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.     

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.     

Signaling in the Internet craze of initial public offerings

We explain the clustering of underpricing in initial public offerings (IPOs). The model features an industry with aggregate demand uncertainty and asymmetric information about firms' quality. In the IPO market, firms can signal quality by underpricing or under-issuing new shares. Expected aggregate demand for the industry's products increases with the publicity that the industry creates through IPO underpricing. We show that asymmetric information and expectations on aggregate product demand interact with each other to generate multiple equilibria. Underpriced IPOs cluster in one equilibrium but not in the other. We use these results to explain why the clustering often occurs in particular industries, is short-lived, and is sensitive to economic conditions.     

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     

Issuers’ incentives and tests of Baron’s model of IPO underpricing

This paper reexamines the validity of Baron’s (J Financ 37:955–976, 1982) model of IPO underpricing, in which IPO underpricing is caused by asymmetric information between issuers and investment bankers. Muscarella and Vetsuypens (J Financ Econ 24:125–135, 1989) find that lead-manager IPOs are significantly more underpriced than non-self-marketed IPOs and conclude that their empirical results do not support Baron’s model. We compare self-marketed underwriters’ IPOs with non-self-marketed underwriters’ IPOs and with IPOs they lead. Our empirical results show that it is premature to reject Baron’s model of IPO underpricing when we take issuer incentives into account.     

Underpricing,stock allocation,ownership structure and post-listing liquidity of newly listed firms

This study investigates the relationship between underpricing, ownership structure and post-listing liquidity of initial public offerings (IPOs). It is argued that higher underpricing induces both broader investor participation and creates a more diffuse ownership structure. These two factors are in turn positively associated with the level of post-listing trading, and therefore offer an explanation of how underpricing can influence liquidity. Using a sample of Australian IPOs, we provide evidence of statistically significant relationship between underpricing and various proxies for shareholding distribution and liquidity. This result remains robust after controlling for a number of potential underlying factors that may drive both underpricing and ownership allocation decisions. Overall, our analysis suggests that liquidity is a partial but important benefit of underpricing an IPO.     

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.     

Testing for deliberate underpricing in the IPO premarket: a stochastic frontier approach

We reevaluate the IPO underpricing phenomenon using the stochasticfrontier methodology. The advantage of the stochastic frontieris that it can be used to measure the level of deliberate underpricingin the premarket without using after-market information. Thisis accomplished through the estimation of a systematic one-sidederror term that measures 'inefficiency' or the difference betweenthe maximum predicted offer price and the actual offer price.Data for the analysis are comprised of 1,035 IPOs of commonstock issued by firm commitment between 1975 and 1984. IPOsappear to be deliberately underpriced in the premarket in bothhot-market and nonhot-market periods. Moreover, the determinantsof the maximum IPO price have different effects in the two timeperiods.     

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.     

Voluntary Disclosure of Management Earnings Forecasts in IPO Prospectuses

Asymmetric information and mechanisms for its resolution in the initial public offering (IPO) process are subjects of extensive research and debate. In this paper, we investigate the impact of one such mechanism, namely voluntary disclosure of management earnings forecasts by issuers of IPOs, as a means of reducing asymmetric information as well as ex ante uncertainty. Our focus is on the relative importance of this voluntary disclosure mechanism on both IPO underpricing and post‐issue return performance. Our results indicate that management earnings forecasts provide important and incremental information compared to other means of reducing asymmetric information, and these disclosures appear to improve the environment of IPO issuance. For example, our underpricing results show that firms that choose to provide forecasts leave 'less money on the table' with a lower degree of underpricing. In terms of post‐issue performance, firms whose forecasts turn out to be optimistic are penalized significantly relative to other forecasters and non‐forecasters.     

The effects of R&D, venture capital, and technology on the underpricing of IPOs in Taiwan

Information asymmetry and value uncertainty causes high -research and development (R&D) or high-tech Initial Public Offerings (IPOs) to become underpriced. Venture capital can serve as a moderator to mitigate the information asymmetry and value uncertainty to reduce IPO underpricing. High-tech industries significantly contribute to Taiwan??s economic growth. With the unique Taiwan data, we find that venture-backed IPOs are less underpriced. More importantly, IPO underpricing due to technology decreases with the use of venture capital and decreases with the interaction between R&D expenditure and technology. Technology requirement reduces the underpricing of high-R&D IPOs. Accordingly, R&D spending reduces the underpricing of high-tech IPOs.     

Accounting conservatism and IPO underpricing: China evidence

This study examines how accounting conservatism impacts underpricing of initial public offerings (IPOs) in the Chinese stock market. In addition, we investigate how information asymmetry affects the association of accounting conservatism with IPO underpricing. Based on regression analysis of 674 A-shares companies that went public through IPOs at both Shanghai and Shenzhen Stock Exchanges in China during 2001–2009, we find that (1) accounting conservatism is negatively associated with the magnitude of IPO underpricing; and (2) the relationship between accounting conservatism and IPO underpricing is more pronounced when information asymmetry is high. The findings should shed a light on what drives IPO underpricing and how it could be affected by accounting conservatism in an emerging economy.     

The effect of language on IPO underpricing: Evidence from a multinational research

This paper examines how language characteristics affect initial public offerings (IPO) underpricing. We conjecture that Future-Tense Reference (FTR) language characteristics will informally influence human cognition of future rewards, raise their investment sentiment, and thus affect IPO underpricing. Using a sample of 33,414 IPOs in 30 countries, we find evidence that issuing firms operating in weak-FTR environments tend to experience a higher level of underpricing than those in strong-FTR settings. Our results remain robust after controlling for other linguistic and cultural characteristics, using various fixed-effect structures, and adopting the instrumental variable approach. The positive relationship between weak FTR and IPO underpricing is less pronounced in countries (regions) with higher education levels and higher institutional shareholding ratios, supporting the role of FTR on human cognition. Furthermore, our findings provide evidence supporting that the linguistic characteristic of FTR can impact firms' IPO decisions and the market's liquidity. Overall, the result highlights the importance of informal linguistic characteristics in explaining global IPO underpricing differences.     

