research@hec - Issue #14 - (Page IV)
Breaking Underwriter Dominance
in the transaction.
François Derrien earned his PhD at HEC in 2002 and then spent five years as an assistant professor at Rotman School of Management, University of Toronto. In 2007, he joined the HEC faculty as professor of finance. His research focuses on corporate finance, and more precisely on IPO mechanisms and the role investment banks play in IPOs. Derrien is also interested in analyst behavior and the impact of potential institutional investors on corporate reasoning and decisions.
THREE IPO MECHANISMS Derrien explains that, theoretically, there are three IPO mechanisms for companies aiming to access capital by going public. • Fixed pricing: Share price is defined and communicated in advance to all potential investors. Shares are distributed according to the amounts requested. • Bookbuilding: The underwriter sets the share price with the agreement of the issuer. The under-
In 2004, Google’s announcement of its forthcoming IPO (initial public offering) auction caused quite a commotion in the investment banking universe. The company’s strength enabled it to impose this mechanism, but when other firms tried to follow suit, investment banks flat out refused! Why are underwriters so reluctant to offer their clients IPO auctions? To answer this question, François Derrien and his co-researchers conducted the first empirical study on the performance of auctioned IPOs auctions. Their conclusions are enlightening. Investment bankers may be disappointed, but auctioned IPOs are indeed a highly credible alternative to bookbuilding!
Are IPO auctions a credible alternative to bookbuilding? François Derrien,
François Degeorge, and Kent L. Womack have uncovered an answer to this
question by studying 19 auctioned IPOs in the United States. They have found auction mechanisms to be effective in strengthening the investor’s position
writer also chooses which investors will be allowed to purchase the shares. •Auction: Investors submit price and quantity bids. With this IPO mechanism, share price and quantity are determined by offer and demand.
CRITICISM OF BOOKBUILDING The bookbuilding approach was developed in the United States and is currently the most commonly used IPO mechanism on both sides of the Atlantic. However, the opacity of the system is drawing increasing criticism, especially because it is suspected of granting underwriters too much power. Not only do they determine share price, but they also select the investors to whom they are sold. Derrien explains that in comparison, “the auction system is far more transparent, because the market determines share price and quantity per investor.” Nonetheless, at the current time, this mechanism is practically inaccessible to companies. For example, at the time of this study, WR Hambrecht was the only investment bank in the United States to provide this option. Does that mean that bookbuilding is a better system? No, says Derrien. He believes that investment banks lobby companies to con-
Table of Contents for the Digital Edition of research@hec - Issue #14
Cover & Contents
- Strategic Innovation is Accessible to All
- Auctioned IPOs : Breaking Underwriter Dominance
- The Independence and Competence of Auditors
- The Just Hand of theManager
research@hec - Issue #14