“Equilibrium in the IPO Market” by Jay RITTER
University of Florida
Much of the initial public offering (IPO) literature can be summarized as fitting square pegs into round holes. In this survey, I criticize the ability of popular asymmetric information-based models to explain the magnitude of underpricing that is observed. I suggest that the quantitative magnitude of underpricing can be explained with a market structure in which there is limited competition between underwriters, underwriters want to underprice excessively, and issuers are focused on services bundled with underwriting rather than on maximizing the offer proceeds. Since the technology bubble burst in 2000, IPO volume has been low in many developed countries. I suggest that low returns on small firms account for some of this decline in activity. I also discuss the long-run performance literature. My interpretation of the evidence is that except for the smallest companies going public, IPOs have long-run returns that are similar to those on seasoned stocks with the same characteristics.