Heterogeneous Beliefs,IPO Valuation,and the Economic Role of the Underwriter in IPOs

We empirically analyze the economic role of the underwriter in initial public offerings (IPOs), distinguishing between the “certification” and “market power” hypotheses. We find that equity in high‐reputation underwriter backed IPOs is priced higher and further away from intrinsic value than that in low‐reputation underwriter backed IPOs. Our results are robust to controlling for the endogenous selection of firms to take public by underwriters. Overall, our results support the market power hypothesis and reject the certification hypothesis, indicating that the role of underwriters is to obtain the highest possible valuation for the IPOs that they back rather than to price the equity close to intrinsic value.     

Underwriter Compensation Structure: Can It Really Bond Underwriters?

Underwriter compensation can be structured as all cash or a combination of cash and warrants. Using a sample of small initial public offerings (IPOs), we find that underwriter compensation contracts that include warrants in exchange for cash can serve as certification for IPO firms by substituting for reputation capital. When underwriters accept warrants when they could have received more cash compensation, the IPOs avoid the well documented long‐run underperformance. However, when underwriters receive warrants after maximizing cash compensation, the IPO experiences higher underpricing and poorer long‐run performance. The findings are consistent with a motivation by the underwriters to circumvent regulatory constraints.     

UNDERWRITER REPUTATION AND AFTERMARKET PERFORMANCE OF CLOSED‐END FUNDS

I find a positive relation between underwriter reputation and the initial and long‐run aftermarket performance of closed‐end funds. This relation persists even after controlling for fund characteristics, types, and investment strategies. The positive relation between underwriter reputation and initial returns supports the notion that prestigious investment bankers tend to promote a price run‐up in the immediate aftermarket to enhance their reputation with the issuers and the investors. The better long‐run performance for funds underwritten by prestigious underwriters suggests that prestigious underwriters protect their reputation by underwriting only high‐quality issues that will perform well in the long run.     

Underpricing and long-run performance of Chinese IPOs: the role of underwriter reputation

This study examines the impact of underwriter reputation on IPO underpricing and long-run performance in the China stock market over the period 2001 to 2006. This sample period is notable for the implementation of a verification and approval system that occurred during it, which provided underwriters more freedom to price IPOs. We develop two alternative proxies to measure underwriter reputation based on either the ratio of the total gross proceeds raised or the number of IPOs managed by each underwriter. We find that underwriter reputation does not affect the level of underpricing, but that the level of long-run underperformance is significantly mitigated when IPOs are managed by more prestigious underwriters.     

Underwriter Spread, Underwriter Reputation, and IPO Underpricing: A Simultaneous Equation Analysis

This paper studies the relationships between underwriter reputation, underwriter spread, and IPO underpricing. We consider the information content of underwriter spread and find that it conveys information pertinent to IPO quality. Because underwriter spread is endogenous, underpricing and underwriter spread are jointly determined in a simultaneous equation system. Also, we examine the IPO market for evidence of segmentation, and our results suggest some market segmentation. Underwriter spread impacts initial underpricing for a group of medium-reputation underwriters, while underpricing affects underwriter spread for groups of low- and high-reputation underwriters. Consequently, high-risk IPOs may not be priced the same way as low-risk IPOs. We attribute this finding to regulation, competition, and/or market segmentation.     

Underwriter reputation,earnings management and the long‐run performance of initial public offerings

This study contributes to the extant literature on the nature of earnings management surrounding initial public offerings (IPOs) by investigating the role of underwriter reputation. We argue that prestigious underwriters will protect their reputation by carefully monitoring and certifying financial information on IPO firms, thereby limiting any potential earnings manipulation. As a result, those IPO firms that are associated with more prestigious underwriters are likely to exhibit substantially less‐aggressive earnings management. Conversely, we find the existence of a negative relationship between earnings management and the post‐offer performance of an IPO firm’s stocks only for those firms associated with less‐prestigious underwriters.     

Two‐Sided Matching: How Corporate Issuers and Their Underwriters Choose Each Other

In this article, the authors update and confirm the findings of a 2005 article that was the first to view corporate underwriter choices as the outcome of a two‐sided matching process in which issuers look to the abilities of the underwriters offering their services and underwriters focus on the quality of the issuers that wish to use their services. This view offers a contrast with both the conventional representation of issuer‐underwriter associations as one‐sided decisions (by either issuers or underwriters) and the classical economist's representation of a competitive market in which prices serve as the primary market‐clearing mechanism. In their examination of both initial public offerings (IPOs) and seasoned equity offerings (SEOs) during the period 1980–2010, the authors continue to find strong evidence that higher‐quality issuers associate with more reputable underwriters and lower‐quality issuers match with lower reputation underwriters. Moreover, when examining cases of underwriter switching between an IPO and SEOs by the same issuer, they find that cases involving the largest divergence in the relative rankings of issuer and underwriter were the most likely to produce a change of underwriter—and that issuers that experienced larger post‐ IPO increases in quality were more likely to find more reputable underwriters for their SEOs (than for their IPOs). The authors also find that the larger the number of offerings brought to market in a given year, the smaller the market share of the top‐tier underwriters, likely reflecting the willingness of the most reputable underwriters to turn down business to maintain quality and reputation. Finally, the most reputable underwriters appear to benefit from the fact that the issuers whose IPOs they underwrite end up raising larger amounts of capital, both at the time of the IPO and in the larger and more frequent seasoned offerings by such issuers that come after the IPO. This evidence in support of two‐sided matching suggests that, especially for high‐quality issuers, the reputation of the underwriters they contract with for security offerings is likely to be more important than the underwriting fees they incur. What's more, the authors' finding that the most reputable underwriters are less likely to lose high‐quality clients and have more stable market share—and that the higher‐quality issuers they attract end up raising larger amounts of capital over their lives as public companies—suggests that underwriters' investments in building and preserving their reputations have a large expected payoff.     

