Academic journal article Business Economics

Efficiency in IPO Issuance Processes? A Case Study of Google's IPO-The Advantages of Online Auctions May Be More Theoretical Than Real

Academic journal article Business Economics

Efficiency in IPO Issuance Processes? A Case Study of Google's IPO-The Advantages of Online Auctions May Be More Theoretical Than Real

Article excerpt

Is the online auction an efficient mechanism for pricing initial public offerings (IPOs)? Its intent was to minimize first day price surges in IPOs, which represented "money left on the table" for issuers. Evidence from Google's IPO suggests that the online auction process may not have minimized the first day price surge, since 82 percent of the IPOs issued in 2004 using the traditional process experienced less of an increase. Furthermore, a comparison of auction IPOs with traditional IPOs issued in the same year and in the same three-digit SIC code suggests that 44 percent of the auction IPOs have greater first day price surges than their traditional counterparts. A broader comparison of the pricing behavior of auction IPOs with traditional IPOs presents a mixed picture and suggests that the size of underwriter may be an important factor. The mispricing that occurs in auctions may be due to an informational asymmetry on the part of small investors. This informational gap could arise because small investors lack access to the information sources that institutional investors have or because companies are not required to provide detailed information in the online process, inasmuch as they don't undergo the rigorous scrutiny of investment banks in the traditional bookbuilding process. This informational gap may be alleviated by the SEC reforms of the "quiet period" and by the issuer providing more detailed information on the uses of the funds.

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The resurgence in the initial public offering (IPO) market in 2004 and 2005 raises questions of whether IPOs issued recently will develop pricing patterns similar to those exhibited by IPOs during the dot.com years and whether alternative IPO issuance processes, such as the online auction process used by Google, would provide more efficient pricing. The increase between the offer price and the open price for newly issued IPOs still remains a matter of concern, although these increases are not nearly at the levels exhibited by IPOs in 1999, when, for example, Enel, VA Linux, and Sycamore Networks experienced increases between their offer prices and their open prices of 966.9 percent, 896.7 percent, and 612.8 percent, respectively.

Critics of the existing IPO allocation process argue that minimizing offer-to-open price appreciation is important because the preferred clients of the investment banks, who were initially allocated shares of the IPO under the traditional process, are the beneficiaries of the price increase, rather than the issuing company. Consequently, from the perspective of the issuing company, the increase between the offer price and the open price represents "money left on the table." The development of the Dutch auction process, used in Google's IPO, represents one of the most recent of the attempts to efficiently price IPOs by setting a sufficiently accurate offer price that the offer-to-open price increase and any substantial, immediate price appreciation in the absence of news are minimized. This would result in the issuer receiving proceeds that are a more accurate reflection of the economic value of the firm.

In the traditional IPO allocation process, the investment banks in charge of the IPO take the issue on a "road show" to various possible investors (often large mutual funds or preferred clients of the investment bank) and build a demand curve of possible prices for the new issue based upon the indications of interest that they receive from the investors. In return, these investors often receive the initial allotments of IPO shares partially to compensate them for revealing this pricing information and hence benefit from the price appreciation imbued in the price surge on the first day.

As numerous press articles have noted, the Dutch auction method would in theory minimize or eliminate the offer-to-open price increase on the IPOs first day by developing an offer price that is a more accurate reflection of the company's value. …

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