Partial adjustment to public information in the pricing of IPOs |
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| Affiliation: | 1. Norwegian School of Economics, Helleveien 30, 5045 Bergen, Norway;2. Centre for Finance, Box 640, 405 30 Gothenburg, Sweden;3. ECGI, c/o the Royal Academies of Belgium, Palace of the Academies, 1000 Brussels, Belgium;4. CEPR, 33 Great Sutton Street, London EC1V 0DX, UK;1. Economics Department, University of Leuven, Belgium;2. Economics Department, University of Arizona, and NBER Research Associate, United States;3. Economics Department, University of North Carolina at Greensboro, and NBER Research Associate, United States;1. European Central Bank, 60640 Frankfurt am Main, Germany;2. University of Amsterdam, Roeterstraat 11, 1018WB Amsterdam, the Netherlands;3. Tinbergen Institute, Gustav Mahlerplein 117, 1082 MS Amsterdam, the Netherlands;1. Wharton School, University of Pennsylvania, 3620 Locust Walk, Philadelphia, PA 19104, USA;2. Leeds School of Business, University of Colorado at Boulder, 995 Regent Drive, Boulder, CO 80302, USA;1. Bangor University, Bangor Business School, Hen Goleg, Bangor University, College Road, L57 2DG, Bangor, UK;2. European Central Bank, Directorate General Research, Financial Research Division, Sonnemannstraße 20, 60314, Frankfurt am Main, Germany;1. Department of Economics, Carleton University for James, C-870 Loeb Building, 1125 Colonel By Drive, Ottawa, ON K1S 5B6, Canada;2. School of Accounting and Finance, University of Waterloo, 200 University Avenue West, Waterloo, ON N2L 3G1, Canada |
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| Abstract: | Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a rational explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)’s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This “incentive effect” receives strong empirical support in a sample of 6300 IPOs in 1983–2012. Controlling for the incentive effect, the positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is held to be most informative, effectively resolving the predictability puzzle. |
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