Why Do IPO Underwriters Allocate Extra Shares when They Expect to Buy Them Back?

Donghang Zhang

Journal of Financial and Quantitative Analysis, 2004, vol. 39, issue 3, 571-594

Abstract: I argue that overallocation is used as a marketing strategy to increase the offer price and aftermarket price of an initial public offering (IPO). I show that, when there is weak demand, it can be optimal for the underwriter to oversell an issue and take a naked short position. The issuing firm benefits from a higher expected offer price. This is in spite of the fact that, in equilibrium, allocating more shares when there is weak demand requires greater underpricing when there is strong demand.

Date: 2004
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