Underpricing is common in initial public offerings. But some firms
consistently sell new stock issues at a much greater discount than
others. Is this phenomenon driven by purely competitive forces, or by a
system that does not adequately protect IPO issuers from predatory
underwriting practices?
Gerard Hoberg, assistant professor of finance, is one of many
academians exploring the lines between ethical and unethical conduct in
the wake of the spectacular corporate scandals of recent times. His
research indicates that some underwriters may use underpricing as a
profit-maximizing strategy, to the detriment of the issuers, average
investors and the engine that drives business development.
“Institutional underwriters persistently underprice because it is
profitable for them,” says Hoberg bluntly. “They would say that they
choose the investors whose hands are the strongest, to build a stable
investment base for the issuer. But these same institutional investors
often sell their shares within days of the IPO, while the average
investor holds on to stocks for a long time.”
The practice of persistently discounting stock prices in IPOs has a
distinct downside. “There are two effective losers—the issuers and
society,” says Hoberg. “The issuers lose because they realize less
capital on their IPO when their stock is underpriced. But society loses
too, because of the wealth loss involved when that issuing company isn’t
able to grow as fast and create as many new jobs.” Average investors
also lose out when stocks are highly discounted, simply because they are
unable to get shares in an oversubscribed offering.
Random allocation, Hoberg believes, would make it much less
profitable for underwriters to persistently underprice. “If you take
away an underwriter’s ability to profit from allocation, then they would
be relying simply on commission for profit. And competition will drive
commissions to the right level.”
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research in Research@Smith. |
