ABSTRACT
This chapter examines the role of distribution in new issue markets. It argues that distribution by the investment bank provides a partial control of the adverse selection bias created by the presence of informed investors. The chapter demonstrates that investment banks can reduce the amount of under pricing required to compensate the uninformed for the adverse selection bias by rationing in a preferential manner to "regular clients" who behave as uninformed investors. Economists have recognised for some time that adverse selection biases can exist when pre-purchase quality information is costly to produce. The chapter reviews alternative methods of making new issues in the UK and the US and specifies a test of the hypothesis that investment banks choose a method of distribution which provides a partial offset to the adverse selection bias. Rationing in a preferential manner to regular clients produces a gain in efficiency if the rationing mechanism rewards those investors who are uninformed.
