The IPO process is presently being assesed for possible unethical behavior. Some underwriters
provide the CEO's of firms that mite go public in the near future with shares of other IPO's. The shares are sold to these
CEO's at the offer price. The return on shares that can be purchased at the offer price is usualy high. It can be argued that
this special deal provided by investment banks to CEO's is a payoff in anticipation of the CEO's steering future business
to the investment bank. For example, suppose that an investment bank (IB) is about to serve as underwriter for a firm (Firm
X) that is going public.(IB) knows that Firm Y and Firm Z also plan to go public in the near future. IB is competing with
other investment banks to serve as the underwriter of the future IPO's by Firm Y and Firm Z. IB informs
the CEO's of Firm Y and Firm Z that it is willing to sell them shares from the IPO of Firm X at the offer price. The CEO's
of Firm Y and Firm Z will probably earn large returns on their investment because IB allowed them to purchase shares at the
offer price. IB expects that the CEO's of these two firms will return the favor by steering future business to IB. That is
these CEO's may suggest to their respective board of directors that their firm hire IB as the underwriter for their own firms
IPO. or for other business. The typical fee for underwritiner in an IPO is 7% of the offering. Since most offerings exceed
$40 million, the underwriter fee is usualy at least $3 million.
When firms engage in an IPO, the investment bank that served as lead underwriter tends to have one of its
analysts assign a rating to the firm. IN virtually all cases, the analysts from the investment bank that also serves
as underwriter assigns the highest possible rating to the firm over the next several months. It is commonly argued that the
investment banks use the analsts high rating to prevent the firms stock price from declining. Thus , the firms that engage
in an IPO benefits from a price that is somewhat inflated or stabilized after the IPO. The investment bank that underwrites
the IPO benefits in the form of fee's charged to the firm. The only potential loser is the indivigual invester who was not
able to obtain shares at the offer price, who will likely pay too much for the shares she or he purchased.
ONe might argue that the IPO shares sold at the offer price to CEO's of other firms are the
cost of doing business. However, some CEO's have made millions of dollars from holding these shares for just a short period.
This suggest that shares could have been sold at a higher offer price, which would have generated more funds for the firm
whose shares were being sold during the IPO.