Signalling in the Internet Craze of Initial Public Offerings

In this paper we analyze the clustering phenomenon of underpricing in initial public offerings (IPOs), where firms in a particular industry choose to issue their new shares at the same time and at great discounts. The industry consists of many firms that have private in-formation about their own qualities (high or low) and that must raise external capital first before production. In the product market, firms compete through quality ladders, where each high-quality firm monopolizes the production of a particular variety of product. We show that self-fulfilling multiple equilibria arise. In one, no firm underprices the IPO. In the other, all high-quality firms underprice their IPOs, resulting in clustering. Moreover, the clustering is more likely to occur in economic upturns than in downturns, and in an easy credit market than in a tight market.