Working Paper: CEPR ID: DP1211
Authors: Michael J. Brennan; Julian Franks
Abstract: In this paper we examine how separation of ownership and control evolves as a result of an initial public offering (IPO) and how the underpricing of the issue can be used by insiders to retain control. Using data from a sample of 69 IPOs in the United Kingdom, we argue that IPO underpricing is used to ensure over-subscription and rationing in the share allocation process so as to allow owners to discriminate between applicants for shares and reduce the block size of new shareholdings. We find that of the pre-IPO shareholders in a firm, directors sell only a small fraction of their shares at the time of the offering and in the seven subsequent years; in contrast, holdings of non-directors are virtually eliminated during the same period. As a result, in less than seven years almost two-thirds of the offering company's shares have been sold to outside shareholders, thereby substantially advancing the process of separation of ownership and control. Additional evidence in the paper suggests that rationing in the IPO discriminates against applicants who apply for large blocks, and that the greater the underpricing, the smaller the size of new blocks assembled after the IPO.
Keywords: underpricing; rationing; private benefits; IPOs
JEL Codes: G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| IPO underpricing (G24) | oversubscription (D45) |
| oversubscription (D45) | rationing scheme discriminating against large applicants (D45) |
| IPO underpricing (G24) | size of new blocks of shares post-IPO (G24) |
| size of new blocks of shares post-IPO (G24) | large outside shareholders accumulating significant stakes (G34) |
| fraction of underpricing costs borne by directors (G34) | IPO underpricing (G24) |
| size of largest outside holding (G34) | degree of underpricing (G19) |
| director holdings pre-IPO (G24) | director holdings post-IPO (G34) |
| non-director holdings pre-IPO (G24) | non-director holdings post-IPO (G34) |