Pricing IPOs of mutual thrift conversions: the joint effect of regulation and market discipline

A large number of mutual savings and loan associations (MSLs) converted their charters into stock ownership between the mid-1980s to mid-1990s. Because these conversions tended to generate windfall profits for insiders and investors, new conversion guidelines and regulations were proposed by the FDIC to make sure that prices of the conversion IPO were right and fair. As pointed out by Mr. Henry B. Gonzales, former Chairman of the House Banking Committee, \"conversion regulations of the Office of Thrift Supervision have ensured that insiders and acquirers don't benefit at the expenses of the institutions and its account holders. ; This study examines the price behavior of the mutual-to-stock conversions from 1985 to 1996. We show that if the thrift members exercised their rights to subscribe the new shares allotted to them or were allowed to sell their rights, whether the conversion IPOs were under-or-over-priced would not create any wealth transfer. Given the absence of wealth transfers, in order to guarantee full subscription, price discounts might be necessary. Empirically, we find that under- pricing was common for the thrift conversions, but not as significant as found in non-banking industries. We also examine the relationship between insider the subscriptions and after market price movements and find that insider-subscriptions have a positive correlation with after-market performance. We believe that insider- subscriptions can therefore be used as a \"signal\" to encourage unsophisticated mutual depositors to exercise their in-the-money rights. Finally, using options-pricing theory, we find that underwriters' spreads can be explained by volatility but not by the relationship between the offering price and the estimated market price. Therefore, the use of uninsured rights, instead of rights with standby underwriting, appears to be a more cost-effective method of equity flotation for thrift conversions. This occurs because the \"insurance premium\" associated with the latter does not reflect the discount that would increase the probability of the offer's success.