A Test of the Signaling Value of IPO Underpricing with REIT IPO-SEO Pairs

The asymmetric information hypothesis states that IPO underpricing signals superior firm value. During the post-IPO period, the market learns the firms true worth such that good quality firms issue seasoned equity at favorable prices and recoup the loss sustained at IPO. Since REITs have no special incentive to issue debt because of their tax-exempt status, and since they must pay out 95 percent of net income as dividends, REIT managers are hard pressed to raise capital through seasoned equity. Consequently, the signaling link between IPOs and SEOs is critical for REITs. Consistent with the signaling model, we find strong evidence that (1) REITs that underprice IPOs more are likely to sell seasoned equity sooner, (2) higher IPO underpricing results in larger joint amount of capital raised through an IPO-SEO pair, and (3) firms that underprice IPOs underprice SEOs as well. IPO underpricing does not mitigate the valuation loss associated with seasoned offerings, however.     

Information content of IPO grading

In the year 2007, Indian capital market regulator-SEBI, introduced a unique certification mechanism for IPOs whereby all IPOs have to undergo mandatory quality grading by independent rating agencies. In this paper we argue that such objective, independent and exogenous certifying mechanism provides a better opportunity to test the well established certification hypothesis, especially in the context of emerging markets with institutional voids. Using a sample of 163 Indian IPOs we test the efficacy of IPO grading mechanism. We find, grading decreases IPO underpricing and positively influences demand of retail investors. Grading reduces secondary market risk and improves liquidity. However, grading does not affect long run performance of the IPOs. IPO grading successfully capture firm size, business group affiliation and firm’s quality of corporate governance. Our findings imply that, in emerging markets, regulator’s role to signal the quality of an IPO contributes towards the market welfare.     

A Review of IPO Activity, Pricing, and Allocations

We review the theory and evidence on IPO activity: why firms go public, why they reward first–day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective is threefold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phenomena. Instead, we believe future progress in the literature will come from nonrational and agency conflict explanations. We describe some promising such alternatives.     

THE EFFECT OF THE TRADING SYSTEM ON IPO UNDERPRICING: EVIDENCE FROM THE 1997 ORDER‐HANDLING RULES

We use a natural experiment resulting from the 1997 Securities and Exchange Commission rule mandating a change in the order‐handling rules (OHR) for all NASDAQ stocks to test whether secondary market structure affects initial public offering (IPO) underpricing. We find that the increase in liquidity that the OHR represent led to a decrease in underpricing for cold NASDAQ IPOs, suggesting that when liquidity is lowest, changes in market liquidity display a negative relation to initial returns.     

Global trends in IPO methods: Book building versus auctions with endogenous entry

The U.S. book-building method has become increasingly popular for initial public offerings (IPOs) worldwide over the last decade, whereas sealed-bid IPO auctions have been abandoned in nearly all of the many countries in which they have been tried. I model book building, discriminatory auctions, and uniform price auctions in an environment in which the number of investors and the accuracy of investors’ information are endogenous. Book building lets underwriters manage investor access to shares, allowing them to reduce risk for both issuers and investors and to control spending on information acquisition, thereby limiting either underpricing or aftermarket volatility. Because more control and less risk are beneficial to all issuers, the advantages of book building's allocational flexibility could explain why global patterns of issuer choice are surprisingly consistent. My models also predict that offerings with higher expected underpricing have lower expected aftermarket volatility; that an auction open to large numbers of potential bidders is vulnerable to inaccurate pricing and to fluctuations in the number of bidders; and that both book-built and auctioned IPOs will exhibit partial adjustment to both private and public information.     

IPO underpricing and mutual fund allocation: New evidence from registration system

We study the effect of mutual fund allocation on China's IPO market under the new registration system. The introduction of mutual fund bids significantly increases the IPO offer price, resulting in a low initial short-term return and suppressed IPO underpricing. Those newly listed stocks witness lower volatility in the following weeks due to preferential allocation to the mutual fund at the primary market. Further analysis suggests that large investors' net purchase strengthens IPO after-market return and volatility. Besides, the effect of mutual fund participation on IPOs is stronger in places where the COVID-19 outbreak. This new evidence suggests that mutual fund allocation plays a critical role in IPO price discovery and decreases investor lottery trading.     

Narcissistic managers and IPO underpricing

Using hand-collected data on the signature size of managers in Chinese initial public offerings (IPOs) from 2007 to 2019 as a proxy for managerial narcissism, we examine how IPOs with narcissistic managers (narcissistic IPOs) affect IPO underpricing. The findings suggest that narcissistic IPOs have higher underpricing than non-narcissistic IPOs. Specifically, we find that on average, a narcissistic IPO exhibits approximately 11.3% higher underpricing than a median IPO firm. Our results are robust to alternative metrics of narcissism and underpricing after controlling for endogeneity. Additional analyses suggest that narcissistic IPOs are more likely to engage in earnings management than non-narcissistic IPOs. The former exhibits excessive risk-taking behavior, gauged by earnings volatility pre-IPO and a higher beta post-IPO. In the cross-sectional analyses, we document that the impact of managerial narcissism on IPO underpricing is more salient for IPOs facing unsophisticated investors, high market sentiment, or poor corporate governance.