Blog on the Run: Reloaded

Friday, June 17, 2011 7:00 pm

Numbers don’t lie, but the numbers guys do

Filed under: I want my money back. — Lex @ 7:00 pm
Tags: , ,

Back in the early 1990s, when I was first applying database analysis to newspaper reporting (I mean when I was starting to do it; lots of other people did it before me), I attempted to tackle the question of whether bids for milk contracts between dairies and N.C. public school systems were being rigged, as we were hearing. I gathered contract data from as many years as I could from as many school systems as I could — at least three and sometimes seven or eight years’ worth of data for almost every system in the state, in fact — and looked at what the numbers showed.

To my untrained eye, they appeared to show home-town favoritism, exclusive long-term relationships and a number of other things that you wouldn’t expect in a competitive market. Moreover, although transportation costs were the second biggest factor in the price of milk after the cost of the raw milk itself, contract prices tended to go up a lot more quickly and down a lot more slowly than did fuel costs.

But, having only an untrained eye, I sent my data to an agricultural economist at a large research university in another state and then called (this was in the immediate pre-email era for most Americans) and asked him whether what I thought I was seeing was actually what I was seeing. I pretty much expected him to say that there were, in fact, logical explanations for what I was seeing in the data, significant drivers of milk prices that I had overlooked,  subtleties of the school-milk marketplace that contract numbers didn’t account for, and so on and so forth.

Instead, what he said was, “Oh, yeah. If I was a DA, I could have a lot of fun with this.”

As it happens, the United States government has the equivalent of a DA for investment bankers, the United States Attorney for the Southern District of New York, in Manhattan, where most American investment banks are based. That individual could have a lot of fun with this:

Mark Abrahamson, Tim Jenkinson, and Howard Jones, of Oxford University, have an utterly compelling paper out proving that there’s collusion among investment banks in the US — it doesn’t matter whether they’re European or American banks — to keep IPO proceeds set at 7%. Using a very high-quality new dataset, they compare US and European IPOs, and get the following result:


This chart just shows IPO fees for deals between $25 million and $100 million (in 2007 dollars). But the pattern is universal:

Between 1998 and 2007, 95.4% of U.S. IPOs between $25m and $100m had gross spreads of exactly 7%. The comparable figure between 1989 and 199… While Chen and Ritter showed virtually no IPOs over $150m with a 7% gross spread, we find that 77% of all offerings between $100 and $250m charge exactly 7%. (Note from Lex: The visual fooled me at first. That solid black line at 7% isn’t just an illustrative line. It’s that solid and that black because THOSE ARE ALL THE DATA POINTS.)

European IPO fees do not cluster, and only 1% of offerings raising $25m or more experience gross spreads as high as 7%. Within the $25m-$100m range, fees for European IPOs average just over 4%. Indeed, European IPOs are always cheaper: we find that there is a “3% wedge” between European and U.S. IPOs after controlling for size, issue characteristics, syndicate structure and time or country effects. Fourth, whilst gross spreads are lower for the larger offerings in both regions, our multivariate analysis indicates that fees for the larger U.S. IPOs have tended to increase in our sample period, while European IPOs have been getting cheaper.

The paper runs down a list of possible reasons why US IPOs might be so much more expensive than their European counterparts, and finds none of them convincing; their conclusion — the correct conclusion, I think — is that there’s an implicit cartel in the US, devoted to keeping IPO fees artificially high. (The term of art is “strategic pricing”: although it might be in any bank’s short-term interest to compete on price for any given deal, it’s in all of their long-term interest not to ever do so.)

The cost to issuers of this collusion is huge:

Our best estimates suggest that had these IPOs been conducted at European fee levels the savings to U.S. issuers over the period would have totaled $11.4 billion – or over $1 billion per year.

The moral of the story, first told to me when I worked in PR for investment banks in New York in the early 1980s, is that no one makes money on IPOs except investment banks. (That’s why I didn’t try to get in on the Netscape IPO even though, unlike most Americans, I’d actually tried the product at the time and KNEW it would be popular.) What’s different about this is that now we know why. What’s not different is that they’re going to keep getting away with it just as they have with everything else.

