Abstract
Initial public offerings (IPOs) transform private firms into publicly traded ones, thereby improving liquidity of their shares. Better liquidity increases firm value, which we call liquidity value. We use a simple model and hypothesize that issuers and IPO in- vestors bargain over the liquidity value, resulting in a discounted offer price, i.e., IPO underpricing. We find supporting evidence that underpricing is positively related to the expected post-IPO liquidity of the issuer, controlling for firm and deal characteristics and market conditions. We also explore two regulation changes as exogenous shocks to issuers' liquidity before and after IPO, respectively. With a difference-in-differences approach, we find that underpricing is more pronounced with better expected post-IPO liquidity or lower pre-IPO liquidity.
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