Rigging the IPO game
nytimes.com
nytimes.com
Mixing trading and underwriting in the same firm is bound to create enormous conflicts of interest, no matter how tall the internal "Chinese walls" between departments are. This is imho definitely a place where strong regulations and strong checks are needed.
The other solution would be to be to have an adjustable underwriting fee that declines depending on how much the stock is up using the ~5 day average closing price after the IPO. If the stock was up some percent over the IPO price, say 40%, the underwriting fee would drop from 7% to 1%. Over 50%? No fees. Something along those lines would keep the banks honest. You failed (purposefully or not) to price the offering correctly and needlessly transferred hundred of million in wealth from the company to trading clients? Fine, you dont get paid.
For the hot issues, trust me, there is still plenty of demand. Tons. You really think no one would buy Splunk at $35, that an IPO would fail? It happens millions of times per day already in the secondary market, so clearly there's more than enough demand. The difference would be that the hedge funds who generate utterly insane commission dollars wouldn't have an interest in the offering...it would be more buy-and-hold guys subscribing, and those folks just aren't that profitable for the bank trade desks. I used to work at one of these big funds and I've seen this all first hand and it's ridiculous.
I'm talking about first day pops. These are situations that are clearly mismanaged. A stock that's supposedly worth $20 at 5pm on Tuesday is magically worth $35 at 9:30am on Wednesday despite nothing having changed. No supposedly functional market should be that inefficient. Unfortunately it's by design.
Except they still get kickbacks from their double dealing.
Banks are fragmented and individual portions of the bank don't always agree with each other.
Fun fact: a certain large bank (I won't say which one) is spending ~$10-90M on an internal matching engine. This is because they spend millions on unnecessary transaction costs - trader A wants to go long and trader B wants to go short, both of them hit the public markets rather than simply trading with each other.
I'm intrigued by the possibility that an individual person closely connected with pricing the IPO might have expressed a view akin to: "we've got to set a sub-market price to ensure our institutional investors make a killing on the first day, because this stock will be in trouble once the hype dies down"
But still, that was over a decade ago, and I'm sure no investment banker would ever be so cynical today...
* Hand holding through a new, high-risk process
* A scapegoat in case something goes wrong
SecondMarket is probably in the best position to implement this - they already have access to trading activity of mature private companies, and while they don't do auctions, they do run order books for large lots.
Google was then forced to lower the IPO price to $80 or so. It's hard to say for sure, but that probably wasn't a fair price, as the shares were trading for more than double within 6 months.
Although they were also trading for 4-5x not too shortly after that, since the company was in a spectacular growth phase at that time, so it is hard to say.
> ...Goldman has argued that, contrary to popular belief, underwriters do not have a fiduciary duty to the companies they are underwriting.
Why would anyone use a financial institution who doesn't think they have a fiduciary duty to their clients?
The investment banks are playing the line between moral and legal obligations. They will win, of course. And then hopefully we will see "IPO brokers" and corresponding laws appear.
There were a bunch of people using the fact that the stock didn't pop and that they had to use the greenshoe to prop up the price as a sign of failure when in fact it was really a way to approximate the dutch auction process by overselling and then pulling back to get to market equilibrium.
Then there were all the investors saying they were hurt by the IPO because it didn't pop and they couldn't sell it a few hours after buying it, so they took a loss. They then argued that this was a bad move because now Facebook stock had a bad name in the markets which would hurt more long-term than if they had just submitted to common practice by giving them some free profits for doing no work.
The old days of making 4x returns in a few hours of busy work on a trading terminal must have been really nice.
Why not just divide the shares up amongst the existing shareholders, and just let them sell them normally on the market? Then the company/founders/vcs can just sell shares at whatever pace they want to, at whatever fair market value is.
It seems like the only possible outcome of a single day sale is information asymmetry, which means someone will always get "screwed".
There is no such thing as information symmetry between any person, or in any trade. No two people on the planet have the same information.
> which means someone will always get "screwed".
Both parties always benefit from the trade, or the trade would not have taken place. Unless someone is deliberately misrepresenting information (fraud), then nobody gets "screwed" by trade.
Both parties always benefit from the trade, or the trade would not have taken place
How can you say these two things, right at the same time? Does the former not contradict the latter?
Furthermore, the Founders/VCs/Employees just don't have the reach or the technical know-how to appropriately price the stock to maximize their potential gains - the investment banks have both but, as you read in this article, they often use their expertise to their own advantage.
Lastly, the Founders/VCs are in fact able to sell off their shares during the IPO for their own personal benefit so long as there is no clause in their IPO terms stating that they cannot. This will enrich them personally BUT it is highly advised that they don't because the signal they're sending to the market is "cash out early!"
Also each time you sell shares in an IPO you need to have people make lots of calls to institutional and other investors to determine the demand and thus proper pricing and supply of new shares. Having to do this everyday will be expensive. You (as a bank managing the IPO) also probably don't want to pester fund managers too much (They have to take care of other stocks in their portfolio, too), otherwise you'll have trouble doing IPOs for other companies.
EDIT: I take that last sentence back, it seems like they really want those IPOs regardless if the bank is a vampire squid, or not.
Underwriting does get you what it says, a guarantee that they will take the whole allocation, which was the original reason for underpricing. There have been a few cases where underwriters lost a lot of money (eg the BP floatation in the UK), but usually the underwriting fee is pure profit, especially if you can get the launch undervalued, and there are usually options that make it pretty hard to lose money (as with Facebook).
The rules aren't terribly stringent, and if you can stay above this then it might work.
The problem is no underwriter would take an IPO for a million shares at say $10/share. It's just not something that they can make money on.
This would require a new type of low cost underwriter.
Alos remember, the reason why we can set a price on the stock is that we know the float ahead of time and we can estimate what the company is worth.
How can you price a share if the amount of tradable shares is materially changing each day?
If the stock won't trade, they won't let it list, period:)
If you're offering a small fraction of the outstanding float, you don't need an underwriter because you've elected to reduce your risk. If markets are unfavourable, you raise less. Oh well. You've kept plenty of shares to try again next time.
We need to get over this "go big or go home" mentality.
With out an institutional investor( Buy side) your stock will have a hard time getting any traction.
I'm a firm believer that releasing all the shares and allowing the market to decide what they'll pay for the stock, based on their own valuation method, is the most efficient method.
Fair enough that the bankers may have nefarious intent and they shouldn't get away with it but agreeing to such a shitty deal out of ignorance is pretty stupid.
If they didn't play both sides of this market it would be in their interest to price is as accurately as possible.
Look at these cases; there's a lot of guesswork, it's not rocket science. If you have no clue what your business is worth, and are deferring completely to a third party, why are you even going public?
Sad.
I don't think this guy has a clue what "happened to the country". He doesn't even seem to understand his own state of affairs.
I think he understands just fine.
It's long as winter, but it actually made IPOs very relatable, not to mention exciting.
It gives you a good understanding of the circus surrounding the offering price.
In short, game theory strikes again: lazy auctioneers bid high blindly and hope that others will do the actual research to set the end price fairly, but those others have less incentive to do research because they are getting priced out by the lazy bums anyways. Another problem is that some bidders irrationally assume that a more popular stock is more valuable, so they too contribute to overpricing. As a result, sophisticated investors are staying away from auctions.