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Good IPOs Draw in Bad: Inelastic Banking Capacity and Hot Markets

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  • Naveen Khanna
  • Thomas H. Noe
  • Ramana Sonti

Abstract

We posit that screening IPOs requires specialized labor which is in fixed supply. A sudden increase in demand for IPO financing increases the compensation of IPO screening labor. This results in reduced screening, encouraging sub-marginal firms to enter the IPO market, further fueling the demand for screening labor. The model's conclusions are consistent with empirical findings of increased underpricing during hot markets, positive correlation between issue volume and underpricing, and with tipping points between hot and cold markets. Finally, the model makes sharp predictions relating the IPO market to fundamental values of firms and to investment banking returns. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhm018
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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 21 (2008)
Issue (Month): 5 (September)
Pages: 1873-1906

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Handle: RePEc:oup:rfinst:v:21:y:2008:i:5:p:1873-1906

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Cited by:
  1. Premti, Arjan & Madura, Jeff, 2013. "Motives and consequences of IPOs in cold periods," The Quarterly Review of Economics and Finance, Elsevier, vol. 53(4), pages 486-496.
  2. Thomas J. Chemmanur & Jie He, 2012. "IPO Waves, Product Market Competition, and the Going Public Decision: Theory and Evidence," Working Papers 12-07, Center for Economic Studies, U.S. Census Bureau.
  3. Hertzel, Michael G. & Huson, Mark R. & Parrino, Robert, 2012. "Public market staging: The timing of capital infusions in newly public firms," Journal of Financial Economics, Elsevier, vol. 106(1), pages 72-90.

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