We study the effect on IPO proceeds of uniform-price restrictions and restrictions on the allocation of oversubscribed issues. Our model suggests that underwriters, given the opportunity to allocate IPOs among both regular and retail investors, would maximize proceeds by using a combination of price and allocation discrimination. Uniform-price restrictions increase the cost of soliciting information from regular investors and, when combined with evenhanded distribution restrictions, make information gathering impossible. We also provide conditions under which either adverse selection or the cost of soliciting information is likely to be the dominant force behind IPO discounting.

Underwriters have an incentive to overstate investor interest in order to persuade some investors to purchase shares at a price in excess of their initial estimate of the fair value. We show that this incentive is eliminated when the underwriter commits to secondary market price stabilization. Destroying the underwriter's incentive to overstate interest reduces the total surplus captured by initial investors in initial public offerings. Further efficiency gains are associated with penalty bid systems that permit the underwriter to make the stabilization commitment selectively. Price stabilization can thus be viewed as a bonding mechanism that improves the efficiency of the primary equity market.

We estimate the structural links between IPO allocations, pre-market information production, and initial underpricing and find that (1) allocation policies favor institutional investors, both in the US and worldwide; (2) increasing institutional allocations results in offer prices that deviate more from the pre-marketing price range; (3) constraints on bankers’ discretion reduce institutional allocations and result in smaller price revisions, indicating diminished information production; and (4) initial returns are directly related to information production and inversely related to institutional allocations. Our results indicate that discretionary allocations promote price discovery in the IPO market and reduce indirect issuance costs for IPO firms.

The evidence reported in this paper suggests that institutional investors capture a large fraction of the short-run profits associated with IPOs. The favored status enjoyed by institutional investors in underpriced offerings appears, however, to carry a quid pro quo expectation that they will participate in less-attractive issues as well. This finding conforms with the Benveniste and Spindt (1989) and Benveniste and Wilhelm (1990) prediction that U.S. underwriters behave strategically in the allocation of IPOs.

Exchange members claim that the professional relationships that evolve on exchange floors yield benefits not easily duplicated by an anonymous exchange mechanism. We show that longstanding relationships between brokers and specialists can mitigate the effects of asymmetric information. Moreover, a specialist who actively attempts to differentiate between informed and uninformed traders can achieve equilibria that Pareto-dominate an equilibrium in which the two types of trades are pooled. Our model also elucidates the role of block trading houses in mitigating information problems in the block market.

Unlike in the U.S., the initial price range for European IPOs is seldom revised, although issues are often priced at the upper bound. We develop a model that explains this seemingly inefficient pricing behavior. As in Europe, but not in the U.S., underwriters in the model obtain information from investors before establishing the indicative price range. A commitment to stay within the range is necessary to extract private information from investors. Ours is therefore the first treatment in which the bookbuilding range has a clear economic role. The model has important implications for empirical research based on European primary market data.