Abstract

Do Investment Banks Compete in IPOs? The Advent of the 7% Plus Contract

Robert Hansen

Virginia Tech

The large mass of IPOs with a reported spread of 7% has fostered the view that investment banks have colluded and fixed price in unprecedented fashion to profit from IPOs. An alternative view is that the 7% contract is an efficient innovation that customizes the standard firm commitment contract to better suit the IPO. I test several implications of these two views. In the 7% contract era IPO market structure is unconcentrated, there is no apparent evidence of cartel power nor of extra-competitive profit from the7 % IPO, and there is significant entry of new banks. There is evidence of competition between banks in the underpricing. Further results are consistent with the view that the insurance function of IPO underpricing complements the fixed spread.