The underpricing of initial public offerings: A theoretical and empirical reconsideration of the adverse selection hypothesis

In this paper we generalize Rock's theory regarding the underpricing of IPOs. In Rock's model, informed investors have a firm-specific informational advantage pertaining to a firm's cash flow. We derive the new results that the level of beta and the size of the market risk premium positively affect underpricing. These implications extend the adverse selection theory and further distinguish this theory from the current state of signalling theories of underpricing. The results put the “hot and cold” issue markets phenomenon in a theoretical context. Empirical results are consistent with the theoretical propositions and provide support for Rock's theory of underpricing.     

The Underpricing of Venture and Nonventure Capital IPOs: An Empirical Investigation

In this paper, we examine the premarket underpricing phenomenon within a group of venture-backed and a group of non-venture-backed initial public offerings (IPOs), using a stochastic frontier approach. Consistent with previous research, we find that venture-backed IPOs are managed by more reputable underwriters and generally are associated with less underwriter compensation. However, unlike other papers in the literature, we find that the initial-day returns of venture-backed IPOs on average, are, higher than the non-venture-backed group. We observe a significantly higher degree of premarket pricing inefficiency in the initial offer price of venture-backed IPOs. Further, our results show that a significant portion of the initial day returns is due to deliberate underpricing in the premarket.     

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.     

The Strategy of Going Public: How UK Firms Choose Their Listing Contracts

Abstract:   UK firms going public have a choice between public offers and placings. This choice has important implications in terms of who bears the risk of the issue failing and of its costs. We find that firms with higher ex ante uncertainty choose a placing contract. Highly reputable sponsors and creditor screening serve as signals of firm quality, enabling such firms to choose a public offer. Large and multinational firms usually choose a public offer whereas there is some evidence that very small issues choose a placing. Finally, the 'hotness' of the IPO market increases the probability of placings.     

Initial Public Offerings in Australia 1994 to 1999, Recent Evidence of Underpricing and Underperformance

This paper analyses whether financial and non financial characteristics of Australian initial public offerings (IPOs) can explain observed underpricing and long term underperformance over the period 1994 to 1999. A number of previous Australian studies have investigated initial day underpricing and longer term underperformance of IPOs and this study updates those papers. We find that initial day underpricing can in part be explained by market sentiment, forecast dividend per share yields, underwriter options and share options. Our longer term analysis supports the finding of previous studies in that IPOs on average, underperform the market in the first year following their listing.     

U.S. banks’ IPOs and political money contributions

This study analyses the effect of political money contributions on U.S. banks’ IPOs. We employ unbalanced panel data of 367 U.S. banks’ IPOs for the period January 1998 to December 2019. Our findings reveal that investors perceive Political Money Contributions (PMC) by U.S. banks as a proxy for political reach and connectedness. We document an inverse relationship between total PMC and the level of underpricing, which implies that both lobbying and PAC expenditure pay off on issue day as donors incur less underpricing. Initial returns decrease with PAC contributions to House of Representatives candidates, whereas the returns relate to the partisan identity of the candidates receiving PAC contributions. We document that those individual contributions by directors bring significant benefits to the IPO banks. Finally, we show that the political contributions of board members, particularly those of CEOs and founders, are associated with better returns in the long term.     

Offer pricing of Australian industrial initial public offers

In the present paper we examine the setting of offer prices for Australian industrial initial public offers (IPOs) by fixed price offers. Our investigation focuses on the associations between offer prices and both market prices and accounting based measures of intrinsic value. Fixed‐price offers are less likely to be influenced by the canvassing of market demand when compared to the US setting, where book‐builds are typically used. We conclude that while Australian industrial IPOs are underpriced, they are not systematically undervalued. Contrary to research undertaken by Purnanandam and Swaminathan in the US book‐build setting, we do not conclude that Australian IPOs are systematically overvalued. As part of our analysis, we develop an empirical model of offer prices based on interviews with several leading Australian stockbrokers involved in setting them. Finally, using the ratio of offer price to intrinsic value measure, we find some evidence that undervaluation is positively related to underpricing.     

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.     

