Venture Capital Valuation,Partial Adjustment,and Underpricing: Behavioral Bias or Information Production?

Using a sample of venture capital (VC)‐backed initial public offerings (IPOs), we analyze the role played by perceived valuation changes on IPO underpricing. We find that perceived valuation change from the last pre‐IPO VC round to the IPO affects IPO underpricing in a nonlinear way. Further analysis indicates that information‐based theories, not behavioral biases, explain this nonlinearity. We also find that the previously documented partial adjustment effect and its nonlinear impact on IPO underpricing are related to the trajectory of the perceived valuation changes, which stands in stark contrast to prior evidence of the importance of behavioral biases.     

Monitoring or colluding: the role of venture capital investors in the IPO process

We argue and provide evidence that instead of playing a monitoring role, venture capital (VC) investors collude with controlling shareholders in the IPO process of Chinese non‐state‐owned enterprises (non‐SOEs). We show that VC‐backed IPOs’ applications are more likely to be approved by regulators, especially in firms with excess control rights, but have worse post‐IPO performance. Through investing in firms with excess control rights, VC investors are able to make higher exit returns. We further document that VC investors’ role in the IPO process is stronger when they have political connections, hold higher ownership, and when they make pre‐IPO investment.     

The Wealth Effect of Demutualization: Evidence From the U.S. Property-Liability and Life Insurance Industries

This study examines the wealth effect of demutualization initial public offerings (IPOs) by investigating underpricing and postconversion long‐run stock performance. Our results suggest that there is more “money left on the table” for demutualized insurers than for non‐demutualized insurers. We show that higher underpricing for demutualized firms can be explained by greater market demand, market sentiment, and the size of the offering. Further, contrary to previous research reporting an average underperformance of industrial IPOs, we show that demutualization IPOs outperform non‐IPO firms with comparable size and book‐to‐market ratios and non‐demutualized insurers. We present evidence that the outperformance in stock returns is mainly attributable to improvement in post‐demutualization operating performance and demand at the time of the IPOs. The combined results of underpricing and long‐term performance suggest that the wealth of policyholders who choose stock rather than cash or policy credits is not harmed by demutualization. Stockholders who purchase demutualized company shares either during or after the IPO have earned superior returns. Our findings are consistent with the efficiency improvement hypothesis.     

UNDERPRICING OF IPOS THAT FOLLOW PRIVATE PLACEMENT

In this study we examine the underpricing of initial public offerings (IPOs) by firms that have private placements of equity before their IPOs (PP IPO firms). We find that PP IPOs are associated with significantly less underpricing than their peers. Furthermore, PP IPOs are associated with lower underwriting spreads, more reputable underwriting syndicates, and greater postissue analyst coverage as compared to IPOs that are issued by their industry peers under similar market conditions. Consistent with the implications of the information asymmetry explanation for IPO underpricing, our findings suggest that companies could benefit by conveying their quality via successful pre‐IPO private placements that help reduce the cost of going public.     

The price of rapid exit in venture capital-backed IPOs

This paper proposes an explanation for two empirical puzzles surrounding initial public offerings (IPOs). Firstly, it is well documented that IPO underpricing increases during “hot issue” periods. Secondly, venture capital (VC) backed IPOs are less underpriced than non-venture capital backed IPOs during normal periods of activity, but the reverse is true during hot issue periods: VC backed IPOs are more underpriced than non-VC backed ones. This paper shows that when IPOs are driven by the initial investor’s desire to exit from an existing investment in order to finance a new venture, both the value of the new venture and the value of the existing firm to be sold in the IPO drive the investor’s choice of price and fraction of shares sold in the IPO. When this is the case, the availability of attractive new ventures increases equilibrium underpricing, which is what we observe during hot issue periods. Moreover, I show that underpricing is affected by the severity of the moral hazard problem between an investor and the firm’s manager. In the presence of a moral hazard problem the degree of equilibrium underpricing is more sensitive to changes in the value of the new venture. This can explain why venture capitalists, who often finance firms with more severe moral hazard problems, underprice IPOs less in normal periods, but underprice more strongly during hot issue periods. Further empirical implications relating the fraction of shares sold and the degree of underpricing are presented.      

