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A noob question: Why don’t companies just bypass the underwriters and offer their stock for sale using a Dutch auction, where the price starts very high and gra

by alexkon 10y ago

A noob question: Why don’t companies just bypass the underwriters and offer their stock for sale using a Dutch auction, where the price starts very high and gradually decreases until the most optimistic investors decide to buy? That way, the company always sells at the highest price the market is ready to offer.

Hermel 10y ago
I think Google tried something like that, with mixed success. I think that firms should actually do IPOs in multiple incremental steps.
gjem97 10y ago
Companies with limited name recognition outside of their industry--Okta comes to mind--may not be able to scare up enough liquidity in the marketplace to absorb the millions of shares on offer by the company. A true unrestricted dutch auction may end up going off close to zero. That's what the IPO roadshow is about, giving your pitch and soliciting bids for shares. The investment banks act as gatekeepers to these potential investors, and arguably getting face time with their clients is a large part of what the fees the company pays are for.
- jcfrei 10y ago
  Couldn't such an auction be performed entirely online? An online dutch auction where institutional and retail investors can buy shares in an online live auction? There might be some technical hurdles to solve to ensure everybody is updated while the auction is running but this would at least reduce the liquidity problem for these auctions.
  - gjem97 10y ago
    Yes, however I think the hard part is getting the attention and interest of the investors in the first place. The IBs also act as a quality signal in the other direction, too. That is, I, as a potential investor am more likely to invest if the deal is brought to me by Morgan Stanley than if presented on some startup platform. I'm not passing judgement on that mindset, I'm just pointing out that it is the case for a large percentage of those potential investors.
DenisM 10y ago
Dutch auction has notable downsides, namely the free-rider problem. The way it's supposed to work is that a number of investors do due diligence, decide on the price they think it's worth it to them, and make their bids. Once enough pledges been made, the lowest price is given to all bidders. However an investor may decide to join in without any effort put into due diligence. Instead he will decide to bid high and rely on others to set the fair price. First, the "honest" investors end up paying for the free riders. Second, the free-riders end up crowding in and bidding up the price above the reasonable level. Consequently the "honest" investors put all the effort into it and end up with nothing to buy at their determined price. In the end "honest" investors end up not participating at all, so the Dutch auction thing just fell apart. In short, smart money was in charge setting correct price, but smart money was crowded out by dumb money. This problem is not unique to Dutch auctions, but it appears that that's where it is the most acute.
- CobrastanJorji 10y ago
  Could you explain a bit more? I don't see how free riders are a problem. Anyone who's willing to pay an arbitrarily high price in order to get in on the stock should probably get some stock. If there are enough such actors, they'd significantly raise the sale price, but that's the point, isn't it?
  - DenisM 10y ago
    Two problems: 1. Suppose two funds compete, and the both partake in a Dutch auction. They end up with having the same stock at the same price at the dutch auction, and so the same income. However the free-rider gets fewer expenses so his profits are higher. The diligent fund is losing to the free rider in profits. After a while there are no more diligent funds. 2. The diligent fund prices stock at "proper" value, the free-rider prices it higher hoping to pay the lower, "proper" price but getting ahead of the diligent fund in the queue. If there are many free-riders they all end up in the queue before the diligent fund, so the latter may get less stock, or no stock at all. After a couple of such experiences the diligent funds stop partaking in any new Dutch auctions.
- alexkon 10y ago

by alexkon 10y ago

Hermel 10y ago

I think Google tried something like that, with mixed success. I think that firms should actually do IPOs in multiple incremental steps.

gjem97 10y ago

Companies with limited name recognition outside of their industry--Okta comes to mind--may not be able to scare up enough liquidity in the marketplace to absorb the millions of shares on offer by the company. A true unrestricted dutch auction may end up going off close to zero. That's what the IPO roadshow is about, giving your pitch and soliciting bids for shares. The investment banks act as gatekeepers to these potential investors, and arguably getting face time with their clients is a large part of what the fees the company pays are for.

jcfrei 10y ago
Couldn't such an auction be performed entirely online? An online dutch auction where institutional and retail investors can buy shares in an online live auction? There might be some technical hurdles to solve to ensure everybody is updated while the auction is running but this would at least reduce the liquidity problem for these auctions.
- gjem97 10y ago
  Yes, however I think the hard part is getting the attention and interest of the investors in the first place. The IBs also act as a quality signal in the other direction, too. That is, I, as a potential investor am more likely to invest if the deal is brought to me by Morgan Stanley than if presented on some startup platform. I'm not passing judgement on that mindset, I'm just pointing out that it is the case for a large percentage of those potential investors.

DenisM 10y ago

Dutch auction has notable downsides, namely the free-rider problem. The way it's supposed to work is that a number of investors do due diligence, decide on the price they think it's worth it to them, and make their bids. Once enough pledges been made, the lowest price is given to all bidders. However an investor may decide to join in without any effort put into due diligence. Instead he will decide to bid high and rely on others to set the fair price. First, the "honest" investors end up paying for the free riders. Second, the free-riders end up crowding in and bidding up the price above the reasonable level. Consequently the "honest" investors put all the effort into it and end up with nothing to buy at their determined price. In the end "honest" investors end up not participating at all, so the Dutch auction thing just fell apart. In short, smart money was in charge setting correct price, but smart money was crowded out by dumb money. This problem is not unique to Dutch auctions, but it appears that that's where it is the most acute.

CobrastanJorji 10y ago
Could you explain a bit more? I don't see how free riders are a problem. Anyone who's willing to pay an arbitrarily high price in order to get in on the stock should probably get some stock. If there are enough such actors, they'd significantly raise the sale price, but that's the point, isn't it?
- DenisM 10y ago
  Two problems: 1. Suppose two funds compete, and the both partake in a Dutch auction. They end up with having the same stock at the same price at the dutch auction, and so the same income. However the free-rider gets fewer expenses so his profits are higher. The diligent fund is losing to the free rider in profits. After a while there are no more diligent funds. 2. The diligent fund prices stock at "proper" value, the free-rider prices it higher hoping to pay the lower, "proper" price but getting ahead of the diligent fund in the queue. If there are many free-riders they all end up in the queue before the diligent fund, so the latter may get less stock, or no stock at all. After a couple of such experiences the diligent funds stop partaking in any new Dutch auctions.
alexkon 10y ago