At Amundsen Investment Management, we think that IPOs and Equity Capital Markets transactions in general would benefit from more academic research into the topic, to spur innovations and discussion about how companies finance themselves in the market. Through a series of posts, I will highlight some of the most interesting academic research on the topic – and I will begin today with Lasse Pedersen’s Sharpening the arithmetic of active management (Financial Analysts Journal, 2018).

In his 2018 paper, Lasse Pedersen challenges Sharpe’s assertion that active management is a zero-sum game. The paper provides a number of real-life reasons why the equity market is not closed, and one important reason is the existence of IPOs and other Equity Capital Markets transactions. He proposes a thought experiment about what would happen if all investors were passive (but still participate in IPOs, for their “natural” share of the market”):

“What if we ensured that everyone was passive in both the primary and secondary markets? In this case, all shares would be bought in every IPO at whatever the offer price because no investor would perform security analysis and every investor would simply request his fraction of shares (the same fraction that he or she owned of the rest of the market). This indiscriminate buying might initially lead to a fantastic IPO boom at high prices as most anybody could take a company public at any price. Ultimately, when many of these new, “opportunistic” companies go bankrupt, the confidence in the financial system would quickly vanish as investors would exit from the market, leading to a collapse in security prices, a complete halt in new issues, even for good companies. The economy would then come to a grinding halt. In summary, in order for investors to be willing to buy new securities, these securities need to be sold at fair prices. To set fair prices, some investors must be active and collect information about the securities. Hence, when we take into account that capital markets are also about raising capital, we see that informational efficiency, which requires active investors, can have a significant positive impact on the real economy.”

His conclusion also illustrates one of the reasons we founded Amundsen Investment Management:
“More broadly, the capital market is not a zero-sum game – it is a positive-sum game. Firms benefit from access to capital markets, passive investors benefit from low-cost access to investing in diversified markets, and active managers benefit from their information collection efforts through potentially even higher investment returns before costs. Active management is socially valuable when it helps finance promising new firms, which increases the collective wealth.”

Paper available here: