Rent Seeking, Brokerage Commissions, and Pricing and Share Allocation in Initial Public Offerings

Abstract

Using investor bidding data from 175 Chinese IPOs, we examine the effects of underwriters’ rent-seeking incentives. We find that Chinese IPO underwriters, with no discretion to allocate more shares to favored investors, instead favor mutual funds paying them greater brokerage commissions by discounting offer prices to make more orders from them eligible for IPO share allocations, which results in greater IPO underpricing. Further, underwriters choose price levels at which there are more bids from commission-paying mutual funds as offer prices. Rent seeking is more pronounced for underwriters who are top brokers and therefore place more weight on bidding investors’ interests.