Summary
Why would a company do a direct listing? What are the key differences between an IPO and a direct listing? And what are the tradeoffs involved in this new approach? In the discussion that follows, Joe Grundfest, W.A. Franke Professor of Law and Business, answers these questions, and more, about direct listings.
What is a direct listing and how does it compare to the traditional IPO process?
In the traditional IPO, there are really two price setting mechanisms that occur within a few hours of each other. First, the underwriter tries to estimate the price at which the security will trade in an active secondary market, and based on that estimate sells the securities at the “IPO price,” typically to a group of institutional or high net worth investors. Your average retail investor typically can’t get into an IPO at the IPO price. Then, a few hours later, the stock starts trading on the Nasdaq market or on the NY Stock Exchange. There, it’s an entirely different group of buyers and sellers that establish an equilibrium price, and that secondary market trading price can diverge significantly from the IPO price.
In contrast, in a direct listing the underwriters never set an IPO price and never sell to a select group of purchasers. Instead, trading begins on the secondary market with any purchaser able to submit a price at which they are willing to buy the shares. The underwriters don’t sell at a price they determine to a select group of purchasers. The market sets the price at the very first instance.
Is the traditional IPO process broken?
Some market participants think it’s working just fine, others think there’s room for improvement, and others think that the process is profoundly broken. The major cause of the debate is a phenomenon known as the “IPO pop” – the tendency for the price of some issuer’s shares to increase significantly above the IPO price on the first day of trading. To the strongest critics of the system, “the pop” is evidence that underwriters are failing to get the best price for issuers. Their concern is not only that the issuers are leaving money on the table because they could have sold their stock at a higher price. They also fear that underwriters underprice because it generates profits for the underwriters’ clients who get to purchase shares at the cheap IPO price, and that the clients return the favor to the underwriter by directing more business to the firms that get them into these hot deals.
Read More