IPO Auctions: English, Dutch, ... French, and Internet

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12 BIAIS AND FAUGERON-CROUZET To address these issues, this paper develops a unified theoretical model to analyze the workings of the different IPO mechanisms listed above: the Book Building method, the fixed price auction, the Mise en Vente, and the uniform price market clearing auction. The participants in the IPO process are the sellers, financial intermediaries, and potential investors. In the model presented in Section 2 we assume the sellers seek to maximize the proceeds from the IPO, and the financial intermediary acts in their best interest. Some investors are large, strategic, institutional investors, with private information about the valuation of the stock in the secondary market. For simplicity, we assume that only the investors have private information, and abstract from the important problems arising when the sellers have private information (see, e.g., Allen and Faulhaber (1989), Grindblatt and Hwang (1989), Welch (1989), and Chemmanur (1993)). In addition to the large investors, there are smaller, and uninformed, but rational, investors. The funds available to these small investors are limited, hence they cannot absorb the whole issue. In Section 2, in the line of Benveniste and Spindt (1989), Benveniste and Wilhelm (1990), and Spatt and Srivastava (1991), we consider the optimal direct mechanism, and its implementation within the context of the Book Building method. In Section 3, we show that, in the fixed price auction, since prices cannot adjust to demand, winner’s curse problems, as in Rock (1986), lead to severe underpricing. Since the winner’s curse effect reflects the absence of adjustment of prices to demand it is natural to expect that the market clearing uniform price auction should perform better. Yet, we show that this auction can be conducive to tacit collusion between bidders, as in Wilson (1979), leading to large underpricing. This provides an alternative interpretation for the underpricing empirically evidenced by Kandel et al. (1997) in IPOs in Israel. In contrast, we show that the Mise en Vente can be structured to implement the optimal mechanism and to rule out tacit collusion, in contrast with the uniform price auction. In this auction, investors with good signals submit large demands, this drives prices up and thus enhances price discovery. In Section 4, we present empirical evidence from Mise en Vente auctions consistent with our theoretical result that it can implement the optimal mechanism, similar to the Book Building method. Hanley (1983) showed that, consistent with the implications from Benveniste and Spindt (1989) and Benveniste and Wilhelm (1990), prices somewhat underreact to demand; i.e., the covariance between price adjustment and underpricing is positive. This is also the case empiricaly in the Mise en Vente. Cornelli and Goldreich (1999) show empirically that, in the Book Building method, prices are set deliberatey below the market clearing level and that, anticipating this, investors inflate their demand. This also arises in the Mise en Vente. Conclusions emerging from our analysis are the following: • Efficient price discovery in IPOs requires some adjustment of prices to demand. Consequently, fixed price selling methods are inefficient. This is consistent
IPO AUCTIONS 13 with the empirical finding by Loughran et al. (1994) that auction-like mechanisms lead to more efficient pricing than fixed price offers. • Yet, prices should not adjust to demand too strongly, lest this should spur tacit collusion. Consequently, the standard market-clearing uniform price (or Dutch) auction is not the optimal mechanism. In this auction, bidders can tacitly collude by placing demand functions such that the market clearing price is very low, and such that, any attempt to bid more aggressively, to gain market share, would push prices too high to be attractive. In the Mise en Vente, in contrast, since prices underreact to demand, tacit collusion on low prices can be unravelled. Indeed, underreaction implies that, if the other bidders were to bid at low prices, one investor could gain a large market share, without impacting the price too much. • In spite of obvious differences in institutional characteristics, two auctions, the Mise en Vente and the Book Building method, can be designed to implement the optimal IPO mechanism. From a theoretical perspective, it is not unnatural that different institutions can be used to implement the same optimal direct mechanism. From an empirical perspective, it is interesting that, consistent with our theoretical finding that the two institutions are comparable, data generated by the Book Building method in the United States or the United Kingdom and by the Mise en Vente in France, exhibit the same observable patterns, in particular underreaction of prices to demand and oversubscription. • This analysis has implications for the design of Internet-based IPO auctions. While the Dutch auction format proposed by Open IPO seems a priori attractive, our theoretical model shows that it can lead to tacit collusion on the part of bidders, and in that case it can be quite inefficient. In these collusive equilibria, the optimal strategy of the investors is to shade their bids rather than to “make a bid at the maximum price at which they are comfortable owning shares of the issue” as advised on Open IPO’s website. In fact, our analysis suggests that, in contrast with the Dutch auction, it can be optimal to let prices underreact to demand. Note that, in a recent IPO (Andover.net, Inc.), Open IPO actually set the IPO price at a significant discount relative to the market clearing price, more in line with the rules governing the book building or the Mise en Vente than with those of the Dutch auction. A challenge facing internet IPO auction designers is to translate into explicit computer algorithms the rather implicit rules that map demand into prices in the Mise en Vente or the Book Building method. 2. MODEL There are S unseasoned shares for sale. The seller faces N large, strategic, institutional investors with private information about the valuation of the firm by the market and large bidding capacity, and a fringe of small, retail investors who are uninformed and cannot absorb the whole issue. All agents are rational and
Page 1 and 2: Journal of Financial Intermediation
Page 3: IPO AUCTIONS 11 TABLE 1 IPO Selling
Page 7 and 8: IPO AUCTIONS 15 that the others wil
Page 9 and 10: IPO AUCTIONS 17 investor has the po
Page 11 and 12: IPO AUCTIONS 19 First note that con
Page 13 and 14: IPO AUCTIONS 21 FIG. 1. Buy orders
Page 15 and 16: IPO AUCTIONS 23 Consistent with our
Page 17 and 18: IPO AUCTIONS 25 TABLE 3 IPO price R
Page 19 and 20: IPO AUCTIONS 27 FIG. 3. OLS regress
Page 21 and 22: IPO AUCTIONS 29 investor’s anonym
Page 23 and 24: p(0) = v0, this can be rewritten as
Page 25 and 26: IPO AUCTIONS 33 Her task is to choo
Page 27 and 28: IPO AUCTIONS 35 Cornelli, F., and G

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