Purchasing Ipos with Commissions

Abstract

Using a proprietary database of institutional trades, we find direct evidence that institutions churn stocks, increase the average commission per share they pay, and pay unusually high commissions on some trades in order to send abnormally high commissions to lead underwriters of upcoming profitable IPOs. We show that these excess commission payments are a particularly effective way for transient investors to receive lucrative IPO allocations, and that the presence of abnormal commission payments is related to underwriter characteristics, including the concentration of the underwriter’s client base. Our results suggest that the underwriter’s concern for their long-term client relationships limits the payment-for-IPO practice. We estimate that abnormal commission payments are large for the most profitable issues, and that an additional $1 excess commission payment to the lead underwriter results in $2.21 in investor profits from allocated shares.

JEL Classification: G14