International Review of Finance, 2:3, 2001: pp. 151±178
On the Demand Elasticity of Initial
Public Offerings: An Analysis of
Discriminatory Auctions*
y
YU-JANE LIU,y K. C. JOHN WEIz AND GWOHORNG LIAW§
Department of Finance, National Chengchi University, Taipei, zDepartment of
Finance, Hong Kong University of Science and Technology, and §Department of
Economics, Tunghai University, Taiwan
ABSTRACT
We analyze 52 Taiwanese IPOs that were introduced through discriminatory
auctions (you pay what you bid) between December 1995 and October
1998. The evidence suggests that the elasticity of demand for IPOs in
Taiwan through discriminatory auctions is relatively flat. The elasticity is
significantly negatively correlated with bidders' heterogeneity, which is
consistent with the investor heterogeneity hypothesis. We also find that
the average winning bidders earn a significant average abnormal return of
7.83% in the post-IPO market. The post-IPO market abnormal return is
positively correlated with the demand elasticity, the idiosyncratic risk of
stock returns and the institutional participation rate, and is negatively
correlated with the auction clearing price, which is consistent with theory.
Finally, there is evidence that informed investors have an incentive to
shade their demand for IPOs to avoid the winner's curse. The most
aggressive bidders (the top 5% of the winning bidders) on average incur a
small loss of 1.64% (not significant) in the market-adjusted initial returns.
I. INTRODUCTION
Traditional finance theory (such as the CAPM, the APT, the Black±Scholes model
and the Modigliani±Miller propositions) assumes that financial assets have
perfect substitutes and their values are independent of their supply. This perfect
* The authors thank the Chinese Securities Association for providing the auction data, and Jay
Ritter, Ann Sherman, Sheridan Titman (the editor), Avi Wohl, two anonymous referees and
seminar participants at the 2001 American Finance Association meetings in New Orleans, the 2000
NTU International Conference on Finance in Taipei, the Chinese Finance Association meetings in
Taipei, the Seventh Conference on the Theories and Practices of Security and Financial Markets in
National Sun Yat-sen University, Kaoshiung, Taiwan (1998) and the Hong Kong University of
Science and Technology for their comments and suggestions and Dr Virginia Unkefer for editorial
assistance. The paper won the best paper award in the 2000 NTU International Conference on
Finance. John Wei acknowledges the financial support from the RGC Research Infrastructure Grant
of Hong Kong Special Administration Region, China (RI/93/94.BM02) and the Wei Lun Fellowship.
ß International Review of Finance Ltd. 2001. Published by Blackwell Publishers, 108 Cowley Road,
Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA.
International Review of Finance
substitution assumption implies that the demand curves are almost perfectly
elastic. In contrast, in many financial models that allow for asymmetric
information, the demand curves for financial assets are not perfectly elastic. As
a result, it is an interesting empirical issue to examine whether actual demand
curves for financial assets are perfectly elastic.1
Studies by Bagwell (1991b, 1992) and Kandel et al. (1999; referred to hereafter
as KSW) employ data from the auctions of common stocks to estimate the
magnitude of price elasticity.2 Bagwell (1992) examines 31 Dutch auction
repurchases of stocks in the US and finds an average (median) supply elasticity of
0.68 (1.05). This implies that the assumption of perfect elasticity is not a valid
approximation of actual demand schedules in this Dutch auction repurchase
sample. On the other hand, KSW analyse the demand schedules of 27 Israeli IPOs
that were introduced through non-discriminatory (uniform-price) auctions and
report an average (median) demand elasticity of 37.2 (21.0) at the auction
clearing price.3 The evidence suggests that IPO demand schedules in Israel are
quite elastic.
Given the conflicting findings of Bagwell and KSW, it is interesting and
important to test the robustness of their results using different samples and
different auction methods.4 The purpose of this study is to analyse the demand
schedules of IPOs in Taiwan that use a different auction method, namely
discriminatory auctions.5 It represents an extension of Bagwell and KSW on the
analysis of the elasticity of demand for common stocks. Since the auctions we
study are discriminatory, they are a strategic rather than a truthful revealing
mechanism. That is, bidders have an incentive to shade their bids to avoid the
1 Asquith and Mullins (1986), Masulis and Korwar (1986) and Loderer et al. (1991), among
others, have reported a significant drop in stock prices when firms announce seasoned equity
offerings. Scholes (1972), Mikkelson and Partch (1985), Holthausen et al. (1990) and Keim and
Madhavan (1994), among others, have found significant price movements for large block
trades. Harris and Gurel (1986), Lynch and Mendenhall (1997), Pruitt and Wei (1989) and
Shleifer (1986), among others, have documented a positive stock price reaction to the
inclusion of a stock in the S&P 500 index. These results appear to be inconsistent with the
notion of perfect price elasticity. However, these papers do not provide evidence on the
magnitude of demand elasticity for stocks.
2 Unlike prior studies that assume that demand curves are stationary, these studies analyze the
actual demand curves observed from the auction data at a given point in time.
3 The two elasticity estimates by Bagwell and KSW are not directly comparable. See the
discussion in KSW.
4 Theory might well predict that demand elasticity is higher than supply elasticity, since any
investor can potentially purchase shares, while only existing stockholders or the firm can sell
shares.
5 In a recent paper, Nyborg et al. (2002) analyze the demand for Swedish Treasury bills and
bonds, which are also offered through discriminatory auctions. However, there are two
differences between their data and ours. First, there are only 14 dealers who can participate in
the Swedish Treasury bills and bonds auctions, while any investor can participate in the
Taiwanese IPO auctions. Second, the auctioned Swedish bills and bonds are concurrently
traded in the secondary market with few exceptions, while the stocks in our sample are initially
offered.
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On the Demand Elasticity of Initial Public Offerings
winner's curse. This bidding behaviour may result in the demand curves being
more elastic than those from nondiscriminatory auctions.
Since December 1995, firms that issue IPOs in Taiwan have been allowed to
choose between a pure public offer with a fixed price or a hybrid of an auction
followed by a public offer (hereafter referred to simply as the `auction method').6
If a firm decides to use the auction method, the IPO must be conducted as a
discriminatory auction that sets a minimum price but not a maximum price. In
these auctioned IPOs, each investor submits a sealed bid that specifies the
demanded quantity and price. Multiple bids from the same investor are
permitted. Both individual and institutional investors are allowed to participate
in the auction. During the sample period, a total of 52 IPOs are introduced
through the auction method.7 We have obtained the full demand schedules of all
these 52 auctioned IPOs from the Chinese Securities Association.8 We find that
the average (median) demand elasticity at the clearing price was 24.45 (20.06).
That is, in the vicinity of winning bids, each 1% price drop was associated with a
24.45% increase in the quantity of shares demanded. This is quite large and one
can conclude that the demand schedules for IPOs in Taiwan are quite elastic.
Our data offer unique advantages and opportunities, which could not be fully
utilized by KSW and Bagwell due to their lack of relevant information. First of all,
our unique discriminatory auction data provide more complete information that
allows us to test the winner's curse. Our analysis indicates that informed bidders
have an incentive to shade their demand to avoid the winner's curse. The most
aggressive 5% of the winning bidders on average incurred only a small loss of
1.64% (not significant) in market-adjusted initial returns. Second, we can
examine auction theories that appear to explain the cross-sectional variation of
elasticity. Specifically, we propose two hypotheses that are not mutually
exclusive. The first hypothesis, the investor heterogeneity hypothesis, suggests
that bidders' heterogeneity induces finite price elasticity. The second hypothesis,
the competition hypothesis, which is derived from the common value (CV)
auction model and the winner's curse, predicts that the relationship between
elasticity and competition among bidders in demand can be positive or negative
depending on how investors shade their bids.9 Our results appear to support the
6 Firms that issue seasoned equity offerings have a third choice, the book-building method.
Since the choice of IPO methods is not the focus of this paper, we will leave the analysis of this
choice to a future project. See Sherman (2001) for a detailed discussion about the global trends
in IPO methods.
7 During the same period, a total of 72 IPOs adopted the pure public offer method.
8 The Chinese Securities Association has 394 representatives who represent 223 securities firms
in Taiwan. One of the Chinese Securities Association tasks is to provide an orderly auction
market for firms to raise capital.
