The Underpricing and Excess Returns of Initial Public Offerings in Taiwan Based on Noisy Trading: A Stochastic Frontier Model

Initial public offerings (IPOs) are typically offered at prices lower than the transaction price in the early aftermarket. With a stochastic frontier model, we measured the fair offer price of an IPO and then the deliberate IPO underpricing and the market misvaluation based on the estimated fair offer price. Our results show that IPOs are deliberately underpriced. The extent of noisy trading leading to significantly higher market transaction prices explains the excess IPO returns. We conclude that initial IPO returns result primarily from the noisy trading activities instead of the deliberate IPO underpricing.     

Fixed price and book building methods in an exogenous environment: Evidence from Indonesia stock market

Book building has become a popular method of selling new shares. Although previous models suggest that book building is an efficient method for price discovery in initial public offering (IPO) issuance, empirical evidence provides mixed results. Previous empirical findings on IPO methods have been obtained from markets that allow issuers to choose the IPO method, and this setting is not free from endogeneity issues. We investigate the effect of IPO method (fixed price vs book building) in Indonesia, which is an emerging market that offers an exogenous setting for IPO methods. More specifically, Indonesia used the fixed price method for IPOs before October 2000 and used the book building method thereafter following the introduction of new IPO regulations. Using estimation methods that consider clustering phenomena, we find that book building yields larger underpricing and greater volatility than the fixed price method. Moreover, a positive relationship is observed between underpricing and aftermarket volatility for the book building method and book building IPOs underperform fixed price IPOs. No relationship was observed between underpricing and long-term performance for book building IPOs. Compared with previous models, our findings suggest that book building does not represent a quality IPO method and suffers from agency conflict; thus, this method needs improvement.     

西方IPO抑价理论及对中国IPO研究的启示

西方IPO抑价理论大多在信息不对称、委托代理、信号显示等信息经济学框架下,基于资本市场的有效性假设而提出的,即假定二级市场对股票的定价是合理的,IPO抑价是源于发行定价偏低.中国A股市场IPO抑价率长期高企但逐年下降,对该问题的研究,不能简单套用西方理论,而必须结合我国证券市场环境及IPO发行审核制度,将制度因素作为内生变量来考察.     

An examination of IPO secondary market returns

IPO stock prices increased approximately 2.3% on the first day of secondary market trading over the period 1993 through 2003. While these aftermarket returns are accentuated during 1999 and 2000, they persist after the bubble burst and even increase as a percentage of total underpricing. We explore several non-mutually exclusive hypotheses to explain our findings including price support, laddering, retail sentiment, and information asymmetry. Our results are most consistent with the view that higher secondary market returns accrue to IPOs with more information asymmetries possibly due to price and aggregate demand uncertainty.     

THE MARKET'S PRICING OF DEBT IPOs

Based on the authors' recent study published in the Journal of Financial Economics , this article summarizes new evidence on the first-day and aftermarket price performance of a firm's first public offer of bonds after its equity IPO. Unlike equity IPOs, such bond IPOs are not underpriced on average. However, bonds that are more equity-like (junk bonds) are underpriced at the initial offer whereas high-grade debt is actually overpriced. This finding supports the view that riskier debt issues have a larger equity component and, as a consequence, a higher degree of information asymmetry.
The authors' study also showed that less prestigious underwriters are associated with more underpriced offers, and that the issuer's stock market listing plays an important role in determining the first-day price performance of bond IPOs. The degree of underpricing is lower for bonds issued by firms whose equity is listed on NYSE/AMEX than for bonds issued by firms listed on Nasdaq. Finally, the aftermarket performance for the full sample and various subsamples is consistent with bond market efficiency in the sense that, once prices adjust after the first day of trading, there are no clearly exploitable opportunities for excess returns.     

