Results for “ipo auction” 14 found
Why don’t issuers choose IPO auctions?
Most firms try to sell their initial public offerings at predetermined prices, rather than just holding an auction. After the shares are sold, there appear to be immediate excess returns, which suggests some money may have been left on the table. Why do things this way?
Ravi Jagannathan, Andrei Jirnyi, and Ann Sherman have a new and comprehensive study (NBER) of this long-standing question. Here is the abstract:
At least 25 countries have used IPO auctions, but most have since abandoned them. We argue that this is because auctions, being indirect mechanisms, require a level of sophistication above that of many investors. Through suitably calibrated examples, we show that even sophisticated investors can make mistakes while bidding in auctions, especially when facing uncertainty about the number and type of bidders, and such mistakes impose costs on other participants. We provide empirical support for our arguments. IPO auctions have been plagued by unexpectedly large fluctuations in the number of participants, return chasing investors, and high-bidding free riders. Our analysis suggests that a direct mechanism that resembles a transparent version of book building would be preferable to auctions.
Here is one summary of the piece. Here is a different, 2007 paper on the question. Here is another related paper, and here (by Jagannathan and Sherman, much older draft, minus Jirnyi). Here is a one-year-old ungated version of the main paper, I am not sure how much it differs. Do any of you know of an ungated version of the current draft?
Here is an earlier Alex post on the Google IPO, which was held as an auction.
Why do IPO auctions seem to fail?
Remember when Google (partially) bypassed the investment banks and held its own auction of its shares? Many people thought this was the trend of the future. Why let investment banks underprice the issue and take such a big cut? Well it turns out that when IPO auctions are available they usually end up abandoned:
We document a somewhat surprising regularity: of the many countries
that have used IPO auctions, virtually all have abandoned them. The
common explanations given for the lack of popularity of the auction
method in the U.S., viz., issuer reluctance to try a new experimental
method, and underwriter pressure towards methods that lead to higher
fees, do not fit the evidence. We examine why auctions have failed and
verify, to the extent possible, that they are consistent with what
academic theory predicts. Both uniform price and discriminatory
auctions are plagued by unexpectedly large fluctuations in the number
of participants. The free rider problem and the winner’s curse hamper
price discovery and discourage investors from participating in
auctions. That may explain the inaccurate pricing and poor aftermarket
performance of IPOs using auctions.
Here is the link and paper, by Ravi Jagannathan and Ann Sherman. Here are free copies of the paper. The explanation is not complete, because the auctions often provide a superior price. Nonetheless the risk is greater plus buyers are more likely to abandon the market in subsequent periods. This article is long and not always fun to read, but it definitely falls into the "I learned something today" category.
Dutch Auction IPO
Here is a nice graphic from the NYTimes explaining the Dutch auction IPO. I think Google’s IPO will be a success, it will raise more money for Google than a traditional IPO with its high transactions costs (which flow to the investment banks). Remember the standard to measure success is the cost per dollar of raised funds it is not whether the stock price hits a predefined target and not whether the stock pops. Indeed, Google’s stock price is unlikely to pop. The success of a traditional IPO is often counted by the size of the pop but that is ridiculous. A pop means the firm left money on the table – money which was transferred to a handful of insiders who were allocated stock at the low IPO price. A pop is thus the sign of a bad IPO not a good one. The Dutch auction method ensures that the initial price is a market price (thus Google’s price is unlikely to plummet either). There has been a lot of negative publicity about the Google IPO but my guess is that this was stirred up by the investment banks who are fearful that their halcyon days are ending.
Are IPO price pops signs of market irrationality?
Maybe not, or so I argue in my latest Bloomberg column. As you may know, the first day price pops for Airbnb and Doordash were considerable, Airbnb more than doubling in its first day of trading: Here is one excerpt:
On IPO day, each prospective buyer is wondering what the shares will be worth, and to a great extent looking to the judgment of the other investors. A buyer might start the day willing to pay $60 a share, but upon seeing that many others are willing to pay more, maybe she will, too. It is like Keynes’s famed “beauty contest,” where investors are guessing as much about each other as about the company.
In such a setting, prices can rise or fall extremely quickly, as the very process of trading reveals information about the stock’s value. That in turn makes it possible for the share price to soar on the first day of trading, creating the “pop.”
Now consider this scenario from the perspective of the issuing investment bank. If it sets the IPO price too high, it may set off a downward spiral of negative enthusiasm. Traders will see that most of the other traders think it is overpriced, leading to a plunge.
