A company has a set IPO date and has filed documents with SEC on the number of shares they intend to float. The company thus has an urgency to sell 100% of that block of shares the day prior to the IPO or risk headlines of IPO being pulled due to the "lack of interest".
Investor doesn't quite have the same urgency. Sure, they could buy the stock the day prior to the IPO, but they could also get it the day of IPO, or the next day, or the next week, or a year after. That's the beauty of the public markets - there's always more shares as long as one is willing to put up cash.
Now, how will the company compensate the investor for the urgency?
You need incentives to encourage price discovery. It doesn't just happen. The system may not be perfect but that "bundle" is (in part) what allows the public market to retain the efficiency it does have.
The facts that they are the primary beneficaries of underpriced IPOs (ie, the biggest reward for the smallest risk) and that they are the all-powerful gatekeepers of the process and that most of these IPOs shoot up in price on day one (meaning that their customers are leaving huge amounts of money on the table) is a pretty good indication. If you don't count fully aligned incentives as evidence, it's at least very clearly a process ripe for collusion and corruption, and should be handled with extreme care and skepticism.
Investment banks are not the primary beneficiary of an IPO, it's the current shareholders of an illiquid stock. Hopefully a banker can fill in some of the details but I will provide a couple of broad strokes here on the process. The underwriting banks are the ones taking the risk in an IPO. They are purchasing the shares from the company to be sold to the public. If they get that wrong they are the ones who will shoulder the loss. The underwriting banks are usually (maybe always) contractually obligated to support the price of a company they underwrite on the date of the IPO. If you look at the NASDAQ ITCH data from Facebook's IPO you can see the price levels fill up with orders when the price declined toward the IPO price.
There is also a lot of other considerations to consider when fielding a proposal from an investment bank, from research analyst assignment, purchasing from the AM arm, access to lines of credit and other financial arrangements.
You could argue that companies should be allowed to take themselves public and list directly. However in a world where people are clamoring for ever more regulation that is unlikely to be a common way for a major company to go public. Personally I would like to see less regulation in the equity market, but I am unlikely to receive that ;-)
> The facts that they are the primary beneficaries of underpriced IPOs (ie, the biggest reward for the smallest risk) and that they are the all-powerful gatekeepers of the process and that most of these IPOs shoot up in price on day one (meaning that their customers are leaving huge amounts of money on the table) is a pretty good indication
On the other hand, the entity that they are taking money from is literally the company that's IPOing (when the price shoots up, it's called leaving money on the table, because it's money that the company isn't raising in their IPO, and is instead going to the banks).
There's a reasonable degree of competition between banks to underwrite an IPO, and companies have the ability to choose which bank to work with, so any conspiracy here would require actual widespread collusion between underwriters (which would be illegal the same way horizontal integration generally is in any industry). While not impossible, that's the sort of claim which warrants tangible evidence, rather than indirect evidence just from the existence of shareholder prices increasing on the opening bell.
"Well-established protocols" can result in IPO prices being systematically set too low. Yes, theoretically a bank should be able to break the ranks, but all they would get for their trouble is smaller profits, and a potential lawsuit from investors. After all, they did diverse from the "established accounting standards" when pushing the IPO price up.
> "Well-established protocols" can result in IPO prices being systematically set too low. Yes, theoretically a bank should be able to break the ranks, but all they would get for their trouble is smaller profits, and a potential lawsuit from investors. After all, they did diverse from the "established accounting standards" when pushing the IPO price up.
Assuming a roughly competitive market with n players that do not engage in direct collusion, if IPO prices are being set too low from the perspective of the companies IPOing, there's room for an additional player (n+1) to set their prices slightly higher. Assuming their ability to predict the risk on the opening bell prices is the same as the other n players' ability to predict risk, that bank will produce IPOs that are consistently favorable for the companies IPOing, and companies will choose that bank as their underwriter. Ceteris paribus, their profits would grow, not shrink.
There are factors that impede this from happening perfectly in practice - such as barriers to entry for the underwriters - which is (part of) what explains why this disparity won't trend to exactly zero. But it's wrong to say that banks would get punished by either companies or their investors for responding to this disparity by raising prices - the exact opposite would happen. And in itself, that still doesn't point to widespread collusion between banks, or even any sort of implicit conspiracy.
Not sure how you'd get that (n+1) business off the ground. Even with the current happy-go-lucky funding climate, I don't see much success in pitching the idea. "We'll take on the giant incumbents, by accepting additional risk on behalf of our clients, in return of reduced profits".
I agree that there would be a solid market demand for this company. The same way there would be much demand for a telecom/isp that provides more speed at reduced price. Consumer demand isn't always the only thing needed for a business to succeed, despite what pg says.
> Not sure how you'd get that (n+1) business off the ground. Even with the current happy-go-lucky funding climate, I don't see much success in pitching the idea.
This is a thought experiment, designed to illustrate that auctions (which IPOs are - an auction between underwriting banks) converge towards the maximum price that individual participants would be willing to pay. You can easily extend this logic to any individual participant.