China’s Securities reforms and IPO wealth loss

We revisit initial public offering (IPO) underpricing in China before and after the 2001 China Securities Regulatory Commission reforms targeting the IPO process and strengthening corporate governance, using Habib and Ljungqvist’s (2001) wealth loss measure instead of headline underpricing. Habib and Ljungqvist argue that the extent to which owners care about underpricing depends on both headline underpricing and the percentage of IPO shares issued relative to total shares outstanding. We find that in the post-reform period, relative to the pre-reform period, the wealth loss for pre-IPO owners is lower, the incremental effect of the association between wealth loss and state-retained ownership is significantly positive, and a higher proportion of independent directors on the board moderates the wealth loss. Our findings suggest that the more market-oriented IPO process and the corporate governance reforms provide insiders of Chinese IPO firms with greater opportunities to influence IPO pricing and thereby reduce their wealth loss.     

The IPO and first seasoned equity sale: Issue proceeds,owner/managers' wealth,and the underpricing signal

Recent models of IPO underpricing suggest that high-quality firms underprice their IPOs to differentiate themselves from low-quality firms and, thus, receive a more favorable market response to subsequent equity offerings. We test this suggestion for 172 industrial firms that made an initial public offering during 1987–1991 and made a subsequent seasoned equity offering within three years of their IPO. We examine two measures of the impact of the hypothesized underpricing signal net of the cost of employing that signal. Inconsistent with the underpricing signal hypothesis, we find no evidence that firms recover the cost of an underpriced IPO in either higher issue proceeds or in greater wealth for the firm's initial owners.     

Venture capital and underpricing: capacity constraints and early sales

I present a model of the venture capital (VC) and public markets in which VCs suffer from capacity constraints, due to the shortage of skilled VC managers. Consequently, VC firms can only handle a limited number of new projects at once, having to divest from ongoing projects in order to take advantage of new opportunities. This framework is able to match key features presented by the VC and initial public offer (IPO) empirical literatures: (1) VC-backed firms are younger, smaller, and less profitable at the IPO than their non-VC backed counterparts; (2) VC-backed IPOs are more underpriced than non-VC backed ones, (3) there is a positive relationship between underpricing and VC fundraising; (4) small and young VC firms usually take portfolio firms public earlier than their large and mature counterparts; (5) in hot IPO markets, VCs are more likely to take public both very young and small firms as well as mature and large firms, compared to cold markets. Differently, non-VC backed firms are usually smaller and younger in hot markets than in cold ones.     

Audit quality, auditor compensation and initial public offering underpricing

We jointly study the impact of audit quality on auditor compensation and initial public offering (IPO) underpricing using a sample of Australian firms going public over the period 1996–2003. We find that quality (Big Four) audit firms earn significantly higher fees than non-Big Four auditors, and audit quality is positively associated with IPO underpricing. The positive relation between audit quality and underpricing is more pronounced for small issues, IPOs underwritten by non-prestigious underwriters, and those that are not backed by venture capitalists. Taken together, our results suggest that quality auditors serve as a signalling device that enhances post-issue market value of equity.     

Size and diversity in VC syndicates and their impact on IPO performance

This paper investigates the impact of venture capital (VC) syndicate size and composition on the IPO and post-IPO performances of investee companies in an attempt to shed some light on the extent to which larger and more diverse syndicates are more likely to suffer from internal agency problems which might hinder the decision-making process and lead to less value added for their portfolio companies. The question is of great relevance because, while the vast majority of the empirical literature compares VC backed IPOs with non-VC backed ones, most VC funding is provided by syndicates of two or more financiers. We construct alternative measures of size as well as diversity based on several VC characteristics such as age, geographic location, type and affiliation of VC firms and find that larger and more diverse syndicates are associated with higher underpricing and lower valuation at the IPO date. Furthermore, we provide evidence that that diversity and size are negatively correlated to the long-term performance of the IPO firms and this finding is robust to several alternative measures of long-term performance.     

