The '7% Solution' and IPO (Under)Pricing

We investigate the effect of the “7% solution”—the fact that underwriters in the U.S. charge a 7% spread to most IPOs between $20 million and $100 million in size—on the ensuing pricing of the offerings. Our identification exploits the variation in spreads that is due to distinct kinks in the relation between spread and offer size at these two thresholds. We find that the spread positively influences underpricing but also the offer-price adjustment from the filing range’s midpoint. Our evidence indicates that the spread influences the aftermarket price, suggesting that underwriters can shape, not merely discover, investor valuations.