> in return of reduced profits
You keep saying "reduced profits". If you seriously believe that banks are artificially keeping bids low, then there would be no reduced profits - any individual bank willing to outbid the rest consistently would completely sweep the entire market, capturing all profits across the market of banks which underwrite IPOs.
Of course, this won't happen, because banks aren't artificially keeping bids low, which is the whole point. You can't just point at the fact that post-opening bell prices are greater than IPO prices to show that banks are colluding with each other, because that doesn't prove anything. The current prices are completely consistent with a competitive market.
> when the price shoots up, it's called leaving money on the table, because it's money that the company isn't raising in their IPO, and is instead going to the banks
While true, the company can manage that risk by limiting the amount of shares to float, and then allocate more shares for sale in a secondary offering (Tesla just did one in 2016).
The game theory kicks in, though - when the float is too small, who's going to be the first sucker to bite on the buyers' side, knowing that a massive amount of shares is prepared for a secondary float shortly afterwards? I sure as heck wouldn't touch it, why not have someone else do price discovery.
I think it's simply stating the obvious: rather than using a market-based mechanism for price discovery, they pick a price to sell at. For a bunch of people who are such big fans of markets, this looks really dubious. "Markets for thee, but not for me".
Isn't that how just about everything is sold? My box of Cheerios isn't auctioned off; they picked a price. They had several factors that went into picking that price, just like those that set up the IPOs have.
The pricing of Cheerios doesn't seem to suffer from the principle-agent problem, though. No one but consumers really 'wins' if cheerios are underpriced. And to my knowledge they don't continue to be traded once they're bought, either, so it's sort of apples to oranges.
> The pricing of Cheerios doesn't seem to suffer from the principle-agent problem, though. No one but consumers really 'wins' if cheerios are underpriced
This is not an example of a principal-agent problem. There are two competitive markets: the competitive auction between underwriting banks, and the competitive market between public traders. The price between these two differs because the underwriting banks assume a great deal of risk in the process - risk which otherwise would be borne by the company.
> And to my knowledge they don't continue to be traded once they're bought, either, so it's sort of apples to oranges.
Breakfast cereals are definitely sold wholesale by third-party suppliers (as are apples and oranges as well).
I was an intern at a Wall Street investment bank in 2004 and I remember the unbridled anger that animated any senior banker who started talking about Google and their efforts to "cut out the Street." It's not "collusion." It's simply that Wall Street banks are the ones with access to mutual funds and other buy-side investors, not tech companies. The bankers work with those investors every day, the tech companies once in their history. The behavior is enabled by what in Silicon Valley would be called a "moat."
I make no claim they are or not, simply that making a claim about banks doing something isnt anti-intellectualism, unless you believe making an unverified claim (in your eyes) is anti-intellectual.
Wikipedia states "Anti-intellectualism is a hostility to and mistrust of intellect, intellectuals, and intellectualism commonly expressed as deprecation of education and philosophy or dismissal of art, literature, and science as impractical and even contemptible human pursuits.[1]"
None of that is happening in the grandparent (as far as I can tell.)
You can certainly accuse them of biased unverified information and demand proof, its just not anti-intellectualism.
The banks compete against each other on price - the company gets to freely choose the underwriter and they take price into account.
Do you have evidence the banks are colluding on price?
Edit: to clarify, no the banks do not really set the IPO price. The banks offer different underwriting prices. The company ultimately chooses the price among the many banks' offers.
> Do you have evidence the banks are colluding on price?
Nope, which is why I wrote that I have no opinion on that. Edit: I think that very direct collusion would probably not be a stable arrangement, long term. But perhaps 'not competing too hard' between a low number of competitors with big barriers to entry is realistic.
> Edit: to clarify, no the banks do not really set the IPO price. The banks offer different underwriting prices. The company ultimately chooses the price among the many banks' offers.
That's still a way less transparent and market-oriented option than auctioning the shares. It's a hell of a lot easier for a few banks to be 'gentlemanly' in their competition than it is for lots of people trying to get some shares at an IPO via an auction.
I mean, we're discussing an IPO that was "oversubscribed" at the set price, meaning money was being left on the table, right?
> They are quite literally setting the prices of IPO's though, by fiat, and not via an auction or some other market-oriented mechanism.
Er, no, it's literally set by an auction (the auction occurring between the different banks who can underwrite the IPO).
A bank that is consistently able to predict the IPO opening-bell price better than the others, or is willing to accept a slightly smaller cut than the others, will win the auction, and will outperform the others on average.
You started pretty aggressive and your replies are getting more so.
For one, you asked for proof that banks are colluding on pricing when nobody claimed that.
It's well known that the IPO company and issuer price the stock to try to get a "pop" on the date of the IPO, to toss some money the bank's way. It doesn't always work, but they do not try to price the company optimally. Similarly, the IPO company doesn't want to price it TOO low because they don't want to leave too much money on the table.
