Jointly with CEPR, CSEF organised the EuroConference on The Design of Primary Equity Markets, with financial support provided by the NYSE and the EU Commission. The conference was held at the Hotel Palace in Capri on 15-17 June 2000.

The impressive growth of equity markets in the last decade has been largely due to the increased number of companies that listed their stock for the first time on public markets, via initial public offerings (IPOs). The number and frequency of IPOs has risen impressively in the United States, in Europe and in developing countries, as part of a shift away from private or bank finance and towards funding via public security markets. This process is commonly explained by the decreased cost and greater availability of equity finance associated with more integrated markets and faster information linkages among them.

Improvements in the design and performance of primary equity markets may also have contributed to this process. Among these are the diffusion of book-building techniques, better disclosure rules, greater competition among investment banks, and possibly competition among stock markets. The task of this conference was to assess these improvements and their implications. The insights that could be taken away from the papers presented fall broadly in two classes: those concerning the microeconomic aspects of IPOs, and those concerning the overall performance and impact of the primary equity market.

The microeconomics of initial equity offerings

It is well known that "IPO underpricing" is a key determinant of the cost of equity capital for companies that tap the stock market for the first time. Typically, IPO prices are below the level that they reach on the market a few days or weeks later, when more complete public information is available. The conference added three important insights to this much-researched topic. First, IPO underpricing is lower when also other companies go public, because each IPO generates beneficial information externalities for other companies that are about to go public. Second, designing the IPO procedure also matters: bookbuilding allows substantial cost savings, but these saving materialize only if underwriters are willing to let the issue price vary outside the range initially chosen in response to demand. The third insight concerns the motivation itself of IPOs: the decision to go public is affected by firms’ ownership structure. When their shares are held by only one owner and when banks own shares, companies are more likely to prefer private rather than public sales of equity.

The first finding was presented by Benveniste, Wilhelm and Yu in their paper on "Evidence of Information Spillovers in the Production of Investment Banking Services". They highlighted various implications of information externalities in the IPO process: bunching by industry, implicit subsidies from the leader to the followers, and lower underpricing when many companies go public. These predictions are consistent with U.S. evidence: the number of IPOs affects the proceeds revisions in the pre-offer period, and IPO underpricing is reduced by clustering and by firm-specific information that was not publicly available. Moreover, the information spillover is twice as large for information-sensitive industries as for other industries.

The second finding was reported by Jenkinson, Ljungqvist and Wilhelm in their paper "Has the Introduction of Bookbuilding Increased the Efficiency of International IPOs?" Using a large cross-country data set, they show that bookbuilding has higher costs but also countervailing benefits when the IPO is marketed by U.S. banks and sold to U.S. investors. The authors attribute these benefits to the US underwriters’ willingness to price outside the initial range. This may reflect the lack of legal or regulatory impediments and greater transparency and competition for issues marketed by U.S. banks to U.S. investors.

Cornelli and Goldreich confirm that non-U.S. banks are reluctant to respond to unexpectedly high demand by raising prices outside the initial range, thus undermining book-building. In their paper "Bookbuilding: How Informative is the Order Book?" they explore the actual order books for 64 international issues sold by a European investments bank, and report that there is a high percentage of issues priced at the top of the initial price range, with a substantial oversubscription at the issue price.

The discussion of the last two papers brought to the fore that underpricing depends not just on the sale method (bookbuilding versus other mechanisms) but also on the objective function of underwriters and their regulatory constraints. The real question then is whether underwriters have the "right" objective function, face tough competition and are not restricted by regulatory constraints. For the US underwriters, this seems to be the case, which helps explain why they dominate the IPO industry. By the same token, insufficient competition among bidders and collusion between investment bankers and bidders may explain the higher IPO underpricing when U.S. banks were not involved.

