Empirical evidence suggests that better-informed investors in bookbuilt IPOs submit more informative bids and receive better allocations than do investors with less precise information. While the traditional bookbuilding argument accounts for this evidence as better-informed investors being rewarded with more favorable allocations for providing more useful information, the present paper adopts the winner's curse argument and shows that better-informed investors get better allocations by being better able to pick underpriced issues, even though in equilibrium investors' bids fully reveal their information. The paper offers empirical implications that allow the two arguments to be separated.

The empirical evidence on initial returns in IPOs reveals average overpricing as well as underpricing, depending on the type of security offered for sale. Consistent with this evidence, the present paper develops a model in which an IPO may be overpriced in equilibrium relative to its expected (or average) aftermarket price. Overpricing disappears, however, once the offer price is compared to a ‘float-weighted’ expectation, where the weights are given by the extent to which the number of securities that are floated in the offering (at the posted price) is positively related to the demand for allocations. Empirically, the model implies that equally-weighted returns underestimate initial returns in IPOs, and hence that inferences based on equally-weighted returns may be misleading.

This paper generalizes the informational environment of the Rock model to address empirical evidence and conjectures that cannot be addressed within the standard model based on informed and uninformed investors such as underpricing being positively related to market returns observed prior to the IPO, the number of IPOs being positively related to market returns, underpricing being partly predictable based on public information, and the return to uninformed participation being negative overall but positively related to market returns observed prior to the IPO. Finally, the model suggests that a positive relation between market returns and underpricing need not represent an inefficiency in the pricing of IPOs.