9 The CV model assumes that the object at auction has some `true value,' which is common
(through a resale market in the post-market) but is not known to all bidders. Each bidder
independently estimates the true value conditioning on her or his own private information.
Another auction model is called the independent private value (IPV) model. In this model,
bidders place independently subjective values on the object to be sold. Value differences arise
due to different tastes. Each bidder knows her or his own valuation, but does not know her or
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International Review of Finance
investor heterogeneity hypothesis. We also find a positive but insignificant
relationship between bidders' competition and elasticity.
We next examine whether underpricing exists in auctioned IPOs.10 KSW argue
that the existing theoretical explanations for IPO underpricing are based on the
situation in the US and other countries where IPO prices are fixed either by the
issuers or the underwriters. Obviously, these theoretical explanations are not
appropriate in a market where the stock price is not fixed prior to the IPO and
where allocations are not determined by the issuers or the underwriters or a
lottery. Surprisingly, Pettway and Kaneko (1996), as well as KSW, find that the
introduction of public auctions reduces, but does not eliminate, IPO
underpricing. Consistent with this earlier evidence, we find a significant
market-adjusted initial return of 7.83% in Taiwan for the average winning
bidders.
Finally, we examine the cross-sectional relation between the information
released by the underwriters after the auctions and the initial abnormal returns of
the auctioned shares. KSW argue that the magnitude of demand elasticity
represents the uncertainty of the auctioned shares. If this is the case, the initial
abnormal returns should be positively related to elasticity. In addition, in a
discriminatory auction, due to the winner's curse, the higher the price uncertainty
in the post-IPO market, the more likely it is that informed bidders will have an
incentive to shade their demand. There is also a very long waiting period of 10±12
weeks between the auction day and the first trading day. These considerations
suggest that the initial IPO returns in discriminatory auctions should be
positively correlated with the idiosyncratic risk of stock returns and the
institutional investor participation rate; they should be negatively correlated
with the auction clearing price. Our results appear to confirm all of these
predictions.
The remainder of the paper is organized as follows. Section II describes our
data. Section III summarizes the statistics of the demand elasticity in our sample,
while Section IV analyses the cross-sectional variation of demand elasticity in
detail. In particular, we test hypotheses regarding the determinants of demand
elasticity. In Section V, we examine the performance of auctioned IPOs in the
post-IPO market. In Section VI, we investigate the cross-sectional determinants of
post-market abnormal returns for IPO shares. Section VII reports the results on
the winner's curse. Finally, Section VIII sums up the findings.
his competitors' valuations. The IPV model assumes no resale market and predicts that the
price of winning bids increases as the number of bidders increases due to competition. In the
CV model, the winners in the first-price sealed bids are subject to the winner's curse (the
overbidding problem). Since each bidder bids her or his ex ante estimate of the object's value,
winning the bid conveys bad news to the winner because it indicates that all other bidders'
estimated values of the object are lower. As the number of bidders increases, the winner will,
on average, pay more than the true value. Therefore, if every bidder does not have an incentive
to shade her or his demand, the winner is almost certain to be `cursed'.
10 Loughran et al. (1994) and others document that IPO underpricing is a global phenomenon.
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On the Demand Elasticity of Initial Public Offerings
II. DATA
Firms in Taiwan that issue IPOs traditionally used the public offer method.
Since March 1995, firms have had three choices for an IPO method. When an
IPO is a `secondary offering' ± that is, it is a public offering by existing
shareholders ± the firm can choose either a fixed-price public offer method or
a hybrid method with 50% of the shares to be auctioned followed by a fixedprice public offer for the remaining shares.11 However, if an IPO is a `primary
offering' (i.e. a public offer by the company itself) the firm can choose either
the public offer method or a hybrid method with 50% of the shares to be sold
via book-building, followed by a public offer for the remaining shares (referred
to as the `book-building method'). Since the introduction of the auction
method, auctions have gradually gained some popularity. On the other hand,
the book-building method has never been popular, since firms seldom issue
shares via primary IPOs.
If a firm chooses the auction method, the IPO must be conducted as a
multiple-price (discriminatory price), sealed-bid auction. That is, auction
winners pay what they bid. According to the Security Law in Taiwan, qualified
bidders include individuals, institutional dealers, investment trust funds,
foreigners and government funds. Unlike in Israel where IPO firms sell
common stocks and additional securities (i.e. warrants, convertible bonds or
straight bonds), IPO firms in Taiwan sell only common stocks. In addition,
according to the Security Law on IPOs in Taiwan, half of the shares are offered
in a multiple-price, sealed-bid auction, while the remaining half are later
introduced through a public offer with a fixed price determined by the
auction results, with a cap.
Two to three days before the beginning of the order submission day (referred to
as day 1, all in business days), issuing firms and underwriters together determine
and announce in the newspapers the number of shares offered and the minimum
share price, among other information.12 Any interested investor can participate
11 The underwriting fee in Taiwan is 0.4% plus a fixed cost for auctions and 1.0% for public offers.
As a result, it may not be economical for small firms to have IPOs conducted as auctions.
12 The listing or minimum price for an IPO is usually recommended by the underwriter. The
determination of the minimum price is based on the formula set by the Security and Futures
Commission (SFC) in Taiwan (equivalent to the SEC in the US). Specifically, the listing price is
the weighted average of the average earnings per share in the past three years multiplied by the
P/E ratio of comparable firms in the same industry (40%), the net wealth (i.e. book equity
value) per share (20%), the estimated dividend per share in the current year divided by oneyear deposit interest rate (20%) and the average dividend per share in the past three years
divided by the dividend yield of comparable firms in the same industry (20%). However, the
final listing price can deviate from the price set by the formula, if the explanation to the SFC is
satisfactory. Once the auction has been announced to the public, the number of shares offered
and the minimum share price cannot be revised even if the market condition has changed. The
current year dividend is estimated from dividends of the past three years. The company, the
lead underwriter and the CPA firm together determine the estimate, with the lead underwriter
and the CPA firm responsible for any fraud.
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International Review of Finance
in an auction. The submission fee of any quantity for a specific bid price is
NT$500 for small or large IPOs.13 For the auctioned IPOs, any investor can
summit one or multiple limit orders specifying her or his demanded quantity and
a specified price for each order. However, the total awarded shares by any
investor, either individuals or institutions, cannot exceed 3% of the total shares
auctioned. The submission of orders to any participating securities firm (i.e.
brokerage firms) lasts for four business days (day 1 to day 4). Investors can submit
their orders on any of these four days, but most investors submit their orders on
the last day. Orders may be placed at prices that exceed the minimum price by
increments of one-tenth of a new Taiwan dollar (NT$).
Day 8 is the auction day. Each securities firm sends the order information to
the lead and co-lead underwriters between 9:00 a.m. and 10:00 a.m. At 2:00 p.m.,
the Chinese Securities Association aggregates the bids provided by the lead and
co-lead underwriters and announces the auction results. The auction clearing
price is the minimum winning bid price that clears the supply. Orders at prices
exceeding the clearing price are fully filled. Orders at the clearing price are filled
on a pro rata basis. Orders under the clearing price are left unfilled. All winning
bidders pay what they bid.
On the morning following the auction day, the lead underwriter
publishes the auction results in Taiwan's newspapers. The announced
information includes the auction clearing price, the minimum price, the
oversubscription rate at the minimum price and the information on the
bidding price, quantity and total dollar amount for each winner.14 If the
auctioned shares are undersubscribed, the unsold auctioned shares
together with the shares designated for the public offer are later offered
to the general public. The public offer price is fixed at the quantityweighted winning bid price calculated from the auction results or 1.5 times
the minimum (reservation) price, whichever is lower. Only individual
investors with valid Taiwan identification cards can participate in the
public offer.15 Each investor is allowed to submit only one order of exactly
1,000 shares, with a submission fee of NT$30. Until recently, investors did
not have to pay for the subscribed shares in advance, and there was no
penalty for not purchasing the shares that were allocated to them. If the
shares are not fully taken up in the public offer, the underwriters take up
all unsold shares. The publicly offered IPO is conducted about four weeks
after the auction.16 The issued shares begin to trade either on the Taiwan
Stock Exchange (TSE) or on the ROC Over-the-Counter Securities Exchange
(ROSE) approximately six to eight weeks after the public offer via a
13 During our sample period, one US dollar was worth between NT$27 and NT$34.
14 The detailed data on losing bids are not available to the public. In comparison, in Israel, only
the auction clearing price, the minimum price and the oversubscription rate at the minimum
price are available to the public.
