IPO-mechanisms, monitoring and ownership structure

This paper analyzes the effect of different IPO mechanisms on the structure of share ownership and explores the role of underpricing and rationing in determining investors' shareholdings. We focus on the agency problem that results when large institutions are the only investors capable of monitoring the firm whereas small shareholders free-ride on these activities. The major conclusion is that some well-known aspects of IPOs may be explained as rational responses by the issuer to the existence of regulatory constraints in public capital markets. There is a two-stage offering mechanism in which the investment banker, acting in the interests of the issuer, optimally rations the allotment of shares to small investors in order to capture the benefits associated with better monitoring by institutions. Importantly, in our model, the existence of underpricing land oversubscription) is an indication that the issuer has received a higher ex ante price than would have been obtained through a competitive Walrasian-type offering process. (C) 1998 Elsevier Science S.A. All rights reserved.