In our paper, The Economic Consequences of IPO Spinning, which was recently accepted for publication in the Review of Financial Studies, we investigate the practice of spinning using a sample of 56 companies that went public during the period 1996-2000. Spinning is the allocation by underwriters of the shares of hot initial public offerings (IPOs) to company executives in order to influence their decisions in the hiring of investment bankers and/or the pricing of their own company’s initial public offering. The term spinning refers to the fact that the shares are often immediately sold in the aftermarket, or “spun,” for a quick profit, and an IPO is termed “hot” if it is expected to jump in price as soon as it starts trading.
Despite the fact that IPO spinning is one of the four scandals associated with IPOs that have been the subject of regulatory settlements, it is the only scandal that has not yet received any systematic study due in large part to the unavailability of data. We overcome this limitation through the careful hand collection of a detailed dataset. More specifically, for our empirical analysis, we use data gathered from court cases, the media, and documents requested through the Freedom of Information Act. From these sources, we obtain data on 146 officers and directors at 56 companies that were recipients of hot initial public offering (IPO) allocations. All of these companies were taken public by Deutsche Morgan Grenfell (DMG), Credit Suisse First Boston (CSFB), and Salomon Smith Barney (SSB) during 1996-2000.
There is evidence in Securities and Exchange Commission (SEC) settlements and Congressional testimony that Piper Jaffray, Goldman Sachs, and other investment banking firms also engaged in spinning. Our empirical analysis, however, is restricted to IPOs for which DMG, CSFB, or SSB was the bookrunner. The reason that we impose this restriction is that the companies identified in press reports and settlements suffer from a selection bias, frequently containing examples of prominent executives at well-known companies. In contrast, the data for the three investment banking firms that we focus on is systematic, composed of all of the executives who were being systematically spun by CSFB as of March 21, 2000; executives who were being spun by CSFB and lived in Silicon Valley, including those being spun after March 21, 2000; or those being spun by SSB at any time during 1996-2000. For each executive that had a brokerage account with the SSB unit in charge of spinning, we have data on the allocations to each executive for 48 IPOs.
We estimate the effect of spinning on IPO underpricing and the awarding of future investment banking mandates. We find that holding everything else constant, IPOs in which the executives are being spun are 23% more underpriced (e.g., 43% vs. 20%). The average dollar value of this incremental underpricing, the incremental money left on the table, is approximately $17 million, where money left on the table is the underpricing per share multiplied by the number of shares issued. The average first-day profit received from hot IPO allocations by the executives of a company being spun is $1.3 million. The ratio of these numbers indicates that only 8% of the incremental amount of money left on the table flows back to the executives being spun. The effect of spinning on subsequent investment banking mandates relates to the literature that asks why firms do or do not switch underwriters—this literature has focused on performance dissatisfaction, graduation to a more prestigious underwriter, and analyst coverage reasons as factors that affect switching decisions. We add another reason, the co-opting of executive decision-makers, to this list. We find that companies with executives who are being spun are dramatically less likely to switch underwriters for their first seasoned equity offering. For companies not being spun, the probability of switching underwriters is 31%. For companies being spun, the probability of switching is only 6%.
Overall, our findings suggest that the spinning of executives accomplished its goal of affecting corporate decisions. More generally, this paper presents evidence on the economic consequences of an agency problem arising from the delegation of decision-making to corporate managers.
The full paper is available for download here.