15 This public offer price will not be revised even if the market condition has changed.
16 Since November 1998, the waiting time between the auction day and the public offer day has
been shortened to two to three weeks.
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On the Demand Elasticity of Initial Public Offerings
computerized call auction (e.g. without market markers and without bidask
spreads).17
A total of 52 IPOs were introduced through the auction method between
December 1995 and October 1998.18 We have obtained the detailed bidding
information for these 52 auctioned IPOs from the Chinese Securities Association.
Thirty-one of them are from the TSE and 21 are from the ROSE. The TSE is for
established firms, while the ROSE, like the Nasdaq in the United States, is for
young firms (and mainly high-tech or securities firms). When a firm traded on the
ROSE satisfies certain criteria, such as earnings, it can apply to be listed on the
TSE. The Chinese Securities Association also provided the information on public
offers.
Table 1 reports the summary statistics for our sample of auctioned and publicly
offered IPOs. The results indicate that on average IPO firms issue about 7% of
shares from existing shareholders via auctions.19 The average (median) number of
bids is 1148 (647), with a range from 88 to 5406. Although the number of bids is
large, it is still small compared with that in Israel, where the average number of
bids is over 4000. Institutional investors do not participate very actively in
auctions in Taiwan. On average, the total number of shares bid for by
institutional investors is around 8.4 million shares, as compared with 35 million
total shares bid for by all investors.20 The average (median) institutional
participation rate is only 22.25% (19.03%). The average (median) allocation at
the auction clearing price is 34.7% (30.93%) for all investors and 27.06%
(18.30%) for institutional investors. This reflects the fact that individual investors
are dominant in the stock markets in Taiwan.21
17 Since November 1998, the waiting time between the public offer day and the first trading day
has been shortened to two to four weeks.
18 There are several differences between Israeli auctioned IPOs and Taiwanese auctioned IPOs.
First, the auctioned IPOs are non-discriminatory auctions in Israel but discriminatory in Taiwan.
This implies that the winner's curse is more severe in Taiwan than in Israel if bidding strategies
do not adjust. Second, the bidding competition in Israel is more intense than in Taiwan, as
evidenced by the number of bidders in Israel being about three times greater than in Taiwan.
Third, the individual participation rate is much higher in Taiwan than in Israel. Fourth, there
are publicly offered IPOs about four weeks after the auctions in Taiwan, whereas there are no
public offers after the auctions in Israel. Fifth, the time span between the auction day and the
first trading day is very short (between two and three days) in Israel, but it is very long (10±12
weeks) in Taiwan. This implies that the auctioned IPO shares are riskier in Taiwan than in
Israel. Finally, the auction clearing price is 29.5% above the minimum price in Israel, while it is
60% above the minimum price in Taiwan. The reason for this difference might be that
investors in Taiwan bid more aggressively or that underwriters in Taiwan set lower minimum
prices than do underwriters in Israel.
19 Another 7% of the shares are conducted as public offers.
20 However, institutions such as venture capital firms might have invested in the firms long
before the IPOs.
21 In Taiwan, institutional investors account for less than 10% of stock trading activities in the
secondary market. However, on the first trading of newly listed IPO firms, institutions account
for about 20±25% of trading activities. The higher trading activities for institutions might
come from the non-IPO shares.
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158
Table 1
Summary Statistics for Auctioned IPOs in Taiwan
Variable description
Std. Dev.
Median
Min
Max
Shares sold in auctioned IPOs (thousands)
9,034
Outstanding shares before IPOs (thousands)
133,985
Ratio of shares sold in auctioned IPOs to outstanding shares (%)
7.18
Number of bids
1,148
Total shares bid (thousands)
35,054
Shares bid by institutions (thousands)
8,389
Allocation at the auction clearing price (%)
34.70
Institutional participation rate (%)
22.25
Institutional allocation rate (%)
27.06
79.84
Maximum bidding price in NT$ (Pmax)
66.12
Quantity-weighted winning price in NT$ (Pw)
63.69
Auction clearing price in NT$ (Pc)
52.11
Quantity-weighted losing price in NT$ (Pl)
40.52
Minimum bidding price in NT$ (Pmin)
58.89
Public offered IPO price in NT$ (Pipo)
103.87
Spread between Pmax and Pmin relative to Pmin (%)
59.57
Spread between Pc and Pmin relative to Pmin (%)
28.23
Spread between Pmax and Pc relative to Pc (%)
4.48
Spread between Pw and Pc relative to Pc (%)
Closing price on the first trading day (NT$)
61.59
Closing price at the end of hitting limits (NT$)
74.07
ÿ6.46
Initial return on the first trading day based on Pw (%)
Cumulative initial return until the end of hitting limits based on Pw (%) 10.21
7,700
125,058
2.79
1,269
40,353
11,830
21.28
16.92
23.16
43.28
38.60
37.97
30.11
22.98
33.78
44.64
31.65
16.53
4.14
35.54
49.24
12.10
25.68
7,230
93,050
7.69
647
20,268
5,024
30.93
19.03
18.30
66.10
54.20
52.85
42.25
34.00
49.08
100.14
57.69
24.41
3.17
49.55
56.75
ÿ3.76
4.43
1,362
36,300
1.56
88
3,194
0
5.85
0.00
0.00
22.20
19.10
18.00
16.35
11.00
16.50
30.59
0.00
8.02
0.28
17.20
17.80
ÿ49.14
ÿ27.38
38,788
715,520
10.02
5,406
207,594
60,004
100.00
66.56
100.00
245.00
222.61
219.00
167.00
115.00
172.50
264.67
200.00
98.02
21.97
184.00
240.00
7.94
99.38
This table reports the summary statistics for 52 IPOs auctioned on the Taiwan Stock Exchange (31) and the ROC Over-the-Counter Exchange (21)
between December 1995 and October 1998. All variables have 52 observations except the quantity-weighted losing price, which has 50
observations. The loss of observations is due to the fact that all bids were awarded in two cases. `Allocation at the auction clearing price' is equal to
`Shares sold in auctioned IPOs' divided by `Total shares bid'. `Quantity-weighted winning price' (`Quantity-weighted losing price') is the quantityweighted average of bid prices that were (were not) awarded shares. `Institutional participation rate' denotes the ratio of quantity demanded by
institutional investors to the total quantity demanded. `Institutional allocation rate' denotes the ratio of awarded quantity to demanded quantity
by institutional investors. One US dollar was approximately equal to NT$27±34 during this period.
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Mean
On the Demand Elasticity of Initial Public Offerings
The average auction clearing price is NT$63.69, which is about 60% higher
than the average minimum (or reservation) price of NT$40.52. The quantityweighted winning bid price is NT$66.12, which is 4.5% higher than the auction
clearing price and about 12.3% higher than the average publicly offered IPO price
of NT$58.89, because if the average winning bid price is greater than 1.5 times the
minimum price, the public offer price is set at 1.5 times the minimum price. The
average (median) spread of bidding prices is 103.87% (100.14%) based on the
minimum price, while the average (median) spread of winning bid prices is
28.23% (24.41%) based on the auction clearing price. The mean (median)
cumulative initial return until not hitting the price limits is 10.21% (4.43%),
based on the quantity-weighted winning bid price. The average dollar amount
raised by the issuing firms via auctioned IPOs is NT$618 million, which is
equivalent to around US$20 million.
III. SUMMARY STATISTICS FOR DEMAND ELASTICITY
A. Shapes of demand schedules
Our data allow us to analyse investors' demand schedules for IPOs on the auction
day. To illustrate how we analyse the data, we plot the demand schedule for the
median IPO firm, Fortune Electronics, in our sample (in terms of its elasticity) in
Figure 1. Fortune offered 7,656,000 shares at a minimum (reservation) price of
NT$30 each. At the minimum price, there were 84,300,000 shares demanded,
with an oversubscription rate of 11 times. The auction clearing price was
NT$52.7, 75.7% above the minimum price. Orders at prices above NT$52.7 were
fully filled. Orders at the auction clearing price were filled on a pro rata basis. The
highest bid price was NT$65, 23.3% higher than the auction clearing price. The
quantity-weighted winning bid price was NT$53.85, 2.2% higher than the
auction clearing price. This indicates that winning bids are clustered around the
auction clearing price in this case.
