Initial Public Offerings: Room For Improvement

In the U. S., individuals can turn their ideas into products and then, by tapping the public equity market, gather more capital to build their businesses. The same can be said for other economies, but in no other society is company creation so widespread or the securities market so central to economic growth. That is one reason why the U. S. spawns so many companies with vast growth potential, such as the 100 on our hot-growth list.

An even more efficient market for first-time stock offerings would add to the U. S.'s strategic advantage in global financial competition. Several recent public issues, however, were seriously underpriced by investment bankers, and a handful were grossly overpriced as stock prices plummeted on the first day of trading. There is nothing academic about such margins of error: An underpriced stock deprives a fledgling company of badly needed cash, while an overpriced stock takes money out of investors' pockets, and dampens demand for other offerings. The initial public offering (IPO) market is not working as well as it could.

Investment bankers are right that pricing initial public offerings is more art than science--especially in the case of a young company with little earnings history. It's even trickier for companies in cutting-edge industries such as biotechnology--in which salable products and revenues, let alone profits, are years away.

Investment bankers have been setting IPO prices since stocks began trading on what is now Wall Street two centuries ago. Perhaps it's time the Street devised a better way to raise capital for some emerging growth companies. One idea: Institutional investors already trade equities and other securities with one another using computerized networks and bypass brokers. Why not launch new stock offerings the same way? Auctions of selected IPOs, provided they have an earnings history and a decipherable balance sheet, may be able to improve on the current hit-or-miss system of pricing. In time, any new auction system would make room for individual investors, who are often shut out of the hottest IPOs, to participate in the offering.

A few of these public auctions could add more efficiency to the capital-raising process. And that would go a long way toward helping ensure that the next generation of emerging companies gets the funds it needs for growth.

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