The effects of afﬁliations on the initial public offering pricing Manuela Geranio a , Camilla Mazzoli b, * , Fabrizio Palmucci c a Department of Finance, Bocconi University, Via Roentgen 1, 20136 Milano, Italy b Department of Management, Universit a Politecnica delle Marche, P.le Martelli 8, 60121 Ancona, Italy c Department of Management, University of Bologna, Via Capo di Lucca 34, 40126 Bologna, Italy ARTICLE INFO JEL classiﬁcation: G24 G31 G23 Keywords: Initial public offerings Conﬂicts of interest Underpricing Information asymmetries Price adjustment ABSTRACT This paper studies the impact of afﬁliations between lead managers, venture capitalists, and institutional investors on the Initial Public Offering (IPO) pricing. Using a sample of 1996 US IPOs issued between 1997 and 2010, we ﬁnd that afﬁliations strongly and positively affect the offer price by improving the information production process. We also show that the underpricing is affected by afﬁliations because of conﬂicts of interest that exist between the players: when an institutional investor is afﬁliated with a lead manager or with a venture capitalist we observe nepotistic behavior in hot IPOs and dumping ground behavior in cold IPOs. 1. Introduction The presence of afﬁliations between players in ﬁnancial operations is widespread in the ﬁnancial ﬁeld (Berger, Demsetz, & Strahan, 1999; Crockett, Harris, Mishkin, & White, 2004). Indeed, the industry's structure has been extensively shaped by consolidation and also by the implementation of diversiﬁcation strategies brought into play by the major investment banks over the last few decades. Moreover, regulators have progressively reduced the barriers to cross-ownership of ﬁnancial companies (see the Financial Services Modernization Act of 1999). As a result, investment banks are allowed to contemporaneously perform at least two of the following: underwrite an IPO; manage a mutual fund investing in the IPO; or manage a venture capital fund selling the company in the IPO. Data on US IPOs show that it is quite common for lead managers (LMs) to be afﬁliated with the mutual funds (MFs) buying the IPO or with the venture capitalists (VCs) selling the IPO; it is also common that MFs are afﬁliated with VCs. In the past, the Investment Company Act of 1940 and Rule 10(f)-3 adopted by the SEC in 1958, 1 limited the participation of funds afﬁliated with any manager of an IPO; the ‘spirit’ of the rules was to prevent the lead manager from using funds under its control as a * Corresponding author. E-mail addresses: manuela.geranio@unibocconi.it (M. Geranio), c.mazzoli@univpm.it (C. Mazzoli), f.palmucci@unibo.it (F. Palmucci). 1 The Investment Company Act of 1940 and Rule 10(f)-3 adopted by the Security and Exchange Commission (SEC) in 1958 imposed restrictions on mutual funds buying any of the shares in a security offering during the existence of the syndicate if the fund was in any way related to any syndicate members. In the following years, the SEC amended Rule 10(f)-3 several times. In 1979 a limit was introduced to allow an afﬁliated fund to buy up to 4% or $500,000 of an offering, whichever was the greater, although in no circumstances could the purchase be more than a maximum percentage limit of 10% of the offering. In 1997 the SEC amended the rule again, raising the maximum percentage limit to 25%, and the dollar amount limit was dropped. The SEC further amended the rule in 2003 to apply the percentage limit only when the afﬁliated underwriter was the principal underwriter. Contents lists available at ScienceDirect International Review of Economics and Finance journal homepage: www.elsevier.com/locate/iref http://dx.doi.org/10.1016/j.iref.2017.06.002 Received 24 November 2015; Received in revised form 1 June 2017; Accepted 15 June 2017 Available online 19 June 2017 1059-0560/© 2017 Elsevier Inc. All rights reserved. International Review of Economics and Finance 51 (2017) 295–313