Price Stabilization as a Bonding Mechanism in New Equity Issues
Posted: 6 Nov 2000
There are 3 versions of this paper
Price Stabilization as a Bonding Mechanism in New Equity Issues
Price Stabilization as a Bonding Mechanism in New Equity Issues
Date Written: October 1994
Abstract
Firm-commitment offerings in the U.S. are characterized by offer prices conditioned on information gleaned fromindications of interest solicited from prospective investors. When such information can be used to persuade some investors to purchase shares at a price in excess of their initial estimate of the fair value, underwriters have an incentive to overstate investor interest. Our analysis shows that his incentive is eliminated when the underwriter makes a commitment to secondary market price stabilization. Destroying the underwriter's incentive to overstate interest reduces the total surplus captured by initial investors in IPOs. Further efficiency gains are associated with penalty bid systems that permit the underwriter to make the stabilization commitment selectively. Price stabilization can thus be viewed as a bonding mechanism that improves the efficiency of the primary equity market.
JEL Classification: G12, G13
Suggested Citation: Suggested Citation