Fabrizio Adriani, Luca G. Deidda and Silvia Sonderegger :
075_DP93 Over-signaling vs Underpricing: The Role of Financial Intermediaries in Initial Public Offerings
JEL Classification:
G24; D82
Abstract:
We consider a model of Initial Public Offerings (IPOs) where issuing firms of better quality are more reluctant to go public. IPOs either generate or destroy value depending on the type of the issuing firm, which is only observed by the issuer. We show that, when the issuer directly offers the shares to the investors, market breakdown occurs. This is caused by the issuer’s attempts to signal his type through the o¤ering price. Things change if we introduce a financial intermediary which: 1) underwrites the shares, 2) influences the offering price. Underwriting creates a wedge between the interests of the intermediary and those of the issuer, which allows trade with investors to be restored. A by-product of this conflict of interest is that trade is characterized by underpricing. Another implication is that the intermediary may act as a reliable screening device when she possesses private information about the firm’s quality. In general, our analysis suggests that collusion between the intermediary and the issuer hinders trade, whereas collusion between the intermediary and investors may promote it.Keywords: IPO, Signaling, Financial Intermediary, Underwriting, Underpricing
