In this paper we examine how separation of ownership and control evolves as a result of an Initial Public Offering (IPO) and how the underpricing of the issue can be used by insiders to retain control. Using data from a sample of 69 IPOs in the UK, we show that underpricing is used to ensure oversubscription and rationing in the share allocation process so as to allow owners to discriminate between applicants for shares and to reduce the block size of new shareholdings. We find that of the pre-IPO shareholders in a firm, directors sell only a modest fraction of their shares at the time of the offering and in the seven subsequent years. In contrast, holdings of non-directors are virtually eliminated during the same period. As a result, in less than seven years, almost two-thirds of the offering company's shares have been sold to outside shareholders, thereby substantially advancing the process of separation of ownership and control. Additional evidence in the paper suggests that rationing in the IPO discriminates against applicants who apply for large blocks, and that larger under-pricing is associated with smaller blocks being held by new investors some seven years after the IPO. Also, there is a low level of hostile takeovers in the period of up to ten years after the IPO, which is consistent with effective protection by insiders against hostile changes of control.
Journal of Financial Economics – Elsevier
Published: Sep 1, 1997
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