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Vanderbilt Law Review

First Page

964

Abstract

The market for initial public offerings ("IPOs") of common stock is inefficient, and this fact is not reflected in securities law. New statistical evidence shows that, on average, companies go public at times when the general stock market is priced 22.7% higher than its normal level, and that underwriters sell IPO stock at a further 12.5% premium to the prevailing, high market. These two figures are based on the long-term performance of IPOs and comparable non-IPO stocks over the period 1970 to 1990, and are consistent with the beliefs of knowledgeable practicing investors.

The value and number of IPOs varies greatly from year to year, but overpayment by the public averages out to at least $1.4 billion annually, counting both of the aforementioned pricing phenomena. The effort to capture this inefficiency draws resources away from productive economic activity and so imposes a drag on national well-being beyond the amount of the overpayment. To at least some degree, the short-term benefits to issuing companies and investment banks are offset by the intense cyclicality of the IPO market. Certain practices of underwriters facilitate IPO overpricing. These practices include stabilization, issuance of unduly positive research reports on recent IPOs, the syndicate penalty bid, and refusal to lend shares for short sales. Securities law can and should be used to discourage or eliminate these activities.

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