Research On Initial Public Offering And Underpricing Finance Essay

Research On Initial Public Offering And Underpricing Finance Essay Initial Public Offering (IPO) of firm is widely underpriced. IPO underpricing is presented as the percentage difference between the offer price and the closing price of the first-trading-day, usually in appearance of initial positive return when shares are newly issued. IPO underpricing is seen as selling shares at discount in the initial offering. The discount requires issuer to leave money on the table to compensate investors, which incur wealth loss for the issuer (Camp, Comer and How, 2006). Therefore, there are numerous theories established to explain the reason for this discount sale in IPO, which generally categorized into four branches: asymmetric information, institutional reasons, control considerations, and behavioral approaches (Ljungqvist, 2007). Among these theories, asymmetric information theory is the most studied direction in the past 40 years. Nevertheless, studies on the institutional and behavioral aspects are heating recently, especially when shedding lights on e merging IPO markets where lack of efficient institutional support and exist over-speculation behavior environment. Evidence of underpricing IPO underpricing phenomenon is firstly academic documented in 1970s (Stoll and Curley, 1970; Reilly, 1973; Logue, 1973; Ibbotson, 1975). Early findings (exclusively focused on US market) indicate that underpricing is influenced by particular periods (Ibboston and Jaffe, 1975) and particular industry, usually natural resource (oil and gas) industry (Ritter, 1984). However, these findings are challenged by Smith (1986) who claimed that underpricing occurs in the entire period of 1960s-1980s, rather than concentrates in particular periods, and underpricing level exists across all industries with average exceeds 15%. Recent study is more convincible with larger time period and sample observations. Loughran and Ritter (2004) document this underpricing discount has averaged around 19% in the US since the 1960s. Nevertheless, underpricing level (i.e. the average first-day return) tends to fluctuate, 21% in the 1960s, 12% in the 1970s, 16% in the 1980s, 15% in 1990-1998 and then exploded to more than 65% in the 1999-2000 internet bubble period, and falling back to 12% in 2001-2008 (reference). Table Empirical studies have extended the scope of research from the US to the whole world. Underpricing is internationally documented, and the level is extremely high in emerging markets. According to (reference)s research, China (1990-1996, 226, 388%); US (1960-1996, 13308, 15.8%); Japan (1970-1996, 975, 24%). Table. (Reference) provides wider research. France: 3-14%; Australia: 11-30%; Taiwan: 30-47%; Greece: 48-64%; Brazil: 74-78.5%; China: 127-950%. Table Due to its short history with strong government control characteristics, Chinese IPO market draws research interest. The average initial return of IPOs in China during 1999-2002 was 3.3 times the average emerging markets initial return (excluding China) and 6.9 times that of developed countries (Reference). Sample size Sample period Initial return (%) Mok and Hui (1998) 87 1990-1993 289.20% Datar and Mao (1998) 226 1990-1996 388.00% Su and Fleisher (1999) 308 1990-1995 948.59% Chen et al. (2000) 277 1992-1995 350.47% Liu and Li (2000) 781 1991-1999 139.40% Chi and Padgett (2002) 668 1996-2000 129.16% Su (2003) 587 1994- 1999 119.38% Chan et al. (2003) 570 1993-1998 175.40% Chan et al. (2003) 286 1999-2000 104.70% Wang (2005) 747 1994-1999 271.90% Kimbro (2005) 691 1995-2002 132.00% Li (2006) 314 1999-2001 134.62% Asymmetric information theory The cornerstone of this theory is that there is asymmetric information among parties (issuer, underwriter, and investor) in the IPO. Chambers and Dimson (2009) proved that the level of trust between investors, issuers, and underwriters plays a crucial role on the level of IPO underpricing over time in the UK. Asymmetric information leads to ex ante uncertainty among parties. Higher ex ante uncertainty results in higher underpricing. Ritter (1984) raised the changing risk composition hypothesis, which assumes that riskier IPOs will be underpriced by more than less-risky IPOs. Beatty and Ritter (1986) then extend Rock (1986)s asymmetric information model (winners curse) by introducing the ex ante uncertainty about an IPOs market clearing price. The ex ante uncertainty among investors over the value of firm determines the underpricing level of the IPO (Loughran and Ritter, 2004). The level of underpricing increases with the degree of ex ante uncertainty about the value of the firm (Beat ty and Ritter, 1986; Ljungqvist, 2007). Firms with more uncertainty about growth opportunities have higher levels of underpricing than other firms on average (Ritter, 1984; Beatty and Zajac, 1994; Welbourne and Cyr, 1999). Under the scope of asymmetric information theory, there are three models: winners curse, principal-agent and signaling. Winners curse assumes informed investors have better information. Principal-agent model argues underwriters gain better information. Signaling model emphasizes on the better information retained by issuers. Winners curse model is based on asymmetric