Channeling Funds into the Group: IPO Pricing in Business Groups

Abstract

We demonstrate that business groups use financial intermediaries to boost the stock prices of affiliated firms in initial public offerings (IPO). Using a complete sample of all IPOs and all mutual funds in Israel during a four-year period, we find that the participation of mutual funds affiliated with the business group leads to economically significant overpricing for those IPOs. We show an increased likelihood of participation of mutual funds in the offerings of related firms and a rapid disposal of those stocks in subsequent trade. Our findings expand on the tunneling hypothesis by demonstrating that the transfer of resources can come from sources external to the group, such as assets managed by mutual funds, in a phenomenon we call “channeling.”

Keywords: IPO, business groups, mutual funds, internal capital markets, tunneling, channeling

JEL Classification: G23, G34