UPDATE: Hedge-fund manager John Thomas reminds us that because the seller of any security likely knows a lot more about it than you do, any explanation regarding why a company is going public usually translates to, “The insiders are getting out at the top.”


  1. You left us hanging. I went looking for the rest of the story. Found this and 12 others on the same subject.

    Greensboro News & Record-March 1, 1992
    Author: LEX ALEXANDER Staff Writer

    Rigging school milk bids may have cost state taxpayers more than $8 million, but the dairies did it to stay alive.


    It’s tough for dairies to make a profit.

    But investigators say it was easy for them to milk taxpayers out of more than $8 million by rigging bids on school milk contracts.

    North Carolina schools are a huge milk market – they buy 800,000 half-pints a day under annual contracts.

    If dairies could set prices without worrying about being underbid, they could charge extra and make a decent profit selling to schools nearby. Competitors could do the same.

    That’s just what state and federal investigators say happened for years, starting when today’s eighth-graders were in kindergarten.

    In one county, for example, two dairies made identical bids – to the hundredth of a penny – on three types of milk four years in a row.

    Three dairies have pleaded guilty, including Pet, which admitted rigging bids in Alamance County in 1985-86.

    At least four other dairies had bidding and sales patterns resembling those of dairies that pleaded guilty, according to a News & Record analysis of records from 112 of the state’s 133 school systems.

    The seven dairies frequently had exclusive, long-term relationships with school districts where they had plants or distribution centers. Flav-O-Rich, for example, which has a plant on West Market Street in Greensboro, won the Guilford County schools’ milk contract every year from 1981-82 to 1990-91.

    In years said to be the height of the bid-rigging, the dairies’ prices tended to rise more quickly and fall more slowly than the price the N.C. Milk Commission set for raw milk.

    During that six-year period, prices bid by five of those dairies routinely varied in a given year by more than 15 percent, and one dairy’s bids varied as much as 60 percent – significant swings in a business with an average profit margin of less than 2 percent.

    “I think that if I was a lawyer, I’d have some fun with a differential that big,” Hal Harris, a Clemson University economist who has studied Southeastern milk markets, said of the 15 percent swings.

    “I would not disagree with that,” said Jim Gulick, the official leading North Carolina’s investigation.

    He would not discuss the News & Record’s findings but said at least five milk processors and distributors remain under investigation.

    Investigators don’t think school officials were involved, he said.

    Harris said he thinks dairies were just looking for breathing room.

    “I don’t think there was any blatant attempt to rip school sys

    Comment by Fred Gregory — Friday, June 17, 2011 8:39 pm @ 8:39 pm

  2. Yeah, I didn’t quite remember the quote verbatim, but I got the gist.

    Comment by Lex — Saturday, June 18, 2011 2:31 pm @ 2:31 pm

  3. Who is Ed Mezvinsky???

    Edward “Ed” Mezvinsky, born January 17, 1937, is a former Democrat congressman. As a Democrat, he represented Iowa ‘s 1st congressional district in the United States House of Representatives for two terms, from 1973 to 1977.

    In March 2001, Mezvinsky was indicted and later pleaded guilty to 31 of 69 charges of bank fraud, mail fraud, and wire fraud.

    Nearly $10 million was involved in the ponzi scheme. After serving five years in federal prison, he was released in April 2008. He is expected to remain on federal probation until 2011, and still owes $9.4 million in restitution to his victims. So who is he???

    He’s Chelsea Clinton’s father-in-law.

    Nary a mention of this in any of the media. If this guy was Jenna or Barbara Bush’s — or better yet — one of Sarah Palin’s daughters father-in-law, the news would have replaced the oil spill.

    Oh, and guess what Chelsea’s husband does for a living……INVESTMENT BANKER….imagine that!!!!

    Comment by Fred Gregory — Wednesday, June 22, 2011 2:09 am @ 2:09 am

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