Allocation to Anchor Investors,Underpricing, and the After‐Market Performance of IPOs

We study bidding by anchor investors in a two‐stage initial public offering (IPO) process and document a negative, causal relation between allocation to anchor investors and underpricing. We find that anchor investors are likely to invest in hard‐to‐place offerings characterized by valuation uncertainty. We also document a positive relation between allocation to reputed anchor investors and returns up to lock‐up expiration. Our evidence provides support for information revelation and targeting specific investors’ theories of book building. Anchor‐backed IPOs earn superior returns mainly due to monitoring. Who bids in an IPO seems to matter just as particular types of bids do.     

Initial and Long-Run IPO Returns in Central and Eastern Europe

ABSTRACT

This article provides original evidence on IPO underpricing and long-run underperformance in Central and Eastern Europe (CEE) and compares results to the European Union’s developed capital markets from 2000 to 2009. Using both index-adjusted and CAPM-adjusted returns, we find significant underpricing that is significantly higher than underpricing of comparable IPOs in the European Union’s developed capital markets. We show that the CEE’s initial IPO returns also exhibit significantly higher volatility. In line with the asymmetric information theory, we indicate that smaller IPOs in the CEE region have greater underpricing than the larger IPOs. Contrary to the literature, we unambiguously confirm long-run underperformance toward the benchmarks. In some model specifications, we also find that IPO long-run underperformance in the CEE region is less present than in the European Union’s developed capital markets.     

Underpricing,ownership dispersion,and aftermarket liquidity of IPO stocks

Booth and Chua [Booth J., Chua L. Ownership dispersion, costly information, and IPO underpricing. Journal of Financial Economics 1996; 41; 291–310] hypothesize that IPOs are underpriced to promote ownership dispersion, which in turn increases aftermarket liquidity of IPO stocks. We examine a sample of 1179 Nasdaq IPOs and find that underpricing is positively correlated with the number of non-block institutional shareholders after IPO but negatively correlated with the changes in the total number of shareholders. Firms with many non-block institutional shareholders tend to have high liquidity in the secondary market. These results provide support to Booth and Chua's hypothesis. Underpricing also has direct effects on secondary market liquidity after controlling for ownership structure and other factors.     

What drives the valuation premium in IPOs versus acquisitions? An empirical analysis

Using a hand-collected data set of private firm acquisitions and IPOs, this paper develops the first empirical analysis in the literature of the “IPO valuation premium puzzle,” which refers to a situation where many private firms choose to be acquired rather than to go public at higher valuations. We also test several new hypotheses regarding a private firm's choice between IPOs and acquisitions. Our analysis of private firm valuations in IPOs and acquisitions indicates that IPO valuation premia disappear for larger VC backed firms after controlling for various observable factors affecting a firm's propensity to choose IPOs over acquisitions. Further, after controlling for the long-run component of the expected payoff to firm insiders from an IPO exit, we find that the IPO valuation premium vanishes even for larger non-VC backed firms and shrinks substantially for smaller firms as well. Our Heckman-style treatment effects regression analysis demonstrates that the above results are robust to controlling for the selection of exit mechanism by firm insiders based on unobservables. Our findings on private firms' choice between IPOs and acquisitions can be summarized as follows. First, firms operating in industries characterized by the absence of a dominant market player (and therefore more viable against product market competition) are more likely to go public rather than to be acquired. Second, more capital intensive firms, those operating in industries characterized by greater private benefits of control, and those which are harder to value by IPO market investors are more likely to go public rather than to be acquired. Third, the likelihood of an IPO over an acquisition is greater for venture backed firms and those characterized by higher pre-exit sales growth.     

