Conflicts of Interest and Efficient Contracting in Ipos

Abstract

We study the role of underwriter compensation in mitigating conflicts of interest between companies going public and their investment bankers. Making the bank's compensation more sensitive to the issuer's valuation should reduce agency conflicts and thus underpricing (Baron (1982), Biais, Bossaerts, and Rochet (2002)). Consistent with this prediction, we show that contracting on higher commissions in a large sample of U.K. IPOs completed between 1991 and 2002 leads to significantly lower initial returns, after controlling for other influences on underpricing and a variety of endogeneity concerns. These results indicate that issuing firms' contractual choices affect the pricing behavior of their IPO underwriters. Moreover, we cannot reliably reject the hypothesis that the intensity of incentives is optimal, and so that contracts are efficient.

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

JEL Classification: G32, G24