© Evanston Photographic
Research: Ravi Jagannathan, Finance
Ravi Jagannathan, Kellogg School professor of finance,
makes a bid to improve the way initial public offerings are
"left on the table" after an initial public offering (IPO)
of equities can be staggering, particularly when companies
making the IPO use bookbuilding — the mechanism of generating
investor interest and attention prior to pricing the issue
in preparation of the offering, says Ravi
Jagannathan, the Chicago Mercantile Exchange Distinguished
Professor of Finance and co-director of the Center
for Financial Institutions and Markets at the Kellogg
that the solution to this problem is to restructure the bookbuilding
system to suit the needs of companies going public and their
left on the table, defined as the difference between the first
day's closing price and the offering price multiplied by the
number of shares sold, dwarfs direct costs, Jagannathan says.
From 1980-2001, about $488 billion was raised in 6,249 new
equity issues, leaving $106 billion, or 22 percent, of the
amount raised on the table.
(1) In 1999 alone, $38 billion out of $67 billion
was left on the table.
money needs to be left on the table and IPO shares offered
at a discount to fair value to encourage price discovery and
induce an investor to participate in the issue," he says,
lest the investor waits to buy shares in the after market.
everyone waits," Jagannathan says, "the issue would be a failure."
Under the current bookbuilding method, when a large amount
of money is left on the table inadequate oversight can lead
to potential abuses by issue managers when allocating shares
among investors in an IPO.
an expert in the areas of asset pricing, capital markets,
financial institutions and portfolio performance evaluation,
says auctions may not be any better at reducing money left
on the table and in fact have a poor track record. In his
work with Ann Sherman (2)
, professor of finance at the University of Notre Dame,
Jagannathan documents that auctions have been tried in many
countries, then abandoned in almost all of them in favor of
bookbuilding. Of the 46 countries examined in their study,
IPO auctions of one type or another have been used in 20 countries.
Of those, at most four (including the United States) currently
use auctions, which play a small role even in these nations.
the auction method doesn't necessarily mean issuers are hesitant
to try new methods. Auctions were tried in Italy, Portugal,
Sweden, Switzerland and the United Kingdom in the 1980s, and
in Singapore, Taiwan and Turkey in the 1990s, before bookbuilding
the rarity of IPO auctions is not due to unfamiliarity," notes
Jagannathan, who has contributed his thought leadership, as
both writer and editor, to several top finance and management
main problem with standard auctions," says Jagannathan, "is
that they do not adequately reward those who devote time and
effort to serious evaluation of an unlisted company." In a
non-discriminatory uniform price or "Dutch" auction, where
everyone who receives an allocation pays the same price, "there
is the temptation to bid high, even by those without valuable
information on the fair value."
uninformed investors try to "free ride" on the back of sophisticated
investors, the sophisticated investors start avoiding IPO
auctions, Jagannathan says. The result is scant price discovery
during the auction and little liquidity in the market for
the stock after the issue starts trading.
in which people pay the price they bid don't suffer as much
from the free-rider problem as do non-discriminatory auctions,"
such auctions will dissuade investors who may not have an
informed opinion about the fair value of an issue, but whose
participation is necessary to reduce the price risk and increase
the liquidity in the market when the issuer's stock starts
trading following the IPO.
work with Sherman suggests that, while it may be possible
to devise a nonstandard auction that will overcome these problems,
such an auction may not look very different from bookbuilding.
to reducing money left on the table after an IPO, Jagannathan
says, is to modify the process of bookbuilding by making the
allocation process more transparent and subject to oversight,
while at the same time maintaining confidentiality.
strategies may be more productive than a radical shift to
an IPO auction method that has failed repeatedly around the
globe," says Jagannathan.
1 Excludes issues with an offer price of less
than $5,000, ADRs, unit offers, closed end funds, REITs, partnerships,
banks and S&Ls, and foreign firms going public in the
United States without ADRs. See Ritter and Welch, Journal
of Finance, Aug. 2002, Table I.
"Why do IPO auctions fail?" manuscript, 2004.