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Why Have Auctions Been Losing Market Shares to Bookbuilding in IPO Markets?. Ji-Chai Lin Louisiana State University Yi-Tsung Lee National Chengchi University Yu-Jane Liu National Chengchi University Comments welcome. Good things about IPO auctions. All bidders are on equal footing

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Why Have Auctions Been Losing Market Shares to Bookbuilding in IPO Markets?

Ji-Chai Lin

Louisiana State University

Yi-Tsung Lee

National Chengchi University

Yu-Jane Liu

National Chengchi University

Comments welcome


Good things about ipo auctions
Good things about IPO auctions

  • All bidders are on equal footing

  • No favoritism

  • Less average underpricing (e.g., Derrien and Womack (2002), Kandel, Sarig, and Wohl (1999), and Pettway and Kaneko (1996)).


Some puzzling facts about ipo auctions
Some puzzling factsabout IPO auctions

  • Sherman (2002)

    • Losing market share to bookbuilding

    • Only Taiwan and Israel

    • Many countries that experimented with IPO auctions in the 1990s or 1980s abandoned them within a few years.

  • Ljungqvist, Jenkinson, and Wilhelm (2003)

    • Auctions are rarely used in IPO markets

    • Increasing popularity of bookbuilding


Why are ipo auctions not popular
Why are IPO auctions not popular?

  • Auctions are popular in many settings in selling items with uncertain valuation.

  • Why not in IPO markets?

  • Could we get some answers from auctions data?

  • Would key players in IPO markets be better off under bookbuilding?


Three issues
Three Issues

1) In bookbuilding, allocation policies favor institutional investors.

  • Would auctions be a fairer mechanism in IPO allocations?


Second issue
Second Issue

2) Sherman (2002) postulates that bookbuilding has an edge in pricing over auctions.

  • What empirical evidence can be offered to suggest that auctions may not perform as well as bookbuilding?


Third issue
Third Issue

3) Benveniste and Spindt (1989) posit that institutional investors could increase their expected profits under bookbuilding from a tradeoff between a higher allocation of shares and a lower level of underpricing.

  • Do observed institutional allocations and underpricing required by institutional investors in auctions make the tradeoff feasible?


The objective
The objective

  • Analyze the bidding data from 89 Taiwan IPO auctions to provide answers to the three empirical questions.

  • Shed some light on why auctions have been losing market shares to bookbuilding.


Taiwan auctioned ipos
Taiwan Auctioned IPOs

  • Competitive bidding for half of the IPO shares

  • Public subscription at a fixed price for the remaining half of the shares.

  • The public subscription is limited to only one round lot (i.e., 1000 shares) per person.

  • No bidder shall be allowed to win more than six percent of the shares designated for auction.

  • Winning bidders pay what they bid.





Institutional allocations
Institutional Allocations

  • Inst_Alloc=The percentage of shares won by institutions.

  • Average Inst_Alloc=19%

    (much lower than the norm of around 70% in countries using bookbuilding)

  • Ten auctions with Inst_Alloc=0

  • Auctions with high Inst_Alloc

    if Inst_Alloc > 20%


Auctions with high inst alloc
Auctions with high Inst_Alloc

  • set a higher base price

  • put more shares for IPO auction

  • attract more bidders


Institutional investors
Institutional Investors

  • Represent less than 5% of all bidders.

  • Submit about 22% of shares in all bids.

  • Seem to know in which auctions and at which prices they should bid to win shares.


Table 3 characteristics of institutional investors and retail investors in ipo auctions
Table 3. Characteristics of Institutional Investors and Retail Investors in IPO Auctions





The pricing performance of taiwan ipo auctions
The pricing performance of Taiwan IPO auctions

  • On average, winning bidders earn about two percent from the auction day to the 20th day of exchange listing.

  • All three metrics suggest that the initial returns are insignificantly different from zero.

  • Our finding appears to be the first one showing that an IPO pricing mechanism leads to insignificant underpricing.



