Is money really left on the table? The role of regular investors in IPO pricing

Abstract

We study how ongoing relationships between lead underwriters and institutional investors affect initial public offering (IPO) pricing. By introducing a new approach, we find that stronger relationships reduce the partial adjustment of the offer price, leaving ‘excess underpricing’ that favors regular investors, especially in hot IPOs, while generating an agency cost for issuers. At the same time, stronger relationships lead to higher offer prices, since they reduce information asymmetries and uncertainty in the primary market. This ‘excess price adjustment’ creates value for issuers. Taken together, these two apparently contradictory results reveal a win-win outcome for issuers and regular investors.