Conflicts of Interest and Efficient Contracting in Ipos

Abstract

We study the role of underwriter compensation in mitigating conflicts of interest betweencompanies going public and their investment bankers. Making the bank s compensation moresensitive to the issuer s valuation should reduce agency conflicts and thus underpricing. Consistent with this prediction, we show that contracting on higher commissions in U.K. IPOs leads to significantly lower underpricing: a one percentage point increase in the commission rate reduces the initial return by 11 percentage points, after controlling for other influences on underpricing. Moreover, we present evidence consistent with issuers choosing commission rates optimally. Overall, our results indicate that issuers and banks contract efficiently in U.K. IPOs.

Keywords: Initial public offerings, Underpricing, Intermediation, Integrated securities houses, Underwriting contracts