Information production and bidding in IPOs - An experimental analysis of auctions and fixed-price offerings
Trauten Andreas, Langer Thomas
Despite their theoretical efficiency in selling shares to the public, auctions are not the preferred mechanisms in Initial Public Offerings (IPOs). Chemmanur and Liu (2006) and Sherman(2005) provide a rational explanation for this puzzle based on the notion that issuers are not only interested in the offering proceeds, but also the secondary market price, and thus try to induce investors to produce information about the IPO. In this paper, we report the results of an experimental study set up to test the basic mechanisms underlying this reasoning. Our findings strongly support the theoretical argument. If the issuer has some discretion in setting the offering price (as with bookbuilding or fixed-price offerings), he can maintain investors' propensity to produce informationby appropriately adjusting the offering price even if information costs are high. In auctions, however, high information costs inevitably result in a low propensity to produce information as investors bid too competitively to recover the costs of information production. Our results provide experimental support for the theoretical argument that an auction is not the preferable offering mechanism for young and risky IPO firms because, while there is strong demand for information about such firms,the costs of producing this information are high.
Initial Public Offerings; IPO auctions; Fixed-price offerings; Endogenous entry; Experimental finance