Relationship Markets and the Decision to Go Public

40 Pages Posted: 13 Sep 2006

See all articles by Ananth Madhavan

Ananth Madhavan

BlackRock, Inc.

Leslie M. Marx

Duke University - Fuqua School of Business, Economics Group

Venkatesh Panchapagesan

The Goldman Sachs Group, Inc.

Date Written: September 2006

Abstract

The equity markets for smaller issues are characterized by close economic relationships between new issuers and the underwriters who bring the stock public. Underwriters sponsor new issues and often provide liquidity in the secondary market by acting as market makers. This paper analyzes theoretically the operation of so-called "relationship markets" and their role in facilitating capital formation. The model is consistent with stylized facts concerning both primary and secondary markets and yields several testable predictions. In particular, we show that smaller companies can lower their cost of capital by using relationship markets. However, for sufficiently large issues, a secondary market structure without a dominant primary market maker is preferred. We test the model using data on IPOs from 1996-2000 identifying post-IPO market making activity, using a choice model to control for endogeneity. The results support the conclusion that underpricing is related to anticipated secondary market activity by underwriters.

Keywords: IPO, underpricing, underwriting

JEL Classification: G24, G32

Suggested Citation

Madhavan, Ananth and Marx, Leslie M. and Panchapagesan, Venkatesh (Venky), Relationship Markets and the Decision to Go Public (September 2006). Available at SSRN: https://ssrn.com/abstract=929846 or http://dx.doi.org/10.2139/ssrn.929846

Ananth Madhavan

BlackRock, Inc. ( email )

400 Howard Street
San Francisco, CA 94105
United States

Leslie M. Marx (Contact Author)

Duke University - Fuqua School of Business, Economics Group ( email )

Box 90097
Durham, NC 27708-0097
United States

Venkatesh (Venky) Panchapagesan

The Goldman Sachs Group, Inc. ( email )

85 Broad Street
New York, NY 10004
United States

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