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The Pricing of IPO Services and Issues: Theory and Estimation

Ari Kang; Richard Lowery
The Review of Corporate Finance Studies 2014 2(2), 188-234
We estimate a model for the process for setting IPO spreads and offer prices. We establish that the partially rigid spread schedule observed for IPOs, where over 90% of IPOs with proceeds between $20 and $80 million have a spread of 7%, can be rationalized as optimal collusion. Optimal collusion creates a rationale for high underpricing, and we use data on both spreads and underpricing to estimate structural parameters. Our estimates suggest that firms benefit from holding IPOs but that idiosyncratic manager preferences may drive much of the IPO market. Much of the money left on the table is estimated to accrue to underwriters.

Optimal Incentive Contracts and Information Cascades

Praveen Kumar; Nisan Langberg
The Review of Corporate Finance Studies 2014 3(1-2), 123-161
We examine information aggregation regarding industry capital productivity from privately informed managers in a dynamic model with optimal incentive contracts. Information cascades always occur if managers enjoy limited liability: when beliefs regarding productivity become endogenously extreme (optimistic or pessimistic), learning stops. There is no learning if initial beliefs are extreme, or if agency conflicts are severe. In contrast to the literature, cascades occur even when signals have unbounded precision or when there are rich action spaces. Relaxing limited liability constraints is not sufficient to avoid cascades; we provide sufficient conditions for efficient information aggregation through incentive contracts.

Long-Term Debt and Hidden Borrowing

Heski Bar-Isaac; Vicente Cuñat
The Review of Corporate Finance Studies 2014 3(1-2), 87-122 open access
We consider borrowers with the opportunity to raise funds from a competitive banking sector that shares information, as well as from other hidden lenders. The presence of hidden lenders allows borrowers to conceal poor results from their banks and, thus, restricts the contracts that can be obtained from the banking sector. In equilibrium, borrowers obtain funds from both the banking sector and ine cient hidden lenders simultaneously, so that dierent types of borrowers cannot be distinguished by banks. This generates cross-subsidies between dierent borrowers that are observationally equivalent to the banking sector. We show that the cheaper the cost of hidden borrowing, the lower is welfare and the lower is the variety of funding arrangements in the banking sector. In particular, while high costs of hidden borrowing allow each dierent (viable) type of borrower to access dierent terms from the banking sector, as the cost of hidden borrowing falls, more and more borrowers face identical terms up to the point where all borrowers who access the banking sector (which may include inecient ones) face identical terms. We generalize the model to allow for partially-hidden lenders and obtain qualitatively similar results.

Investment Bank Reputation and “Star” Cultures

Zhaohui Chen; Alan D. Morrison; William J. Wilhelm
The Review of Corporate Finance Studies 2014 2(2), 129-153
We develop a model in which individual and institutional reputation concerns conflict with one another to study why investment bank reputation concerns may have diminished in recent years. Unproven but talented bankers have incentive to signal their ability through actions that may or may not best serve their clients. In the spirit of Kreps (1990), we treat the bank as a hierarchical firm whose only asset is its institutional reputation for curbing behavior that is suboptimal for the client. The conflict between individual and institutional reputation concerns is more likely to resolve in favor of institutional reputation when firms recruit only the most talented people, and less so when unique ability is especially valuable. We discuss how technological change has contributed to a “star” culture that is unfavorable toward preservation of institutional reputation.

Venture Capitalists Versus Angels: The Dynamics of Private Firm Financing Contracts

Thomas J. Chemmanur; Zhaohui Chen
The Review of Corporate Finance Studies 2014 3(1-2), 39-86
An entrepreneur, with private information about his firm, contracts over two periods with an outside financier, a venture capitalist (VC) or angel. The financier can reduce his information disadvantage by learning about the firm over time. VC financing is scarce relative to angel financing. Further, unlike an angel, a VC may exert effort, which, together with the entrepreneur’s effort, increases the firm’s success probability. The equilibrium VC financing contract ensures optimal effort-exertion by both entrepreneur and VC. We characterize the firm’s equilibrium choice between VC and angel financing, its equilibrium contractual provisions, and the dynamic evolution of its financing contract.

Is the Stock Market Just a Side Show? Evidence from a Structural Reform

Murillo Campello; Rafael Perez Ribas; Albert Y. Wang
The Review of Corporate Finance Studies 2014 3(1-2), 1-38 open access
The 2005 split-share reform in China mandated the conversion of previously non-tradable stocks into tradable status. The reform was swift and changed investors’ability to trade corporate equities in a US$400 billion market. This paper examines the e¤ects of stock markets on …rms ’ real and …nancial outcomes. It does so exploiting multiple institutional features of the Chinese equity conversion program. We …rst examine a pilot trial conducted at the beginning of the reform, which we are able to replicate using the same data and selection criteria that was used by policy-makers. We also take advantage of the staggered nature of the conversion schedule used in the second phase of the reform, whereby over one thousand …rms converted their shares at di¤erent times within a government-dictated window. These various wrinkles produce counterfactuals against which to gauge the economic importance of secondary equity trading. Using a time-varying treatment estimation approach, we identify increases in corporate pro…tability, investment, value, and productivity as shares start to trade freely in organized exchanges. We also identify changes in …rms’propensity to issue new shares and engage in merger deals, as well as changes in their dividend and capital structure policies. Our …ndings provide new insights on the role of stock markets in shaping corporate activity