In 2014, the UK FCA began a review of financial markets, which gave them access to the IPO books for 220 EMEA IPOs between 2010 and 2015. With access to this dataset, the paper by Tim Jenkinson, Howard Jones and Felix Suntheim is quite unique, as it is one of the few studies that leverages information about actual investor demand, interaction and allocations. The main question they try to answer is how #IPO allocations are determined – and whether it is based on help in information gathering, or “quid pro quo”, ie. to their “good” clients.
As they say in their introduction, “Initial public offerings (IPOs) play an important role in the financial system, enabling companies to raise equity finance and providing investors with a tradeable asset. Doubts remain, however, about how well the IPO market operates for issuing companies.”
They find “evidence consistent with syndicate banks making favorable allocations to investors
who provide them with information likely to be useful in pricing the IPO. Investors who submit price sensitive bids and, in particular, those that attend meetings with the issuer during the IPO process, are favored in allocations. Our findings therefore lend support to information revelation explanations for IPO allocations and underpricing. At the same time, bookrunners make favorable allocations to investors from which they generate the greatest revenues elsewhere in their business, particularly through brokerage commissions.”
The accompanying FCA paper contains some additional nuggets on investor engagement. Over the period, there was a median of 140 bids in IPO books. Of these, only about half were price-sensitive, and only 4-5% (ie. 7!) of investors bidding attended pilot-fishing/early-look meetings.
It also addresses a question of after-market liquidity: “Book-runners sometimes justify allocating to hedge funds in IPOs on the grounds that they provide valuable aftermarket liquidity. We find no evidence for this: hedge funds allocated shares in our sample of IPOs provide negligible aftermarket liquidity”
Quality feedback from investors, providing information about the sensitivity of the market to pricing and helping the banks set a correct price, is essential. It is hard work in practice: you have to become an expert on a company that you do not have a history with in a short amount of time, and be ready to provide a full valuation of the company. This is not an easy task for investors who already have their hands full managing their portfolios. But our research team: Gautier RousseauClotilde GinestetEinar Lilloe-Olsen and Florian Remay is dedicated to this. And doing this, we play our part in making the IPO process a success.
The full paper is very accessible and worth a read, if you are interested in the IPO topic.
Paper available here
FCA paper available here