The conference also added new insights about the motives why companies go public. The identity of the initial owners of the company appears to play a role in this decision. Boehmer and Ljungqvist in their paper "The Choice of Outside Equity: Evidence on Privately-held Firms" analyze 266 German firms that have pre-announced their intention to go public, and show that firms that issue new shares are more likely to complete the IPO process. In contrast, other companies and in particular those with a majority owner or a shareholding bank tend to use the pre-announcement to signal their willingness to find new partners but eventually remain private. In "Why do Governments List Privatized Companies Abroad?", Bortolotti, Fantini and Scarpa point that when a company is being privatized, political and legal variables also play an important role in the decision to go public, and in the choice of the exchange. Examining 342 listings of privatized companies in 42 countries, the authors find that privatized companies in OECD countries tend to list in countries offering better legal protection of shareholders.

Overall performance and macroeconomic impact of the primary equity market

Assuming that market participants do as well as possible in designing the sale mechanisms of new stock issues, one is still left with two important questions. First, is it possible and worthwhile to try and encourage IPOs by fostering the venture capital industry and by setting up special markets such as the "New Markets" that have recently sprung up in Europe? Second, should the markets where these new issues are traded be designed and regulated in any special way?

Michelacci and Suárez shed some light on the first issue with their theoretical paper on "Business Creation and the Stock Market", where they show that the "informed capital" of venture capitalists and the stock market play complementary roles: the stock market allows venture capitalists to recycle their scarce informed capital. In their model, new businesses require a special type of capitalists who can solve information and incentive problems, so as to postpone their IPO until their profitability prospects are clearer. The scarcity of this informed capital, therefore, acts as a constraint on the rate of business creation. The lower the listing costs of firms, the faster venture capitalists can unload the firms they have funded on the stock market and "recycle" their informed capital with new businesses.

This suggests that any policy that can reduce the listing costs of new businesses translates into faster recycling of informed capital and faster real growth. In this framework, the difference between the IPO market (and the rate of business creation) in Europe and in the U.S. could be attributed to higher listing costs and lower availability of venture capital in Europe.

However, even assuming that listing costs are higher in Europe than in the U.S., listing costs may not be a crucial variable in the decision to go public. In their paper "Vagabond Shoes Longing to Stray: Why Foreign Firms List in the United States", Blass and Yafeh show that high-tech, high growth, export-oriented Israeli companies flock in droves onto the Nasdaq market in the U.S., forgoing the substantial tax benefits to listing in Tel-Aviv – not even by cross-listing their shares in Israel after listing in the U.S. In fact – they argue – these companies list in the U.S. precisely because it is costlier than in Israel, in order to signal their superior quality. Only firms with very large growth and profit opportunities can face the larger costs of a U.S. IPO, in terms of lower private benefits of control, larger underpricing and underwriting fees, and forgone tax benefits in Israel.

A similar signaling story was told by Kukies to explain why the recent IPO boom in Germany was associated with the creation of the Neuer Markt (NM) in 1997. To list on the NM, firms must be first admitted to the traditional exchange of the Deutsche Börse, and besides must fulfill additional requirements, especially in terms of information dissemination and accounting rules. Therefore, the companies that went public on the NM could have gone public before, but did not. In his paper on "The Effects of Introducing a New Stock Exchange on the IPO process," Kukies argues that the NM’s stringent information disclosure requirements provided a precommitment device that did not exist before. Listing on the NM acted as a signaling device for the most promising companies, just as listing on Nasdaq did for the best Israeli companies according to Blass and Yafeh.

Whatever the intrinsic merits of the requirements imposed by the Nasdaq and the NM, it should be realized that both the design of these markets and the listing choices of the companies across markets are endogenous. Increasingly, stock markets tend to compete for listings against each other, and will tend to differentiate their listing requirements and trading mechanisms so as to soften such competition, as shown by Foucault and Parlour in their paper "Competition for Listings." For instance, a possible equilibrium configuration is one in which one market displays low trading costs but high listing fees while another does the opposite. The first market will be attractive for large companies, which will be ready to pay the high listing fees in return for a more liquid market for their shares, while the second market will specialize in smaller companies – an example strikingly reminiscent of the differences between the NYSE and Nasdaq.