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.     

A Comparison of Underwriting Costs of Initial Public Offerings by Investment and Commercial Banks

We examine differences in underwriting costs between commercial‐bank‐Section‐20‐underwritten initial public offerings (IPOs) and investment‐bank‐underwritten IPOs. Our results suggest that total underwriting costs (gross margin plus underpricing) are significantly lower for commercial bank IPOs. The lower cost for commercial bank IPOs is attributable to less severe underpricing for these issues. Gross margin costs generally do not differ between commercial bank and investment bank issues. Furthermore, we find that the long‐run stock price performance for commercial bank issues is superior to that of investment bank issues. That is, lower underpricing for Section 20 issues may not be a short‐run phenomenon. Rather, there appears to be a favorable outcome for investors in the long run for holding IPOs underwritten by Section 20 commercial banks. These results are inconsistent with the conflict of interest hypothesis often associated with merging commercial and investment bank functions in one organization.     

Dual Class IPOs ARE Underpriced Less Severely

We analyze a sample of dual and single class initial public offerings (IPOs) to investigate whether empirical estimates of underpricing determinants are consistent across alternative measures of firm size and alternative techniques intended to account for underwriter price stabilization efforts. We find that results from long‐standing methods for estimating underpricing relations are generally robust to one's choice of size proxy and are consistent with estimates obtained from censored regressions of first‐day returns and from least squares regressions of longer horizon initial returns. We also confirm an existing finding in the literature that dual class IPOs endure less underpricing than do single class firms.     

Regulatory underpricing: Determinants of Chinese extreme IPO returns

The Chinese stock market with its unique institutions is rather different from western stock markets. The average underpricing of Chinese IPOs is 247%, the highest of any major world market. We model this extreme underpricing with a supply-demand analytical framework that captures critical institutional features of China's primary market, and then empirically test this model using a sample of 1377 IPOs listed on the Shanghai and Shenzhen Stock Exchanges between 1992 and 2004. We find that Chinese IPO underpricing is principally caused by government intervention with IPO pricing regulations and the control of IPO share supplies. Besides the regulatory underpricing, this paper also documents some specific investment risks of IPOs in China's stock market.     

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.     

Model specification and IPO performance: New insights from Asia

This study examines the post-issue stock price performance of initial public offerings (IPOs) from advanced and emerging Asian markets from 1991 to 2004. We provide a comparative assessment on the short- and long-term stock performance of Asian IPOs with comprehensive international evidence. We use several different methods to examine the robustness of IPO performance. Our results reveal that whilst there is initial underpricing in Asian IPOs, the existence of long-run underperformance for the Asian IPOs depends resoundingly on the methodology used for assessment.     

Differences of opinion,institutional bids,and IPO underpricing

Miller (1977) hypothesizes that IPO underpricing arises because the issue price is based on the average opinion while the aftermarket price is set by a minority of optimistic investors. Using a unique data set of institutional bids for a large sample of Chinese IPOs, we show that the IPO issue price is positively related to the quantity-weighted average bid price and unrelated to the market-clearing bid price. In contrast, the first-day closing price is positively related to the market-clearing bid price and unrelated to the average bid price. Overall, our results provide strong support for Miller's explanation of IPO underpricing.     

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.     

Short selling in initial public offerings

Short sale constraints in the aftermarket of initial public offerings (IPOs) are often used to explain short-term underpricing that is subsequently reversed. This paper shows that short selling is integral to aftermarket trading and is higher in IPOs with greater underpricing. Perceived restrictions on borrowing shares are not systematically circumvented by “naked” short selling. Short sellers, on average, do not appear to earn abnormal profits in the near term and our findings are not driven by market makers. Short selling in IPOs is not as constrained as suggested by the literature, implying that other factors may be responsible for underpricing.     

Underpricing of IPOs: Firm-, issue- and country-specific characteristics

Using a large firm-level dataset of 2920 IPOs from 21 countries we examine the impact of country-level institutional characteristics on the underpricing of IPOs. Through hierarchical linear modeling we are able to control for firm-specific and issue-specific characteristics and test whether country-specific institutional characteristics add explanatory power to explain the level of underpricing. Our results show that about 10% of the variation in the level of underpricing is between countries. The quality of a country’s legal framework, as measured by its level of investor protection, the overall quality of its legal system and its level of legal enforcement, reduces the level of underpricing significantly.     

Explaining underpricing of IPOs in frontier markets: Evidence from the Nigeria Stock Exchange

The paper provides empirical analyses of IPO underpricing on the Nigerian Stock Exchange, from the period 1990 to 2006. The results indicate an average abnormal initial day returns of 43.1%. There is evidence of long-run underperformance of 0.6%. Results from our regression model explaining initial abnormal returns for the IPOs of Nigeria show that size of firm and audit quality are important variables affecting underpricing. The results also show the presence of a non-linear relationship between the offer price and underpricing.     

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 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.     

Executive stock options and IPO underpricing

In about one-third of US IPOs between 1996 and 2000, executives received stock options with an exercise price equal to the IPO offer price rather than a market-determined price. Among firms with such “IPO options”, 58% of top executives realize a net benefit from underpricing: the gain from the options exceeds the loss from the dilution of their pre-IPO shareholdings. If executives can influence either the IPO offer price or the timing and terms of their stock option grants, there should be a positive relation between IPO option grants and underpricing. We find no evidence of such a relation. Our results contrast sharply with the emerging literature on managerial self-dealing at shareholder expense.     

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.      

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.     

Underpricing of Chinese A-share IPOs and short-run underperformance under the approval system from 2001 to 2005

This paper analyses underpricing and short-run underperformance of the Chinese A-share IPOs from Mar, 2001 to 2005 when the new approval system was adopted. We find that the average market adjusted first-day return is 93.49% in this period, a more reasonable level when compared with those in previous periods in China. The findings show that underpricing in this period is significantly affected by offering mechanisms and inequality of demand and supply of IPOs. The effect of shareholder's structure is tested in the model and state-owned share's weight is shown to increase the degree of underpricing. Meanwhile, this paper analyses IPOs' short-run underpricing on their 10th, 20th, 30th trading days. It is found that most IPOs' underpricing shrinks and the degree of shrinking degrees is different across the groups categorized by offering mechanisms. Further, the underperformance of IPOs which are underwritten by more prestigious underwriters shows a comparatively lower range and is less severe in the short-run.     

The JOBS Act and the Costs of Going Public

We examine the effects of Title I of the Jumpstart Our Business Startups Act for a sample of 312 emerging growth companies (EGCs) that filed for an initial public offering (IPO) from April 5, 2012 through April 30, 2015. We find no reduction in the direct costs of issuance, accounting, legal, or underwriting fees for EGC IPOs. Underpricing, an indirect cost of issuance that increases an issuer's cost of capital, is significantly higher for EGCs compared to other IPOs. More importantly, greater underpricing is present only for larger firms that are newly eligible for scaled disclosure under the Act. Overall, we find little evidence that the Act in its first three years has reduced the measurable costs of going public. Although there are benefits of the Act that issuers appear to value, they should be balanced against the higher costs of capital that can occur after its enactment.