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Optimal IPO design with informed trading

Author

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  • Sarah Parlane
  • Fabrice Rousseau

Abstract

We characterize optimal IPO design in the presence of distinct adverse selection problems: one affecting the IPO stage and one arising in the after-market. Allocating shares to an investor with superior information in the after-market depresses the share?s value to less informed investors. However, because it facilitates truthful interest report at the IPO stage it increases the expected offer price provided disadvantaged investors are suffciently unlikely to flip their share. We compare the book-building's outcome to that of uniform price auction. The auction can enhance the expected offer price only if it systematically allocates a share to the strategic trader.

Suggested Citation

  • Sarah Parlane & Fabrice Rousseau, 2007. "Optimal IPO design with informed trading," Working Papers 200706, School of Economics, University College Dublin.
  • Handle: RePEc:ucn:wpaper:200706
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    File URL: http://hdl.handle.net/10197/41
    File Function: First version, 2007
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    References listed on IDEAS

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    4. Fishe, Raymond P. H., 2002. "How Stock Flippers Affect IPO Pricing and Stabilization," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(02), pages 319-340, June.
    5. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
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    7. Laurie Krigman & Wayne H. Shaw & Kent L. Womack, 1999. "The Persistence of IPO Mispricing and the Predictive Power of Flipping," Journal of Finance, American Finance Association, vol. 54(3), pages 1015-1044, June.
    8. Ellis, Katrina, 2006. "Who trades IPOs? A close look at the first days of trading," Journal of Financial Economics, Elsevier, vol. 79(2), pages 339-363, February.
    9. Philippe Jehiel & Benny Moldovanu, 2000. "Auctions with Downstream Interaction Among Buyers," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 768-791, Winter.
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    11. Benveniste, Lawrence M. & Spindt, Paul A., 1989. "How investment bankers determine the offer price and allocation of new issues," Journal of Financial Economics, Elsevier, vol. 24(2), pages 343-361.
    12. Boehmer, Beatrice & Boehmer, Ekkehart & Fishe, Raymond P. H., 2006. "Do Institutions Receive Favorable Allocations in IPOs with Better Long-Run Returns?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 41(04), pages 809-828, December.
    13. Jenkinson, Tim & Ljungqvist, Alexander, 2001. "Going Public: The Theory and Evidence on How Companies Raise Equity Finance," OUP Catalogue, Oxford University Press, edition 2, number 9780198295990.
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    More about this item

    Keywords

    Initial Public Offer; Book-building; Auction; Informed trading; Dealer market; Going public; Securities; Secondary market;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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