Shares Valuation Throughout the IPO Procedure: A Perspective from Game Theory

Abstract

Ever since the appearance of economic activities, the idea of game theory has been closely connected to the development of economic framework and applications. For years, the game theory, as an economic topic, has been rarely applied in the research regarding the financial market. As one of the most intriguing topics in the financial market, asset valuation has consistently developed with theoretical knowledge. The initial public offering (IPO) which has been regarded as the most lucrative equity investment, the share valuation is the pivotal issue of the financial service industry. As observed in my industrial interviews, pricing the shares for the IPO is not the skill of the valuation, but the art of the valuation. The first essay is mainly focus on the IPO contract designing issue of the company which initiates the IPO. Different from the conventional one-by-one contract design, the first essay proposes the cross application of the auction theory and bargaining theory to facilitate the channel coordination. Compared with the conventional bargaining theory which commonly uses the ‘price’ as the strategic variable, here uses the ‘quantity’ as the strategic variable. This strategic variable setting will make the bargaining more suitable to the practical situation in the IPO. In the model, there will be two different types of contracts, the first is the customised type and the standardised type. The customised contract enables the seller and the underwriter to reach their own contract while the standardised contract refers to identical contract for every underwriter. The research finds that the different strategic variable setting would shape the initial demand function in great degree, while the seller and the underwriters will have different preferences toward the types of the contract based on their relative bargaining power. As for the auction setting, if all the underwriters are risk-neutral, then the equilibrium result would be the same regardless of the auction types. But for the future planning of the seller, the seller tends to adapt the second price auction which could better help the seller to get the insight regarding the true valuations. The second essay is concentrating on the area of the facilitation of channels. For different negotiation mechanisms, the bargaining parties usually consider themselves. Under the assumption that each participant is rational, the bargaining results tend to be beneficial for individual participant. This would result in the low efficiency throughout the whole channel. In articles that discuss the possible solution of improve the channel efficiency, some possible methods have been proposed including side payment, buyback contract etc. However, the fundamental idea of the channel efficiency improvement remains untouched. In the essay, it has been found that once the model has been set, the total profit that can be earned by all participants is set. What side payment act throughout the channel coordination is first create a bigger pie and split the pie based on the relative negotiation power of participants. In another word, the side payment helps both participants to be better off compared to the initial independent bargaining situation, but the individual participant cannot fully enjoy the incremental profit, and the partial profit sacrificed under the side payment condition is dependent upon relative bargaining power. The third essay is concerning the bargaining situation regarding the seller and the underwriter when the market demand is a stochastic information and remains private to the underwriter. The bargaining mechanisms concern price matching and simultaneous negotiation. The model comprises belief construction procedure regarding the underwriter and offer proposition process under an alternating negotiation mechanism. The model illustrates the appropriate disclosure behaviour of the underwriter and preferences of the seller regarding the negotiation mechanism has certain deviations compared with the circumstance of the certain market demand base. The existence of the outside option could help the seller to avoid the exploitation from the underwriter who possess the private information. This essay provides managerial insights to both the seller and underwriters regarding the appropriate behaviours throughout the bargaining procedure that comprises stochastic elements.