Ljungqvist, Nanda and Singh (2003) study the impact of bargaining power on the first
day return and so on underpricing. They use as a proxy for bargaining power “the ownership
structure”. A firm with a highly concentrated ownership, is reflecting a high incentive to
bargain hard, while an increased ownership fragmentation, and an increased frequency and
size of “friends and family” share allocations, make the issuing firm decision-makers less
motivated to bargain for a higher offer price .
Ljungqvist, Nanda and Singh assume that the issuing firm’s ownership structure is such that β
of the extracted surplus from the investor sentiment is captured by the issuing firm and 1-β is
captured by a combination of the regular investor and the investment bank. For a firm with
highly concentrated ownership, they believe β will be close to 1 reflecting the high incentive
to bargain hard over the surplus, while for a firm with dispersed ownership or other agency
problems β will be significantly smaller than 1.
An issue firm with a concentrated ownership and high bargaining power requests a higher
offer price and faces a lower underpricing. Ljungqvist and Wilhelm (2003) show that
companies with more concentrated ownership at the time of the IPO suffer lower
underpricing, consistent with the findings of Ljungqvist, Nanda and Singh (2003).
And an issue firm characterized by ownership fragmentation and so by lower bargaining
power, can not bargain hard for a higher offer price. The issue price will be set at a lower
level and underpricing will be higher in the first day of trading. Tim Loughran and Jay Ritter
(2004) (8) also use the ownership structure as a proxy for bargaining power and find that an
increased ownership fragmentation induces a decrease in the bargaining power of the issuing
firm, a lower offer price is presented inducing a higher level of underpricing.
The greater the issuing firm’s bargaining power relative to the underwriter, the higher is the
offer price and the lower is the first-day return and vice-versa.
8 Loughran and Ritter (2004) argue that this argument has little support as an explanation for underpricing.