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How Important are Relationships for IPO Underwriters and Institutional Investors? Murat Binay, Christo Pirinsky, and Qinghai Wang The Issues Participation in the IPO market is restricted IPOs are significantly underpriced (Table1) 20.1% over 1980-2000 4.7% in 1984 77.3% in 1999

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how important are relationships for ipo underwriters and institutional investors

How Important are Relationships for IPO Underwriters and Institutional Investors?

Murat Binay, Christo Pirinsky, and Qinghai Wang

the issues
The Issues
  • Participation in the IPO market is restricted
  • IPOs are significantly underpriced (Table1)
      • 20.1% over 1980-2000
      • 4.7% in 1984
      • 77.3% in 1999
  • The amount of money (Loughran and Ritter, 2002)
      • $9.1mil. (average IPO)
      • $27bil. (during 1990-1998)
  • Regular investors benefit
the agency view
The Agency View
  • Anecdotal evidence that underwriters build clienteles of regular investors  use IPOs as side-payments for commission revenues
      • Financial press
      • SEC investigations
      • Regulatory settlements
  • Statistical evidence  Reuter (2006)
  • Favoritism is at the expense of highly underpriced firms
  • Why would firms participate?
      • Changing objectives (Loughran and Ritter, 2002)
      • Limited information
the book building view
The Book-building View
  • The Book-building process
      • Involves a group of sophisticated investors
      • Investors submit (P,Q) combinations
      • Investment banks set up price and allocations
  • Underpricing
      • Rewards investors for their information
      • Cost for the issuing firm
  • Book-building has become increasingly popular around the world
the book building view5
The Book-building View
  • Regular investors improve the efficiency of the IPO process (Benveniste and Spindt, 1989; Benveniste and Wilhelm, 1990)
      • Repeated-game set up: leverage
      • Lower underpricing
      • Liquidity
  • Endogenous information acquisition (Sherman, 2000; Sherman and Titman, 2002)
  • Book-building is not the only possible world for initial placement of equity…
research objective
Research Objective
  • Do underwriters build clienteles of regular investors?
  • What are the implications?
  • Limited empirical evidence
      • Reuter (2006) √
      • Hanley (1993), Cornelli and Goldreich (2001), Hanley and Wilhelm (1995)
  • Major results
      • Yes! Underwriters build networks of regular investors
      • Improve efficiency
      • We do not exclude the possibility for agency-based allocations
roadmap
Roadmap
  • Data
  • Relationship participation measure
  • Properties of the measure
  • Determinants of Relationship participation
  • Implications
slide8
Data
  • IPOs of U.S. common stocks over 1980-2000
      • SDC New Issue Database
      • Filters
  • Institutional holdings
      • CDA Spectrum Database
      • Quarterly frequency
  • Is the end of the issuing quarter a good proxy for institutional participation?
      • Hanley and Wilhelm (1995): 38 IPOs – correlation is 0.91
      • Aggarwal (2003): short-term flipping is small – 15%
      • Large sample
relationship participation measure
Relationship Participation Measure
  • Lead underwriter
  • Control for unconditional participation
  • Only active institutions are included
  • Only recent history: last 10 deals within past 5 years
relationship participation
Relationship Participation
  • RP and underpricing
  • RP for subperiods
relationship participation13
Relationship Participation
  • RP and underwriter reputation
  • RP for subperiods
relationship participation14
Relationship Participation
  • RP for Internet and Technology IPOs
relationship participation15
Relationship Participation
  • RP for Several Underwriters
relationship participation17
Relationship Participation
  • Do more connected underwriters offer lower underpricing, on average?
conclusion
Conclusion
  • Underwriters build strong clienteles of regular investors when allocating IPOs
  • Regular investors benefit more than casual investors by participating more in underpriced issues
  • Participation rates of regular investors
      • More information production
      • Less liquid IPOs
      • In IPOs that are more difficult to value
      • This efficiency – weaker in the late 90s
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