An initial public offering is an offering of a shares in a company for the first time publicly. They could have privately placed shares, a small company. I had a company, Case-Schiller Weiss Incorporated, formed with my student here at Yale, Allan Weiss, and we were private. We didn't issue shares very often and we were not listed. You won't find anything about us on stock exchanges. Then we sold the whole company that was in 2002. So there were never any shares, public shares. Public shares are shares that are regulated for the general public. It's very clear, the SEC does not judge the investment potential of companies. They don't get into deciding. Is Facebook going to succeed or not, that's not their business. They only are deciding that it's not manipulative and distortion-driven. So an IPO is an initial public offering. It's been documented that the price in the aftermarket tends to be higher than the offering price in an IPO. This is a well-known fact. It jumps immediately. And again the issuer then might complain to the underwriter. The issuer then says, "Hey, you priced our issue at $25 a share and the next day it was $30 a share. So why didn't you ask $30 a share? We would have gotten $5 more." And I can tell you what the underwriter will say. The underwriter will say, "We do this all the time." He might not be so blunt about it, it's a trick. "It gets people positive about our company. If you don't like this, go to some other underwriter, but I'll tell you the other underwriter won't be as successful. He'll only get $20 a share for you because he doesn't have the goodwill of the public." So it's a sort of manipulation, deliberate. They under-price the offer and from what they know they could get, that way it sells out quickly, it looks great. In fact, it's also a problem, with IPOs, is that you can't get into them as a purchaser. You try. You call up as a Yale undergraduate, a broker and say, "I have a little money, like a few thousand dollars, my parents gave me. I'd like to invest in an IPO." And your broker will say, "Come back in 10 years. We'll talk later." He won't do it. Why won't they? Well, because they under-priced them and they want to give that to their favorite customers. So, this all sounds like a manipulation. Well, it is sort of. In my book with Akerlof, Phishing for Phools, we described the real world as filled with manipulation. Everyone's trying to trick you, but we don't make it that evil. It's usually okay. And what IPO underwriters are doing is sort of okay. So you as the issuer of new shares are consoled by the fact that even though you didn't get that extra $5 for your share, you got $25, which is pretty good and that's just the way the world works. Now the other thing is this manipulation is in some sense too successful because in the long run, IPO prices tend to fall. Jay Ritter whose a professor at University of Florida, wrote a famous article in 1991 said that, at least as of 1991, the average IPO jumped 16 percent on the first day in the aftermarket. So they were really under-pricing. But then if you wait awhile, wait a couple of years and it's gone, so they tend to fall. This is a secret that the IPO person, broker, won't tell you about. That's why you can't get into an IPO. So you are a hotshot, young student and you call a broker and say, "I'd like in on this IPO." The broker is thinking, "This guy is just going to flip it. I don't want customers like this. You know you'll make 16 percent on the first day but I'm not going to sell you, I'm going to sell to some elderly couple who are not paying attention. They won't sell the next day. I know who I'm selling to. I don't want to sell the next day because I might have to support it in the aftermarket." So you say, "No to you, hot shot young guy. We're going to sell it to stable." And it's all kind of manipulated like that. And then they'll notice that it went up the first day and they'll call me and say, it's looking good, isn't it? Then others completely forget about it and then they'll lose the money eventually. But you know, it's not all that bad. You've put them into a decent investment and eventually it will go up. But maybe not for three years. But, hey, I know my clients. You have to hope these people have some ethics and I think they do have some ethics. It's just the real world, right? There's a lot of tricks played. So I call this in some paper about the impresario hypothesis, I make it in the what underwriters do is analogous to what concert impresarios do. So I suppose you are managing a artist, a singer or an orchestra. What do you do? Have you ever thought about how you would do this? Well, what you want to do is create talk about your client, right? You want sold out conference, sold out audiences and you want newspaper stories saying people were standing in line all night to get into this such and such concert. And then that impresses the public and then you fill up concert halls because the news spreads and people think this is hot. But immediately, you might ask, "Well, why don't you just raise the price on the concert and then you'll make more money?" But you see that would be shortsighted, an impresario knows better. Keep the price low and you want these hungry looking young people coming to the concert and standing in line. You want that and the only way you get that is if you under-price it because they can't afford. If you charge the maximum you could charge for that, you wouldn't fill up the auditorium, your profit maximizing in the short run. You wouldn't fill up the auditorium and you'd get all these old people or a comfortable looking wealthy businessman that would just destroy the whole atmosphere of the concert. So you've got to keep those young people, the excited people in. Impresarios are known for this, right? They do stunts. They do publicity stunts and they also don't charge the highest price. That's why we have the price pop in IPOs at the beginning.
