Berkeley Program in Law and Economics

Book-building, the prevailing method for IPO's, is widely considered flawed, because it results in stock under-pricing. Auction-IPO, on the other hand, is considered, by conventional wisdon, an alternative method that will eliminate the under-pricing. This paper shows how, contrary to customary belief, auction-IPO's may well result in under-pricing. In auction-IPO's, the under-pricing of the stock price is induced by undetected investors' manipulative strategic behavior. I analyze the requirements for such strategic behavior in a linear model. To reduce investors' incentive to manipulate their bid in the auction, this paper proposes to restrict auction participants from trading in the aftermarket immediately following the IPO.