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IPO Fun & Games


As banking fees and margins have declined, we see them backing away from capital intensive activities


Editor's Note: Minyanville is a community of people who share an interest in fiscal literacy. As perspective is an important aspect of our daily routine, we share this exchange with hopes that it adds balance to your process.

Prof. Succo,

I have a question about IPO's. I used to work on a sell-side equity desk but I've been out of both the sell side and the equity world for about 10 years now. Back then, when we priced an IPO and sold it to a syndicate, there was absolutely NO WAY we would let that IPO trade under the pricing. Our market maker would literally sit on the bid and buy millions of shares if necessary to protect our buyers of the deal. Letting the IPO fall under the pricing on the first day of trading was literally grounds for dismissal.

These days, I see many IPO's break their pricing within minutes of opening trading. What's going on here?

Minyan Stephen


You explain eerily well how Wall Street works.

An investment bank used to take some of the large fees they earned for underwriting IPO's (paid by the company in either direct fees or a discount on the issue) in stocks (and other securities) and use the profits to support the stock trading for a day or two. This allowed investment managers a free option to make money: if the deal was successful it could be sold into a rising market; if the deal was heavy, some of these managers would "flip" it back to the underwriter by selling it on the floor (this is why the underwriter was especially careful to choose accounts that would not sell too much stock). Trading type accounts took advantage of this and would "pay back" the underwriter in other ways.

As investment banking fees have declined over time and margins for investment banks are shrinking, we see them backing away from all types of capital intensive activities including market making. The activity you mention I think is in this category: because of less liquidity and less money being made by banks and managers alike, this activity has diminished.

Prof. Succo

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