Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

FSA’s Concerns about Competitive IPOs

The Financial Services Authority of the United Kingdom has expressed its concerns about
competitive Initial Public Offerings. It was in fact so worried about them that it highlighted them in a
supplement
to its quarterly newsletter List!. The FSA wrote that “we felt we needed to
tell the market about [these issues] immediately, rather than waiting until our next full edition”.

The FSA expressed its concern about the new form of conducting Initial Public Offerings as follows.

“In a standard IPO, the lead manager and other
brokers involved in the IPO are appointed at a
very early stage of the process, forming a
syndicate of brokers. Under competitive IPOs, the
syndicate members, their roles and remuneration
are not defined until late on in the process. This
maintains competitive pressure on the potential
syndicate members as not all the firms involved in
the competitive IPO process will be appointed to
the syndicate after the initial ‘beauty parade’.
In a standard IPO, the lead manager and other
brokers involved in the IPO are appointed at a
very early stage of the process, forming a
syndicate of brokers. Under competitive IPOs, the
syndicate members, their roles and remuneration
are not defined until late on in the process. This
maintains competitive pressure on the potential
syndicate members as not all the firms involved in
the competitive IPO process will be appointed to
the syndicate after the initial ‘beauty parade’.. This
may create ‘pressure points’ and new conflicts of
interest — particularly around the preparation of
pre-deal research and pre-marketing activities. We
understand that one of the reasons issuers favour
competitive IPOs is that it gives them greater
control over the IPO process and greater leverage
over the firms involved.

In a competitive IPO the issuer may be able to
exert pressure on the competing firms, directly or
indirectly, to produce research that is favourable
or which justifies a higher valuation range. This is
because firms could be providing their draft
research to the issuer in circumstances where the
firm is still trying to win a role in the syndicate. In
a competitive market, firms may find it difficult to
resist such pressure. Even where individual firms
have some reservations about the process, they
may feel compelled to participate so they are not
excluded from transactions.”

This concern of the FSA appears quite strange to me. It suggests that
regulators have not learnt the right lessons
from the IPO scandals that took place during the dot com boom in the United States.
Those scandals showed that the investment banks were not trying to get the best
possible price for the shares in the IPO. Competition between investment banks
was of the non price variety. Worse, in some cases, it took the form of allotting
hot stocks of other underpriced IPOs to the CEO and other key decision makers
in an attempt to win the IPO mandate. An IPO process that increases competition on the
basis of price is a move in the right direction.

Regulators however continue to act as if anything unfamiliar is worse than the
status quo even when it is potentially better. The US SEC did the same when
Google decided to auction shares instead of doing a normal IPO. The risk factors
that the SEC forced Google to incorporate in its offer document showed that
the SEC too had not learnt any lessons from the IPO scandals that took place under
its own watch.

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