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In Discussion Paper No. 1211, Michael Brennan and Research Fellow Julian Franks examine how the separation of ownership and control evolves as a result of an initial public offering (IPO), and how the underpricing of an issue can be used by insiders to retain control. They argue that pre-IPO shareholders, who derive private benefits of control, have incentives to underprice new issues so as to ensure oversubscription and rationing. The authors suggest and examine three propositions. First, that insiders use underpricing to discriminate against large investors and in favour of small applicants so as to reduce the size of the largest shareholdings and limit the probability that they will be subject to the monitoring of a larger shareholder or to a hostile takeover. They find strong evidence in favour of this hypothesis. Second, as a result of the rationing process, it is more costly to assemble large blocks of shares. This is also confirmed empirically. Third, if directors obtain private benefits from control and also set the issue price, the underpricing should be more pronounced the lower the fraction of underpricing costs borne by the directors. The empirical results show that these costs are not a significant variable in explaining underpricing although the coefficient has the right sign. Underpricing, Ownership and Control in Initial Public Offerings of Equity Securities in the UK Michael J Brennan and Julian Franks Discussion Paper No. 1211, July 1995 (FE) |