Acquisition Activity and IPO Underpricing

We propose an “M&A activity” hypothesis as a partial explanation for initial public offering (IPO) underpricing. When going public during active corporate control markets, managers may take actions to safeguard their control. In support of this conjecture, we find that pre-IPO M&A activity directly explains IPO underpricing. We also find that underpricing and ownership dispersion are positively correlated, as are ownership dispersion and the probability of remaining independent. Considering the possibility that some managers take their firms public to be acquired, we find that the positive link between M&A activity and underpricing is not robust for firms that are viewed as likely targets.     

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.     

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.     

The marketing role of IPOs: evidence from internet stocks

This paper explores the potential marketing benefits of going public and of IPO underpricing. We examine the impact of IPO underpricing on website traffic, which is a direct measure of product market performance for internet firms. If underpricing attracts media attention and creates valuable publicity, we expect an increase in web traffic following the IPO. We find that web traffic growth in the month after the IPO is positively and significantly associated with initial returns, and the effect is economically significant. We also investigate media reaction to initial returns for a broader sample of IPOs. The results suggest that the marketing benefits of underpricing extend beyond the internet sector and the “hot issues” market of the late 1990s.     

Does earnings management lead to favorable IPO price formation or further underpricing? Evidence from Japan

This study addresses an important but unanswered question regarding the relationship between earnings management and underpricing. Earnings management has long been one of the central issues in initial public offerings (IPOs), however little evidence exists on whether earnings management leads to favorable price formation or further underpricing. Using several proxies for earnings management, this study finds evidence that firms with aggressive earnings management during the pre-IPO period tend to be more underpriced than firms without it, in contrast to the dominant hypothesis that IPO firms can sell their stocks at inflated prices by manipulating earnings upwardly. This finding is consistent with the asymmetric information theory of underpricing and suggests that aggressive earnings management increases valuation uncertainty of IPO firms and leads to steeper price discounts.     

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.     

Litigation risk,underpricing, and money-losing IPOs

We examine the impact of firms' pre-IPO earnings on the relationship between litigation risk and IPO underpricing. We confirm the insurance effect of the lawsuit avoidance hypothesis; however, we find that the use of underpricing to reduce litigation risk is mainly associated with firms with negative earnings at the time of going public. Our results are robust to the timelines over which sample firms were sued, alternative underpricing measures, the addition of various control variables to our baseline regression models, and different proxies to categorize IPO firms. We also investigate the relationship between litigation risk, pre-IPO earnings, and underwriter gross spreads. The results indicate that, when dealing with firms facing a high risk of litigation, underwriters charge significantly higher spreads to negative-earnings issuers than profitable IPO firms.     

How Persistent Is the Impact of Market Timing on Capital Structure?

This paper examines the capital structure implications of market timing. I isolate timing attempts in a single major financing event, the initial public offering, by identifying market timers as firms that go public in hot issue markets. I find that hot‐market IPO firms issue substantially more equity, and lower their leverage ratios by more, than cold‐market firms do. However, immediately after going public, hot‐market firms increase their leverage ratios by issuing more debt and less equity relative to cold‐market firms. At the end of the second year following the IPO, the impact of market timing on leverage completely vanishes.     

Issuer surplus and the partial adjustment of IPO prices to public information

This study develops a model in which rational issuers maximize the expected surplus from going public by choosing an offer price that weighs the benefit of higher proceeds if the offer is completed against the cost of foregone surplus if the offer fails. Increases in the market valuation of comparable firms during the waiting period imply higher surplus associated with going public; issuers respond with a partial revision in the offer price to elevate the probability of completion. The model offers insights into many facts associated with initial public offering pricing, including partial adjustment to market returns, the inverse relation between withdrawal and market returns, the asymmetric price adjustment to up versus down market returns, hot-issue markets, and unconditional underpricing.     

Issuer-oriented underpricing costs in initial public offers: Evidence from Hong Kong

This paper estimates the underpricing cost associated with new shares issued and sold when firms go public in a traditional British-style IPO market in contrast to prior work which focussed on the underpricing cost to pre-IPO investors. Secondly, the estimates account for interest income on application funds received by issuing firms. Using data from the Hong Kong IPO market, the results show that the issuer underpricing cost of new share issues is on average only 14% of headline underpricing. When interest on application funds is taken into account, net issuer underpricing cost reduces to just around 7% of headline underpricing. This finding provides a compelling explanation of why issuing companies may not be concerned about underpricing in traditional British-style IPO markets. Thirdly, we also find that pre-IPO investors take steps to minimise wealth transfer to new investors either by selling a very small proportion or none of their pre-IPO shares. These findings suggest that explanations of IPO underpricing to the various parties involved in the process should, in part, be sought in the institutional structures and investment banking practices of the relevant primary capital market.     

THE UNDERPRICING OF “SECOND” INITIAL PUBLIC OFFERINGS

The underpricing of initial public offerings (IPOs) of equity represents a well-documented empirical phenomenon. One prominent explanation for this underpricing relies on the uncertainty investors feel about the value of the issuer. In this paper, this asymmetric information hypothesis is tested by examining the underpricing of IPOs of seventy-four firms for which the uncertainty about the value of the firm is likely to be substantially reduced. These firms were once publicly owned, then taken private, and subsequently returned to public ownership. Findings show that the IPOs of these “reverse leveraged buyouts” are significantly less underpriced than typical IPOs. These results support the asymmetric information hypothesis.     

