Underwriters’ Allocation Power and Adverse Selection Costs in the IPO Process

33 Pages Posted: 17 Feb 2014

See all articles by Khelifa Mazouz

Khelifa Mazouz

University of Bradford - School of Management

Brahim Saadouni

Alliance Manchester Business School, The University of Manchester

Shuxing Yin

University of Sheffield - School of Management

Date Written: February 12, 2014

Abstract

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

Mazouz, Khelifa and Saadouni, Brahim and Yin, Shuxing, Underwriters’ Allocation Power and Adverse Selection Costs in the IPO Process (February 12, 2014). Asian Finance Association (AsianFA) 2014 Conference Paper. Available at SSRN: https://ssrn.com/abstract=2394754 or http://dx.doi.org/10.2139/ssrn.2394754

Khelifa Mazouz

University of Bradford - School of Management ( email )

Emm Lane
Bradford, West Yorkshire Bd9 4JL
United Kingdom

Brahim Saadouni (Contact Author)

Alliance Manchester Business School, The University of Manchester ( email )

Crawford House
Oxford Road
Manchester M13 9PL
United Kingdom

Shuxing Yin

University of Sheffield - School of Management ( email )

9 Mappin Street
Sheffield, S1 4DT
United Kingdom

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