The shapes of Fortune's and all other firms' demand schedules are very similar.
In all demand schedules, we observe a very flat section around the quantityweighted winning price and the auction clearing price. We also observe a small
number of shares demanded at prices that far exceed the quantity-weighted
winning bid price, and a slightly steep section near the minimum price.22 In the
case of Fortune, which finished with an auction clearing price of NT$52.7,
131,000 shares were demanded at prices above NT$60 (which is equivalent to
1.71% of 7,657,000 shares demanded at the auction clearing price.) Unlike with
non-discriminatory auctions, we cannot interpret these high-price bids as `virtual
market' bids, since the winners pay what they bid. The only explanation is that
these high-price bidders were too optimistic, a typical phenomenon of the
22 The shape of our demand schedules is comparable with the shape of demand schedules in
Israel.
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Figure 1 The Demand Curve for the Fortune Electronics in the IPO Auction. The
figure plots the full demand schedule for the Fortunate Electronics ± the IPO with the
median constant elasticity in our sample. The Company offered 7656 thousand shares
for auction at a minimum (reservation) price of NT$30. The auction clearing price was
NT$52.7 and the quantity-weighted winning bid price was NT$53.85. The horizontal
axis represents the demand quantity in 1000 shares, while the vertical axis represents
the bid prices in NT dollars.
winner's curse. In the Fortune IPO, there were one lead underwriter and two colead underwriters.23 The bidding information for Fortune for all investors and
institutional investors is summarized in Table 2. In this case, institutional
investors were very conservative. They contributed around 23% of the shares
ordered, but received only 9% of the offered shares.
In Figure 2, we construct the average demand schedule for all 52 auctioned
IPOs. As in KSW, all offered quantities and auction clearing prices are normalized
to 1.0. Several observations are in order. First, the shapes of the demand schedules
in both Israel and Taiwan are very similar. They are relatively flat around the
auction clearing price. Second, the average demand curve in Taiwan is a little bit
concave to the origin, while the average demand curve in Israel is convex to the
origin. Third, although both average demand schedules have small high-price
bids, the prices and quantities of high-price bids in Israel are relatively higher and
larger than those in Taiwan, suggesting that the discriminatory auctions
discourage aggressive bidders from bidding too aggressively (i.e. to bid too high)
in order to avoid the winner's curse. Finally, in the average demand schedule, the
section near the minimum price is slightly steeper in Taiwan than in Israel.
23 The lead underwriters are responsible for the details of underwriting, including the negotiation
with the IPO firm to decide on the number of shares to be sold, the listing price, the IPO
method and the IPO timing. Listing is a long process in Taiwan. Typically, a firm that wants to
seek a listing normally signs a contract with a lead underwriter five years before the IPO.
During this consultation period, the lead underwriter will help the firm to meet the listing
requirements set by the SFC. In this sense, the lead underwriters play an important role in
bringing firms to eventual IPOs. The co-lead underwriters mainly help the lead underwriter in
the distribution and allocation of shares and take up part of the unsold shares according to
their pro rata shares.
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Underwriter
Lead underwriter
Co-lead underwriter 1
Co-lead underwriter 2
Total
No. of bids
No. of shares
bid (thousands)
No. of winning
bids
1,309
985
498
2,792
45,106
22,709
16,482
84,297
Panel A: All bids
189
63
38
290
No. of shares by
winning bids
(thousands)
Value of winning
bids (thousand NT$)
5,304
1,573
779
7,656
283,641.5
85,540.1
43,058.0
412,239.6
Panel B: Institutional bids
Lead underwriter
Co-lead underwriter 1
Co-lead underwriter 2
Total
80
25
34
139
11,339
3,417
4,527
19,280
5
0
0
5
694
0
0
694
This table reports the bidding information by all investors and institutional investors for Fortune Company.
NA
NA
NA
NA
On the Demand Elasticity of Initial Public Offerings
ß International Review of Finance Ltd. 2001
Table 2 Summary of Bidding Information for Fortune Company
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International Review of Finance
Figure 2 The Average Demand Curve for Auctioned IPOs in Taiwan. This figure
plots the average demand schedule for 52 auctioned IPOs in Taiwan between
December 1995 to October 1998. All offered quantity and auction clearing prices are
normalized to one.
B. Statistics for demand elasticity measures
Table 3 reports statistics for four measures of the slope of the IPO demand
schedules: two measures of the demand elasticity, one of the oversubscription
rate and one of the overall allocation rate. The oversubscription rate is the ratio of
the total quantity demanded at the minimum (reservation) auction price to the
offered quantity. The overall allocation rate is calculated as the ratio of the offered
quantity to the total demanded quantity. Since the full demand schedules are
observable in our sample and since in particular the winning demand schedules
are publicly available, we can calculate, in theory, as many true elasticity
measures as we want. However, we consider only two elasticity measures that we
believe are relevant and important to our case.
Table 3
The Demand Elasticity of Auctioned IPOs
Elasticity at the auction clearing price
Gross elasticity
Oversubscription
Overall allocation (%)
Mean
Std
Dev.
Median
Min.
Max.
24.45
10.42
4.36
34.70
21.02
5.31
3.31
21.28
20.06
9.19
3.24
30.93
1.31
3.04
1.00
5.85
120.41
25.93
17.09
100.00
This table reports different measures of demand elasticity for 52 IPOs auctioned in Taiwan
between December 1995 and October 1998. `Elasticity' denotes the elasticity of the demand
schedules at the auction clearing price and the auction offered quantity. `Gross elasticity' denotes
the global elasticity of the demand schedules at the mid-point of the maximum bid price and the
auction clearing price. `Oversubscription' denotes the ratio of quantity demanded at the
minimum (reservation) auction price to the offered quantity. `Overall allocation' is calculated as
the ratio of the offered quantity to the total demanded quantity.
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On the Demand Elasticity of Initial Public Offerings
The first elasticity measure, e(Pc), is the elasticity of demand calculated at the
auction clearing price, Pc or Pauction, as follows:
e…Pc † ˆ
…Qauction ÿ Qauction‡1NT$ †=Qauction
;
1=Pauction
…1†
where Qauction and Qauction + 1NT$ are the quantities demanded at the auction
clearing price and at 1 NT$ above it, respectively. This measure is also used by
KSW. The elasticity, e(Pc), is the most relevant to investors, since the auction
clearing price is the price that determines whether or not an investor won the bid.
Since the computation of e(Pc) requires detailed information of the demand
schedules, we also calculate a second elasticity measure based on the winning bid
schedules ± gross elasticity ± that is much easier to compute. This gross elasticity
measure, ge(win), is calculated based on the quantities demanded at two points:
the maximum price (Pmax) and the auction clearing price (Pc):
ge…win† ˆ ÿ
…Qauction ÿ Qmax †=‰…Qauction ‡ Qmax †=2Š
…Pauction ÿ Pmax †=‰…Pauction ÿ Pmax †=2Š
…2†
KSW calculate the gross elasticity measure (ge(loss)) based on two points on the
losing bid schedules ± the quantity demanded at the auction clearing price and at
the minimum price, Pmin ± because only these data are available to the public.24
The reason to use the elasticity measure of eqn (2) instead of KSW's gross elasticity
measure is that, in a discriminatory auction, investors are more concerned about
the winning demand schedules than the losing demand schedules.
The results in Table 3 indicate that the average (median) elasticity of demand,
e(Pc), is 24.45 (20.06) and the average (median) gross elasticity of demand,
ge(win), is 10.42 (9.19). For comparison, KSW find that the average (median)
elasticity of demand, e(Pc), is 37.16 (21.03) in Israel. In addition, the minimum
e(Pc) of 1.31 and the minimum ge(win) of 3.04 suggest that all measures of
elasticity for all auctions are larger than one and that both elasticity estimates are
statistically and economically larger than one even for a very weak
nonparametric test. The results appear to support the notion that the demand
schedules for IPOs in Taiwan are quite elastic.
In sum, we find that the demand schedules of auctioned IPOs appear to be
more elastic than indicated in previous findings, except KSW. Although our IPOs
were introduced through discriminatory auctions, while KSW's IPOs were
introduced through non-discriminatory auctions, findings from both studies seem
to indicate that the auction methods may not affect the elasticity of demand for
IPOs. While auction theory suggests that the elasticity of demand is larger in a
discriminatory auction than in a uniform auction, the greater active role of
individual (uninformed) investors in Taiwan than in Israel may suggest the
opposite. The latter might be the reason that the elasticity of demand for IPOs is
larger in Israel than in Taiwan.
