Security Design in Initial Public Offerings*

Abstract

We investigate an IPO security design problem when information asymmetries across investors lead to a winner's curse. Firms that are riskier in down markets can lower the cost of going public by using unit IPOs, in which equity and warrants are combined into a non-divisible package. Furthermore, firms that have a sizeable growth potential even in bad states of the world can fully eliminate the winner's curse problem by making the warrants callable. Our theory is consistent with the prominent use of unit IPOs and produces empirical implications that differentiate it from existing theories.

Financing Entrepreneurial Production: Security Design with Flexible Information Acquisition

“…Some predict debt as optimal to deter adverse selection (Myers and Majluf 1984;Gorton and Pennacchi 1990;DeMarzo and Duffie 1999). Others predict nondebt securities (including equity and convertibles) as optimal in various circumstances (see Nachman and Noe 1994;Chemmanur and Fulghieri 1997;Chakraborty, Gervais, and Yilmaz 2011;Fulghieri, Garcia, and Hackbarth 2016).…”

A story on SPACs

“…Chemmanur and Fulghieri (1997), believe that unit IPO solves the information asymmetry problems and enables companies that are considered risky by outsiders, to signal their true value. Chakraborty et al (2011) provide theoretical explanation for the possibility of the lack of underpricing in unit IPO. They find an optimal ratio of stocks and warrants in a unit.…”

An Optimal ICO Mechanism

“…Riskier projects in down markets can lower the cost of ICOs by combining tokens and warrants together: when the information from better-informed investors is about the downside risk of the project, investors with less information are less disadvantaged combining tokens and warrants together, reducing the cost of doing an ICO and the negative effects of the winner's curse. Moreover, the winner's curse can be fully eliminated for projects that have a sizeable growth potential even in down markets by making the warrants callable, yielding the first-best outcome [CGY10]: if the potential success and profitability of the project in down markets is sufficiently large, the callability of the tokens allow the dynamic creation of a security whose ultimate payoff is insensitive to the initially held private information of informed investors.…”