Short‐Term Performance of U.S.‐Bound Chinese IPOs

Firms from emerging markets, including China, increasingly seek to raise capital outside of their home markets. We examine the short‐term performance of U.S.‐bound Chinese initial public offerings (IPOs) and find that these IPOs have significantly lower underpricing than a matched sample of U.S. counterparts. We also find that the magnitude of IPO underpricing for U.S.‐bound Chinese firms is positively related to revisions in offer price.     

The oversight role of regulators: evidence from SEC comment letters in the IPO process

This study investigates how regulatory oversight affects the price formation of initial public offerings (IPOs). We provide evidence on the oversight role of the US Securities and Exchange Commission (SEC) by examining the effects of comment letters issued by the SEC in the process through which companies are initially listed. We find that IPO issuers reduce their offer price if they receive comment letters. The reduction in price from the IPO filing date to the final issue date is greater when the IPO firm has more correspondence with the SEC. The pricing impact of SEC comment letters is more pronounced for IPO issuers with greater hyping incentives. Moreover, we find that IPO firms that receive more comment letters have similar levels of underpricing and outperform over the long run after the issue date, compared with IPOs with fewer comment letters.     

Venture Capital Backing and Overvaluation: Evidence from the High‐Tech Bubble

We investigate the association between venture capital (VC) backing and the likelihood of firm overvaluation in the high‐tech bubble period. We find strong evidence that a VC‐backed firm is more likely than a non‐VC‐backed firm to be overvalued during the bubble period. A further investigation suggests that such an association exists only for VC‐backed firms that have gone public recently and VC‐backed firms over which venture capitalists (VCs) have high ownership or control. But outside the bubble period, all the differences in overvaluation between VC‐backed and non‐VC‐backed firms disappear. Our findings provide additional evidence supporting VC opportunism in boom periods.     

Initial Public Offering Underpricing: The Issuer's View—A Comment

I consider the underpricing of initial public offerings (IPOs) and the wealth transfers implicit in that underpricing. I find that initial returns properly measure the “issue cost” effect of underpricing as a fraction of offer size, as in Ritter (1987) . I present a measure of the wealth effect of underpricing per share retained. In general, the wealth effects on existing shareholders depend on the extent to which they participate in the offering. From the perspective of issuer's wealth, I find that Dawson's (1987) measure is appropriate only in the special case in which all of the prior owners'; shares are sold in the IPO.     

Urban Economic Openness and IPO Underpricing

This paper represents a first attempt to employ a macroeconomic approach to explain the high and varying IPO underpricing within a single emerging market. We examine the empirical impact of trade openness on the short-run underpricing of initial public offerings (IPOs) using city-level data. Particularly, we argue that urban economic openness (UEO) has a significant impact on the productivity and on prices of both direct and indirect real estate due to productivity gains of companies in more open areas. This in turn positively affects the firm’s profitability, enhancing the confidence in local real estate markets and future company performance, hence decreasing the uncertainty of the IPO valuation. As a result, issuers have less incentive to underprice IPO shares. We use a sample of Chinese real estate IPOs, which offer a suitable laboratory thanks to their strong geographic investment patterns focused locally and a country with a highly heterogeneous openness across regions. Controlling for traditional firm- and issuing-specific characteristics of IPOs that are used for developed markets and Chinese-related features (i.e. listing location and state ownership), we find the evidence that companies investing in economically more open areas experience less IPO underpricing. Our results show great explanatory power and are robust to different specifications.     

Liquidity Benefits from IPO Underpricing: Ownership Dispersion or Information Effect

The positive correlation between initial underpricing and liquidity in the secondary market several months after an initial public offering (IPO) has previously been attributed to ownership dispersion induced by underpricing. We find that public information production is another channel by which underpricing improves liquidity. Using a sample of IPOs from Euronext, we find that analyst coverage engendered by initial underpricing reduces information asymmetry costs and illiquidity in the secondary market. The impact of information asymmetry is statistically more significant on measures based on adverse selection costs than on those based on the proportion of informed traders in the market.