24 In KSW, ge…loss† ˆ ÿ‰…Qmin ÿ Qauction †=Qmin Š=…Pmin ÿ Pauction †=Pmin .
ß International Review of Finance Ltd. 2001
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International Review of Finance
IV. DETAILED ANALYSIS OF CROSS-SECTIONAL VARIATION OF
DEMAND ELASTICITY
In this section, we examine what determines the demand elasticity crosssectionally. The elasticity may be related to bidders' heterogeneity and
competition and to how bidders shade their bids to avoid the winner's curse in
a discriminatory auction. We propose the following two hypotheses that are not
mutually exclusive.
A. Investor heterogeneity hypothesis
Investor heterogeneity induces finite elasticity of the demand curve for common
stocks. Bagwell (1991a) develops an equilibrium game model for share
repurchases as a takeover deterrent in the presence of heterogeneous shareholder
valuations. The main conclusion is that when the supply curve for shares is
upward-sloping, repurchases can alter the distribution of shareholder reservation
values and thereby increase the cost of a potential acquirer. Bagwell (1991b, 1992)
provides direct evidence of the upward-sloping demand curves (i.e. finite
elasticity) for the repurchase auctions of common stocks in the US. She proposes
that tax rules, transaction costs, non-tradable risks and heterogeneous beliefs may
induce finite elasticity for common stocks.
Gay et al. (1996) derive the optimal investor strategies in a Dutch auction for
share repurchases. They suggest that investor heterogeneity might be due to
different expectations or different tax bases. Since investors have different tax
bases and different expectations, they have different valuations for holding
stocks. Bernardo and Cornel (1997) examine the heterogeneity hypothesis using
the auction information on complex collateralized mortgage obligations (CMOs).
Their results reveal that the bidders' valuations differ substantially, implying a
significant finite elasticity of demand.
Unfortunately, the previous research fails to investigate the relation
between price elasticity and heterogeneity directly. Our auctioned IPOs
provide detailed data on the demanded quantity at each price for the full
demand schedule, including winning bids and losing bids. These detailed data
allow us to estimate directly the heterogeneity in demand and thus to test the
hypothesis directly.
B. Competition hypothesis
The independent private value (IPV) model in auction theory, where there is no
resale market, predicts that the value of winning bids increases as the number of
bidders increases. In empirical studies, the number of bidders is often used as a
proxy for the degree of competition. The IPV model suggests that, as the number
of bidders increases, the probability of a bid to be a winning bid decreases.
Consequently, bidders will raise the value of bids in order to increase the winning
probability of the bids. Brannman et al. (1986) provide evidence to support this
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ß International Review of Finance Ltd. 2001
On the Demand Elasticity of Initial Public Offerings
argument in bond, oil and timber auctions, while Saidi and Marsden (1990)
report evidence to support this argument in oil lease auctions.
Recent studies show that the winner's curse induces more elasticity in demand
if there is a resale market.25 The competition hypothesis suggests that if informed
bidders shade their bids to avoid the winner's curse, the elasticity of demand
increases with competition (i.e. the number of bidders). Stevens and Dumitru
(1992) and Reinhart (1992) argue that the multiple-price, sealed bid (such as our
discriminatory auctioned IPOs) reduces the bid demand curve and makes the
curve more price sensitive (i.e. more elastic). Because bidders must mark down
their bids to avoid the affliction of the winner's curse, this markdown ensures
that, in equilibrium, bidders do not regret their bids ex post.
Wilson (1977), Milgrom (1979) and Smith (1982) demonstrate that competition should eliminate all abnormal profits and that winning bids should
converge to the common value. These authors argue that the winner's curse may
be incurred due to the increase in the number of bidders. As a result, bidders may
shade their bids towards the perceived market consensus in order to avoid the
winner's curse, implying that the demand curve at the auction clearing price
should be flat. In other words, the demand elasticity at the auction clearing price
is expected to increase with the number of bidders in discriminatory auctions if
bidders shade their bids. However, Levin and Smith (1991) have shown that
shading does not necessarily increase with the number of bidders, suggesting that
elasticity may not increase with competition. We will test which argument is
more consistent with our data.
C. Test results for different hypotheses
To test the above hypotheses, we perform the following regression:
e…Pc †i ˆ 0 ‡ 1 CMPi ‡ 2 HETi ‡ 3 SCALEi ‡ "i ;
i ˆ 1; . . . ; N
…3†
where CMP and HET are competition and investor heterogeneity, respectively,
derived from the demand schedules, and SCALE is a scale variable that serves as a
control for the quantity of the supply by the issuing firm. Following the auction
literature, we use the logarithm of the number of bids, ln(NB), as a proxy for
competition, CMP. For investor heterogeneity, HET, we use the standard
deviation of bid prices, SD(Bid), as a proxy. SD(Bid) is calculated by normalizing
the minimum price to 100. Finally, we use the ratio of shares offered for auction
to the number of outstanding shares before IPOs as a proxy for scale (SCALE).
25 The winner's curse does not come into effect in the Dutch auction because the winners would
pay a uniform price at the minimum winning bid price, which induces the probability of
overbidding. The result is that more bidders are attracted and the revenues of sellers increase.
That is the reason why many researchers, such as Bikhchandani and Huang (1989), Reinhart
(1992) and Stevens and Dumitru (1992), suggest that Dutch (non-discriminatory) auctions
should be used instead of English (discriminatory) auctions to increase revenues for
governments or issuing firms.
ß International Review of Finance Ltd. 2001
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166
Table 4
Correlations between Demand Elasticity, Post-Market Abnormal Returns and Explanatory Variables
e(Pc)
ge(win)
Roffer
SD(Bid)
Rtn
Beta
SD(Rtn)
ß International Review of Finance Ltd. 2001
Rinst
Rpcpmin
ÿ0.037
(0.790)
0.026
(0.856)
ÿ0.038
(0.791)
0.269
(0.054)
ÿ0.142
(0.314)
ÿ0.018
(0.901)
ÿ0.119
(0.401)
0.071
(0.617)
Roffer
0.244
(0.081)
ÿ0.199
(0.157)
0.176
(0.211)
0.035
(0.806)
0.047
(0.739)
0.305
(0.028)
ÿ0.167
(0.238)
ln(NB)
0.022
(0.877)
0.110
(0.436)
ÿ0.041
(0.775)
0.306
(0.028)
0.020
(0.887)
0.366
(0.008)
SD(Bid)
ÿ0.317
(0.022)
0.047
(0.738)
0.155
(0.272)
ÿ0.400
(0.003)
0.600
(0.000)
Rtn
0.200
(0.155)
0.477
(0.000)
0.299
(0.031)
ÿ0.261
(0.062)
Beta
0.282
(0.043)
0.194
(0.167)
ÿ0.055
(0.699)
SD(Rtn)
ÿ0.072
(0.613)
0.301
(0.030)
Rinst
0.435
(0.001)
e(Pc) denotes the elasticity of the demand schedules at the auction clearing price and the auction offered quantity. ge(win) denotes the gross
elasticity of the demand schedules at the mid-point of the maximum bid price and the auction clearing price. Roffer is the ratio of shares sold in
auctioned IPOs to outstanding shares (%). Ln(NB) is the logarithm of number of bids. SD(Bid) is the standard deviation of bid prices deflated by the
minimum (reservation) price multiplied by 100. Rtn is the market-adjusted cumulative initial IPO returns based on the quantity-weighted winning
price. Initial IPO returns are calculated from the first trading day up until the day on which the IPO price does not hit the limit. Beta and SD(Rtn)
are the beta coefficients and the residual standard errors estimated from the market model. Rinst is the institutional participation rate that is
defined as the ratio of quantity demanded by institutional investors to the total quantity demanded. Rpcpmin is the ratio of the auction clearing
price to the auction minimum price minus one. p-values are in parentheses.
