IPOs

1. Analysis of IPOs often begins with 2 overriding empirical regularities: Under pricing Waves Our focus is on the role of the investment bank, and the design of the process, and why the process is the way it is. One objective is to understand these empirical regularities in this context. IPOs

2. IPOs2 The process of doing an IPO is not an auction. Rather, the Investment Banker sets a price, and elicits quantity bids at that price. It is not surprising, in light of this process that most IPOs are oversubscribed (i.e., there are bids for many more shares than are being sold).

3. IPOs 3 Demand is assessed using a book-building process. During this process, the investment banker elicits interest from potential investors.

4. IPOs 4 An investment banker-focused process makes sense in an information poor environment. Recall the prospectus of the new York Central Rail Road – from the heyday of Pierpont Morgan. Investors in this equity offering had only the implicit warranty of the investment banker to provide assurance against fraud – and to assess value.

5. IPOs 5 There does appear to be some residue of this phenomenon today. Recall that Goose Sasso told us that DLJ bought back stock of Penton Media at $30 from disgruntled institutional investors, who watched the price fall from that level after a secondary equity offering. This process is known as price support. Exactly how investment bankers do this today is somewhat unclear – and controversial. It would certainly appear that some important investors are granted a put option – that is not provided to the general public.

6. IPOs 6 Certainly in the “old days” – before the SEC, and before GAAP, investors had precious little information about: • The macro economy • Industry Conditions • The Company Itself: • Management • Financials • Markets • Risks

7. IPOs 7 The good name of a reputable investment banker was the only reliable information. In the Morgan era, the US system resembled the keiretsu system in Japan – if Morgan underwrote an offering, there were often Morgan executives on that company’s board of directors. And we have already seen, these companies were less capital constrained than companies with no Morgan ties.

8. IPOs 8 As we try to understand why we still use a mechanism that is anachronistic in many ways, consider that entrepreneurs – who may stand the most to gain from changing the system – only do an IPO once. The experts on the process are the investment bankers.

9. IPOs 9 We will note the irony of a capitalist system – defined by the use of the price mechanism to ration scarce goods – price is not used when a company goes public for the first time. An allocation mechanism that looks more like a sale of concert tickets is used instead.