Knowledge that Transforms

To resolve the IPO underpricing puzzle it is essential to analyze who knows what when during the issuing process. In Germany, broker-dealers make a market in IPOs that starts as soon as the offer range is published. We examine these pre-IPO prices and find that they are highly informative. They are closer to the first price subsequently established on the exchange than both the midpoint of the offer range and the offer price. The pre-IPO prices explain a large part of the underpricing left unexplained by other variables. The results imply that information asymmetries are much lower than the observed variance of underpricing suggests. They cast doubt on the informational role of bookbuilding and the relevance of the winner's curse problem.

We analyze the disinvestment decisions of venture capitalists in the course of an IPO of their portfolio firms. The capital market learns of the project quality only in the period following the IPO. Venture capitalists with high-quality firms must choose between immediately selling their stake in the venture at a price below the true value and waiting until the true value is revealed. We show that this choice is facilitated by a reputation-based mechanism in a repeated-game setting. This allows us to explain the phenomenon of “hot-issue market behavior” involving early disinvestments and a high degree of price uncertainty. In a further step, we provide a new rationale for underpricing. We show that young venture capitalists may use underpricing as a device for credibly committing themselves to establishing reputation.

In this paper we analyze the interrelatedness of security analysis and market-making activities. Our results indicate that there exists a bidirectional and positive relation between analyst following and the number of market makers. Using detailed data on analyst and dealer affiliations, we also find that dealers are more likely to make markets in stocks that are tracked by analysts who are affiliated with the same company. Similarly, analysts follow and issue earnings forecasts more proactively for stocks that are handled by affiliated market makers. We interpret these results as evidence that analysts and market makers work as a team to benefit the company. We discuss a possible conflict of interest between investors and brokerage firms that arises from this collaborative endeavor between analysts and dealers.

Managements (“insiders”) of many corporations, especially small or newly-public firms, invest considerable resources in investor relations. We develop a model to explore the incentives of insiders to undertake such costly investments. We point out that insiders may undertake such investments not necessarily to improve the share price, but to enhance the liquidity of their block of shares. This leads to a divergence of interest between insiders and dispersed outside shareholders regarding investor relations. Our model predicts that the demographics of insiders (e.g. liquidity needs, size of equity stakes) are important determinants of the extent of investor relations across firms.

We analyze the impact of takeover threats on long-term relationships between the target owners and other stakeholders. In the absence of takeovers, stakeholders' bargaining power increases their incentive to invest but reduces the owners' incentive to invest. The threat of a takeover that would transfer value from the stakeholders reduces their ex ante investment. However, the stakeholders may appropriate ex post some value created by a takeover. This can prevent some value-enhancing takeovers. We examine extensions to the disciplinary role of takeovers, takeover defense mechanisms, and trade credit, and discuss empirical predictions.

This paper analyzes determinants of the incidence of relationship lending. We explore self-assessments of German universal banks with respect to their Hausbank status in corporate lending and relate loan contract and borrower characteristics to this attribution. The analysis shows that Hausbank status is positively related to better access to information and the bank's influence on borrower management. While the duration of the bank–borrower relationship is not related to Hausbank status, banks are more likely to be Hausbanks when their share of borrower debt financing is higher and when the number of bank relationships is lower. We also find that the likelihood of observing a Hausbank relationship is non-monotonically related to bank concentration in local debt markets. For low and intermediate values of concentration, Hausbank relationships become more likely as competition increases. This contradicts the conjecture that relation lending requires monopolistic market structures. Nevertheless, in highly concentrated markets, less competition fosters Hausbank relationships.

We study mechanisms by which the provision of incentives to new entrants is influenced by lenders' financial interests in incumbents. When a financier has a strong interest in protecting incumbent rents, he stifles the entrant's internal efficiency with a highly dilutive claim, and bribes her for not accessing more aggressive finance elsewhere. By contrast, when the financier's protective interest in the incumbent is less strong, then it can spur the destruction of incumbent rents. This is because it strengthens the financier's commitment to penalize the entrant for managerial slack by forcing her into market exit, which sharpens her internal efficiency and competitiveness. While the corresponding decrease in incumbent firm value is partially internalized by the financier, he is more than compensated by the incremental firm value of the entrant, part or all of which accrues to him. The model has implications for the competitive effects of industry-focused lending styles.