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Why Do IPO Underwriters Allocate Extra Shares when They Expect to Buy Them Back?

Published online by Cambridge University Press:  06 April 2009

Donghang Zhang
Donghang Zhang
Affiliation:
zhang@moore.sc.edu, Moore School of Business, University of South Carolina, 1705 College Street, Columbia, SC 29208.
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Abstract

I argue that overallocation is used as a marketing strategy to increase the offer price and aftermarket price of an initial public offering (IPO). I show that, when there is weak demand, it can be optimal for the underwriter to oversell an issue and take a naked short position. The issuing firm benefits from a higher expected offer price. This is in spite of the fact that, in equilibrium, allocating more shares when there is weak demand requires greater underpricing when there is strong demand.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 39 , Issue 3 , September 2004 , pp. 571 - 594
Copyright
Copyright © School of Business Administration, University of Washington 2004

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