IPO Underpricing and Discretionary Investments

Abstract

We study the relationship between initial public offering (IPO) underpricing and subsequent firm strategy. Utilizing prospect theory and the house money effect, we argue that managers of underpriced firms operate from a “gain” frame, and will engage in increased levels of investment into both R&D and SG&A. Using a sample of hi-tech firms that hold an IPO between 1990 and 2014, we find that the degree of underpricing positively impacts the levels of discretionary spending in the period after IPO. Further, we examine the extent to which this results in value creation or destruction for the firms. We find that firms that experience both high levels of underpricing and respond with high levels of investments hurt firm value as proxied by Tobin’s Q. Through this work we highlight that feedback from the financial markets during the IPO process have real effects on firm strategy and ultimately firm value.