In this paper we seek to understand if the IPO allocation process works in the interest of issuer clients or whether conflicts of interest may result in banks favouring their highest-revenue clients when deciding on final allocations in IPOs.
Show Occasional Paper No. 15 (PDF)[1]
Erratum: In the version of Occasional Paper 15 published on 13 April 2016, on page 11 we stated that 'Investors in the top quartile of the book-runners' clients receive allocations, relative to the amount they bid, that are around 50% higher than those received by investors who are not clients of the book-runner'. This was corrected to 'Investors in the top quartile of the book-runners' clients receive allocations, relative to the amount they bid, that are around 60% higher than those received by investors who are not clients of the book-runner'.
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Summary
Investment banks face potential conflicts of interest when conducting initial public offerings (IPOs) of shares. They work for issuing firms, and advise them on the pricing and allocation of the shares. They also have long-term relationships with buy-side investors for whom they offer trading, research, and many other services. IPOs are, on average, underpriced (i.e. the offer price is below the price at which shares trade immediately after the IPO), and investors who are allocated shares benefit from any such underpricing. Research to date into the determinants of IPO allocations has been limited by a lack of relevant data, particularly about the revenues from the buy-side clients of the book-running investment bank, and about the subsequent trading activity of investors.
This paper draws on data gathered as part of the FCA’s market study of investment and corporate banking[3]. The paper finds evidence that syndicate banks make favourable allocations to investors who provide them with information likely to be useful in pricing the IPO, particularly investors who submit price-sensitive bids, and those who attend meetings with the issuer before the IPO. At the same time, book-runners make favourable allocations to investors from whom they generate the greatest revenues elsewhere in their business, notably through brokerage commissions. Long-only investors seem to receive more favourable allocations than hedge funds.
We do not find evidence that banks make less favourable allocations to investors who go on to sell those shares shortly after the IPO, nor that they favour investors who provide aftermarket liquidity.
Authors
Tim Jenkinson, Howard Jones and Felix Suntheim.
Tim Jenkinson and Howard Jones are at the Saïd Business School, University of Oxford. Felix Suntheim works in the Chief Economist’s Department of the Financial Conduct Authority.
Disclaimer
Occasional Papers contribute to the work of the FCA by providing rigorous research results and stimulating debate. While they may not necessarily represent the position of the FCA, they are one source of evidence that the FCA may use while discharging its functions and to inform its views. The FCA endeavours to ensure that research outputs are correct, through checks including independent referee reports, but the nature of such research and choice of research methods is a matter for the authors using their expert judgement. To the extent that Occasional Papers contain any errors or omissions, they should be attributed to the individual authors, rather than to the FCA.