Restrictions on Allocation Discretion: Evidence from Clawbacks in Hong Kong IPOs

The presence of both restricted and unrestricted, US-style, bookbuilt initial public offer (IPOs) in Hong Kong provides an ideal environment to test numerous underpricing models by simultaneously measuring the effects of allocation restrictions on the investment bankers' price discovery, underwriting, and distribution functions. While clawbacks, a set of allocation restrictions favoring retail investors not participating in the roadshow result in diminished and more expensive price discovery, they also reduce the investment bankers' dependence on institutional investors to dispose off IPO shares, resulting in lower underpricing. This favors models that highlight the importance of the underwriting function on underpricing, and shows that allocation restrictions can impact more than just price discovery. In addition, this study shows that individual investors can partially offset the loss of roadshow information caused by clawbacks, countering the idea that investment banks are unable to extract any pricing information from investors outside their list of roadshow regulars.