Quid Pro Quo in IPO Auctions

Abstract

It is widely accepted that quid pro quo or favoritism exists in bookbuilding IPOs where the securities underwriter has share allocation discretion, and that auctioned IPOs should be largely free from quid pro quo because the underwriter does not have share allocation discretion. Using proprietary data on IPO auctions from China and a unique share allocation regime change, we show that when the share allocation rule shifts from pro rata to lottery draw (that makes quid pro quo valuable to a bidder), mutual fund families having stronger pre-shift brokerage commission ties with the underwriter submit bids later, place more strategic bids, have more bids qualified for the allocation round, and are more likely to receive share allocation than fund families that have weaker commission ties with the underwriter before the regime change. The evidence is consistent with the existence of quid pro quo in IPO auctions facilitated by the underwriter’s leakage of confidential bidding information, which is a hidden and unethical practice that not only discourages information production but also gives rise to unfairness.

Keywords: uniform price; auction; quid pro quo; underwriter favoritism

JEL Classification: G24, G28, G32