Performance of Private to Public MBOs: The Role of Venture Capital

Abstract:   Using a unique dataset, we examine financial performance, and venture capital involvement in 167 MBOs exiting through IPOs (MBO‐IPOs) on the London Stock Exchange, during the period 1964 –1997. VC backed MBOs seem to be more underpriced than MBOs without venture capital backing, based on average value‐weighted returns. MBOs backed by highly reputable VCs tend to be older companies, and exit earlier than MBOs backed by less reputable VCs. The results contradict 'certification' and 'grandstanding' hypotheses supported by US data ( Megginson and Weiss, 1991 ; and Gompers, 1996 , respectively). We found no evidence of either significant underperformance, or that VC backed MBOs perform better than their non‐VC backed counterparts in the long run. However, MBOs backed by highly reputable venture capital firms seem to be better long‐term investments as compared to those backed by less prestigious venture capitalist firms. The results remain robust after using different methods to measure performance, and after controlling for sample selectivity bias.     

China’s Securities reforms and IPO wealth loss

We revisit initial public offering (IPO) underpricing in China before and after the 2001 China Securities Regulatory Commission reforms targeting the IPO process and strengthening corporate governance, using Habib and Ljungqvist’s (2001) wealth loss measure instead of headline underpricing. Habib and Ljungqvist argue that the extent to which owners care about underpricing depends on both headline underpricing and the percentage of IPO shares issued relative to total shares outstanding. We find that in the post-reform period, relative to the pre-reform period, the wealth loss for pre-IPO owners is lower, the incremental effect of the association between wealth loss and state-retained ownership is significantly positive, and a higher proportion of independent directors on the board moderates the wealth loss. Our findings suggest that the more market-oriented IPO process and the corporate governance reforms provide insiders of Chinese IPO firms with greater opportunities to influence IPO pricing and thereby reduce their wealth loss.     

Do Excess Funds Make Financially Constrained Firms Better Off? Evidence from IPOs in China

Firms in transition economies often suffer financial constraints. In initial public offerings (IPOs), however, many newly listed Chinese firms raise funds in excess of what is originally planned. This paper examines whether these excess IPO funds are wasted on value-destroying spending or enable firms to take growth opportunities. After controlling for the endogeneity issue, we find that Chinese firms with excess IPO funds have better post-IPO operating performance, especially those with limited financing channels. In revealing the mechanism, we find that excess IPO fundraising alleviates financial constraints and reduces the cost of debt.     

The Pricing of Property Trust IPOs in Australia

Following Brounen and Eichholtz (2002) this paper adds to the international literature investigating the underpricing of REIT initial public offerings (IPOs), with a study into Australian property trusts. This study finds that initial day returns can in part be explained by forecast profit distributions (or dividends) and the market sentiment towards property trusts from the date of the prospectus to the date of listing. There is some support for the “winners curse” explanation of underpricing with evidence that large investor or institutional involvement at the outset of the IPO also has some explanatory power.     

Value Gains on Flotation and IPO Underpricing

Abstract:  Utilising a unique dataset of 502 UK IPOs we undertake an empirical analysis of the relationship between underpricing and value gains on flotation. We find support for our hypothesis that IPO underpricing is related to the extent of anticipated value gains on the private to public transition. We analyse alternative driving mechanisms behind this relationship, and our results suggest that the underpricing of IPOs is driven by both underwriters and issuing company directors, each of whom derive net benefits over the longer term from underpricing at the IPO.     

Single versus multiple banking: lessons from initial public offerings

A vast research in banking addresses the question of the costs and benefits of multiple bank relationships versus a single bank relationship. Although no clear-cutting conclusion is reached, several contributions suggest that multiple bank relationships might lead to a sub-optimal level of monitoring, compared to a single bank relationship, as a result of free riding and coordination problems. We take a novel approach to tackle this research question, by looking at the role, if any, played by the number of lending relationships in initial public offerings (IPOs). We look at the short-term performances of IPOs as measured by underpricing and find that firms that go public with multiple bank relationships exhibit more underpricing than those that go public with a single bank relationship. This finding is independent of the number of bank relationships and/or whether any of the lending banks also acts as underwriter in the offering. We interpret our results as suggesting that the market attributes a weaker certification role to multiple bank relationships because of their less effective monitoring of IPO firms.