Develops a theory for the demand for the advising and distribution services of investment banks when there is information asymmetry between an issuer of new securities and the investment bankers. The advising services of the investment banker are valuable when the banker has better information about the capital market, while the distribution services are useful when the banker is able to create demand for the issue. This analysis considers the delegation contract between the issuer and the banker in a negotiated, fixed price offering. The delegation contract exists when the issuer enlists the banker to both advise on the offering price and distribute the securities. In this case, the banker's decision as to whether the contract should be accepted is based on the banker's private information. Given these conditions, a model is presented, and an example is provided to illustrate the optimal delegation contract. Also examined are the situation in which the issuer only utilizes the distribution services of the banker and the situation in which the investment banker is not engaged at all. Results show that when the banker is better informed than the issuer, the new issues are underpriced. Further, those issuers of unseasoned securities who are less informed about the capital market than the issuers of seasoned securities are more likely to seek the advice of investment bankers. (SRD)

This paper presents a theory of the demand for investment banking advising and distribution services for the case in which the investment banker is better informed about the capital market than is the issuer, and the issuer cannot observe the distribution effort expended by the banker. The optimal contract under which the offer price decision is delegated to the better‐informed banker in order to deal with the adverse selection and moral hazard problems resulting from the informational asymmetry and the observability problem is characterized. The model demonstrates a positive demand for investment banking advising and distribution services and provides an explanation of the underpricing of new issues.

We consider the problem of how to regulate a monopolistic firm whose costs are unknown to the regulator. The regulator's objective is to maximize a linear social welfare of the consumers' surplus and the firm's profit. In the optimal regulatory policy, prices and subsidies are designed as functions of the firm's cost report so that expected social welfare is maximized, subject to the constraints that the firm has nonnegative profit and has no incentive to misrepresent its costs. We explicitly derive the optimal policy and analyze its properties. IN THEIR CLASSIC PAPERS Dupuit [2] and Hotelling [5] considered pricing policies for a bridge that had a fixed cost of construction and zero marginal cost. They demonstrated that the pricing policy that maximizes consumer well-being is to set price equal to marginal cost and to provide a subsidy to the supplier equal to the fixed cost, so that a firm would be willing to provide the bridge. This first-best solution is based on a number of informational assumptions. First, the demand is assumed to be known to both the regulator and to the firm. While the assumption of complete information may be too strong, the assumption that information about demand is as available to the regulator as it is to the firm does not seem unnatural. A second informational assumption is that the regulator has complete information about the cost of the firm or at least has the same information about cost as does the firm. This assumption is unlikely to be met in reality, since the firm would be expected to have better information about costs than would the regulator. As Weitzman has stated, An essential feature of the regulatory environment I am trying to describe is uncertainty about the exact specification of each firm's cost function. In most cases even the managers and engineers most closely associated with production will be unable to precisely specify beforehand the cheapest way to generate various hypothetical output levels. Because they are yet removed from the production process, the regulators are likely to be vaguer still about a firm's cost function [12, p. 684]. As this observation suggests, it is natural to expect that a firm would have better information regarding its costs than would a regulator. The purpose of this paper is to develop an optimal regulatory policy for the case in which the regulator does not know the costs of the firm. One strategy that a regulator could use in the absence of full information about costs is to give the firm the title to the total social surplus and to delegate the pricing decision to the firm. In pursuing its own interests, which would then be to maximize the total social surplus, the firm would adopt the same marginal cost pricing strategy that the regulator would have imposed if the regulator had