Underwriter Reputation, Initial Returns, and the Long-Run Performance of IPO Stocks

We find that the underperformance of IPO stocks relative to the market over a three-year holding period is less severe for IPOs handled by more prestigious underwriters. Consistent with prior studies, we also find that IPOs managed by more reputable underwriters are associated with less short-run underpricing. Among the various existing proxies for underwriter reputation, the Carter–Manaster measure is the most significant in the context of initial returns and also in the context of the three-year performance of IPOs. The study also provides an updated list of the Carter–Manaster measure for various underwriters.     

Issuer Operating Performance and IPO Price Formation

We study the relation between issuer operating performance and initial public offering (IPO) price formation from the initial price range to the offer price to the closing price on the first trading day. For a post‐bubble sample of 2001–2013 IPOs, we find that pre‐IPO net income and, in particular, operating cash flow are strongly, positively associated with the revision from the mid‐point of the initial price range to the offer price and that the “partial adjustment phenomenon” concentrates among issuers with the strongest operating performance. As for why publicly observable information helps predict changes in valuation from when the initial price range is set to when the offer price is set, our findings suggest that strong‐performing issuers, especially those offering small slices of ownership, have lower bargaining incentives and are susceptible to the underwriter(s) low‐balling the price range. Overall, our results suggest an important role for accounting information in understanding the pricing of book‐built IPOs and are consistent with the presence of agency problems between issuers and underwriters.        

Stabilization and the aftermarket prices of initial public offerings

The paper examines the determinants of stabilization and its impact on the aftermarket prices. We use a unique dataset to relax several assumptions in the stabilization literature. We find that underwriters support IPO prices shortly after listing, particularly in cold markets and when demand is weak. We also show that stabilized IPOs are more common amongst reputable underwriters. This finding suggests that stabilization may be used as a mechanism to protect the underwriter’s reputation. It also implies that reputable underwriters may possess private information and price IPOs closer to their true values (i.e., higher than those indicated by the weak premarket demand). Consistent with the latter view, we show that stabilized IPOs are offered at higher prices and suffer less underpricing than those indicated by the premarket demand, firm characteristics and market-wide conditions. The post-IPO performance results indicate that stabilized IPOs are unlikely to be mispriced as their prices do not exhibit any significant reversal after the initial stabilization period. We conclude that stabilization may be superior to underpricing as it protects investors from purchasing overpriced IPOs, benefits issuers by reducing the total money “left on the table” and enhances the overall profitability of underwriters.     

Underwriter reputation and the quality of certification: Evidence from high-yield bonds

This paper provides primary evidence of whether certification via reputable underwriters is beneficial to investors in the corporate bond market. We focus on the high-yield bond market in which certification of issuer quality is most valuable to investors owing to low liquidity and issuing firms’ high opacity and default risk. We find bonds underwritten by the most reputable underwriters to be associated with significantly higher downgrade and default risk. Investors seem to be aware of this relation, as we further find the private information conveyed via the issuer-reputable underwriter match to have a significantly positive effect on at-issue yield spreads. Our results are consistent with the market-power hypothesis, and contradict the traditional certification hypothesis and underlying reputation mechanism.     

Multiple lead underwriting syndicate and IPO pricing

This paper examines the role of multiple lead underwriters (MLUs) in pricing initial public offerings (IPOs) by considering certification and market power hypotheses. Consistent with the notion that MLUs provide certification to the issue, we find that IPOs backed by MLUs price the offer closer to the intrinsic value of the firm than firms backed by single lead underwriters. Our results also indicate that IPOs led by MLUs experience lower initial return, lower variability of initial returns and better long-run performance. The results are robust to self-selection and omitted variable biases. MLU led offerings also exhibit a lower risk of withdrawal and are more likely to conduct a larger secondary equity offering.     

UNDERWRITER REPUTATION AND REPETITIVE PUBLIC OFFERINGS

A recent examination of underwriter reputation and initial public offerings (IPOs) suggests that one of the reasons prestigious underwriters market low-risk IPOs is to increase the expected present value of subsequent offerings. There is a greater likelihood that a firm issuing low-risk IPOs will be a viable future operation with the potential for subsequent offerings than a firm issuing high-risk IPOs. I examine the hypothesis that the likelihood of subsequent offerings is negatively related to IPO risk. In addition to finding support for this hypothesis, I show that the likelihood of subsequent offerings is positively related to the IPO underwriter's reputation and negatively related to the IPO gross spread. Finally, I find that the likelihood of firms switching IPO underwriters for subsequent offerings decreases with increasing IPO underwriter reputation.     