information between informed and uninformed investors (Rock, 1986). This model assumes informed investors have better information about the new firms prospects than the issuer and its underwriters. Uninformed investors would only get unattractive IPO firms shares because informed investors have already picked up attractive firms share with better information. That is to say, uniformed investors would only expect negative return. Consequently, uniformed investors are willing to participate only if new-issue offer prices are low enough to compensate them for expected losses on less attractive issues (Rock, 1986; Ritter and Welch, 2002). Under this assumption, issuers or underwriters have to underprice their IPO shares, i.e. selling with discount, to attract these uninformed investors. Underpricing is seen as compensation to uninformed investors (Beatty and Ritter, 1986). Underwriters have the intention to underprice the IPO shares in order to keep the uninformed investors stay in the market to make offering successful. Underwriter could use underpricing to obtain full subscription in order to make the shares offering successfully. Moreover, Loughran and Ritter (2002) argue that winners curse is not the dominate explanation in IPO underpricing now. Winners curse problem and dynamic information acquisition were main explanations in 1980s in US IPO market. In 1990s US, analyst coverage and side payments to CEOs and venture capitalists (spinning hypothesis) are main reasons (ibid). Welch (1992) claims that underpricing is caused by the cascades effect in the IPO market. This Cascades effect is presented as the asymmetric information between informed and uninformed investors. Underpricing generates information momentum, which results in a higher market clearing price at the end of the lockup period (the time between share-offer day and listed day) when insiders (first buyers) typically start to sell some of their shares. These first buyers behavior would influence the following buyers perception on value of shares. Since there is selling pressure when IPO ends and the analyst coverage starts, the market price could still maintain at a high level in the first-trading-day, thus incur significant underpricing level (Bradley et al. 2003; Ofek and Richardson, 2003; Bradley, Jordan, Roten, and Yi, 2001; Brav and Gompers, 2003; Field and Hanka, 2001). Principal-agent model focuses on asymmetric information between underwriters and issuers (Baron and Holmstrom, 1980; Baron, 1982). Baron (1982) assumes that underwriter is better informed about demand conditions than the issuer, leading to a principal-agent problem. In this model, the function and role of underwriters are mainly studied. Underwriters want to underprice IPOs (Baron and Holmstrom, 1980; Baron, 1982; Loughran and Ritter, 2002/2004; Ljungqvist and Wilhelm, 2003). First of all, underwriter has to underprice in order to sell all shares, i.e. underwriters use underpricing to obtain full subscription in order to make IPO successfully. There are uninformed investors who have the money to invest in the market. Underwriters convince issuers into underpricing to prevent these uninformed investors from leaving the IPO market. Underpricing is to induce underwriters to put forth the correct level of effort (Baron, 1982). Underwriter has to balance this trade-off in the principal-ag ent problem. On one side, underpricing would incur wealth loss for the issuer and reduce commission revenue for underwriters, on the other side, Beatty and Ritter (1986) argue that as repeat players, underwriters have an incentive to ensure that new issues are underpriced by enough lest they lose underwriting commissions (especially for those uninformed investors) in the future. Empirical studies (Nanda and Yun, 1997; Dundar, 2000) claim that underwriters subsequently lose IPO market share if they either underprice or overprice too much. However, the principal-agent model is challenged by Muscarella and Vetsuypens (1989), who argue that underpricing phenomenon still exists in underwriter (investment bank) IPO itself in which there is no principal-agent problem. Second, underpricing could incur over-subsucription in an IPO, which gives underwriter the discretion to allocate IPO shares. Underwriters can decide to whom to allocate shares if there is excess demand. In this case, underwriters discretion acts like interest exchange with their clients. They want to retain the buy-side clients, thus to allocate underpriced IPOs to them. Recurrent institutional investors would get the IPO shares and enjoy a positive initial return (Loughran and Ritter, 2002). Underwriters have an incentive to underprice IPOs if they receive commission business in return for leaving money on the table. Underpricing could facilitate the loyalty between underwriter and its clients, which could in turn facilitate underwriters sale of subsequent IPOs and seasoned offerings. For example, in the late 1990s IPOs were allocated to investors largely on the basis of the past and future commission business on the other trades (Reuter, 2004). Third, spinning effect induces underwriter to underpricing. The spinning explanation describe issuers are willing to hire underwriters with a history of underpricing because issuers receive