Why are IPO Investors Net Buyers Through Lead Underwriters?

Abstract

In Nasdaq IPOs between 1997 and 2002, clients of the lead underwriter bought shares worth $35.36 billion on the first day of public trading but sold shares worth only $21.45 billion, leading to a net buy imbalance of $13.91 billion, or 8.79 percent of the shares issued. The strong net buying activity through the lead underwriter is driven by large trades and widely present in IPOs of various degrees of underpricing. We investigate several explanations and find no support for long-term shareholders buying to build larger positions, for clients buying because of superior execution quality, or for clientele effects. Consistent with lead underwriters extracting rents from their clients, client net buying is driven by large trades, persistent even in cold IPOs, greater for underwriters that issue multiple IPOs, coupled with relatively higher transactions costs and associated with more transient institutional ownership. Price contribution analyses show that client net buying through the lead underwriter contributes significantly to first-day price increases.