1. Why are auction based IPOs underpriced? Panos Patatoukas

2. Motivation and Research Question The underpricing phenomenon of traditional IPOs is a well established fact in the finance literature. But what about auction based IPOs? In theory the clearing price of a well designed auction is virtually equal to the market price so the first day return should be zero and underpricing non existent. But in reality auction offerings are not “underpricing free”! Why?

3. Summary of results My simple two-step experimental design yields results consistent with auction based IPOs being underpriced when information asymmetry is high. It also accommodates for no underpricing when information asymmetry is low. Further, my experimental setting predicts that high underpricings are accompanied by high trading volume, price volatility and bid ask spread

4. Pros and Cons of an experimental design Pros: the experiment allows me to investigate both the pricing of an IPO and the aftermarket performance, volatility and trading volume isolating the effect for example of price support, underwriter/ issuer’s liability concerns, flipping, marketing events etc. Cons: To the extent that my experimental design unreasonably abstracts from reality any results obtained should be cautiously considered.

5. Auction theory Background The auction literature suggests that the pure common value multi unit auction setting is susceptible to underpricing. Further, the magnitude of the underpricing is a function of the information asymmetry among bidders. Introduce the winner’s curse idea in the multi unit auction setting. Intuition: If the bidder has a positive probability of influencing the price then he has an incentive to shade his bid. I model the auction IPO, as a multi unit uniform price auction with pure common values in which each bidder receives a private signal for the value of a unit of stock and accordingly submits his demand schedule in the form of multiple sealed bids.

6. Simple Experimental Design For the auction IPO I adopt the mechanism used in the US; a sealed bid, uniform (descending) market clearing price auction in which bidders participate with multiple bids The SEC allows the auctioneer-investment banker to provide the preliminary results of the auction in the form of private guidance to (institutional) bidders. The market clearing price (stop out price) is the highest price at which the aggregated demand at least equals the supply. In the post issue market the winning bidders are allowed to trade their allocations and both winning and losing bidders are allowed to participate. The post IPO market is designed as an open cry double auction. My experimental design allows for two scenarios, high and low information asymmetry, corresponding to the low and high precision (ε) of the bidders’ privately received signals.

7. Hypotheses My simple experimental setting provides a realistic reflection of the auction based IPO setting in the US and allows me to test the following two hypotheses: H1: Auction based IPOs can be underpriced and the underpricing is more likely to surface when the information asymmetry is high (low signal precision). H2: The trading volume and price volatility is high (low) when the information asymmetry is high (low); high underpricings are followed by high TV and PV

8. Experimental results: Overview Table1: Overview of all treatments Round 1Round 2 low precisionhigh precisionlow precisionhigh precision Auction price14121517 First day close1612.116.217 True value16121617 Pro rata82.47%61.07%67.80%64.52% First day return14.29%0.83%8.00%0.00% Underpricing14.29%0.00%6.70%0.00% Volume56435744 Trading time (in sec.)200 180150 Volatility0.6230.1090.4410.745 Average Bid Ask Spread2.5430.6801.8071.478

9. Experimental results Round 1, low signal precision

11. Experimental results Round 1, high signal precision

13. Experimental results Round 2, low signal precision

15. Experimental results Round 2, high signal precision

17. Conclusions This paper adopts a simple model of pure common values with private affiliated signals in the setting of multi unit sealed bid auctions & provides experimental evidence that auction based IPOs can be significantly underpriced when information asymmetry is high. High underpricings are accompanied by high trading volume, price volatility and bid-ask spread. If the current mechanism adopted for the auction IPOs is prone to underpricing then the blame is not on the investment bankers that carry out the auction offerings, but on the structure of the “game” that delivers the underpricing. The quest for the most efficient IPO mechanism has begun...