Pursuing Value Through Liquidity in IPOs: Underpricing,Share Retention,Lockup, and Trading Volume Relationships

We argue that in an initial public offering (IPO), pre-IPO owners make decisions regarding underpricing, share retention, and share lockup simultaneously and optimally to maximize aftermarket liquidity. We predict that underpricing fosters higher trading volume in both the short run and the long run. Also, liquidity is negatively related to the proportion of shares retained by pre-IPO owners, ceteris paribus, so IPO underpricing should be positively related to the proportion of shares retained, as an offset. We document evidence consistent with these predictions. In addition, we find that, for IPOs with a lockup restriction, underpricing is more substantial and the positive relation between share retention and underpricing is much stronger. We also find that the relationship between underpricing and trading volume is stronger for IPOs with lockup. IPOs with lockup have higher trading volume, and a significant portion of this difference is associated with the effect of underpricing.JEL Classification: G10, G14, G24     

Laddering in initial public offerings

Laddering is a practice whereby the allocating underwriter requires the ladderer to buy additional shares of the issuer in the aftermarket as a condition for receiving shares at the offer price. This paper identifies factors that create incentives to engage in this type of manipulation and models the effect of laddering on initial public offering (IPO) pricing. I show that laddering has a bigger effect on the market price of IPOs with greater expected underpricing (without laddering) and greater expected momentum in the aftermarket; laddering increases the IPO offer price, the aftermarket price, and the money left on the table but does not necessarily increase the percentage underpricing; laddering contributes to long-run underperformance and creates a negative correlation between short-run and long-run returns; and profit-sharing increases the extent of laddering and the percentage underpricing.     

Deliberate premarket underpricing and aftermarket mispricing: New insights on IPO pricing

We decompose initial returns into deliberate premarket underpricing and aftermarket mispricing using stochastic frontier analysis. We model deliberate underpricing as a function of proxies of information asymmetry surrounding IPO value between market participants. Equity retained is an unlikely signalling mechanism to convey IPO value to outside investors through deliberate premarket underpricing. The presence of lock-in agreements, underwriter fees, number of uses of proceeds, and venture capital or private equity backing have positive impacts on deliberate premarket underpricing. Demand for firms' capital also explains deliberate premarket underpricing, whereas new issues market conditions have no impact. All these factors are found to explain a significant fraction of the variations in our deliberate underpricing estimates. Deliberate underpricing is the more dominant component that makes up initial return when compared to the fraction of aftermarket mispricing. We attribute aftermarket mispricing to trading volume in IPO shares on the first day, price adjustment between the filing price range and the offer price, and offer size. Equity retained explains the aftermarket mispricing rather than the deliberate premarket underpricing in contradiction to the signalling argument. More reputable underwriters are likely to provide price support in the early aftermarket, whereas we observe no impact on deliberate premarket underpricing.     

Differences between European and American IPO Markets

This brief survey discusses recent developments in the European initial public offering (IPO) market. The spectacular rise and fall of the Euro NM markets and the growth of bookbuilding as a procedure for pricing and allocating IPOs are two important patterns. Gross spreads are lower and less clustered than in the USA. Unlike the USA, some European IPOs, especially those in Germany, have when‐issued trading prior to the final setting of the offer price. Current research includes empirical studies on the valuation of IPOs and both theoretical and empirical work on the determinants of short‐run underpricing.     

合资承销商影响新股破发率的实证研究

新股破发是目前中国股市目前面临的一个重要现象。本文基于2004年至2010年上市的A股IPO,研究合资承销商对新股破发率的影响。研究发现,合资承销商所承销的新股破发率显著低于本土承销商。合资承销商的低破发率主要归功于更加有效且符合市场预期的一级市场发行定价能力,其表现为合资承销商发行的股票的短期市场价格相对发行价的偏离程度显著低于本土承销商发行的股票。另外,我们还发现合资承销商采取了一定的托市行为,该行为也减小了短期内新股跌破发行价的概率。本文的发现从新股发行的角度提供了开放金融市场对我国资本市场影响的新现象。     

Chinese IPO activity,pricing, and market cycles

We examine the activity, pricing, and market cycles of 1,380 Chinese A share IPOs over the period 1991–2005 and find initial underpricing of 238%. The government restrictions on IPO offer price and quota allocation cause pricing structural breaks and attribute more than half of initial underpricing. A multifactor model that includes firm’s characteristics, excess demand for IPO shares, and the government restrictions explains cross-sectional initial returns, after controlling for industrial differences and stock market conditions. In addition, monthly IPO volume and average initial return are highly correlated. A VAR model indicates that initial return leads IPO volume by 6 months.     

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.     

