Price Stabilization as a Bonding Mechanism in New Equity Issues

Posted: 24 Sep 2002

See all articles by Lawrence M. Benveniste

Lawrence M. Benveniste

University of Minnesota - Twin Cities - Carlson School of Management

Walid Y. Busaba

University of Western Ontario - Ivey Business School

William J. Wilhelm

University of Virginia - McIntire School of Commerce

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Abstract

Firm-commitment offerings in the U.S. are characterized by offer prices conditioned on information gleaned from indications of interest solicited from prospective investors. When such information can be used to persuade some investors to purchase shares at a price in excess of their initial estimate of the fair value, underwriters have an incentive to overstate investor interest. Our analysis shows that this incentive is eliminated when the underwriter makes a commitment to secondary market price stabilization. Destroying the underwriter's incentive to overstate interest reduces the total surplus captured by initial investors in IPOs. Further efficiency gains are associated with penalty bid systems that permit the underwriter to make the stabilization commitment selectively. Price stabilization can thus be viewed as a bonding mechanism that improves the efficiency of the primary equity market.

JEL Classification: G12, G13

Suggested Citation

Benveniste, Lawrence M. and Busaba, Walid Y. and Wilhelm, William J., Price Stabilization as a Bonding Mechanism in New Equity Issues. Available at SSRN: https://ssrn.com/abstract=333082

Lawrence M. Benveniste

University of Minnesota - Twin Cities - Carlson School of Management ( email )

321 19th Avenue South
774 Management and Economics
Minneapolis, MN 55455
United States
612-624-4563 (Phone)
612-626-1335 (Fax)

Walid Y. Busaba

University of Western Ontario - Ivey Business School ( email )

1255 Western RoD
London, Ontario N6G 0N1
Canada
519-661-4178 (Phone)
519-661-4184 (Fax)

HOME PAGE: http://www.ivey.uwo.ca/faculty/directory/walid-busaba/

William J. Wilhelm (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

Rouss & Robertson Halls, East Lawn
P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-924-7666 (Phone)
434-924-7074 (Fax)

HOME PAGE: http://gates.comm.virginia.edu/wjw9a/

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