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Conference of 2007
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Despite their theoretical efficiency in selling shares to the public, auctions are not the preferred mechanisms in Initial Public Offerings (IPOs). Chemmanur and Liu (2006) and Sherman (2005) provide a rational explanation for this “IPO auction puzzle” based on the notion that issuers are not only inter-ested in maximizing the offering proceeds, but also care about the secondary market price and thus try to induce many investors to produce information about the IPO. In this paper, we report an experimen-tal study that was set up to test the mechanisms underlying this reasoning. Our findings strongly sup-port the theoretical argument. If the issuer has some discretion in setting the offering price (as with bookbuilding or fixed-price offerings), he can maintain investors’ propensity to produce information by appropriately adjusting the offering price even if information costs are high. In auctions, however, high information costs inevitably result in a low propensity to produce information. This is a conse-quence of investors’ competitive bidding behavior which prevents them from recovering the costs of information production. Our results provide experimental support for the theoretical argument that an auction is not the preferable offering mechanism for young and risky IPO firms since the costs of pro-ducing information about such firms are high, but there is also a strong need to generate information.
Abstract
Why the Google IPO might stay exotic – An experimental analysis of offering mechanisms
Trauten, Andreas; Langer, ThomasDespite their theoretical efficiency in selling shares to the public, auctions are not the preferred mechanisms in Initial Public Offerings (IPOs). Chemmanur and Liu (2006) and Sherman (2005) provide a rational explanation for this “IPO auction puzzle” based on the notion that issuers are not only inter-ested in maximizing the offering proceeds, but also care about the secondary market price and thus try to induce many investors to produce information about the IPO. In this paper, we report an experimen-tal study that was set up to test the mechanisms underlying this reasoning. Our findings strongly sup-port the theoretical argument. If the issuer has some discretion in setting the offering price (as with bookbuilding or fixed-price offerings), he can maintain investors’ propensity to produce information by appropriately adjusting the offering price even if information costs are high. In auctions, however, high information costs inevitably result in a low propensity to produce information. This is a conse-quence of investors’ competitive bidding behavior which prevents them from recovering the costs of information production. Our results provide experimental support for the theoretical argument that an auction is not the preferable offering mechanism for young and risky IPO firms since the costs of pro-ducing information about such firms are high, but there is also a strong need to generate information.