Divide et impera: Strategic underpricing in privatizations

In several recent initial public offerings in privatization cases shares se emed to be severely underpriced. In this paper we provide a political econo my explanation for this apparent underpricing. Using a variant of Grossmann and Helpmann's (1996) model of special interest politics, we demonstrate t hat governments may raise their election chances by rationing investors bec ause the resulting broader distribution of shares makes regulation that is favorable to the privatized firm more popular. Somewhat surprisingly, even revenues from the privatization can be increased through rationing. The mod el also explains the common practice of bonus systems designed to prevent i nvestors from taking profits immediately.