Equilibrium in the Initial Public Offerings Market

In this review, I criticize the ability of popular asymmetric information-based models to explain the magnitude of the underpricing of initial public offerings (IPOs) that is observed. I suggest that the quantitative magnitude of underpricing can be explained with a market structure in which underwriters want to underprice excessively, issuers are focused on services bundled with underwriting rather than on maximizing the offer proceeds, and there is limited competition between underwriters. Since the technology bubble burst in 2000, U.S. IPO volume has been low. Although regulatory burdens undoubtedly account for some of the decline, I suggest that much of the decline may be due to a structural shift that has lessened the profitability of small independent companies relative to their value as part of a larger, more established organization that can realize economies of scope. I also discuss the long-run performance literature. My interpretation of the evidence is that except for the smallest companies going public, IPOs have long-run returns that are similar to those on seasoned stocks with the same characteristics.