Over-signaling vs Underpricing: The Role of Financial Intermediaries in Initial Public Offerings

Fabrizio Adriani, Luca Deidda and S. Sonderegger

Working Paper CRENoS from Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia

Abstract: We consider a model of Initial Public Offerings (IPOs) where issuing firms of better quality are more reluctant to go public. IPOs either generate or destroy value depending on the type of the issuing firm, which is only observed by the issuer. We show that, when the issuer directly offers the shares to the investors, market breakdown occurs. This is caused by the issuer s attempts to signal his type through the offering price. Things change if we introduce a financial intermediary which - 1) acts as an underwriter,2) influences the offering price. Underwriting creates a wedge between the interests of the intermediary and those of the issuer. This allows trade with outside investors to be restored. A by-product of the conict of interest between issuer and intermediary is that trade is characterized by underpricing. In the benchmark case where her profits are zero, the intermediary acts as a screening device - she underwrites the shares only upon receiving positive information about the issuer.

Keywords: ipo; signaling; financial intermediary; underwriting (search for similar items in EconPapers)
JEL-codes: G24 G32 (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-cfn
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Citations: View citations in EconPapers (2)

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