side-payments. Spinning may be used by the underwriter to acquire IPO deals and influence IPO pricing, but it can also be used as part of a long-term business strategy with a given issuer to attract future underwriter mandates. The side-payments of spinning makes issuers reluctant to change its original underwriter for subsequent offerings (Dundar, 2000; Krigman, Shaw and Womack, 2001; Burch, Nanda and Warther, 2005; Ljungqvist, Marston and Wilhelm, 2006/2009). Spinning effect was first documented by Siconolfi (1997) in a Wall Street Journal article. Specifically, underwriters set up personal brokerage accounts for venture capitalists and the executives of issuing firms in order to allocate hot IPOs to them (Siconolfi, 1997). The hot IPOs means shares those are underpriced and would gain a huge po sitive initial return aftermarket, which would increase the personal wealth of the managers of issuing firms (Loughran and Ritter, 2002). The use of hot IPOs to reward issuers created an incentive for issuers to seek out underwriters who willing to offer this hot IPO through underpricing, rather than to avoid such underwriters. Allocating hot IPOs to the issuers and their friends (through friends and family accounts) allowed underwriters to underprice even more, i.e. selling at a friendly price (larger discount) (Fulghieri and Spiegel, 1993; Loughran and Ritter, 2002; Ljungqvist and Wilhelm, 2003). Underwriters may be more inclined to give favorable allocations of shares to preferred investors (friends, family, executives, etc.) and unfavorable allocations to non-favored non-connected investors. The latter would require higher underpricing to participate in the IPO market. The outcome of this process is not due to ex ante uncertainty, but due to discretionary allocation of shares by underwriters. Furthermore, this discretion is not mitigated by strong institutional framework. During the late 1990s and early 2000, spinning was a widespread practice in the US, despite having one of the strongest investor protection rules at the same time (Liu and Ritter, 2009). Signaling model, first referred by Leland and Pyle in 1977, assumes the issuer itself best knows its prospects (possesses better information). Underpricing is a signal that the firm is good (Allen and Faulhaber, 1989; Grinblatt and Hwang, 1989; Welch, 1989). If the issuer possesses the best information about its true value, a high quality firm could use underpricing as a means to distinguish itself from low quality companies. These firms with the most favorable prospects find it optimal to signal their type by underpricing their initial issue of shares, and investors know that only the best firms can recoup the cost of this signal from subsequent issues. In short, a partial offering of shares is made initially, information is then revealed, and subsequently more shares will be sold. In contrast, low quality companies might tend to price fully (Bergstrom, Nilsson and Wahlberg, 2006). Hiring reputable underwriter with influential analysts would mitigate ex ante uncertainty, thus reduce the underpricing level. Empirical study shows the more market power of underwriter (with strong analyst team, influential and bullish, usually), the more underpricing extent (Hoberg, 2007). Hiring a prestigious underwriter (Booth and Smith, 1986; Carter and Manaster, 1990; Michaely and Shaw, 1994) or a reputable auditor (Titman and Trueman, 1986) is seen as a specific way to reduce the ex ante uncertainty. Carter and Manaster (1990) and Carter et al. (1998) argue that IPOs taken by prestigious underwriters benefit from superior certification. The choice of underwriter indicates the quality of this IPO implicitly, because the reputation of underwriter may provides certain guarantee on the value of the issuer, which in turn, mitigates the ex ante uncertainty, thus the underpricing level would be reduced. Nevertheless, empirical evidences show a mixed result. There is a negative relati on between underwriter prestige and underpricing level in the 1980s, but a positive relation in the 1990s (Beatty and Welch, 1996; Cooney, Singh, Carter, and Dark, 2001). Issuers want to hire reputable underwriters who have, not only because of this could reduce ex ante uncertainty, but also the influential and bullish analyst coverage provided by reputable underwriters (Dunbar, 2000; Clarke, Dunbar and Kahle, 2001; Krigman, Shaw and Womack, 2001). Analyst coverage is crucial on the discovery of true value of the firm, especially its impact on sequent shares offering. Ljungqvist, Jenkinson and Wilhelm (2003) prove that influential analyst could bring the businesses for underwriters (investment banks). Prestigious investment banks also tend to recruit analysts who making optimistic forecasts (Hong and Kubik, 2003). Although analyst coverage is expensive for underwriters (the largest US investment banks each spent close to $1 billion per year on equity research in 2000, for example) (Rynecki, 2002), these costs are covered partly by underwriting fee charging from issuers. Due to the information production cost, many firms would prefer later IPO. Firms d o IPO firstly could incur analyst coverage advantage (more information revelation) for other firms wanting for IPO in the same industry (i.e. free ride effect). In this case, underwriter compensate this information cost for the before Firms with underpricing to investors (Benveniste, Busaba, and Wilhelm, 2002; Benveniste et al., 2003). Moreover, issuers feel reluctant to change its underwriter for seasoned equity offering (SEO) if the underwriter did analyst coverage and the underprice effect is significant in the IPO. Cliff and Denis (2004) proved this with the example 1050 US IPO firms during 1993-2000. When initial offering shares, the issuer increases emphasis on the advertisement effect brought by analyst coverage from underwriter, rather than the level of underpricing itself. Empirical studies (Cliff and Denis, 2004; Dunbar, 2000; Clarke et al. 2007) illustrates that many US issuers accepted underpricing in 1990s since they focused more on choosing an underwriter with an influential analyst than on getting a high offer price. The underlying principal is that underpricing could attract investors attention to this firm. Issuers have the incentive to reduce underpricing, and model their optimal behavior. Firms could gain advertisement benefits from underpricing, which creates beneficial condition for sequent offering (Habib and Ljungqvist, 2001). A high quality firm is underpriced (sell shares at discount) at the initial offering in order to attract market attention through following analyst coverage, usually, massive and efficient analyst coverage would mitigate the asymmetric inf ormation among investors and present the high quality of the firm, finally, the more realization on the true value of the firm among investors could help the firm sell its sequent seasoned offering shares at a higher price (i.e. recoup the loss from the underpricing in the initial offering). This process is called partial adjustment phenomenon (Hanley, 1993). About one-third of all IPO issuers between 1977 and 1982 had reissued equity by 1986, the typical amount being at least three times the initial offering (Welch, 1989). Analyst coverage relates to the future predicted value of the issuer, thus it is important. Moreover, the development of internet and cable television extend the influence of analyst coverage on the share price. In this way, the share price aftermarket would increase, which further provides the opportunity for issuer to offer higher price for its seasoned offering. Behavior Finance Speculative bubble theory After the internet bubble collapse in the US in early 2000, the academic focus transferred to behavior finance. The asymmetric information theory is based on the efficient market hypothesis. The ex ante uncertainty leads to the difficulty on firm valuation for investors, therefore, issuer and underwriter would set higher underpricing level to attract investors. Underpricing is seen as deliberate selling strategy for an IPO, once listed in the secondary market, share price would return to its fair value. Asymmetric information theory predicts lower underpricing if information is distributed more homogeneously across investors (Michaely and Shaw, 1994). However, it is challenged by heterogeneous expectation hypothesis in the stock market (Miller, 1977), which argues this deliberated underpricing strategy of IPO (selling at discount) disrupts the market efficiency (Loughran et al., 1994). According to Miller (1977), there are two assumptions in the market: the heterogeneity expectation and restriction on short-selling. The optimistic investors buy and hold shares, whereas pessimistic investors can not participate in the trade since the short selling is restricted. Consequently, share price reflects the opinion from optimistic investors, and thus the share price is overvalued compared to its fair value. Aggarwal and Rivoli (1990) raised the speculative bubble theory to argue that IPO underpricing is caused by faddish behavior on behalf of investors. This theory reveals there is speculative environment in secondary market, which increases the market price of the first-trading-day, thus incurs severe underpricing phenomenon. The speculative bubble theory to Ibbotsons opinion that underpricing is cyclical, which could date back to 1970s. Ibbotson and Jaffe (1975) found the level of underpricing fluctuates between different time periods. One explanation for the fluctuation may be the fact that there are hot and cold IPO markets (Ibbotson et al., 2001). In a hot IPO market, the average level of underpricing is large and the amount of firms going public increases. Afterwards there is a high rate of firms going public, but the level of underpricing decreases. The following cold period starts with fewer firms going public and very low underpricing or even overpricing. There is strong empiri cal evidence for this recurrent pattern, but the existence of this pattern has not yet seen sufficiently explained theoretically (Ibbotson and Ritter, 1995). Aggarwal (2000) provides empirical evidence to prove there is positive relationship between underpricing level and market index. Faddish investor hypothesis claims that in the hot market, over-optimistic (irrational) investors overpriced the IPO. This means the high initial return of IPO is not caused by deliberate underpricing pre-IPO solely, but is overpriced by optimistic investors in the secondary