It’s all a bit like a restaurant on a Saturday night. If the place is seen as “cool” — whether because of its food and service (the product), its setting (the physical asset) or its ambience (the brand) — there will be a line out the door. Otherwise it will be fairly empty. Furthermore, the presence of a line will draw continued interest over time. It is hard or maybe even impossible to set prices so that every table is filled yet there is no line. To deploy some technical language, the demand curve may be discontinuous.
In this position, the IPO issuer likely will set the initial price too low — leading to a “line,” excess demand, and a big run-up in price on the first day. If the price is super-high in the first place, the market mood would be nervousness rather than eagerness, and most investors wouldn’t be able to see the surges in demand visible in lower price ranges.
Keep in mind that this surge in buying interest only has to make investors modestly more enthusiastic about the quality of the firm to generate a potentially big increase in final valuation.
All this said, in the current case, there is the question of why the initial prices were so low. Several theories present themselves: The markets for DoorDash and Airbnb might be more “winner take all” than usual. The value of those companies might be more closely linked to the value of their intangible assets. Or maybe the future of online services might be especially hard to predict in the midst of a pandemic, thus inducing larger bandwagon effects.
It is worth noting that differing auction systems for IPOs have not produced obviously superior results.
The auction begins
I thank Paul Sherman and Loren Poulsen and Eliot Williams for the pointer; a related link is here.
Will Google’s Dutch auction go well?
It sounds great: cut out the investment banking fees and just offer a straight Dutch auction on the stock. After all, aren’t auctions the perfect market institution?
Co-blogger Alex thinks that the investment banks have had a comeuppance due for a long time; he may well be right.
Under standard practice, the underwriters give underpriced shares to favored investors and executives. The value of those shares rises on opening day. The insiders are happy but the company has left money on the table. In extreme and indeed pathological cases the discount can be as high as eighty percent. So why have companies tolerated this practice for so long?
Under one apologetic view, the kickbacks, underpriced shares, and payola are necessary. Someone has to produce reputation for the stock. The investment bank is paid to do this. The underwriter, in turn, gives insiders good deals to get them to boost the stock. If you own some shares you will do your best to talk up the issue. The efficient markets hypothesis? Well, it may be true at the margin, but how do we get to this margin in the first place?
I heard another point from one industry insider. Investors feel better about a stock if it goes up on day one. For the long-run good of the stock, it is important to have a price rise in the beginning. If investors sour on the stock in its early days, it may never recover its reputation.
Other skeptics wonder how the results of the auction can be predicted? How many people will show up with bids? What if we gave an auction and nobody came? Other worriers fear the temptation for untutored investors to bid too high at first, pushing the shares to unsustainable levels. After all, no single investor will have the final price much with his or her bid.
There is yet another fear. If the auction is fair, the stock will sell at roughly the same price on day one and day two. So if there is some uncertainty surrounding the initial auction, why not just hold off your buying until day two? But then how do liquid markets get established in the first place? How can you get concentrated buying interest on day one, but without violating either fairness or the efficiency of markets?
The resolution: …will have to wait for the facts and thus the actual auction. But my suspicion is the following. Some percentage of the original underpricing, but by no means all, is in fact a legitimate return to the investment banks. I thus worry that Google will not see strong demand on day one. On top of that, there is a puzzle. Unless you think all of the initial share underpricing is an legitimate fee for services rendered, why have markets tolerated this practice for so long?
By the way, David Levy informs me that used book dealer ALibris will try a share auction as well. For whatever reasons, except for Google, only small companies have shown an interest in these alternative institutions. France uses such auctions more commonly; it seems that the first-day price run-up is smaller but still present. On one hand, these other examples suggest that the auctions are a viable institution. On the other hand, it makes you wonder why the practice is not used more often.
Addendum: Here is a very good piece on the auction of Salon.com stock.
Assorted links
1. Previous post on IPO auctions, plus this ungated link to the paper (pdf).
2. Is inequality connected to self-deception?
3. More on the markets for blood, and also love letter transcriptions.
4. Alena is raising the status of scientists, the only way that really counts. Or is it cheap talk?
Friday assorted links
2. Don Boudreaux open letter to me. Here is my original post, and here is AIER being useful. If the GBD had been this second link here, I would be wrong. But it wasn’t.
3. Chinese to vaccinate 50 million for lunar new year.
4. Model and evidence for the IPO market being efficient.
5. Why Iger is a bad pick for ambassador to China.
6. Whether you agree or not, the method and approach of the government/CDC here on vaccine allocation are so low quality as to almost defy belief. Again, whether or not you are convinced by Matt Yglesias, his simple Substack on this same question did a better job (and at a profit, presumably!). A useful reminder for those of you who “blame the CDC problems on Trump.” Here is related NYT coverage. And never forget Glazer. Why do we not prioritize men, who are at higher risk? And from “an expert in ethics.”