International Review of Finance
Ln(NB)
0.312
(0.024)
ÿ0.117
(0.409)
0.126
(0.374)
ÿ0.265
(0.058)
0.167
(0.237)
ÿ0.136
(0.335)
0.123
(0.386)
ÿ0.081
(0.570)
0.122
(0.390)
ge(win)
On the Demand Elasticity of Initial Public Offerings
According to our discussion in the previous subsection, we expect that 1 can
be positive or negative depending on how informed bidders shade their bids and
that 2 is negative. Leland and Pyle's (1977) signalling hypothesis suggests that
the larger the fraction of the firm that insiders retain, the better the firm value
they signal and the lower the information heterogeneity among bidders. Since
SCALE is the fraction of the firm sold in the IPO, Leland and Pyle's (1977)
signalling hypothesis suggests that 3 < 0.26
We first report the correlations between the elasticity of demand, e(Pc), and its
explanatory variables together with other variables in Table 4. The evidence
indicates that elasticity is negatively correlated with the standard deviation of bid
prices and the ratio of auctioned shares and is positively correlated with the
number of bids. However, only the correlation between e(Pc) and the standard
deviation of bid prices is significant at the 0.058 level.
The estimated multiple regression result is (t-values in parentheses):
e…Pc † ˆ 30:11 ‡ 3:99 CMP ÿ 1:94 HET ÿ 1:70 SCALE
…1:43† …1:35†
…ÿ2:28†
…ÿ1:59†
R2adj ˆ 0:079
The results indicate that the elasticity of demand for Taiwanese IPOs is
significantly negatively related to heterogeneity and positively though not
significantly related to competition. These results appear to support strongly the
investor heterogeneity hypothesis and to be only weakly consistent with the
competition hypothesis. We also find that the elasticity of demand is negatively
though not significantly related to the ratio of auctioned shares, suggesting weak
support for Leland and Pyle's (1977) signalling hypothesis. In sum, our findings
from the English auctions in Taiwan are consistent with the findings from the
Dutch auctions studied by Bagwell (1991b, 1992) in the US. That is, heterogeneity
induces finite elasticity in both English and Dutch auctions.
V. STOCK PERFORMANCE IN THE POST-IPO MARKETS
We next examine the winning bidders' returns in the post-IPO markets. In
Taiwan, there is a substantial waiting period between the auction day and the first
trading day in the secondary markets. The average waiting time is about 10±12
weeks. This long waiting period implies that IPO auction bidders are exposed to
more uncertainty than those in Israel, where the waiting time is only 2±3 days.
Following KSW, to measure the winning bidders' returns, we adjust the first
26 However, Bagwell (1991b) finds a positive relation between the elasticity of the supply and the
fraction bought back. KSW predict that the elasticity of demand should be negatively
correlated with the residual risk and positively correlated with the systematic risk of the stock
returns obtained from the post-IPO market. However, the inclusion of beta and residual risk in
the elasticity regressions does not change our results reported below.
ß International Review of Finance Ltd. 2001
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International Review of Finance
trading day return for the market movement in the period from the auction day
to the first trading day. Specifically, we simply deduct the concurrent market
return from the IPO shares' raw return with dividend adjustments to arrive at the
abnormal returns for the IPOs. That is,
ARi …t1 ; t2 † ˆ …Pi;t2 =Pi;t1 † ÿ …Pm;t2 =Pm;t1 †;
…4†
where Pi,t and Pm,t are the closing share price of IPO i and the market index on day
t, respectively. Unlike KSW, we do not use the market model or any other assetpricing model to adjust the IPO share returns for two reasons:
1
2
The waiting period between the auction day and the first trading day is too
long. Hence, any asset-pricing model may not be suitable.27
There was a daily price limit of 7% in either direction for the newly listed IPOs
and the shares in the secondary market in Taiwan during our sample period.
The price limits make the estimation of parameters in the market model more
complicated and less reliable.
Under the price limit rule, the shares are only allowed to trade within the
predetermined price limits based on the public offer price or the closing price
from the previous trading day. Frequently, IPO shares continued to hit the limits
for a few days after the first listing day. In our sample, the average (median)
period between the first trading day and the first day that the IPO share price did
not hit the limits is 5.42 (4.00) days, with a range between 0 and 18 days. As a
result, the initial returns for the IPO shares should be the cumulative return up
until the day on which the limit was not hit.
In discriminatory auctions, winners pay what they bid. As a result, we need to
determine which auction price should be used to compute the initial returns. To
reflect the initial returns for `average' winning bidders, we use the quantityweighted average winning bid price (Pw). In addition, there is a publicly offered
IPO following the auctioned IPO and the publicly offered IPO price (Pipo) is set at
the quantity-weighted winning bid price (Pw) or 1.5 times the minimum
(reservation) price, whichever is lower. As a result, the acquisition cost for an
investor who participated only in the publicly offered IPO and was allocated shares
should be Pipo. Hence, we also report the abnormal initial returns based on Pipo.
Table 5 reports the summary statistics of our 52 auctioned IPOs for the marketadjusted abnormal returns during the first 20 trading days and the cumulative
abnormal initial returns up until the day on which the limit was not hit. The most
appropriate measure for IPO underpricing in our case should be the cumulative
returns up until the day on which the limit was not hit based on Pw. As evidenced
from Table 5, the auctioned IPOs in Taiwan were underpriced. The average
(median) of the market-adjusted cumulative abnormal initial returns is 7.83%
27 We also use the weekly returns to estimate the parameter in the market model first and then
use the estimated parameters to obtain the first trading day's abnormal returns for IPO shares.
Unreported results are very similar to those reported here.
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On the Demand Elasticity of Initial Public Offerings
Table 5
Abnormal Returns on Auctioned IPOs
Trading day
Mean
Std. Dev.
Median
Min
Max
1 (based on Pw)
1 (based on Pipo)
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Cumulative return
up until the day
on which the limit
is not hit
(based on Pw)
Cumulative return
until the day on
which the limit is
not hit (based on Pipo)
ÿ8.44
2.51
4.37
3.05
2.06
0.59
1.04
0.14
0.39
0.02
1.10
0.20
0.51
0.33
ÿ0.24
ÿ0.62
ÿ0.20
ÿ0.29
ÿ0.38
ÿ0.13
ÿ0.44
7.83
15.43
10.03
4.54
5.04
4.11
5.28
3.94
3.62
3.82
3.66
2.92
4.26
3.32
2.92
2.61
3.12
2.82
2.37
2.54
3.06
2.89
22.05
ÿ7.05
2.43
5.88
4.76
2.13
0.05
1.10
ÿ0.13
ÿ0.70
ÿ0.04
0.63
ÿ0.45
0.39
0.37
ÿ0.37
ÿ0.98
0.01
ÿ0.47
ÿ0.70
ÿ0.46
ÿ0.53
6.36
ÿ47.05
ÿ15.78
ÿ10.21
ÿ11.84
ÿ9.52
ÿ9.96
ÿ11.92
ÿ7.31
ÿ10.07
ÿ7.96
ÿ4.31
ÿ11.41
ÿ5.79
ÿ7.12
ÿ6.58
ÿ5.94
ÿ7.43
ÿ5.04
ÿ6.08
ÿ8.50
ÿ7.69
ÿ25.92
22.07
23.10
10.38
11.20
9.50
11.02
8.10
8.40
8.40
8.01
8.26
7.84
7.47
7.50
7.68
8.21
5.84
7.36
6.26
7.41
6.45
84.74
22.29
28.30
15.32
ÿ8.76
141.88
This table reports the abnormal returns on the Taiwanese auctioned IPOs. Trading day denotes
the trading day after the auctioning of the initially offered stocks. Data are for 52 IPOs auctioned
in Taiwan between December 1995 and October 1998. Abnormal returns are adjusted by the
market returns for the corresponding periods. Pw is the quantity-weighted winning price, while
Pipo is the public offered IPO price that is equal to Pw or 1.5 times the minimum (reservation)
price, whichever is lower.
(6.36%). The mean is statistically significant at less than the 0.01 level (t-value ˆ
2.56). The average (median) of the market-adjusted cumulative abnormal initial
returns based on publicly offered IPO prices (Pipo) is even higher, with a value of
22.29% (15.32%).28 The significantly negative average abnormal return for
average winning bidders on the first trading day reflects the fact that the price
28 For the purpose of comparison, the average (median) of the cumulative market-adjusted initial
returns for 72 IPOs that were conducted as pure public offers during the same sampling period
(December 1995 to October 1998) is 16.51% (11.29%). This implies that a firm's total revenue
from an IPO is about the same, irrespective of whether the IPO is conducted as an auction or as
a public offer.
