NASD Regulation of IPO Conflicts of Interest - Does Gatekeeping Work?
Royce de Rohan Barondes
University of Missouri-Columbia School of Law
Tulane Law Review, Vol. 79, 2005
This Article contributes to the debate on the efficacy of third party gatekeeping in regulating the capital markets, by presenting empirical evidence of the efficacy of one kind of gatekeeper, a qualified independent underwriter (QIU). Under NASD rules, when an investment bank participating in a securities offering has one of several enumerated conflicts of interest, the securities cannot be sold at a price higher than that recommended by a QIU. Examining 1,188 IPOs from 1997 through 2000 discloses a negative, statistically significant relationship between IPO initial returns and each of (i) the fact that participating NASD members (or their affiliates) are receiving more than 10% of the IPO proceeds and (ii) the fact that a participating NASD member (or its affiliates) owns at least 10% of the issuer's preferred stock or subordinated debt. On the other hand, there is a positive, statistically insignificant relationship between IPO initial return and the fact that a participating NASD member (or its affiliates) beneficially owns at least 10% of the issuer's common stock. For purposes of assessing the impact of potential endogenity, the ATT on initial IPO return using propensity score matching for each of these three types of conflicts requiring QIUs was estimated, producing similar results.
These results are not consistent with the certification hypothesis of preexisting investment bank/issuer relationships. The conflict involving greatest certification (common stock ownership) is associated with more, not less, underpricing.
The results also indicate proposals to subject all IPO pricing to approval by independent broker-dealers - on which the NASD solicited comments - are likely to be ineffectual.
Keywords: IPO, QIU, qualified independent underwriter, gatekeeping, underpricing
JEL Classification: K22, G24
Date posted: September 30, 2004