Results
Results

  • For auctions with Inst_Alloc=0, retail investors lose an average of 4.3%.

  • For auctions with high Inst_Alloc, the average initial return is about 14%.



A winner s curse
A winner’s curse

  • Retail investors win significantly higher proportions of shares in auctions that yield negative returns.

  • The higher the returns institutions could earn in auctions, the more shares they obtain.


Are auctions a fair allocation mechanism
Are auctions a fair allocation mechanism?

  • The answer is no.

  • Retail investors are more likely to suffer a winner’s curse in IPO auctions (Rock(1986)).

  • They are not better off under auctions than under bookbuilding.


Table 8 the relation between inst alloc and underpricing
Table 8. The Relation Between Inst_Alloc and Underpricing




Underpricing and inst allco
Underpricing and Inst_Allco

  • Underpricing is positively related to Inst_Alloc.

  • This structural relation is opposite to that of bookbuilding IPOs (Ljungqvist and Wilhelm (2002)).

  • Implication: As Inst_Alloc increases, bookbuilding could outperform auctions.


Table 9 inst alloc bids and initial returns
Table 9. Inst_Alloc, Bids, and Initial Returns



The required underpricing by institutions
The required underpricing by institutions

  • Underpricing_inst= -0.14 + 0.853 Inst_Alloc

  • Institutions tend to earn higher returns in auctions in which they win more shares.

  • When Inst_Alloc < 16.4%, underpricing <0, suggesting that not all institutions are informed.


Allocation weighted returns
Allocation-Weighted Returns

  • (R_inst –R_f) w_inst=0.105+1.032(R_m -R_f) w_inst

    (2.03)

  • (R_retl –R_f) w_retl=0.011+1.051(R_m -R_f) w_retail

    (0.43)


Institutions vs retail investors
Institutions vs. Retail investors

  • The allocation-weighted abnormal return for retail investors is closed to zero.

  • The allocation-weighted abnormal return for institutions is 10.5%.

  • Consistent with Rock’s (1986) winner’s curse theory in which uninformed investors earn the R_f.


Could institutions be better off under bookbuilding
Could institutions be better off under bookbuilding?

  • Institutions are informed and have advantages in auctions.

  • The average Inst_Alloc of 19% is much lower than the norm of 70% in countries using bookbuilding.

  • Under bookbuilding, their expected profits could be increased with a tradeoff of a higher allocation and a lowered required underpricing.

  • For example, Inst_Alloc could be doubled to 38%, and the required underpricing be lowered from 10.5% to 6%.


Conclusion
Conclusion

  • There could be many reasons for why auctions have been losing market shares to bookbuilding.

  • This paper contributes three.

    1) Retail investors are likely to suffer a winner’s curse in auctions.

    2) For auctions with high Inst_Allco, underpricing could be large, which could be reduced under bookbuilding.

    3) Institutions could be better off under bookbuilding.


The dark side of bookbuilding
The dark side of bookbuilding

  • If underwriters are given discretion in share allocations, the discretion will not automatically be used in the best interests of the issuing firm.

  • For bookbuilding to outperform auctions, underwriters must act in the best interest of the issuing firm


100

90

80

70

60

NT$

50

40

30

Average Winning Bid Price

20

Average Daily Stock Price

10

0

1

10

19

28

37

46

Day of Exchange Listing

Figure 1. The Average Daily Stock Price of the 89 IPOs


-0.6

0.8

0.6

0.4

0.2

Underpricing (MAR)

0

1

4

7

10

13

16

19

22

25

28

31

34

37

40

43

46

49

52

55

58

61

64

67

70

73

76

79

82

85

88

-0.2

-0.4

Auctions Sorted by MAR within Each Allocation Group

Figure 2. The Distributions of Underpricing in the Zero (auctions1-10), Low (auctions 11-60), and High (auctions 61-89) Institutional Allocation Groups.


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