An analysis of the liquidity benefits provided by secondary markets

Listing shares in liquid secondary markets either to facilitate acquisitions or to diversify owner’s personal wealth are among the most important reasons for firms to go public [Brau, J.C., Fawcett, S.E., 2006. Initial public offerings: An analysis of theory and practice. Journal of Finance 61, 399–436]. We contend that the expected benefits derived from the liquidity provided by secondary markets are relevant for understanding important decisions made in preparation for an IPO. We hypothesize that the potential losses caused by an IPO failure induce firms that benefit more from going public to hire more reputable underwriters and to adopt more conservative pricing policies. We use several proxies for the benefits firms derive from post-IPO liquidity. The results indicate that firms that benefited more from liquidity were taken public by more prestigious underwriters and exhibited substantially larger levels of price revisions and underpricing. Post-IPO liquidity is also important for understanding the decision to retain the lead underwriter in subsequent SEOs.     

The IPO market as a screening device and the going public decision: evidence from acquisitions of privately and publicly held firms

The main purpose of this paper is using a unique data set from IPO filings to study the IPO market as a screening device and the going public decision. We find that private firms that are less likely to have the option to access public equity markets receive 54 cents for each dollar they expected to raise in an IPO, whereas firms that are more likely to have the option to go public but sell privately sell at $1.11 for each dollar they expected to receive at the IPO. This result suggests that the lower valuation for firms sold in private markets compared to firms sold in public markets can be at least partially explained by the lower relative bargaining power of private firms. However, owners that took their firms public before selling received, on average, 40% larger payoffs than owners that had the option to go public but decided to sell privately. The results in this study indicate that these differences in valuation are not fully explained by existing theoretical models on the decision to sell privately or in two stages.     

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.     

Investment cycles and startup innovation

We find that venture capital-backed startups receiving their initial investment in hot markets are more likely to go bankrupt, but conditional on going public, are valued higher on the day of their initial public offering, have more patents, and have more citations to their patents. Our results suggest that VCs invest in riskier and more innovative startups in hot markets (rather than just worse firms). This is particularly true for the most experienced VCs. Furthermore, our results suggest that increased capital in hot times plays a causal role in shifting investments to more novel startups by lowering the cost of experimentation for early stage investors and allowing them to make riskier, more novel, investments.     

Divergence of opinion and initial public offerings

This article analyzes several IPO patterns in the framework of divergence of opinion. Considering a new industry with few publicly traded companies, the investors in this IPO market do not initially have complete knowledge about the industry, but may learn from other IPOs in the sector. Our model shows that the equilibrium is consistent with empirical evidence documented for IPO underpricing and hot issue markets. We also characterize the association between share overhang, trading volume, and IPO prices. Furthermore, we discuss the decision of going public, analyst coverage, and IPO lockup expiration in the presence of divergent opinions.     

Cycles in the IPO market

We develop a model in which time-varying real investment opportunities lead to time-varying adverse selection in the market for IPOs. The model is consistent with several stylized facts known about the IPO market: economic expansions are associated with a dramatic increase in the number of firms going public, which is in turn positively correlated with underpricing. Adverse selection is procyclical in the sense that dispersion in unobservable quality across firms should be more pronounced during booms. Taking the premise that uncertainty is resolved (and thus private information revealed) over time, we test this hypothesis by looking at long-run abnormal returns and delisting rates. Consistent with the model, we find (a) greater cross-sectional return variance, and (b) higher incidence of delisting for hot-market IPOs.     

An international look at the lawsuit avoidance hypothesis of IPO underpricing

We examine the relationship between IPO underpricing and litigation risk in an international setting using a sample of 13,759 firms that went public across 40 countries between 1991 and 2011. While the majority of single-country studies do not find support for the lawsuit avoidance hypothesis, we find a significant positive relationship between litigation risk and underpricing in a cross-country framework. Contrary to all single-country legal liability studies outside the U.S. and consistent with the U.S. studies of Tiniç (1988) and Lowry and Shu (2002), our empirical results support the insurance effect of the lawsuit avoidance hypothesis in an international context. Our findings imply that the degree of litigation risk in a given country affects the level of underpricing for firms that go public in that country. We conclude that differences in legal risk factors can partially explain differences in underpricing across countries.     

A Reexamination of the Costs of Firm Commitment and Best Efforts IPOs

Ritter [14] documents that best efforts IPOs are, on average, more costly to issue than firm commitment IPOs. This paper explains the phenomenon. Two component costs of going public are analyzed: underpricing and underwriter compensation. The model, based on a disagreement about firm value between underwriters and issuers, shows that underpricing is higher for firms using best efforts contracts as these firms, on average, are more speculative. Underwriter compensation is hypothesized to be higher for firms using best efforts contracts because of the high costs of market making for these firms in the aftermarket and the high distribution costs associated with the high risk of a failed offer. Empirical tests strongly support the propositions.     

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.