The US IPO cartel | Hacker News Reader

The US IPO cartel

blogs.reuters.com

122 pointsMaysonL30 comments

It could probably be rationally argued that cartel behavior is as destructive as (or more destructive than) monopoly behavior in a capitalistic economic system.

In a monopolistic situation there's almost always incentive for those "outside" the monopoly to weaken or disband the monopoly's stronghold; if enough individuals join together and engage in cartel behavior independently from the monopoly, the market at least turns into a duopoly. However, in a cartel situation where there's no threat of duopoly or oligopoly, there's more incentive to join the cartel than there is to attempt to disband the central monopoly that's essentially controlling the cartel. It's almost like high-level blackmail because it makes the monopoly stronger while weakening the incentive to compete "outside" the monopoly.

For example -- my favorite soapbox issue: the National Association of Realtors. They could be likened to a cartel of people unified in their incentive to keep their "spread" around 6.x percent. These IPO financiers are likely in the same boat: they all know and silently agree that they're better of keeping their spread at 6.x or 7.x percent than they would be going off on their own or using their "little" money to compete with the "big" money of IPOs.

By the way, that big black line on the 7% level is the data, not part of the chart design.

Yeah, it took me two minutes to figure that out. And then it really sank in.

Likewise. I was like: OK, I guess there's a bit of clustering...HOLY CRAP!

I kept trying to figure out what the divots in the line were supposed to indicate...

Yes, they want a histogram. It would look like this: US: ..| EU:~~~.

Holy Cow, first i thought this was the median line.

In banking we have a common - perhaps trite - word to explain this phenomonen: "precedents". We price/measure almost everything against precedents or "comparables." The fact that 95% of underwriting spreads have been 7% for the last 20+ years will ensure that 95% of future IPO's will continue to be underwritten at 7% for the next 20.

Is what it is. The law of unintended consequences tells me that should the govt try to mingle with this practice, the outcome will likely be that bigger/more desirable companies get preferred treatment (like Google attempted to do) at say 6-7% while the relatively smaller companies pay a liquidity/desirability premium to make up for it. Same thing happened to credit card rates, which are now at all time highs...

The point the authors seem to be making (haven't read the paper, just read the article) is that this phenomenon of pricing IPOs based solely on "precedent" is limited to American banks. Another trite phenomenon, competition, seems to be present in Europe, where deals seem to be priced based on novel parameters like demand, risk, size, and financial complexity.

Also, if your observation above is in fact correct and investment banks continue basing their pricing on what they've done for the last 20 years, then I wouldn't worry about the government coming in and messing with their business - reliance on logic like "it's how we've always done things" is sure to bring about obsolescence first.

That narrative doesn't explain the discrepancy. Why hasn't competition altered the rates?

Would you be more likely to eat at a restaurant that had a big "Tips are only 10% here" sign in the window?

If one restaurant has a "default" service charge of 10%, and another has 20%, it very probably will sway me to the 10% one, yes (these figures will be printed at the bottom of the menu, are normally added to your bill but you can ask to have them removed, and the menu will be at the door or window, visible from the street, I believe it's a legal requirement). But then tipping culture is different in the UK.

I understand what you're trying to get at - giving investment banks an incentive etc. - but the high degree of conformity doesn't make sense. Even large slices of small pies won't interest banks much, and similarly only a small slice of a huge pie ought to interest them plenty.

The point wasn't really so much about the incentive, but just that service fees are often cultural. Conformity doesn't come from economic forces, but cultural ones.

I think there's a big difference between service fees on a $10 dinner and a $100 million-$5 billion IPO. In particular the extent to which they are affected by custom is probably different considering the size of the sums. And the reason for the "tip" . . . nobody feels bad about giving an investment bank as little as they can get away with, but with tips it's a different story.

Financial services industry operates more like healthcare and law than say consumer products with regard to pricing practices and competition (in the context of advisory, not lending). You wont find a lot of doctors or lawyers bragging about how low their rates are because price is a perceived indicator of quality. That being said, a convention began a long time ago that a fair price to pay to a top notch bank is 7% and everyone has stuck to it. If you were a client and were quoted 8%, you would demand to know what makes you different than the hundreds of other (perhaps weaker) companies that got a better deal. If you were quoted 5%, unless the circumstances were extraordinary, the dozens of companies in the pipeline are going to expect the same treatment. So the question to the investment bank comes back to this: why rattle a system that works and is accepted as is?

