Greater Underpricing Research Articles

Sinners or Saints? Top Underwriters, Venture Capitalists, and IPO Underpricing

This paper examines strategic interactions between venture capitalists (VCs) and top underwriters in the IPO process. We test two contrasting hypotheses: certification and rent extraction. On the one hand, the joint involvement of VCs and top underwriters can amplify their certification effect, reducing IPO underpricing. On the other hand, the rent extraction incentives of VCs and top underwriters, particularly in a repeated dealing context, can increase underpricing. We test these contrasting effects on IPO underpricing in the cross-section and around two regulatory shocks. First, VC-backed IPOs, VC-backed deals with top underwriters, and deals with stronger VC-underwriter ties exhibit greater underpricing. The cross-sectional results continue to hold in two-stage least squares estimation with geographical instruments. Second, the 2012 JOBS Act decreased disclosures by issuers and increased informational asymmetry. We find that IPO underpricing increased among VC-backed IPOs involving top underwriters after the JOBS Act. Third, a 2003 NASD rule limited explicit rents that may be extracted from preferential allocations of new IPO issues. We find that VC-backed IPO underpricing declined after the shock, and the effect was concentrated among VC-backed deals involving top underwriters and VCs with ties to underwriters. Importantly, we find no effect of top underwriters alone unless a VC is also involved. The observed decline in IPO underpricing cannot be explained by analyst involvement or the passage of Regulation FD. Moreover, repeat dealing between large institutions and underwriters similarly increases underpricing, but the effect does not explain the role of VC-underwriter ties and does not decline after the 2003 shock. Overall, our results support rent extraction, shed new light on the effects of VC backing, underwriters, and institutions on IPO underpricing, and emphasize the role of strategic interactions between them in the post-dot-com period.

The Dark Side of IPOs: Examining Where and Who Trades in the IPO Secondary Market

We study the levels of lit and dark fragmentation in IPOs. Using a sample of 451 IPOs, we find that measures of dark and lit fragmentation are higher in underpriced issues. We further test the claim that IPO price uncertainty is not fully resolved at the offering and that this ex-post uncertainty is related to aftermarket fragmentation. Our analysis shows that fragmentation, both lit and dark, contribute to this ex-post uncertainty, resulting in greater underpricing. We also document that measures of hidden, algorithmic, and retail trading are higher among underpriced issues. Further, our results indicate that algorithmic trading is relatively low around the offering, increasing in the later periods of IPO trading. Finally, we show that measures of dark and hidden trading exhibit inverse patterns around the offering, confirming that the two forms of dark trading are substitutes rather than complements.

The JOBS Act and the Costs of Going Public

ABSTRACTWe examine the effects of Title I of the Jumpstart Our Business Startups Act for a sample of 312 emerging growth companies (EGCs) that filed for an initial public offering (IPO) from April 5, 2012 through April 30, 2015. We find no reduction in the direct costs of issuance, accounting, legal, or underwriting fees for EGC IPOs. Underpricing, an indirect cost of issuance that increases an issuer's cost of capital, is significantly higher for EGCs compared to other IPOs. More importantly, greater underpricing is present only for larger firms that are newly eligible for scaled disclosure under the Act. Overall, we find little evidence that the Act in its first three years has reduced the measurable costs of going public. Although there are benefits of the Act that issuers appear to value, they should be balanced against the higher costs of capital that can occur after its enactment.

Initial Public Offerings (IPO) Performance during Hot and Cold Issue Market in Pakistan

The main aim of the study is to investigate the hot and cold issue market phenomena in Pakistan. In effect, this study examines IPOs underpricing and underperformance phenomena during hot and cold issue market on the Karachi Stock Exchange (KSE). The significant positive correlation between initial returns and IPO’s volume series confirms the existence of hot and cold issue market phenomena in KSE. The hot and cold periods are segregated on volume based method. The result found that hot market IPOs in the short-run shows on average greater underpricing (high returns) than cold issue market. However, hot market IPOs in long-run shows on average high underperformance (negative returns) than cold market IPOs. The result is consistent with the prediction of windows of opportunity hypothesis and signaling hypothesis.

The JOBS Act and the Costs of Going Public

We examine the effects of Title I of the Jumpstart Our Business Startups Act for a sample of 312 emerging growth companies (EGCs) that filed for an initial public offering (IPO) after April 5, 2012, through April 30, 2015. We find no reduction in the direct costs of issuance, accounting, legal, or underwriting fees, for EGC IPOs. Underpricing, which is an indirect cost of issuance that increases an issuer’s cost of capital, is significantly higher for EGCs than other IPOs. More importantly, greater underpricing is present only for larger firms that are newly eligible for scaled disclosure under the Act. Overall, we find little evidence that the Act in its first three years has reduced the measurable costs of going public. Although there are benefits of the Act that issuers appear to value, they should be balanced against the higher costs of capital that occur after its enactment.

