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A Reexamination of the Costs of Firm Commitment and Best Efforts IPOs

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  • Chua, Lena

Abstract

Ritter documents that best efforts IPOs are, on average, more costly to issue than firm commitment IPOs. This paper explains the phenomenon. Two component costs of going public are analyzed: underpricing and underwriter compensation. The model, based on a disagreement about firm value between underwriters and issuers, shows that underpricing is higher for firms using best efforts contracts as these firms, on average, are more speculative. Underwriter compensation is hypothesized to be higher for firms using best efforts contracts because of the high costs of market making for these firms in the after market and the high distribution costs associated with the high risk of a failed offer. Empirical tests strongly support the propositions. Copyright 1995 by MIT Press.

Suggested Citation

  • Chua, Lena, 1995. "A Reexamination of the Costs of Firm Commitment and Best Efforts IPOs," The Financial Review, Eastern Finance Association, vol. 30(2), pages 337-365, May.
    • Handle: RePEc:bla:finrev:v:30:y:1995:i:2:p:337-65
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    Cited by:

    1. Dunbar, Craig G., 1998. "The Choice between Firm-Commitment and Best-Efforts Offering Methods in IPOs: The Effect of Unsuccessful Offers," Journal of Financial Intermediation, Elsevier, vol. 7(1), pages 60-90, January.
    2. Dunbar, Craig G., 1997. "Overallotment option restrictions and contract choice in initial public offerings," Journal of Corporate Finance, Elsevier, vol. 3(3), pages 251-275, June.
    3. Catherine M. Daily & S. Trevis Certo & Dan R. Dalton & Rungpen Roengpitya, 2003. "IPO Underpricing: A Meta–Analysis and Research Synthesis," Entrepreneurship Theory and Practice, , vol. 27(3), pages 271-295, July.
    4. Lokman Tutuncu, 2020. "Lock-up provisions and valuation of Turkish IPOs," Eurasian Business Review, Springer;Eurasia Business and Economics Society, vol. 10(4), pages 587-608, December.

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