The role of underwriter peer networks in IPOs

This study examines how various aspects of underwriter peer network affect IPOs. We use different network measures to capture underwriter centrality in the global network, cohesion and diversity within network, and prior industry experience of network partners. Our results show that IPOs underwritten by book managers with more central and cohesive networks and partners with previous industry experience are associated with a higher likelihood of an offer price revision and larger price revisions. We also find book managers with more central networks and partners with previous industry experience are associated with higher short-run stock returns, while book managers that maintain more reciprocated peer relationships tend to underprice more. These results indicate that underwriters use peer networks to produce information and place securities, and network structure and characteristics have implications for the quantity and quality of information and the level of cooperative efforts shared among underwriters.     

The Development of Secondary Market Liquidity for NYSE-Listed IPOs

For NYSE‐listed IPOs, limit order submissions and depth relative to volume are unusually low on the first trading day. Initial buy‐side liquidity is higher for IPOs with high‐quality underwriters, large syndicates, low insider sales, and high premarket demand, while sell‐side liquidity is higher for IPOs that represent a large fraction of outstanding shares and have low premarket demand. Our results suggest that uncertainty and offer design affect initial liquidity, though order flow stabilizes quickly. We also find that submission strategies are influenced by expected underwriter stabilization and preopening order flow contains information about both initial prices and subsequent returns.     

Underwriter Reputation,Issuer Ownership,and Pre‐IPO Earnings Management: Evidence from China

This paper investigates the correlation between pre‐initial public offering (pre‐IPO) earnings management and underwriter reputation for issuers with different ownership structures in China. We document a significantly inverse relationship between underwriter reputation and pre‐IPO earnings management for non‐state‐owned enterprises (NSOE) issuers only, while no significant association is found for state‐owned enterprises (SOE) issuers. We also find that for the NSOE new issue market, underwriter reputation is positively correlated with issuer post‐IPO performance indicating that prestigious underwriters can incrementally improve issuer post‐IPO performance.     

Are there long-run implications of analyst coverage for IPOs?

Analyst coverage has been cited increasingly as an important attribute in the selection of an underwriter for a firm about to go public. However, it has also been alleged that affiliated analysts provide biased research. In this study, we examine these interrelated issues by examining the long-run performance of IPOs with coverage from their managing underwriters in a 1993–2003 sample. We find that (1) analysts’ research coverage from their managing syndicate is not related to long-run performance; (2) long-run performance is not different for firms that receive all-star analyst coverage; and (3) investors are not systematically worse off for following lead underwriter recommendations.     

Universal Banking, Asset Management, and Stock Underwriting

This paper examines institutions that underwrite IPOs and have asset management divisions from 1993 through 1998. We provide evidence that these firms use asset management funds as vehicles to help them earn more equity underwriting business. We also show that asset managers affiliated with IPO underwriters use their superior information about their own institution's IPOs to earn annualised market adjusted returns 7.6% above asset managers of firms who did not underwrite the IPO. Superior future returns by asset managers who trade affiliated IPOs are dependent on the information environment for the IPO and the underwriter reputation rank.     

RELATIONSHIPS AND UNDERWRITER SPREADS IN THE EUROBOND FLOATING RATE NOTE MARKET

We examine the role of issuer‐underwriter relationships in determining underwriter spreads for Eurobond floating rate notes from 1992 to 2002. Financial and nonfinancial firms with long‐term relationships pay a higher underwriter spread. Financial issuers that switch underwriters receive a discounted spread that is invariant to the underwriter's reputation and quality of the issue. However, the discount is not evident for nonfinancial firms. For both financial and nonfinancial firms, spreads are higher for noninvestment grade issues and, within investment grade, increase as quality declines. We also find higher spreads when underwriting is syndicated, and a strong negative time trend consistent with increasing competitive pressures.     

Underwriter reputation and underpricing: evidence from the Australian IPO market

Dimovski and Brooks (J Intern Financ Mark Inst Money 14:267–280, 2004b) examined 358 Australian industrial and mining company initial public offerings (IPOs) from 1994 to 1999 to report that more money was left on the table by IPOs that engaged underwriters than those that did not engage underwriters. Loughran and Ritter (Autumn 5–37, 2004) suggested that the negative relation between underwriter reputation and underpricing has reversed in the 1990s with U.S. IPOs. The main purpose of this paper is to study the relationship between underwriter reputation and underpricing in terms of Australian IPO data. In this paper, we use 380 Australian industrial company IPOs from 1994 to 2004 to perform the empirical study. Our results suggest that more prestigious underwriters are associated with a higher level of underpricing. Other variables that are found to be significant in explaining the level of IPO underpricing are market sentiment, share options, total capital raised and underwriter options.