Rigging the IPO game

The (not so) funny thing is that this has been a very well known problem for... ever. I'm reading "The House Of Morgan: An American Banking Dynasty and the Rise of Modern Finance" by Ron Chernow - highly recommended - and you can find the same mechanisms and scandals (with little variances) dating back at least to the 1920s.<p>Mixing trading and underwriting in the same firm is bound to create enormous conflicts of interest, no matter how tall the internal "Chinese walls" between departments are. This is imho definitely a place where strong regulations and strong checks are needed.

I've been on the buy-side for many years and the IPO market is a joke. Every time an IPO pops +20% it's irrefutable evidence that the banks are either incompetent and/or untruthful. I remain mystified that companies, particularly the hot issues like LinkedIn, ProtoLabs, et al, dont opt for auctions. It's the 8th wonder of the world.<p>The other solution would be to be to have an adjustable underwriting fee that declines depending on how much the stock is up using the ~5 day average closing price after the IPO. If the stock was up some percent over the IPO price, say 40%, the underwriting fee would drop from 7% to 1%. Over 50%? No fees. Something along those lines would keep the banks honest. You failed (purposefully or not) to price the offering correctly and needlessly transferred hundred of million in wealth from the company to trading clients? Fine, you dont get paid.<p>For the hot issues, trust me, there is still plenty of demand. Tons. You really think no one would buy Splunk at $35, that an IPO would fail? It happens millions of times per day already in the secondary market, so clearly there's more than enough demand. The difference would be that the hedge funds who generate utterly insane commission dollars wouldn't have an interest in the offering...it would be more buy-and-hold guys subscribing, and those folks just aren't that profitable for the bank trade desks. I used to work at one of these big funds and I've seen this all first hand and it's ridiculous.

Reading this immediately made me think of what Facebook did <i>right</i> with their IPO. Uninformed observers criticized them for overpricing their IPO, while in reality (unlike LinkedIn, eToys) they succeeded in raising as much cash as they could (for more: <a href="http://blogmaverick.com/2012/09/04/facebook-handled-their-ipo-exactly-right/" rel="nofollow">http://blogmaverick.com/2012/09/04/facebook-handled-their-ip...</a>)

Goldman didn't do what they are being accused of, and if they did there is nothing wrong with it. Besides, the best way to prevent this sort of thing from ever happening again is to not punish anyone, except possibly the guy who blew the whistle.

Is there a reason more companies don't do what Google did and simply sell the initial shares by dutch auction? Even without the perverse incentives, I can't see any possible advantage to hiring a wall street bank to guess a price and allocate it to only a fraction of the market.

The line I find most telling:<p>&#62; ...Goldman has argued that, contrary to popular belief, underwriters do not have a fiduciary duty to the companies they are underwriting.<p>Why would <i>anyone</i> use a financial institution who doesn't think they have a fiduciary duty to their clients?

Reading this brought me back to all the comments surrounding the Facebook IPO.<p>There were a bunch of people using the fact that the stock didn't pop and that they had to use the greenshoe to prop up the price as a sign of failure when in fact it was really a way to approximate the dutch auction process by overselling and then pulling back to get to market equilibrium.<p>Then there were all the investors saying they were hurt by the IPO because it didn't pop and they couldn't sell it a few hours after buying it, so they took a loss. They then argued that this was a bad move because now Facebook stock had a bad name in the markets which would hurt more long-term than if they had just submitted to common practice by giving them some free profits for doing no work.<p>The old days of making 4x returns in a few hours of busy work on a trading terminal must have been really nice.

Naive question from someone who knows next to nothing about IPOs:<p>Why not just divide the shares up amongst the existing shareholders, and just let them sell them normally on the market? Then the company/founders/vcs can just sell shares at whatever pace they want to, at whatever fair market value is.<p>It seems like the only possible outcome of a single day sale is information asymmetry, which means <i>someone</i> will always get "screwed".

Why can't companies do a slow rolling IPO? So say you sell 1M shares on day 1 at $20 which is what your underwriters price you at. Then 2M shares on day 2 at market price. Then 4M on day 3 and 8M on day 4 etc.

Why would a company agree to be "IPO'd" for such a low price? Doesn't the company and its shareholders need to accept some blame here?<p>Fair enough that the bankers may have nefarious intent and they shouldn't get away with it but agreeing to such a shitty deal out of ignorance is pretty stupid.

“If you think eToys got screwed, what do you think happened to the country?”<p>Sad.

I remember the article that basically made me care about IPOs was this story about the IPO of Microsoft: <a href="http://features.blogs.fortune.cnn.com/2011/03/13/inside-the-deal-that-made-bill-gates-350000000/" rel="nofollow">http://features.blogs.fortune.cnn.com/2011/03/13/inside-the-...</a>.<p>It's long as winter, but it actually made IPOs very relatable, not to mention exciting.<p>It gives you a good understanding of the circus surrounding the offering price.

When I read articles like this it's always centered around the bigger companies like Goldman and such, are there smaller companies who can handle taking an IPO public? I mean these guys are a business and need to make money, but feel like a smaller firm would be more transparent and willing to work with you and not for their other more well established clients.

To this who ask "why not use an auction", there's been some research on that: <a href="http://insight.kellogg.northwestern.edu/article/why_do_ipo_auctions_fail" rel="nofollow">http://insight.kellogg.northwestern.edu/article/why_do_ipo_a...</a><p>In short, game theory strikes again: lazy auctioneers bid high blindly and hope that others will do the actual research to set the end price fairly, but those others have less incentive to do research because they are getting priced out by the lazy bums anyways. Another problem is that some bidders irrationally assume that a more popular stock is more valuable, so they too contribute to overpricing. As a result, sophisticated investors are staying away from auctions.

Are GS losing business due to this constant negative press which they get?

Are there any startups - or even startup concepts - that have a chance to disrupt entities like Goldman Sachs? How is it that a firm with such a reputation keep getting new business and very high fees?

Why isn't the price of a share set up to an unrealistically high value on the first day? The price would eventually go down to match the proper value of the share.

This article should be read by anyone who wants to understand why things are the way they are now.