Do Advisers Mitigate IPO Underpricing and Withdrawals in Europe?

Many issuers have doubts about the efficiency of the IPO market, despite post-2008 regulations designed to reduce conflicts of interests and the costs of going public.  As a result, fewer companies are choosing to be listed, and many of those that do go public hire independent advisers to gain peace of mind throughout the process[1].

In our new paper, we ask whether such advisers reduce IPO underpricing and whether issuing firms benefit from greater certainty of execution or lower total fees.  We concentrate our analysis on the three leading IPO advisers in Europe (Rothschild, Lazard and STJ Advisors), which together account for 77 percent of advised IPOs by volume in our sample period from 2010 to 2017.  In particular, we examine whether the degree of IPO specialization and contractual features of these three advisers affect the extent to which the IPOs they handle are underpriced or withdrawn.  An issuer typically hires an adviser to monitor underwriters, but there’s a risk of collusion between the adviser and those underwriters[2].  The risk is exacerbated by the small number of underwriters, lead investors, and advisory firms that participate in IPOs repeatedly.

First, we find evidence consistent with monitoring theories (e.g. Ljungqvist and Wilhelm (2003)[3]), namely that first-day returns decrease as an adviser’s monitoring intensity increases.  The variations in how the three leading advisers affect first-day returns is concealed in the insignificant average effect of advised versus non-advised deals and is not examined in prior regulatory or academic studies.

Second, we find that pegging adviser compensation to the IPO price can mitigate agency conflicts, as predicted by underwriting contracting models (e.g. Baron (1982)[4], Biais, Bossaerts and Rochet (2002)[5]). We examine advisers’ contracts and find that the more specialized advisers have monthly retainers, success or ratchet fees, and additional features that allow them to closely monitor underwriting banks.  Less specialized advisers typically have completion fees only. We find no evidence that the greater  underpricing associated with less specialized advisers is explained by their greater incentive to complete IPOs, namely that it represents the extra cost of reducing the withdrawal rate of IPOs.  We conjecture instead that less specialized advisers provide unobserved corporate finance and M&A advice with an IPO, and that greater underpricing may be a de facto payment by issuers for such advice.

Third, in order to explore our hypothesis that less specialized advisers may form coalitions with favored banks, we test for the type of collusion predicted by theories of three-tier (principal-agent-supervisor) hierarchies (e.g. Tirole (1992)[6]). We examine hypothetical adviser-bank pairs to assess any significant impacts on underpricing, fees, or withdrawal rates. We find that the two leading M&A banks by market share in our sample are associated with significantly higher first-day returns when advised by the two less specialized advisers. We test whether such coalitions might be benign for issuers, but find no evidence that IPO withdrawals are reduced and only mixed evidence that issuers benefit from lower total fees or fee payouts.

Finally, we find evidence consistent with “economies of scope” arguments (e.g. Gao, Ritter and Zhu (2013)[7]), namely that the IPO market is not functioning efficiently for small issuers.  Contrary to the notion that advisers provide a form of insurance against agency conflicts for inexperienced owners or managers undertaking their first IPO, we find that the smallest and least sophisticated issuers suffer a higher degree of underpricing in advised versus non-advised deals. This may be a reflection of greater unobserved corporate finance and M&A efforts prior to an IPO, requiring higher first- day returns to get an IPO sold.  It may also be evidence that adviser-bank coalitions prey on unsophisticated IPO issuers who are one-time participants in a game involving repeat players.

The link we discover between underpricing, adviser specialization, and bank-adviser coalitions points to a possible quid pro quo. In a worst case, advisers may be selecting banks and making pricing recommendations against the interests of their issuing clients, particularly if such issuers are small or unsophisticated firms.  In a benign case, advisers may be passing the benefits of coalitions to their issuing clients in the form of reduced fees or lower withdrawal rates.

Our data and findings relate to European IPOs launched in the period following the global financial crisis during which a specialist adviser (STJ) was a new entrant in a fast-growing market for IPO advice previously dominated by two firms (Rothschild and Lazard).  Given low fees and first-day returns in our sample compared with earlier periods and other markets, it seems likely that issuers were mostly encountering benign coalitions in the period of our analysis.  It also raises questions as to whether our findings would apply to other time periods or other markets, in particular the U.S., where another specialist adviser (Solebury Capital) has established itself as a market leader in IPO advice over the past decade.  In any event, competitive equilibriums shift over time, and regulators may wish to protect issuers by requiring greater transparency in advisers’ contracts with issuers and relationships with banks.  This would bring the IPO advisory market in line with current practice for sell-side research analysts and pension and mutual fund investment advisers.  Issuers would then gain the peace of mind they seek.


[1] While the rate of advised IPOs worldwide was below 10 percent prior to 2008, it now stands between one-third and one-half of all IPOs in Asian and European markets, and one-quarter of IPOs in the US.

[2] There is a rich literature on collusion and contracting.  Designing collusion-proof contracts is particularly relevant in low monitoring states, for example in inducing an efficient decision to launch or postpone an IPO, or in choosing between an M&A or IPO exit.

[3] Ljungqvist, A., Wilhelm, W.J., 2003. IPO pricing in the dot-com bubble. Journal of Finance 58, 723- 752.

[4] Baron, D.P., 1982. A model of the demand for investment banking advising and distribution services for new issues. Journal of Finance 37, 955-976.

[5] Biais, B., Bossaerts, P. Rochet, J.-C., 2002. An optimal IPO mechanism. Review of Economic Studies 69, 117-146.

[6] Tirole, J., 1992. ”Collusion and the Theory of Organizations.” in Advances in Economic Theory, vol. 2, ed. J.J. Laffont, Cambridge University Press.

[7] Gao, X., Ritter, J. R., & Zhu, Z., 2013. Where Have All the IPOs Gone? Journal of Financial and Quantitative Analysis, 48(06), 1663-169.

This post comes to us from Emmanuel Pezier, a researcher at Cass Business School, City, University of London, and a former investment banker at Goldman Sachs, JPMorgan, and other firms. It is based on his working paper, “Do Independent Advisers Mitigate IPO Underpricing and Withdrawals in Europe?,” available here.