market. On one side, large amount of irrational investor is the root of high initial return in IPO, because irrational investors determine the transaction price in the secondary market (Ljungqvist, Nanda and Singh, 2003). Ljungqvist and Nanda (2002) claim that personal investor is seen as irrational investor, whereas the issuer, underwriter and institutional investors are seen as rational investor. Ljungqvist and Wilhem (2003) proved that personal investors have over-optimistic expectation on stock return in the hot market and these personal investors are typical noisy traders in IPO market, who prefer to make investment decision in terms of past initial return of previous IPOs. Delong, et al. (1990) reveal the influence of noisy trader on the share price. These noisy traders in IPO market are typical positive market feedback traders. When recent initial returns are high in the IPO market, these investors would purchase new issues, thus these purchases increase the demand for following IPOs, thus raise the initial return for these following IPOs. On the other side, it is believed that inequality of demand and supply of IPO primary market causes or intensifies the speculative environment in the secondary market (Aggarwal, 2000). Inequality between demand and supply leads to speculative opportunity. The underlying reason for this inequality is that IPO mechanism is not market-oriented in some countries, which is controlled by government (China, for example) (Su, 2004). IPO supply in the primary market is not adequate because of the government control. When new issues are over-subscribed, the irrational investors (speculators), who are constrained in the primary market, would be released in the secondary market. Meanwhile, due to the restriction on short selling (in China, for instance), investors could only make money when price increases. Therefore, investors push up the price on the first-trading-day, which causes severe underprcing level. Legal framework theory Legal framework theory could explain the different underpricing level among different countries. Legal framework has significant impact on ex ante uncertainty in IPO market. Ex ante uncertainty caused by regulatory constrains, wealth redistribution, and market incompleteness, leads to the IPO underpricing phenomenon (Mauer and Senbet, 1992). Difference in legal frameworks of various countries explain the ex ante uncertainty degree and the decisions made by investors in the market (La Porta et al., 1997/1998/2002). Cross-country differences in the legal framework affect ownership structure (La Porta et al., 2002), ownership effectiveness (Heugens et al., 2009), capital structure (De Jong et al., 2008), asset structure (Claessens and Laeven, 2003), dividend policy (La Porta et al., 2000), corporate governance (La Porta et al., 2000; Mitton, 2002) and corporate valuation (La Porta et al., 2002). Legal frameworks deem to reduce uncertainty by creating a stable foundation in which subsequ ent human interactions can be grounded (North, 1994; Peng, 2009; Van Essen et al., 2009). First of all, legal framework affects issue firms value. Legal framework can influence the ex ante uncertainty about firm value in more or less the same way as ex ante firm-specific risk at the time of IPO. Firms operating in a legal environment with poor protection of intellectual property rights are unwilling to invest in intangible assets (Research and Development capability, or branding effect, for example), leading to lower firm growth and thus lower firm value. Second, legal framework affects investors decision. Stronger investor protection could reduce the investment risk (for example, lower asset volatility, lower systematic risk, lower stock volatility, higher risk-adjusted return as measured by the Sharpe and Treynor index) (Chung et al., 2007; Hail and Leuz, 2006; Chiou et al., 2010). In countries with weaker legal protection, investors will be more uncertain about realizing a return on their investment (Shleifer and Vishny, 1997). Lower levels of legal protection for investors will create more uncertainty with respect to post IPO strategies and managerial decisions that may negatively affect firm value (Claessens and Laeven, 2003). In a country with a weaker legal framework, managers or dominating shareholders have more opportunities to transfer profits or assets out of the firm at the expense of the minority shareholders. Weaker legal framework could provide opportunity for damaging firm value through transfer pricing, asset strippin g and investor dilution (Cheung et al., 2009; Berkman et al., 2009). This increased probability of ex post expropriation by management or dominating shareholders increases the ex ante uncertainty at the time of IPO (Johnson et al., 2000). The higher the expropriation risk, the more the offer needs to be underpriced to compensate for this ex ante uncertainty. There is conflicts between dominating shareholders and outside shareholders because outside shareholders require higher risk premiums (higher cost of capital) which caused by the weak legal framework (Himmelberg et al., 2004; Giannetti and Simonov, 2006; Albuquerue and Wang, 2008). Although it is argued that issuers can independently improve their level of minority