Over-Signaling or Underpricing? The Role of Financial Intermediaries in Initial Public Offerings

46 Pages Posted: 2 Mar 2007 Last revised: 23 Dec 2007

See all articles by Fabrizio Adriani

Fabrizio Adriani

SOAS University of London

Luca Deidda

Università degli Studi di Sassari - Department of Economics and Business; Universita di Cagliari - Centre for North South Economic Research (CRENOS)

Silvia Sonderegger

University of Bristol - Department of Economics

Date Written: October 2007

Abstract

We consider a model of Initial Public Offerings (IPOs) where issuing firms of better quality are more reluctant to go public. IPOs either generate or destroy value depending on the type of the issuing firm, which is only observed by the issuer. We show that, when the issuer directly offers the shares to the investors, market breakdown occurs. This is caused by the issuer's attempts to signal his type through the offering price. Things change if we introduce a financial intermediary which: 1) acts as an underwriter, 2) influences the offering price. Underwriting creates a wedge between the interests of the intermediary and those of the issuer. This allows trade with outside investors to be restored. A by-product of the conflict of interest between issuer and intermediary is that trade is characterized by underpricing. In the benchmark case where her profits are zero, the intermediary acts as a screening device: she underwrites the shares only upon receiving positive information about the issuer.

Keywords: IPO, Signaling, Financial Intermediary, Underwriting

JEL Classification: G24, G32

Suggested Citation

Adriani, Fabrizio and Deidda, Luca and Sonderegger, Silvia, Over-Signaling or Underpricing? The Role of Financial Intermediaries in Initial Public Offerings (October 2007). Available at SSRN: https://ssrn.com/abstract=967308 or http://dx.doi.org/10.2139/ssrn.967308

Fabrizio Adriani (Contact Author)

SOAS University of London ( email )

Thornhaugh Street
Russell Square: College Buildings 541
London, WC1H 0XG
United Kingdom

Luca Deidda

Università degli Studi di Sassari - Department of Economics and Business ( email )

via Muroni 25
Sassari, Sassari 07100
Italy

Universita di Cagliari - Centre for North South Economic Research (CRENOS) ( email )

Italy

Silvia Sonderegger

University of Bristol - Department of Economics ( email )

8 Woodland Road
Bristol BS8 ITN
United Kingdom

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