Initial Uncertainty and the Risk of Setting a Fixed-Offer Price: Implications for the Pricing of Bookbuilt and Best-Efforts IPOs

Posted: 21 Nov 2014

See all articles by Steven L. Jones

Steven L. Jones

Indiana University - Kelley School of Business - Department of Finance

John C. Yeoman

North Georgia State University

Date Written: April 18, 2014

Abstract

We model the risk of setting the required fixed-offer price in an IPO given initial uncertainty about value, as well as costs of over and underpricing. Assuming that the goal of issuers in bookbuilt IPOs is to maximize net offering proceeds, our analysis indicates that their optimal strategy is to negotiate a relatively small spread, consistent with material underpricing. Similarly, considering the expected costs of overpricing makes the underpricing of best-efforts IPOs in the interest of issuers. Our results rely on neither asymmetric information nor agency costs and provide support for Hansen's (2001) nearly-optimal “conventional” spread and the view that it evolved from adaptive, imitative behavior, consistent with Alchian's (1950) explanation of how economic players evolve practices to survive under uncertainty and incomplete information, as well as Alchian's (1969) work on how fixed prices and queues can efficiently clear product markets.

Keywords: Initial public offering, Underpricing, Investment Banking

JEL Classification: G24

Suggested Citation

Jones, Steven L. and Yeoman, John C., Initial Uncertainty and the Risk of Setting a Fixed-Offer Price: Implications for the Pricing of Bookbuilt and Best-Efforts IPOs (April 18, 2014). Journal of Corporate Finance, Vol. 27, p. 194, August 2014, Kelley School of Business Research Paper No. 15-17, Available at SSRN: https://ssrn.com/abstract=2528251

Steven L. Jones (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

801 W. Michigan Street
Bus/SPEA 4048
Indianapolis, IN 46202-5150
United States
317-278-7771 (Phone)

John C. Yeoman

North Georgia State University ( email )

School of Business
Dahlonega, GA 30957
United States
770-664-4188 (Phone)

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