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International Review of Finance
limit on the first trading day is based on Pipo. In addition, due to price limits, after
the unusual first trading day, the average abnormal returns continue to be
positive and significant for the following three days. After that, the average
abnormal returns are economically and statistically not significantly different
from zero except on days 6 and 10.
KSW also find significant underpricing for auctioned IPOs in Israel using the
non-discriminatory method. In particular, they find an average abnormal return
on the first trading day of 4.5%.29 Pettway and Kaneko (1996) also find
underpricing in 37 discriminatory auctioned IPOs in the Japanese market with
an average first trading day return of 12.5% (t-value ˆ 2.92).30 These instances of
underpricing on auctioned IPOs are quite puzzling. KSW argue that theories that
explain IPO underpricing, such as signalling firm value, reducing the probability of
subsequent class action, enhancing the underwriters' reputations among investors
or implying an underwriter fee to be distributed among loyal clients, cannot be
applied to the auction case. All of these explanations rely on the fact that
underpricing benefits either the issuing firms or the underwriters. Our auctioned
IPO prices, on the other hand, are determined solely by investors and competition
among investors should drive the abnormal returns to zero on average. A more
plausible explanation in our case is that investors should be compensated for the
uncertainty and the under-diversification that arise from the long waiting period
of 10±12 weeks between the auction day and the first trading day.
Rock (1986) argues that if the IPO price is determined before bids are
submitted, there must be underpricing to make sure that the IPO can be fully
subscribed. Specifically, in Rock's model, informed investors do not participate in
overpriced IPOs, but only in underpriced IPOs. As a result, uninformed investors
who cannot distinguish overpriced IPOs from underpriced IPOs will receive a
larger proportion of overpriced IPOs. To entice uninformed investors to
participate in IPOs, underwriters must price IPOs such that uninformed investors
receive a fair return on average. Although Rock's (1986) model cannot explain the
underpricing of the non-discriminatory auctioned IPOs in Israel,31 it may help
explain the cross-sectional underpricing of our discriminatory auctioned IPOs. In
particular, Rock's model implies that when more informed investors participate
in the auction, the underpricing is greater.32
29 In Israel, there is no price limit, so that the abnormal return on the first trading day is the
appropriate measure for IPO underpricing. KSW find the average abnormal returns after the
first trading day to be insignificant.
30 Similarly to Taiwan, half of each Japanese IPO between April 1989 and March 1993 was
generally auctioned. The weighted average price of the successful bids was used to set the
offering price of the other shares in the IPO that were not subject to bidding. The offering price
is used to compute the first trading day return.
31 KSW argue that under uniform-price auctions, every winner pays the same price, which is the
auction clearing price. Consequently, positive abnormal IPO returns will induce more bidders
to submit bids and this increasing competition will drive the positive abnormal returns to zero.
32 When book-building is used to market an IPO, the model developed by Sherman and Titman
(2002) also makes the same prediction.
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On the Demand Elasticity of Initial Public Offerings
In discriminatory auctions, successful bidders pay what they bid. As a result,
there is a winner's curse. To avoid the winner's curse, bidders will shade their bids
towards the perceived market consensus rather than bid at the price that reveals
their private information. This leads many auction theories to argue that if there
is a resale market, the uniform-price auction will yield higher expected revenues
than the discriminatory auction in an IPO firm. The fact that IPO underpricing is
less severe in Israeli non-discriminatory auctions than in Taiwanese discriminatory
auctions seems to confirm this argument. In this light, the avoidance of the
winner's curse by informed investors might partially help explain the
underpricing of our discriminatory auctioned IPOs. If this is the case, we may
see that the abnormal returns should be positively correlated with the
institutional (regarded as informed investors) participation rate. We will formally
test this argument in the next section.
VI. DETAILED EXAMINATION OF ABNORMAL POST-IPO MARKET
RETURNS
In the previous section, we documented a significant market-adjusted initial
abnormal return for 52 discriminatory auctioned IPOs in Taiwan. However,
auction theory suggests that in equilibrium, competition should drive these
initial abnormal returns to zero. On the other hand, other factors, such as
shading behaviour by informed investors, uncertainty, under-diversification
and asymmetric information, may provide possible explanations for the crosssectional variation of initial IPO returns. KSW argue that the initial returns in
auctioned IPOs should be related to new information revealed upon the
completion of the auction and not to information known prior to the auction.
This is the reason why KSW find that the IPO abnormal returns on the first
trading day are (positively) significantly correlated with only gross elasticity,
ge(loss) (which is the information revealed upon the completion of the
auction), but not correlated with elasticity, e(Pc) (which is the information not
publicly available upon the completion of the auction and before the first
trading day), or other information known prior to the auction such as firm
size, the percentage of ownership held by insiders following the IPOs, and the
auction clearing prices.
The KSW argument suggests that the underpricing of our auctioned IPO
should be positively related to the elasticity of demand that the public can
estimate. Although the public in Taiwan can infer the elasticity measure of e(Pc)
and two gross elasticity measures ± ge(win) and ge(loss) ± from the publicly
available data, we argue that, in a discriminatory auction, investors are more
concerned about the winning demand schedules.33 In addition, the computation
33 From the information released by the underwriters, the public in Taiwan can also calculate the
elasticity of demand at different points along the winning bid schedule. In Israel, the public
can only estimate ge(loss).
ß International Review of Finance Ltd. 2001
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International Review of Finance
is more complicated for e(Pc) than for ge(win). Consequently, one would expect
that the initial IPO returns are more correlated with ge(win) than with e(Pc).
When informed investors such as institutions shade their bids to avoid the
winner's curse, they will be more conservative in bidding. This shading behaviour
will result in a lower auction clearing price and in turn a higher initial IPO return.
If this is the case, we should expect that initial IPO returns are positively
correlated with the institutional participation rate and are negatively correlated
with the auction clearing price. This prediction is also consistent with predictions
by Rock's (1986) and Sherman and Titman's (2002) models discussed in the
previous section.
In addition, the degree of underbidding may be related to the risk of the IPO
share prices in the post-IPO market. That is, the higher the price uncertainty in
the post-IPO market, the more likely it is that informed bidders will underbid.
This implies that the post-IPO market returns will be positively related to the
firm's residual risk. Furthermore, there is a long waiting period between the
auction day and the first trading day (more than 10 weeks) in Taiwan. The
compensation for this no-trading risk suggests that the initial IPO returns should
be positively correlated with not only the market risk (beta) but also the firmspecific risk (residual risk) due to investors' under-diversification.
The correlations between the initial return and other explanatory variables
reported in Table 4 indicate that the post-IPO market returns are significantly
positively correlated with the gross elasticity measure of ge(win) but not with the
elasticity measure of e(Pc). In addition, initial returns are highly significantly
positively correlated with the residual risk of stock returns, with a correlation of
0.48. Initial returns are also significantly positively correlated with the
institutional participation rate and are negatively correlated with the auction
clearing price. Table 6 reports the regression results on the initial abnormal
returns in the post-IPO market. We find the results to be consistent with the
results from correlations and all of our predictions. In particular, the marketadjusted abnormal returns are significantly positively correlated with the gross
elasticity, ge(win), but not with the elasticity, e(Pc). In addition, we find the
abnormal returns to be significantly correlated with the residual risk but not with
the systematic risk (beta). We also find the abnormal returns to be significantly
positively correlated with the institutional participation rate and to be
significantly negatively correlated with the auction clearing price. The
significantly positive relation between initial IPO returns and the institutional
participation rate appears to be consistent with the predictions of Rock's (1986)
and Sherman and Titman's (2002) models.
