Underwriters’ Allocation Power and Adverse Selection Costs in the IPO Process
33 Pages Posted: 17 Feb 2014
Date Written: February 12, 2014
This study uses a unique and extensive data set of over 28.2 million investors’ applications to examine the theory of adverse selection under two distinct regulatory regimes (discretionary against mandatory clawback provision) in relation to IPO share allocation. Consistent with Rock’s (1996) theory of adverse selection, we show that, prior to the implementation of the regulation; the probability of receiving an allocation in overpriced IPOs is significantly higher than that of receiving an allocation in underpriced hot issues. However, we find that the probability of an uninformed investor receiving an allocation in an underpriced issue increases significantly following the adoption of the mandatory clawback provision. We also report a significant increase in allocation-adjusted returns earned by uninformed investors in the period following introduction of the mandatory clawback provision. These findings imply that the mandatory clawback provision brings an element of fairness between different investor groups and reduces the winner’s curse in the IPO market.
Keywords: mandatory clawback, adverse selection, allocation-adjusted returns
JEL Classification: G14, G15, G24, G32
Suggested Citation: Suggested Citation