5 ms·

The investment bank's fee is a percentage of the proceeds (typically around 7%), so you're saying that they gave up millions of dollars as a favor to their "fri

by evanpw 11y ago

The investment bank's fee is a percentage of the proceeds (typically around 7%), so you're saying that they gave up millions of dollars as a favor to their "friends". I think it's more likely some combination of: a) they screwed up (60% is too high); b) they have to balance making as much money as possible (=> high price), and not ripping off the investors they hope will participate in future IPOs (=> low price); and c) current shareholders want a healthy secondary market and a good collection of longer-term shareholders, even if that means getting paid somewhat less for the ~5% of the company they just sold off.

btilly 11y ago
Don't forget that the investment bank buys a portion of the IPO for themselves that they sell off later. If the fee is 7% of proceeds and the pop is 60%, then retaining anything above 12% of the IPO would leave them making more from the pop than the IPO. Secondly you have to look at the agency problem. The investment bank earns 7% fees, but the investment banker does not. However the people the investment banker sells the IPO to makes the full pop. And that list these days often includes a nice chunk for "friends and family". Nobody admits to kickbacks, but it is not hard to structure a deal where it is not in the investment banker's personal interest to act in the interest of the company going public. Truth be told, I haven't paid much attention to this for a while. But look at http://www.econ.yale.edu/~shiller/behfin/2002-04-11/loughran-ritter.pdf http://www.econ.yale.edu/~shiller/behfin/2002-04-11/loughran... for an analysis of this issue during the dot com era. Their conclusion was that investment bankers were clearly NOT operating in the best interests of the companies going public.
- evanpw 11y ago
  > Don't forget that the investment bank buys a portion of the IPO for themselves that they sell off later. I think you may be misunderstanding the "green shoe option": http://www.investopedia.com/articles/optioninvestor/08/greenshoe-option-ipo.asp http://www.investopedia.com/articles/optioninvestor/08/green.... The underwriting bank sells short some shares to investors at the IPO price before it starts publicly trading, and has the option to buy back those shares from the issuing company at (a small discount to) the IPO price. If the price goes up after opening, then they buy and sell those shares at (nearly) the same price, so they only make money by making 7% of a larger number. If the price goes down after opening, they can buy shares on the open market at a price less than the IPO price, and keep 100% of those profits. For example, the banks underwriting the Facebook IPO made $100m because of the price drop (http://blogs.wsj.com/deals/2012/05/23/morgan-stanley-other-underwriters-make-100-million-profit-on-facebook-ipo/ http://blogs.wsj.com/deals/2012/05/23/morgan-stanley-other-u...). I also think that this particular agency problem is not as bad as you think. Investment banks typically determine compensation as some (mostly-)fixed percentage of revenue, so the investment banker should expect his pay to be pretty close to proportional to the amount of money he makes for the bank. This is even more true for the people near the top who are making the final decisions about where the IPO will price. I totally agree that the process could be improved, and that a 60% first-day return is too high, but I don't think it's prima facie evidence of corrupt dealings by the underwriters.

by evanpw 11y ago

btilly 11y ago

Don't forget that the investment bank buys a portion of the IPO for themselves that they sell off later. If the fee is 7% of proceeds and the pop is 60%, then retaining anything above 12% of the IPO would leave them making more from the pop than the IPO. Secondly you have to look at the agency problem. The investment bank earns 7% fees, but the investment banker does not. However the people the investment banker sells the IPO to makes the full pop. And that list these days often includes a nice chunk for "friends and family". Nobody admits to kickbacks, but it is not hard to structure a deal where it is not in the investment banker's personal interest to act in the interest of the company going public. Truth be told, I haven't paid much attention to this for a while. But look at http://www.econ.yale.edu/~shiller/behfin/2002-04-11/loughran-ritter.pdf http://www.econ.yale.edu/~shiller/behfin/2002-04-11/loughran... for an analysis of this issue during the dot com era. Their conclusion was that investment bankers were clearly NOT operating in the best interests of the companies going public.

evanpw 11y ago
> Don't forget that the investment bank buys a portion of the IPO for themselves that they sell off later. I think you may be misunderstanding the "green shoe option": http://www.investopedia.com/articles/optioninvestor/08/greenshoe-option-ipo.asp http://www.investopedia.com/articles/optioninvestor/08/green.... The underwriting bank sells short some shares to investors at the IPO price before it starts publicly trading, and has the option to buy back those shares from the issuing company at (a small discount to) the IPO price. If the price goes up after opening, then they buy and sell those shares at (nearly) the same price, so they only make money by making 7% of a larger number. If the price goes down after opening, they can buy shares on the open market at a price less than the IPO price, and keep 100% of those profits. For example, the banks underwriting the Facebook IPO made $100m because of the price drop (http://blogs.wsj.com/deals/2012/05/23/morgan-stanley-other-underwriters-make-100-million-profit-on-facebook-ipo/ http://blogs.wsj.com/deals/2012/05/23/morgan-stanley-other-u...). I also think that this particular agency problem is not as bad as you think. Investment banks typically determine compensation as some (mostly-)fixed percentage of revenue, so the investment banker should expect his pay to be pretty close to proportional to the amount of money he makes for the bank. This is even more true for the people near the top who are making the final decisions about where the IPO will price. I totally agree that the process could be improved, and that a 60% first-day return is too high, but I don't think it's prima facie evidence of corrupt dealings by the underwriters.