Abstract
This study utilizes prospectuses and supplementary valuation reports to investigate the relationship between underwriters’ valuation and underpricing in 113 firms going public on Borsa Istanbul. It argues that underwriter discretion in the valuation is crucial to underpricing in the Turkish market, where fixed price is the dominant method of offering and retail investor allocation is large. Building on the overpricing theories, the study hypothesizes and finds that optimistic valuation bias is a significant determinant of underwriter discounts, and underwriter discounts are negatively associated with initial returns. One standard deviation increase in deliberate discounts is associated with a 30.4% reduction in underpricing. The median underwriter discount in the sample is 21%, while the median market-adjusted initial return is a small 1.45%, indicating that discounts might not be designed to induce underpricing and reward investors. Book-built offerings are overvalued and overdiscounted; however, not underpriced, contrasting the information extraction view.
Highlights
This study investigates valuation of initial public offerings (IPO) and its relation with the well-documented underpricing
Valuation of IPOs and underpricing is investigated in a sample of 113 Turkish firms utilizing data collected from pre- and post-issue filings
Building on the existing theoretical and empirical evidence on underpricing, the study hypothesizes a connection between IPO valuation and initial returns to test the web of relations between offer method, underwriter discounts, optimistic valuation, investor demand and initial returns
Summary
This study investigates valuation of initial public offerings (IPO) and its relation with the well-documented underpricing. A previous version of the paper titled ‘Valuation of Turkish IPOs’ was presented at the 2018 International Conference on Empirical Economics and Social Sciences, Bandirma, Turkey The offer price is often set prior to consultation with institutional investors and extracting their private information In this setting, issuer and investor sentiment becomes more important to initial returns due to highly asymmetric informational environment and lack of mutual deliberations over the value of the issue. Underwriters may not need to underprice the offering to induce institutional investors to reveal their private information, as optimistic investors will provide sufficient demand at a high price level. The relatively high proportion of retail investors and the dominant use of fixed price mechanism in the Turkish market provides a unique opportunity to capture underwriters’ discretion in valuation and enhance the understanding of underpricing
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