The economic role of institutional investors in auction IPOs

We examine the economic role of institutional investors in auction initial public offerings (IPOs) with and without a discretionary tranche of IPO shares pledged to institutional investors prior to public filing. We find that underpricing in auction IPOs with a discretionary tranche is lower (higher) than underpricing in auction IPOs without a discretionary tranche when institutional demand for IPO shares is high (low). The findings, which hold after controlling for potential endogeneity, reveal a cost-benefit tradeoff in auction IPOs that is sensitive to institutional demand, and explain why auction, albeit commonly used for debt instruments, is rarely used for IPOs.