To be frank, price competition exists in banking but most companies dont care about it. There are a lot of IPO's that take place and you'd be amazed how many of them "fail". You just dont hear about them because they are so small and underwritten by smaller banks. Big/successful companies dont care about the arbing the 100-150 basis points and risk jeopardizing the success of their IPO by picking someone other than Goldman.

I would be curious to know if you have any ideas about why this convention doesn't hold in Europe? Is it less important to signal quality by working with a top bank? Are regulations different? As a finance outsider, it seems that European banks would be playing a very similar role to their American counterparts and financing a comparable range of companies. The difference in the spread is quite striking.

So you have extremely strong evidence of legal and anti-competitive practices and nothing can probably be done ?? Is the US financial industry now untouchable? Sounds like some south american banana republic from the 70's to me.

The scary thing is this probably speaks volumes about the insidious effect of the banking industry on the US economy. (BTW - I am a brit and living on the UK but I care because if the US economy goes I'm pretty sure it'll drag the UK and most of western europe down with it.

Implicit collusion is legal in the United States.

Wow! So if you can't prove they are explicitly colluding then its OK? Doesn't this mean they can get away with it by, for example, not having anything written down or recorded? I assume this applies to all industries E.g. the health Industry?

I'm getting more and more worried about the US.

7% is also the realtor commission when buying/selling a house. It's rarely negotiated and totally divorced from the amount of work the brokers do.

But I question if there is always a cartel whenever service fees lump together. If you collected the percentage of dinner checks paid as a tip, you'd see an enormous concentration right around 15-18%. Are all the waiters colluding? Even the ones where tip is not included?

That also makes little sense; in the UK, estate agent fees / commission is somewhere between 1% and 3.5%, and they are negotiable.

Where do you find realtor fees to be 7%? In California, 6% is usually the most anybody pays, and thats negotiable.

You're right, it's 6%. Tt was just so convenient to have them be the same, it overrode my memory.

Percentage-based fees are rarely appropriate, imo; for those paying the fee, naturally. It's a phenomenon that we simple seem to take for granted. I believe that any system where fees are based on percentages is ripe for disruption. I include this particular case, credit card transaction fees for merchants, ebay, estate agent/realtor fees and so on.

Of course, where the market is closed/protected, then the only way to change it is to lobby politically. And good luck with that in the banking domain.

In California, when you (A) Hire a realtor and (B) List your home, the seller determines both the sellers and buyers commission, and it's 100% negotiated (well, the sellers commission is. You just chose the buyers commission). Not sure where the myth of "6%" (not 7%) commission came from. I paid my realtor a 2% base fee + a 5% kicker on anything above a base amount for selling my condo, and a flat 2% to the buyers agent. Took her six weeks of open houses to sell my place, and overseeing the renovations, and she cleared a net 2.3% on the final price. (this was in 2006) - She was with a top tier realty agency as well, Caldwell.

Can't comment on other locations, might be different.

I've heard from several homesellers who were quite convinced either you couldn't negotiate down (or that you wouldn't want to), unless you were doing repeat business. There may be some more flexibility now because I think people are getting increasingly frustrated and looking to alternatives.

Oh, found an article from 2004, so things have been changing for a little longer than I thought, but I think it makes clear that 6% was not always a myth. http://online.wsj.com/article/SB109364276315603265.html

If the American people knew what really goes on around IPOs-- especially how they're priced and allocated-- the streets would be littered with the heads of top bankers. This is one or many areas in which banks are willing to outdo the imagination in terms of sleaze.

"European IPO fees do not cluster."

I'm sorry, but this is obviously not true; there are clusters on exactly 3, 4, 5, and (faintly) 6 percent in the European market. And given that forcing to arbitrary whole numbers _happens_, it suddenly seems very possible that in a (larger) market like the US the forcing acts even stronger.

In other words, we need _evidence of collusion_ to determine for sure if there is a cartel, not just evidence that it is the same.

That said, however, the difference between actual collusion and accidental collusion isn't that thin.

Interesting analysis. Nothing will ever happen or be investigated though. The banks run the WH.

Except that isn't really true. For example, after the Rajaratnam case, SEC insider trading investigations are way up and a lot of people are getting arrested. http://www.cbsnews.com/8301-504083_162-20031043-504083.html

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