The Seven Percent Solution


  • Hsuan-Chi Chen,

  • Jay R. Ritter

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    • Chen is from Fu Jen University, Taiwan, and Ritter is from the University of Florida. We are grateful to William Christie, Stuart Gillan, Jason Karceski, Tim Loughran, Ananth Madhavan, Tim McCormick, Andy Naranjo, Paul Schultz, Shawn Thomas, Steve Wallman, William Wilhelm, Kent Womack, Li-Anne Woo, Hui Yang, Hsiu-Chuan Yeh, two anonymous referees, participants in seminars at Arizona State, Boston College, Cornell, Duke, Maryland, and Tulane, and especially Harry DeAngelo, Mark Flannery, Bruce Foerster, Tracy Lewis, Michael Ryngaert, and René Stulz for helpful comments. Data on analyst forecasts have been supplied by I/B/E/S.


Gross spreads received by underwriters on initial public offerings (IPOs) in the United States are much higher than in other countries. Furthermore, in recent years more than 90 percent of deals raising $20–80 million have spreads of exactly seven percent, three times the proportion of a decade earlier. Investment bankers readily admit that the IPO business is very profitable, and that they avoid competing on fees because they ‘don't want to turn it into a commodity business.’ We examine several features of the IPO underwriting business that result in a market structure where spreads are high.