Price Support in Stock Auctioned IPOs: Some Empirical Evidence

Abstract

Many studies have found underpricing of initial public offerings (IPOs) and attributed the underpricing to information asymmetry either between issuers and underwriters or between informed and uninformed investors. However, by observing the distribution of initial returns on stocks after their IPOs, Ruud (1993) proposes that underpricing could result from underwriter price support. A carefully constructed database of auctioned IPOs offers a better alternative to control and thus limit the effects of information asymmetry In this study, we test and verify if the observed underpricing in auctioned IPOs can be explained by the underwriter price support hypothesis. With a carefully constructed database of auctioned IPOs, distributions of post-IPO returns are empirically analyzed. Our results indicate the existence of underwriter price support during the early post-IPO period and gradual phasing out of the support within a few weeks of trading. The empirical results also suggest that underwriters attempt to target those IPO issues whose offering prices are lower than their average auction prices. We also find that, if auctioned IPOs could be offered using the average auctioned price or are unconstrained by price ceiling limitations, then they would no longer be underpriced. These conclusions are substantiated by the outcomes of Tobit analyses in relation to possible price censoring. Finally, we perform a series of robust checks using maximum rank correlation (MRC) estimation. The findings show that information asymmetry is not a significant factor in causing the excessive abnormal returns and thus confirm the price support hypothesis.