Monthly Archives: November 2016

The U.S. IPO underwriting market is highly profitable. IPO gross spreads, most of which cluster at 7% of the proceeds, are high in both absolute terms and relative to those in other countries. In addition, returns on IPO stocks on the first day of trading (i.e. IPO underpricing) are even higher than the gross spreads, leaving much money on the table. Investors who are allocated underpriced IPO shares are beneficiaries of the money left on the table. Since the allocation of IPO shares is at the discretion of the underwriters, interested investors have incentives to reward underwriters for their favorable allocations. This indirect compensation of the underwriters typically takes the form of “soft” dollars, such as abnormally high trading commissions, spinning, and laddering. There is an ongoing debate as to whether the high profitability of the U.S. IPO underwriting market is suggestive of oligopolistic competition among underwriters—i.e. a situation in which each underwriter sets the price for its services with the objective of maximizing its own expected profit—or, alternatively, of implicit collusion in price setting among underwriters—i.e. a situation in which underwriters cooperate in price setting, i.e. they choose underwriting fees and set IPO offer prices with the goal of maximizing their joint expected profit.

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