investor protection by a listing on a foreign stock exchange with higher standards of investor protection (i.e. cross-listing), it is doubtful that they can fully compensate for the lack of an adequate legal framework at the country-level (Black, 2001; Reese and Weisb ach, 2002; Roosenboom and van Dijk, 2009). Third, Underpricing could avoid potential legal liability, which is another explanation theory provided by Tinic (1988). It is claimed that underpricing reduces both the probability of lawsuits if subsequently the firm does not do well in the aftermarket, because the investor is the direct recipient of the benefit from underpricing (Milgrom and Roberts, 1986; Tinic, 1988). Underwriters are unwilling to price these offerings at high level, in case that the market would concern about lawsuits and thus damage to its reputation if the shares eventually dropped in price aftermarket. The argument is based on that unsophisticated and uninformed investors were bidding up the price to unjustified levels, and the underwriters were unwilling to price the IPOs at the market price determined by these noise traders. Ownership control theory Ownership control theory is described as IPO is expected to bring in new shareholders, who would dilute the control power of original shareholders (managers), therefore, issuers have less motivation to bargain for higher offer price, and result in underpricing. Ljungqvist and Wilhelm (2003) explain this ownership fragmentation would incur underpricing through the realignment of incentives hypothesis. Logically, the issuer firms holding large proportion shares would have incentive to argue for higher offer price thus reduce the underpricing level (Barry, 1989; Habib and Ljungqvist, 2001; Bradley and Jordan, 2002; Ljungqvist and Wilhelm, 2003). Moreover, the excess demand for shares caused by underpricing enables managers to allocate small stakes of shares to many dispersed small investors. Therefore, original managers control power is strengthened since they would be the dominate shareholders. In other words, underpricing could give the managers power on control (Brennan and Franks, 1 997; Boulton et al., 2007). However, the ownership control theory is challenged. Other substitute mechanisms for retaining control such as takeover defenses, non-voting stocks and alike are more effective, because underpricing can not prevent outside investors from accumulating larger stakes of shares once trading begins in the aftermarket (Ljungqvist, 2007). Issue mechanism Fixed price Offer price = Predetermined price Bookbuilding Underwriter set the final offer price by consulting with investors Auction Offer price = lowest price which bid the final share Hybrid Bookbuilding + Fixed price; Auction + Fixed price Bookbuilding, by which underwriter has the discretion on share allocation, can induce investor to reveal their information through their indications of interest, which can reduce information asymmetry thus lower underpricing (Benveniste and Spindt, 1989; Benveniste and Wilhelm, 1990/1997; Sherman and Titman, 2002; Ritter and Welch, 2002; Gondat-Larralde and James, 2008). On one side, underwriters tend to allocate IPOs to investors who provide information about their demand (i.e. the price discovery process). Price discovery eliminates the winners curse problem, thus reduce underpricing level. On the other side, bookbuilding authorized underwriter the discretion on share allocation (so called rationing allocation). After collecting investors indications of interest, the underwriter allocates no (or only a few) shares to any investor who bid conservatively. This rationing share allocation could reduce the underpricing level. Koh and Walter (1989) found the likelihood of receiving an al location in this mechanism was negatively related to the degree of underpricing, and average initial returns fall substantially from 27% to 1% when adjusted for rationing allocation in Singapore case study. Levis (1990) and Keloharju (1993) claim Rationing share allocation mechanism could reduce the initial return in UK, and in Finland respectively. Aggarwal, Prabhala, and Puri (2002) also find that institutional investors earn greater returns on their IPO allocations than do retail investors largely in bookbuilding mechanism, because they are allocated more shares in those IPOs that are most likely to appreciate in price. However, imposing constraints on the underwriters allocation discretion can interfere with the efficiency of the bookbuilding. The quality of bookbuilding in many European and Asian countries is damaged by certain restriction on the use of bookbuilding, which leading to higher underpricing (Ljungqvist et al., 2003). Requiring that a certain fraction of the shares be allocated to retail investors, as is common in parts of Europe and Asia, reduces underwriters ability to target allocations at the most aggressive (institutional) bidders and so may force them to rely more on price than on allocations to reward truth-telling. Moreover, empirical study indicates that bookbuilding in countries outside the US only reduces the level of underpricing when used in combination with US investment banks (underwriter) and targeted at US investors. Although the functioning of the different issuing me