How Should a Firm Go Public? A Dynamic Model of the Choice between Fixed-Price Offerings and Auctions in Ipos and Privatizations

49 Pages Posted: 20 Jul 2003

See all articles by Thomas J. Chemmanur

Thomas J. Chemmanur

Boston College - Carroll School of Management

Mark H. Liu

University of Kentucky - Gatton College of Business and Economics

Abstract

We develop a theoretical analysis of the choice of firms between fixed-price offerings and uniform-price auctions for selling shares in IPOs and privatizations. We consider a setting in which a firm goes public by selling a fraction of its equity in an IPO market where insiders have private information about intrinsic firm value. Outsiders can, however, produce information at a cost about the firm before bidding for shares. Firm insiders care about the extent of information production by outsiders, since this information will be reflected in the secondary market price, giving a higher secondary market price for higher intrinsic-value firms. We show that auctions and fixed-price offerings have different properties in terms of inducing information production. Thus, in many situations, firms prefer to go public using fixed-price offerings rather than IPO auctions in equilibrium. We relate the equilibrium choice between fixed-price offerings and IPO auctions to various characteristics of the firm going public. Unlike the existing literature, our model is able to explain not only the widely-documented empirical finding that underpricing is lower in IPO auctions than in fixed-price offerings (e.g., Derrien and Womack (2000)), but also the fact that, despite this, auctions are losing market share around the world. Our model thus suggests a resolution to the above "IPO auction puzzle," and indicates how current IPO auction mechanisms can be reformed to become more competitive with fixed-price offerings. Our results also provide various other hypotheses for further empirical research.

JEL Classification: G30, G32, C72, D44, D82

Suggested Citation

Chemmanur, Thomas J. and Liu, Mark H., How Should a Firm Go Public? A Dynamic Model of the Choice between Fixed-Price Offerings and Auctions in Ipos and Privatizations. EFA 2003 Annual Conference Paper No. 366. Available at SSRN: https://ssrn.com/abstract=423860 or http://dx.doi.org/10.2139/ssrn.423860

Thomas J. Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Mark H. Liu

University of Kentucky - Gatton College of Business and Economics ( email )

550 South Limestone
Lexington, KY 40506
United States
859-257-9842 (Phone)
859-257-9688 (Fax)

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