8. “Atlantic City has launched an auction in which the winner will get to virtually push the button that starts the long-anticipated implosion of the former Trump Plaza Hotel and Casino building.” Link here.
Why are antiques now so cheap?
Compared with the heyday of antiques collecting, prices for average pieces are now “80 percent off,” said Colin Stair, the owner of Stair Galleries auction house in Hudson, N.Y. “Your typical Georgian 18th century furniture, chests of drawers, tripod tables, Pembroke tables,” he noted, can all be had for a fraction of what they cost 15 to 20 years ago.
That is from Tim McKeough at the NYT, there is plenty more evidence in the article. I can think of a few hypotheses:
1. eBay and the internet have increased supply more than demand. It is much easier to sell an estate, or the contents of your attic, than before. But the upward potential for demand in the market isn’t nearly as significant. Some people say “well, I would in fact buy and collect antiques if I could get the right 18th century pieces at 40% their current values,” but many more people just aren’t interested at all.
2. The article also demonstrates that many buyers are refocusing their demands on newer pieces. Our attitude toward the past may have changed in some fundamental way, with items before a certain date just not existing in most people’s aesthetic universes. It’s a bit like how people collect Elvis memorabilia, or even just treat Elvis as less iconic than they used to.
For many people today, “an English antique represents something that is kind of sad and tired,” said Thad Hayes, a New York interior designer who has recently been emptying antiques-filled homes and designing new rooms with contemporary pieces for wealthy clients both young and old.
Contemporary design, he said, “represents something that’s a lot more optimistic and positive.”
3. Homes have changed: “More homes have open-concept, casual living spaces rather than formal dining rooms and studies, which reduces the need for stately mahogany dining tables, chairs and cabinets.”
4. The aesthetic of the internet itself has pushed people away from “old and musty.” Just look at the kind of images you see on Instagram.
What else?
Shiller on Trills
In this short piece, Robert Shiller explains one of the basic ideas of his work on macro markets:
The governments of the world should issue shares in their GDPs, securities that pay to investors as dividends a specified fraction of GDP, in perpetuity (or until the government buys them back on the open market). Governments need to end their historic reliance on debt financing: governments issuing shares in GDP is analogous to corporations issuing equity. My Canadian colleague Mark Kamstra and I propose issuing trillionth shares in GDP, and so to call these “Trills.” Last year, a U.S. Trill would have paid $15.09 in dividends, a Canadian Trill C$1.72. The dividends will change every year as GDP is announced, and predicting these changes will certainly interest investors, just as in the stock market. Governments can auction off Trills when current government debt comes due and needs to be refinanced, as part of a debt reduction program.
In this piece, Shiller focuses on the benefits of Trills as opposed to debt:
Substituting Trills for conventional debt helps deleverage the government, something whose importance has become very clear with the debt crisis in Europe. The payments required of the government by the Trills is connected to the country’s ability to pay, measured by their GDP.
Trills could also be the foundation for many types of insurance products, for example, products that would pay off when GDP was down helping to alleviate business cycle issues. A market in Trills could also be used to make predictions and to judge policies (see Gurkaynak and Wolfers for an early test). Which policies will most increased the value of future trills? Similarly, by looking at how the market for trills changes as the Iowa Political Markets change we could identify which politicians are best for GDP (not just the equity and bond markets).
I featured Shiller’s work on macro markets in my book Entrepreneurial Economics: Bright Ideas from the Dismal Science. I think of this body of work as his most visionary and deserving of the Nobel.
“Profitable until deemed illegal”
Dutch books and Venus fly traps abound:
I was fascinated to discover the auction hybrid site swoopo.com (previously known as telebid.com). It’s a strange combination of eBay, woot, and slot machine. Here’s how it works:
- You purchase bids in pre-packaged blocks of at least 30. Each bid costs you 75 cents, with no volume discount.
- Each bid raises the purchase price by 15 cents and increases the auction time by 15 seconds.
- Once the auction ends, you pay the final price.
I just watched an 8GB Apple iPod Touch sell on swoopo for $187.65. The final price means a total of 1,251 bids were placed for this item, costing bidders a grand total of $938.25.
So that $229 item ultimately sold for $1,125.90.
