Small Investor Demand and Allocation in Commercial Bank Managed IPOs

There is a burgeoning literature on IPO allocations to institutions with retail clientele typically being treated as a monolithic entity. However, there is potential for differential treatment of different groups of retail investors because of the underlying relationship with the underwriter. We use a unique proprietary dataset from Germany to analyze how commercial banks treat different groups of retail investors in their underwriting of new equity issues. Do banks take advantage of retail investors to dump “lemons” or do their retail investors benefit from getting higher allocation of underpriced issues? We provide evidence that lead underwriters’ retail customers demand more of the highly underpriced issues and end up with a higher allocation of underpriced issues. We additionally provide evidence on the underlying incentives of the bank to treat their retail clientele well by examining cross-selling potential from other services of the bank. In particular, we document an increase in both new brokerage accounts and retail consumer loans which are related to increased IPO underwriting, especially underwriting of underpriced IPOs by the commercial bank. Our results support the notion that the underlying relationship with the retail clientele and the potential to offer other services can not only result in differential or favored retail treatment but can lead to incentives for the bank to underprice IPOs to attract new retail customers. This suggests a number of new research questions relevant in many regimes including the current US regulatory setting where both commercial banks and investment banks underwrite. † Duke University and NBER. Email: [email protected]. Tel: (919) 660-7657; ‡ University of North Carolina. Email: [email protected]. Tel: (919) 962-8466. We thank seminar participants and discussants at the Federal Reserve Bank Chicago, Ohio University, University of North Carolina, 10th Symposium on Finance, Banking, and Insurance in Karlsruhe, and the Symposium on Corporate Finance at the Hong Kong University of Science and Technology.