Alex Petkevich’s research examines the benefits of involving underwriters in the IPO auction process

When a company prepares to go public, investors have a chance to invest in a promising venture early on. The company’s owners have a chance to raise money before they begin trading shares on the stock market.

The process begins when the owners meet with an investment banker, who underwrites the process, setting the company’s value and determining how many shares need to be sold to reach it.

One alternate way to set the price is through an auction. Investors—and, sometimes, the underwriters themselves—bid on how many shares they want and how much they are willing to pay for them.

When there are more bids than shares, the company distributes them via a lottery system.

Of course, these bids are only each investor’s best guess of the company’s worth. The actual price of the stock can be volatile when it hits the open market. And the information of who pays how much is not disclosed in the United States.

Alex Petkevich

“That’s where this paper comes in,” said Alex Petkevich, an associate professor at the Daniels College of Business’ Reiman School of Finance, who published his research last year in the Journal of Financial Markets. “In India, we have access to this data. And what’s very interesting is when we observe that the underwriter is a participant in this, there is more efficient pricing, there is going to be less long-term underwriting on the pricing and there’s going to be less volatility overall in the long term for this company. So it increases transparency and improves the efficiency of this process.”

Right now, Petkevich said, that process is shrouded in a sort of secrecy in the U.S. Investors don’t want to disclose what they are offering so they can earn a bigger piece of the pie. Underwriters, meanwhile, have a clearer picture of the actual valuation—something Petkevich calls “informational asymmetry.”

If underwriters don’t disclose their knowledge of the actual valuation, others tend to overbid, which has consequences down the road.

“Reducing informational asymmetry is a way to improve the whole process,” he said. “And by doing that, the better price of the IPO, the closer it gets to the actual, fundamental true price of the company, the better it is for everyone.

“The company gets less volatility, better pricing and more liquidity because there will be less uncertainty about the actual valuation,” Petkevich said. “If I don’t know the true valuation and you don’t know the true valuation, we’re not likely to buy this company or hold this company. It’s good for investors, it’s good for the company and, at the end of the day, it’s actually good for the underwriters too because they’re going to get more business because they have a better, more efficient process that’s beneficial to everyone.”

With artificial intelligence technology growing every day, Petkevich sees another wave of IPO offerings on the horizon. Before it crests, he said, policymakers should examine ways to improve transparency and make markets more efficient.