Institutional Monitoring and the IPO Pricing Process

Abstract:     
We develop and test a reputable agents model of IPO pricing and allocations that draws from evidence in the accounting and finance literature showing institutional investor monitoring improves firm value. In the model institutional monitoring is enforced by lead underwriters, as both agents guarantee performance with their reputations. Issuers pay the institutions for monitoring with quasi-rents in IPO underpricing. Underwriters assure the monitoring by excluding deceiving institutions from future IPOs and thus, future quasi-rents. The model provides new understanding of IPO pricing and allocations, and new interpretations of several anomalies reported in the literature. Findings corroborate the new understanding and the new predictions. They suggest reputations of institutional owners and underwriters are additional factors in equity valuation beyond the information contained in IPO prospectus accounting reports.

Number of Pages in PDF File: 62

Keywords: Initial public offerings, Going public, Investment banking, Underpricing, Institutional investors, Underwriters

JEL Classification: G32, G34

working papers series