VII. ESTIMATION OF THE WINNER'S CURSE
It is interesting to examine whether or not there is an incentive for informed
investors to shade their demand to avoid the winner's curse in discriminatory
auctions. There is a debate whether there is in fact a winner's curse (for
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ß International Review of Finance Ltd. 2001
On the Demand Elasticity of Initial Public Offerings
Table 6
Regression Results on Post-market Abnormal Returns
Model
Intercept
Beta
Residual risk
Institutional participation
Auction clearing price above the
minimum price
Elasticity
Gross elasticity
Adjusted R2
1
2
ÿ32.88
(ÿ3.92)
0.67
(0.14)
3.87
(3.85)
0.44
(2.84)
ÿ18.95
(ÿ2.08)
ÿ0.04
(ÿ0.01)
4.71
(4.83)
0.25
(1.56)
ÿ0.26
(ÿ2.94)
0.16
(1.40)
0.14
(1.15)
0.30
0.40
3
4
ÿ45.68 ÿ31.77
(ÿ4.99) (ÿ3.37)
1.33
0.54
(0.29) (0.13)
4.03
4.89
(4.36) (5.52)
0.48
0.28
(3.26) (1.93)
ÿ0.25
(ÿ3.20)
1.35
(2.95)
0.40
1.38
(3.30)
0.16
This table reports the regression results on market-adjusted cumulative initial IPO returns based
on quantity-weighted winning prices. Cumulative initial returns are calculated from the first
trading day up until the day on which the IPO price does not hit the limit. `Beta' and `Residual
risk' are the beta coefficients and the residual standard errors estimated from the market model.
`Institutional participation' denotes the ratio of quantity demanded by institutional investors to
the total quantity demanded. `Auction clearing price above the minimum price' is the auction
clearing price less the minimum auction price divided by the minimum auction price expressed
in percent. `Elasticity' denotes the elasticity of the demand schedules at the auction clearing price
and the auction offered quantity. `Gross elasticity' denotes the global elasticity of the demand
schedules at the mid-point of the maximum bid price and the auction clearing price. t-values are
in parentheses.
example, Capen et al. 1971). Laffont (1997) provides evidence of the existence
of the winner's curse based on the finding that the bid value increases as the
number of bidders increases. Since our data provide full demand schedules, it
is possible for us to examine whether there is a winner's curse and whether
there is an incentive for investors, especially aggressive investors, to avoid that
curse. Specifically, we compute the winner's abnormal returns based on their
quantity-weighted average bid prices in three different aggressive winning bid
intervals. The most aggressive bidders are defined as the top 5% of the
winning bidders and their quantity-weighted winning bid price is denoted as
Pw5%. Similar definitions apply to the top 10 and 25% of the winning bidders
and to Pw10% and Pw25%. We then compute the market-adjusted cumulative
returns for these auctioned IPOs from the first trading day up until the day on
which the price does not hit the limit based on these three quantity-weighted
average winning bid prices. If there is a winner's curse, these abnormal returns
should be negative.
Table 7 reports test results on the winner's curse. The results appear to be
consistent with the prediction of the auction theory that bidders in Taiwanese
auctioned IPOs shade their bids toward the market consensus to avoid the
winner's curse. The quantity-weighted average bid price for the top 25% of the
ß International Review of Finance Ltd. 2001
173
174
Table 7
The Winner's Curse on Discriminatory Auctioned IPOs
Std Dev.
Median
Min.
Max.
No. of
positive
71.82
70.66
68.94
ÿ1.64
ÿ0.00
2.67
40.62
40.23
39.61
21.75
21.52
21.41
59.05
57.86
56.32
ÿ3.05
ÿ2.19
ÿ0.21
20.12
20.07
19.70
ÿ44.10
ÿ40.39
ÿ35.10
237.02
235.29
229.58
71.06
71.74
72.98
NA
NA
NA
21
22
25
ß International Review of Finance Ltd. 2001
This table reports the winner's curse for the most aggressive bidders. Data are for 52 IPOs auctioned in the Taiwanese stock market between
December 1995 and October 1998. The highest 5% of the quantity-weighted winning price (Pw5%) is the quantity-weighted winning price for the
top 5% of the highest wining bids (i.e. top 0±5%). A similar definition applies to Pw10% and Pw25%. The market-adjusted return is the cumulative
return adjusted for the concurrent market return from the first trading day up until the day on which the IPO price does not hit the limit.
International Review of Finance
Highest 5% of the quantity-weighted winning price (Pw5%)
Highest 10% of the quantity-weighted winning price (Pw10%)
Highest 25% of the quantity-weighted winning price (Pw25%)
Market-adjusted return based on Pw5%
Market-adjusted return based on Pw10%
Market-adjusted return based on Pw25%
Mean
On the Demand Elasticity of Initial Public Offerings
winning bids was only 4.26% higher than the quantity-weighted average price of
all winning bids. In addition, for the top 25% of the winning bidders, the average
(median) market-adjusted abnormal cumulative returns from the first trading day
up until the day on which the IPO share price did not hit the limit was 2.67%
(ÿ0.21%), which is positive, although not significantly different from zero. The
most aggressive bidders (the top 5%) incurred only a very small loss of 1.64% in
the market-adjusted initial return. If there were a winner's curse, one would
expect the top 5% of the winning bidders to have incurred a significant loss. The
winning bidders who were not among the most aggressive 25% of the top bidders
on average earned a significantly positive market-adjusted abnormal return. All of
these results indicate that there is no obvious winner's curse in Taiwanese
auctioned IPOs.
VIII. CONCLUSIONS
In this paper, we analyse the issues related to demand elasticity using a unique
data set of IPOs, conducted as discriminatory auctions. This data set includes the
full demand schedules for 52 IPOs auctioned in Taiwan. To the best of our
knowledge, this is only the second time that the full demand schedules for
common stocks have been described and analysed and this data set offers the
largest sample size yet. It is also the first time that the full demand schedules for
discriminatory IPO auctions have been examined. We show that the demand
elasticity of the auctioned IPOs in Taiwan is quite elastic. The average (median)
elasticity of demand at the auction clearing price is 24.45 (20.06).
We next examine the relation between stock demand elasticity and investor
heterogeneity and bidder competition. In general, our findings are consistent
with the investor heterogeneity hypothesis. Specifically, the elasticity of demand
for auctioned IPOs in Taiwan is negatively correlated with investor heterogeneity.
We also analyze the IPO returns after listing. We report a significant average
market-adjusted cumulative abnormal return of 7.83% from the first trading day
up until the day on which the limit is not hit using the quantity-weighted average
winning bid price in the auction. We argue that the uncertainty of a long waiting
period of more than ten weeks between the auction day and the first trading day
and the avoidance of the winner's curse by informed investors might have
contributed to this abnormal return.
We then examine possible explanations for the cross-sectional variation of
initial IPO returns. We find that the post-IPO market abnormal returns are
positively correlated with the demand elasticity, the institutional participation
rate and the residual risk of stock returns, and are negatively correlated with the
auction clearing price. The positive relation with the institutional participation
rate and the negative relation with the auction clearing price are consistent with
the predictions of Rock's (1986) and Sherman and Titman's (2002) models and
with the shading behaviour by informed investors to avoid the winner's curse.
The positive relation with the elasticity of demand and the residual risk of postß International Review of Finance Ltd. 2001
175
International Review of Finance
market stock returns is consistent with the uncertainty argument. Finally, we do
not find any winner's curse in our sample. In fact, the top 5% of the winning
bidders on average lost only a very small abnormal return of 1.64% (not
significant). This suggests that informed investors have an incentive to shade
their demand to avoid the winner's curse.
Recently, Hodrick (1999) considered whether stock price elasticity affects the
choice of methods for self-tender repurchases. She argued that the existing theory
predicts that firms choosing the Dutch auction instead of the fixed-price tender
offer should be firms expecting to face greater price elasticity. She found that the
evidence from share repurchases between 1984 and 1989 in the US is consistent
with the theoretical prediction. Similarly, it may be interesting to investigate if
stock price elasticity affects the choice of methods for firms issuing IPOs. The
existing theory predicts that firms choosing the discriminatory auction rather
than the fixed-price public should be firms expecting to face greater price
elasticity. In future research, we will test whether or not the hypothesis proposed
by Hodrick can be applied to the choice of IPO methods.34
Yu-Jane Liu
Department of Finance
National Chengchi University
Taipei
Taiwan
ROC
[email protected]
K. C. John Wei
Department of Finance
Hong Kong University of Science and Technology
Kowloon
Hong Kong
[email protected]
Gwohorng Liaw
Department of Finance
National Chung-Cheng University
Chia-Yi
Taiwan
ROC
[email protected]
34 In a companion paper, Lee et al. (2002) find that more elastic firms tend to adopt the auction
method.
176
ß International Review of Finance Ltd. 2001
On the Demand Elasticity of Initial Public Offerings
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