Towards an Optimal IPO Mechanism

Abstract

Concerns about the negative consequences of the excessive underpricing of the current arrangement in the initial public offering (IPO) market for the provision of entrepreneurial finance—book building—have led to research into the viability of auctions for IPO pricing and allocation. IPO firms face a trade-off between the benefit of accurate and reliable IPO price discovery and the cost of underpricing. The main aim of this paper was to gain new scientific knowledge about this trade-off by measuring the impact of two key variables on this trade-off: capacity restraint and discount on the auction clearing price. Using controlled experiment methodology in multi-unit uniform price auctions we found that the most capacity-restricted auctions that also offer investors a discount are likely to produce the most accurate and reliable price discovery and consequently, the most predictable auction outcome. There are indications that a discount of 8% may suffice to incentivize investors to reliably contribute to price discovery. The resulting underpricing (and its variability) of these auctions is likely to be significantly lower than if book building would be used to price and allocate IPOs. Technological innovation in the IPO market through the application of recent advances in data science, experimental economics and artificial intelligence allows for the optimization of IPO mechanisms and crowdfunding platforms which in turn improves the access to equity required for entrepreneurial finance.

Allocation discretion, price discounts and returns in Turkish initial public offerings

“…Aggarwal and Dahiya (2000) argue that institutional investors are necessary for IPOs to be successful. While institutions are allocated over 70% of new shares in the US (Boehmer et al , 2006; Huibers, 2020), Asian IPOs have lower institutional allocation due to protective regulations for retail investors (Bubna and Prabhala, 2011; Che-Yahya et al , 2014; Ong et al , 2020). Their role in IPOs is widely appreciated due to the price discovery function Benveniste and Spindt (1989) and the long-term nature of their involvement (Boehmer et al , 2006), which alleviate valuation errors Ong et al (2020) and lead to more accurate pricing (Ljungqvist and Wilhelm, 2002; Bubna and Prabhala, 2011).…”

“…Aggarwal and Dahiya (2000) argue that the participation of institutional investors is necessary for IPOs to be successful as they are allocated nearly 75% of the issues. Aware of their instrumental position in the IPO market, institutions expect to receive favorable allocations in discounted offerings (Huibers, 2020). This study aims to show whether allocation discretion is used to offer larger discounts to investors.…”

“…Therefore, a significant association between discounts and institutional allocations is predicted. The proposition is indirectly tested in an experimental setting by (Huibers, 2020), who finds that an 8% discount is sufficient to generate investor attention. Other researchers Mohd-Rashid et al (2018), Mehmood et al (2020) use post-listing initial returns to infer the implied discount on the offer price.…”

“…Prior studies focus on negotiation and information revelation functions of BB offerings for discretionary allocations (DISCs) (Hanley and Wilhelm, 1995;Aggarwal et al, 2002;Ljungqvist and Wilhelm, 2002;Rocholl, 2009), allocations and aftermarket returns (Boreiko and Lombardo, 2011;Boehmer et al, 2006), allocations in shifting regulatory regimes (Bubna and Prabhala, 2011), the interdependence of reallocation and price revision (Bertoni and Giudici, 2014) and impact of mandatory clawback provisions on allocations and initial returns (Mazouz et al, 2017). This study bears relevance to a more recent strand that investigates valuation and investor allocations (Bonaventura et al, 2018;Huibers, 2020;Ong et al, 2020). The Turkish IPO market is; however, unique in two ways:…”

Mixed Mechanisms for Auctioning Ranked Items

“…Perhaps, electricity wholesale spot markets are one of most relevant situations in which these types of auction are applied. Therefore we can find many papers in the literature devoted to different aspects of them (see, for example, References [9,[26][27][28][29][30][31][32]). The most studied auctions of heterogeneous objects have been those of licenses allocations, in particular spectrum licenses in telecommunications (see, for example, References [33][34][35][36][37][38][39][40][41][42].…”