IPO pricing and dealers’ interaction: a stochastic frontier approach

This study investigates the impact of ongoing relationships between lead managers and institutional investors on Initial Public Offerings (IPO) pricing. Differently from previous studies that are focused on allocations of underpriced shares we propose a model of primary market pricing in which the incomplete adjustment of the offer price to its maximum achievable level depends on the intensity of interactions that occurred between players in the years before the IPO. Using a stochastic frontier approach on a sample of 1 677 US IPOs between 2000 and 2016 the paper shows that the more investment banks and investors regularly work together the more the IPO offer price is set closer to the fair value of the issuing firm. This study helps to disentangle the ambiguous effects of underwriters’ discretion on IPO primary market pricing when bookbuilding is used. We then support the idea that banks can maximize value to issuers by fostering a regular clientele of investors.