If traders are overconfident, as much as the finance literature alleges, there ought to be a way to exploit that tendency. And so there is. If you read the article you will see it is even worse than it sounds. Jeff Atwood concludes:
In short, swoopo is about as close to pure, distilled evil in a business plan as I’ve ever seen.
Or are the overconfident people sharing in the evil as well? For the pointer I thank Ambrose Wong, Kevin Markham, and Travis Allison.
Why are all songs the same price on iTunes?
99 cents, but the deals expire in two months. Apple insists on keeping a single price across the board. Why might this be? Why might the retailer care more about price predictability than the wholesalers?
1. The confusion and resentment costs of different prices might be blamed on Apple. But surely we see different prices in many other retail arenas.
2. Perhaps Apple is solving a status game problem. If everyone else is selling for 99 cents and your song sells for $1.20, yours looks special. Music companies might set prices too high, not taking into account the lower demand for iTunes, and music, more generally.
3. Could Apple be enforcing music company price collusion, while receiving implicit kickbacks in the rights agreements? This would require the complainers to be in the minority.
4. Apple makes much of its money on hardware, especially iPods. Low song prices cross-subsidize the hardware, to some extent at the expense of music companies. That said, some music companies wish to charge lower not higher prices.
5. Hit songs are kept at artifically low prices to discourage people from moving into the world of illegal downloads.
6. Price is a signal of quality and Apple doesn’t want to admit it carries "lemon" songs. But won’t demand for the hits go up?
7. Uniform pricing is a precommitment strategy for a durable goods monopoly game.
We must distinguish two aspects of the problem. First, Apple wishes to control retail prices. Second, Apple wishes to make all retail prices the same. Which of these features is more important for understanding the problem?
Here is a proposal for determining prices by auction; no way will we see it. Here are rumors that the uniform pricing will end. Note that the Japanese store already has two tiers of prices. How about keeping the price the same, but bundling hot songs with less desirable ones? Way back when, we used to call these "record albums"…
Google makes money managers work for a living
In the weeks leading up to Google’s IPO, few people had anything good to say about the company or its decision to go public using a modified Dutch auction. (Here’s one notable exception.) But now we’re seeing a welcome backlash to the anti-Google backlash, with a host of articles arguing that, glitches notwithstanding, the IPO worked. (My take is here, but unfortunately you need to subscribe to the Financial Times to read it.)
Most discussions of the IPO have focused, appropriately, on the fact that Google maximized the amount of money it raised by reducing the commissions it paid its investment bankers and by getting itself a fairer price than it would have under the traditional system. (Even though Google’s price did jump 18% on the first day, that was a relatively reasonable discount given all the fear and uncertainty Wall Street had tried to sow about the company and the offering.) As Alex wrote last week, the true test of the success of an IPO is the “cost per dollar of raised funds,” and by that standard Google did well.
But the offering was also a success for another reason, which is that it forced institutional investors to compete, for once, on a level playing field. The problem with the current IPO system isn’t just that companies end up leaving billions of dollars on the table when they go public, but that select mutual-fund and hedge-fund managers (as well as well-connected individuals) are handed what amounts to free money. In a traditional IPO, the investment bank underwriting the offering controls the allocation of shares. In the late 1990s in particular, that allocation process became a way of doling out favors and securing future business. For instance, if you were a mutual-fund manager who funneled a lot of trades through an investment bank — or who agreed to do so — then you were more likely to get a hefty allocation of IPO shares.
This made money managers look a lot smarter than they were — even if you set the bubble aside, there are lots of fund managers whose returns from the late nineties need an asterisk next to them — and it wrecked the price-setting process, since there was no real attempt to let the price reflect the real demand for a stock. It also sabotaged one of the best things about capital markets, which is that in theory they aggregate the opinions of anyone with enough capital and enough risk tolerance to participate, and not just the opinions of those with the right connections. (There should be no velvet ropes in capital markets: if you can pay, you can play.) Google turned all this around: the only way to get shares in the Dutch auction was to do the valuation work and make a reasonable bid. The traditional IPO relies on the power of cronyism. Google’s IPO, flawed as it was, relied on the power of markets. Bad for the Street, good for everyone else.
Markets in everything: Google edition
At lunch recently, Tyler expressed concern about how well the Google auction would work given that no one knew what the stock would open at. Robin Hanson, famed for his role in the Pentagon “terror market,” chimed in that “we could have a market in that.” True, but not necessarily helpful – surely, the regress must end somewhere? Helpful or not, Robin has been proven correct as a descriptive matter. We now have something of a market, or at least a contest, in predicting the Google IPO price. See The Google IPO Swami.
Thanks to Eric Crampton for the pointer.