Abstract
We examine how the offer size of initial public offerings (IPOs) and the market return on their issue date are related to the pricing of 314 IPOs issued by firms in Denmark, Finland, Norway and Sweden at the one-day, one-week and four-week horizons using latent class analysis, which is a structural equation methodology. We identify four latent classes at each time horizon, where classes (i)-(ii) include a greater number of IPOs: (i) large-sized and underpriced IPOs; (ii) small-sized and overpriced IPOs; (iii) small-sized and severely underpriced IPOs; and (iv) large-sized IPOs that are overpriced at the one-day horizon but underpriced at the four-week horizon. The market returns are normal in latent classes (i)-(iii) and weak in class (iv). Approximately half of the IPOs in the technology sector are in the latent class with small-sized and overpriced IPOs, and most of the IPOs in the class with small-sized and severely underpriced IPOs are in the healthcare sector. Finally, the underpricing of IPOs is not corrected after one or four weeks of trading. Instead, the mean return and the standard deviation of returns increase with the time horizon.
Highlights
When a firm goes public, the equity sold in the initial public offering (IPO) tends to be underpriced, resulting in a large increase in the stock price on the first day of trading
We identify four latent classes at each time horizon, where classes (i)-(ii) include a greater number of IPOs: (i) large-sized and underpriced IPOs; (ii) small-sized and overpriced IPOs; (iii) small-sized and severely underpriced IPOs; and (iv) large-sized IPOs that are overpriced at the one-day horizon but underpriced at the four-week horizon
Approximately half of the IPOs in the technology sector are in the latent class with small-sized and overpriced IPOs, and most of the IPOs in the class with small-sized and severely underpriced IPOs are in the healthcare sector
Summary
When a firm goes public, the equity sold in the initial public offering (IPO) tends to be underpriced, resulting in a large increase in the stock price on the first day of trading. Offer Size is the logarithm of the number of shares times the offer price for those shares in the IPO, and Market Return is the stock market return in percent in the relevant market on the issue date of the IPO (i.e., the return on OMXC20 if the IPO’s country of origin is Denmark, the return on OMXH25 if the IPO’s country of origin is Finland, the return on OMXO20 if the IPO’s country of origin is Norway, and the return on OMXS30 if the IPO’s country of origin is Sweden). The advantage of using LCA is that this structural equation methodology is able to detect patterns in sparse and heterogeneous data that ordinary regression analysis might not uncover
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