The ability to withdraw IPOs when demand is weak increases expected proceeds and provides issuers with option value. To enhance this value, the SEC adopted in 2001 the ‘public-to-private’ safe harbor Rule 155 and simplified Rule 477 for withdrawing offerings. The option value can exceed the underpricing associated with soliciting investor demand. Hence, issuers might prefer bookbuilding despite the associated underpricing even if they could sell via fixed price at full expected value. The option value increases faster than underpricing with ex ante uncertainty, generating predictions regarding the use of bookbuilding and the timing of IPOs, and leading to a distinct theory of hot IPO markets.

Investors who possess information about the value of an IPO can participate in the offering as well as trade strategically in the aftermarket. Both the bookbuilding and the fixed price IPO selling methods require more underpricing when aftermarket trading by informed investors is considered. Bookbuilding becomes especially costly, since the potential for profit in the aftermarket adversely affects investors' bidding behavior in the premarket. Unless the underwriter can restrict its bookbuilding effort to a small enough subset of the informed investors, a fixed price strategy that allocates the issue to retail investors produces higher proceeds on average, contrary to the conventional wisdom in the literature. We therefore find a benefit to limiting access to the premarket and, hence, provide an efficiency rationale for the practice by American bankers of marketing IPOs to a select group of investors. We also provide unique policy and empirical implications.

Lawrence M. Benveniste, Walid Y. Busaba, Bookbuilding vs. Fixed Price: An Analysis of Competing Strategies for Marketing IPOs, The Journal of Financial and Quantitative Analysis, Vol. 32, No. 4 (Dec., 1997), pp. 383-403

Firms that go public produce information that influences the production decisions of their rivals as well as their own production decisions. If information-production costs are borne primarily by pioneering firms, market failures can occur in which both pioneers and followers remain private and make ill-informed investment decisions. Solving this coordination problem requires a transfer between pioneers and followers that leads to a more equitable distribution of information-production costs. We contend that investment banks can enforce such a transfer by effectively bundling IPOs within an industry. This suggests an explanation for clustering of IPOs through time and within industries. Journal of Economic Literature Classification Numbers: G24, G28, K32.

We investigate the effect of the “7% solution”—the fact that underwriters in the U.S. charge a 7% spread to most IPOs between 20 million and 100 million in size—on the ensuing pricing of the offerings. Our identification exploits the variation in spreads that is due to distinct kinks in the relation between spread and offer size at these two thresholds. We find the spread positively influences underpricing but also the offer-price adjustment from the filing range's midpoint. Our evidence indicates the spread influences the aftermarket price, suggesting underwriters can shape, not merely discover, investor valuations.

American IPOs are priced after a process of bookbuilding, during which issuers can withdraw at any time. We hypothesize that the option to withdraw reduces underpricing by strengthening the issuers’ bargaining power with respect to investors. Empirical analysis reveals that underpricing is lower when investor perception of an IPO's likelihood of withdrawal is higher. Withdrawing issuers are neither smaller nor less profitable than issuers completing their IPOs, and engage underwriters that are as reputable as those managing completed offerings. Withdrawal is correlated with leverage, intended use of proceeds, expected issue size, venture backing, revenues, NASDAQ returns, and IPO activity.

We examine how an underwriter's reputation accumulates upon each attempt to take a firm public, conditional on the bank demonstrating abnormal performance bringing—or failing to bring—the offering to market. We develop a novel measure of abnormal underwriting performance by weighing the ex-ante difficulty of completing the offering against the actual outcome. We show this measure positively associates with future changes in the underwriter's market share and issuing volume. The effect manifests as access to more offerings and is prominent when difficult offerings are completed, for abnormal performance demonstrated in midmarket (20–100 million) and large IPOs, and for both the primary lead and co‑lead underwriters. Abnormal performance is associated with a higher underwriting spread and aggressive IPO pricing.

We examine whether underwriters price up weakly demanded initial public offerings (IPOs) to prevent withdrawal. Our empirical strategy exploits a discontinuity in the distribution of IPO prices around the low boundary of the filing range. Offerings with a high ex ante withdrawal probability that are priced at this boundary are likely priced up to meet issuers’ reservation prices. We compare the aftermarket returns of these IPOs to the returns of other weakly demanded offerings where issuers’ reservation prices were likely not binding, and we identify a negative 8.4-percentage-point differential attributable to the aggressive pricing inherent in setting the price at the low boundary when withdrawal risk is high.