How investment bankers determine the offer price and allocation of new issues

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Abstract

We investigate how investment bankers use indications of interest from their client investors to price and allocate new issues. We model the process as an auction constructed to induce asymmetrically informed investors to reveal what they know to the underwriter. The analysis yields a number of empirical implications, including that new issues will be underpriced and that distributional priority will be given to an underwriter's regular investors. We also find that tension between an underwriter's propensity to presell an issue and an issuing firm's desire to obtain maximum proceeds affects the type of underwriting contract chosen.

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We would like to thank Narayana Kocherlakota, Robert McDonald, Jay Ritter, Clifford Smith (the editor), and participants at seminars at Duke University, Northwestern University, the University of Michigan, Boston College, the Ohio State University, the University of Utah, the Federal Reserve Bank of Chicago, the Federal Reserve Board, and the Western Finance Association meetings for their useful comments. Benveniste would like to thank Stuart Greenbaum for support from the Banking Research Center of Northwestern University.

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