting commissions. It then empirically tests this argument and finds supporting evidence. Measuring underwriter pricing intention by the NASDAQ-adjusted percentage change from the offer price to the closing price three days prior to the end of the quiet period, we find deliberate overpricing to be more pronounced for offerings that end up priced exactly at the lower boundary of the preliminary price range, especially when the ex ante withdrawal probability is high or when the lower boundary represents a smaller percent drop from the range’s midpoint.

The dissertation then examines the effect of IPO overpricing on the long-term prospects of the underwriters. It empirically demonstrates that overpricing offerings to avert withdrawal not only increases the payoff to the underwriter from the respective deals but also enhances the underwriter’s share of future IPO business. In particular, it finds that banks which engage issuers with a higher ex ante propensity to withdraw, and then aggressively price the offerings to actually avert withdrawal, experience a pronounced increase in their future IPO market share. Such reward is not experienced by underwriters which at the outset avoid engaging issuers with high likelihood of withdrawal. The dissertation also finds that withdrawals have more of an adverse effect on future market share than does mere overpricing. Furthermore, when overpricing is accompanied by even a low level of price support during first-day of public trading, the effect on the bank’s future market share is significantly less adverse than that associated with otherwise letting the offer be withdrawn.

The dissertation extends the IPO bookbuilding theory by developing a model which encompasses the potential for IPO withdrawal, overpricing, and aftermarket price support altogether, and solving for the equilibrium offer-price-maximizing price/allocation schedule. The analysis shows that overpricing can be sustained in equilibrium in a manner that still ensures maximized proceeds to the issuer. The optimal price/allocation rule calls for allocation priority to be given to investors with strong indications of interest; underpricing to occur when premarket demand is strong; and overpricing to be resorted to only as needed to avert withdrawal by the issuer in lukewarmly-received offerings. Aftermarket price stabilization plays two roles in equilibrium: It bonds the underwriter against deliberate overpricing when premarket demand is either strong or too weak; and it adequately compensates investors when overpricing is utilized to avert issue withdrawal.


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