Sunday, March 19, 2006

Why Wall Street Hates Auctions

Those of you with a NYT subscription can read Joe Nocera's Open and Fair: Why Wall Street Hates Auctions for yourself.

My interest is in pointing out the fact that if the auction method for initial public offerings, which is just getting off the ground, is free market, then the old way was not:

...a big firm rounds up the usual suspects (institutional investors), conducts a splashy road show, sets a too-low price that will ensure a big first-day "pop" in the stock, prevents anyone but its Wall Street friends from participating, and then charges the company going public an exorbitant 7 percent fee.

Nocera notes:

The purpose of an initial public offering has never been to enrich big, powerful investors with a guaranteed one-day profit....The purpose of an offering is to raise as much capital as possible for the company, capital it can use to hire employees and roll out products. When an issue is underpriced, it means the underwriter has hurt the company that has hired it. And when an issue is purposely underpriced, it means that the underwriter is taking care of Wall Street instead of its client.

(Remember that the company going public gets only the initial offering price that it sold its stock for, and unless it issues more stock, gets nothing from the first day "pop").

The auction doesn't involve any new technology. It is a different business process. It is better for the company going public than the traditional method. It faces strong resistance from Wall Street insiders (obviously). It mostly has not been practiced. I'l guess that auctions are feasible now, because companies are less vulnerable to the lack of goodwill on Wall Street (there are more players and more sources of the other services). But chalk up one more for non-price barriers to market entry.

"Free market economy" - hahahahahaha! More of a myth than God in Heaven! The core of capitalism consists of, and has consisted of, for the longest time, cronyists and insiders.

A question for the future is - why are we so assiduously sold this myth?