The Performance of Internet Firms Following Their Initial Public Offering

We find that initial returns were more favorable for Internet initial public offerings (IPOs) than non–Internet firm IPOs. Since the demise of the Internet sector, the underpricing of Internet–firm IPOs is not significantly different from other IPOs.
Initial returns of Internet firms are positively and significantly related to underwriter prestige and to pre–IPO market conditions. However, initial returns after the demise of the Internet sector are not significantly related to these characteristics.
The aftermarket performance of Internet firms is initially favorable but weakens over time. Firms that experienced higher initial returns during the strong Internet cycle experience weaker aftermarket performance.     

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.     

Credit ratings and IPO pricing

We examine the effects of credit ratings on IPO pricing. The evidence from U.S. common share IPOs during 1986–2004 shows that when firms go public, those with credit ratings are underpriced significantly less than firms without credit ratings. Credit rating levels, however, do not have a significant effect on IPO underpricing. The existence of credit rating reduces uncertainty about firm value. It is the value certainty that matters, not the value per se. Credit ratings also reduce the degree of price revision during the bookbuilding process and the aftermarket volatility in the post-IPO period. The evidence suggests that credit ratings convey useful information in reducing value uncertainty of the issuing firms as well as information asymmetry in the IPO markets.     

Uncertain Demand,Heterogeneous Expectations,and Unintentional IPO Underpricing

Distinguishing between intentional and unintentional incentives to underprice initial public offerings (IPOs), I develop sufficient conditions for the winners' curse postulated by Miller (1977) and implications for intertemporal changes in the magnitude of underpricing. Specifically, I show that unintentional underpricing (and occasional overpricing) of IPOs is a consequence of investors' heterogeneous expectations of the uncertain value of a stock when the supply is constrained and the underwriter's price discovery process only partially identifies aggregate demand. Moreover, an IPO that is oversubscribed in the premarket sale almost certainly will experience a short‐term price increase in the secondary market.     

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.      

Why are IPOs underpriced? Evidence from Japan's hybrid auction-method offerings

We document discretionary underpricing and partial adjustment of IPO prices in the public offer tranche of Japan's hybrid auction regime, in which investor information differences are not important, there are no roadshows, preferential allocations are negligible, institutional investing is low, and the public offer tranche cannot fail. The magnitude and variation of underpricing in our sample, which spans relatively hot and cold markets, are similar to those reported for US IPOs. The evidence is most consistent with underpricing arising from an implicit contract to allocate risk related to initial mispricing where, in exchange for guaranteeing a minimum price, the underwriter participates indirectly in upside performance. The results raise important questions about interpretations of IPO underpricing in the US.     

IPO initial returns in China: Underpricing or overvaluation?

This paper separates the amount of IPO underpricing(primary market underpricing) and overvaluation(secondary market overvaluation) from the value of an IPO's initial return to evaluate the relative importance of these two factors and their main determinants. Using data on the IPOs of 948 Chinese firms, we find that average initial returns are 66% and that underpricing and overvaluation are between 14–22% and 44–53%, respectively, depending on the method used to assess firms' intrinsic values. In addition, while both the value of the initial return and the extent of overvaluation are significantly negatively related to post-IPO long-run stock performance, overvaluation can predict post-IPO performance better than the value of the initial return. Value uncertainty in IPOs is positively related to both underpricing and overvaluation, and both the underwriter's reputation and the existence of pricing regulation are positively related to underpricing. Investor sentiment has a positive effect on overvaluation but has no effect or a negative effect on underpricing. Overall, our results suggest that in China overvaluation accounts for a larger proportion of the initial return than underpricing,and that underpricing and overvaluation have different determinants.     

Auctions versus book-built IPOs in Japan: A comparison of aftermarket volatility

In a recent theoretical paper, Sherman [Sherman, A.E., 2005, Global trends in IPO methods: Book building versus auctions with endogenous entry, Journal of Financial Economics 78, 615–649.] proposes that: “If book building leads to greater expected underpricing relative to uniform price or discriminatory auctions, then it should also lead to less volatility in aftermarket trading…”. In this paper, we study a Japanese sample and find that book-built IPOs exhibit greater underpricing and higher aftermarket volatility compared to price-discriminatory auctions. Aftermarket volatility wanes with seasoning in both sub-samples, but the book-built volatility levels are persistently higher than those for auctions for as long as one year after the IPO issue date.