My recent "Too Much Left on the Table"
column about my dismay over the continued underpricing of IPOs by investment bankers, in effect leaving a lot of what should be the newly public company's working capital on the table, stirred up many
subscribers, and produced a huge pile of angry reader mail.
Tech Savvy: Join the discussion on
Check out Seymour's
Not angry at me, mind you, but at the investment bankers who do this -- and, as often, at the eager-to-line-their-own-pockets company executives who play along with their investment bankers
("Oooh, they're so hard on us ... we've gotta do what they say!")
at IPO time, in effect raiding their companies' treasuries.
Turns out a lot of
readers have been wondering, and worrying, about this. I also heard from several investment bankers, who generally agreed but also found defenses for the practice. Drawn from all that mail, some more reasons why this happens, to add to the original three listed in my earlier column:
- Avoiding lawsuits: Several writers pointed out that by pricing IPOs low, investment bankers are in effect insuring themselves against malpractice suits by angry company investors. If they priced the issues higher, this defense goes, and the company didn't sell out the IPO and also rise above the offering price on the first day, unhappy investors might sue the bankers for their flawed advice.
"Market" pricing: One amiable cynic says investment bankers are quite consciously abdicating their role as advisers by just deciding to let the market decide an IPO's worth. Run a small-scale IPO, this argument goes, with relatively few shares out there; let the first-day buyers kite 'em up; then bring out a much larger secondary offering shortly afterward, using that jacked-up IPO price as a kind of umbrella to justify a high price on the second round.
Big deal flow: Another argument goes along the same lines, but defends investment bankers' abandonment of their traditional role as trusted advisers by positing that in today's flood of new offerings, the bankers just don't have enough time to figure the real worth of shares in an IPO, so they throw up their hands, let the market decide ... then collect their fees and go on to their next ten deals this week.
Small float: Some writers pointed out that the typically small number of shares available in IPOs aggravates this problem. First, by creating disproportionate demand for the IPO shares, and second, by using the long lever of that tiny slice of the company's presumed value to jack up the remaining 90% or so -- a powerful, if deceptive, tool for increasing founders' paper wealth.
Workin' for The Man: Finally, one reader put it particularly succinctly: Investment bankers don't really work for the company going public, but for that company's executives and founders. The bankers have been interviewed, grilled and put through a sometimes long and usually ugly beauty contest to determine which securities firms will manage the offering. Thus they feel a personal loyalty to the people in the client company who choose them, and less loyalty to the company itself. So of course they want to enrich ("justly reward," they would say) the people who employed them.
No one should underestimate the anger of investors over these low-ball IPO prices.
summarized neatly what many readers' emails said at great length:
I thought I was the only one clinging to the quaint notion that the goal here is raising capital. I've been saying for a better part of this year that the investment bankers advising these IPOs should be taken out and shot at dawn for gross negligence! I readily admit that valuation of these dot-coms is not easy. However, missing the mark by so wide a margin is inexcusable.
The problem also neatly illustrates changing times on the Street. A retired investment banker wrote:
It seems to me that the role of the investment banker has to be considered. In my heyday, back in the early 70s, they were the ones who set the price, not the founding shareholders. The investment banker whose name goes on the prospectus does due diligence and declares that the IPO price offering is a fair price relative to the value of the underlying enterprise ... which in my days always had five years of high growth and profits before making an IPO attempt. What a difference a couple of decades makes.
And finally, reader
got down to the nub of it:
The executives don't care about the lack of capital raised since their own wealth is so sharply increased. In some sense the legal entity, the corporation itself, is shortchanged by the breach of a fiduciary duty, but since the fiduciaries own the company and make out like bandits, there's no one who wants to complain.
Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, neither Seymour nor Seymour Group held positions in any securities mentioned in this column, although holdings can change at any time. Seymour does not write about companies that are current or recent consulting clients of Seymour Group. While Seymour cannot provide investment advice or recommendations, he invites your feedback at