406 A. Ljungqvist
price. Following a bookbuilding exercise, they could, for instance, overstate investor
interest and price the IPO aggressively. Clever IPO investors will recognize this ad-
verse incentive and, in the absence of any counteracting force, may not cooperate in
the bookbuilding exercise in the first place. By implicitly committing themselves to
price support—which is costlier, the more the offer price exceeds ‘true’ share value—
underwriters may convince investors that the issue will not be intentionally overpriced.
According toBenveniste, Busaba, and Wilhelm (1996), the main beneficiaries of
price support should be the institutional investors who participate in bookbuilding.^16 Us-
ing theRock (1986)framework discussed in Section3.1, Chowdhry and Nanda (1996)
instead view retail investors as the main beneficiaries of price support. Analytically, we
can think of price support as a put option written by the underwriter and held by the
IPO investors, in the sense that stabilizing activities put a floor under early after-market
prices and thus act as insurance against price falls. This may reduce the uninformed
investors’ winner’s curse. Indeed, price support may be a more efficient way of counter-
acting the winner’s curse than Rock’s solution that all IPOs be underpriced on average,
because price support is extended in the states of the world when uninformed investors
suffer the most: overpriced offerings. Underpricing, on the other hand, is a blunter in-
strument because (absent price discrimination) it is offered to both uninformed and
informed investors.
4.2.1. How widespread is price support?
Direct evidence of price support is limited because stabilizing activities are generally
notifiable, if at all, only to market regulators, and not to investors at large. Thus it is
hard to identify which IPOs were initially supported, how the intensity of intervention
varied over time, and at what time support was withdrawn. Most work therefore relies
on indirect evidence. For instance, one might investigate after-market microstructure
data for behavior indicative of price support, and relate it to the underwriter’s pre-
market activities such as bookbuilding. This is particularly promising on NASDAQ,
where underwriters can, and usually do, become market-makers for the companies they
take public.
The microstructure variables of interest are the bid–ask spreads that underwriters
charge (especially compared to competing market-makers who are not part of the orig-
inal IPO syndicate); who provides ‘price leadership’ (by offering the best bid and ask
prices); who trades with whom and in what trade sizes; what risks underwriters take
in the after-market; and how much inventory dealers accumulate (indicating that they
are net buyers).Schultz and Zaman (1994)andHanley, Kumar, and Seguin (1993)find
microstructure evidence consistent with widespread price support, especially among
weak IPOs. Using proprietary Nasdaq data that identifies the transacting parties,Ellis,
(^16) After all, if retail investors provide no pricing-relevant information in the pre-market, there is no reason to
reward them by offering them price support.