Over-signaling vs underpricing: the role of financial intermediaries in initial public offerings

We consider a model of Initial Public Oerings (IPOs) where issuing rms of better
quality are more reluctant to go public. IPOs either generate or destroy value depending
on the type of the issuing rm, which is only observed by the issuer. We show that,
when the issuer directly oers the shares to the investors, market breakdown occurs.
This is caused by the issuer's attempts to signal his type through the oering price.
Things change if we introduce a nancial intermediary which: 1) acts as an underwriter,
2) in
uences the oering price. Underwriting creates a wedge between the interests of
the intermediary and those of the issuer. This allows trade with outside investors to
be restored. A by-product of the con
ict of interest between issuer and intermediary is
that trade is characterized by underpricing. In the benchmark case where her prots are
zero, the intermediary acts as a screening device: she underwrites the shares only upon
receiving positive information about the issuer.