Redacting Information at the Initial Public Offering

Nearly 40% of IPO firms redact information from their SEC registration filings. These firms exhibit characteristics consistent with the need to shield proprietary information from potential rivals. They experience greater underpricing, but pre-IPO insiders reduce underpricing-related wealth transfers by selling proportionately less of the firm’s shares at the IPO, raising more equity financing in later seasoned equity offerings, and selling their own holdings at a relatively slow pace. The information environment of redacting firms reflects proportionately more private information than that of non-redacting firms post IPO, but this difference abates by the fourth year. Consistent with the view that redacted proprietary information provides competitive advantages, redacting firms exhibit superior financial performance post IPO. The results illustrate tradeoffs in balancing firms’ needs to protect proprietary information with their capital needs, investors’ needs for information to price securities, and pre-IPO owners’ liquidity needs.

Short selling in initial public offerings

Short sale constraints in the aftermarket of initial public offerings (IPOs) are often used to explain short-term underpricing that is subsequently reversed. This paper shows that short selling is integral to aftermarket trading and is higher in IPOs with greater underpricing. Perceived restrictions on borrowing shares are not systematically circumvented by “naked” short selling. Short sellers, on average, do not appear to earn abnormal profits in the near term and our findings are not driven by market makers. Short selling in IPOs is not as constrained as suggested by the literature, implying that other factors may be responsible for underpricing.

IPO Underpricing, Firm Quality, and Analyst Forecasts

We find that IPO underpricing is positively related to post‐IPO growth in sales and EBITDA, but is not significantly related to growth in earnings. Our evidence suggests that accrual reversals or earnings management may cause this inconsistency. We interpret the growth rates of sales and EBITDA as measures of firm quality, and conclude that our evidence supports the notion that IPO firms with greater underpricing are of better quality. Our tests on analysts' earnings forecast errors show that analysts are less positively biased in their earnings forecasts for IPO firms that have greater underpricing.

Media Coverage and IPO Underpricing

We document that media coverage before the IPO day significantly relates to IPO underpricing. The relation is asymmetrical: more media articles are associated with more underpricing when the offer price is revised upwards from the midpoint of the initial filing range, while there is no significant relationship between media coverage and underpricing when the offer price is revised downward. Conditioning on positive price revision, one extra piece of media coverage is associated with about two percentage points greater underpricing. The positive relationship between media coverage and underpricing is stronger when ex ante uncertainty is greater. We fail to find any relation between positive media coverage and IPO firms' long run under-performance. Overall, our findings are consistent with theories of underpricing being driven by the need to compensate investors for information acquisition, but are not consistent with investor sentiment or prospect theory explanations. Moreover, we find that recent stock market returns have significant explanatory power when media attention is omitted from the regressions but lose most or all of their significance when media attention is included, raising new questions in the debate over partial adjustment to public information for IPOs.

The effect of firm financial characteristics and the availability of alternative finance on IPO underpricing

This article tests the hypothesis that the financial characteristics of the issuing firm, along with the availability of alternative sources of financing, are important determinants of the level of underpricing. While risk and its relationship to underpricing have been examined in previous studies, liquidity risk is unique because of its special implications for a firm’s bargaining position with the underwriter. Consistent with my hypothesis, firms with greater liquidity concerns at the IPO experience greater underpricing. On the other hand, firms with higher levels of venture capital funding and/or debt financing are more fully priced.

Lowballing for 'Pop': The Case of Internet IPO Underpricing

Three explanations are commonly offered for the unprecedented levels of underpricing in recent IPOs by Internet firms: (1) media hype drives underpricing; (2) Internet firms leave money on the table to be able to follow up underpriced IPOs with follow on financing offers; and (3) underpricing is a branding event designed to increase consumer awareness of the Internet company. We examine the relation between the extent of Internet IPO underpricing and proxies to test the three explanations. We measure media hype as the extent of media exposure pre IPO. The desire to return to the market is proxied by the rate at which the firm burns through its IPO offer proceeds on operating and investing activities. Proxies for branding include whether the firm is a Business to Consumer company (B2C) and the extent of revenue increase post IPO. Results indicate that media hype and the desire to return to the capital market are strongly associated with Internet IPO underpricing. Although underpricing is higher for B2C firms, sales increases post IPO are not significantly related to the extent of underpricing. Finally, there is at best weak evidence to suggest that post offer return performance is worse for Internet IPOs with greater underpricing.

Influence-Seeking and the Pricing of Initial Public Offerings and Privatizations: Evidence from the Nigerian Equity Market

An examination of the pricing of new issues of equity in several regions of the world reveals significantly more underpricing of initial public offerings of privatizations (PIPOs) than private-sector initial public offerings (IPOs). This finding is consistent with a model of new issue pricing developed by the author in which managers (including bureaucrats) underprice shares in order to create additional consumer surplus for the benefit of shareholders. Managers then try to capture this contrived surplus in pecuniary and non-pecuniary terms. The non-pecuniary benefits of underpricing are termed influence, and influence-seeking is hypothesized to explain the greater underpricing of PIPOs than IPOs. This paper presents a test of the author's influence-seeking theory of new issue pricing using data on PIPOs and IPOs on the Nigerian Stock Exchange between January 1989 and June 1993. Considerable support for the new model of share pricing is found in the Nigerian equity market.

Pricing of new equity issues in Singapore

This paper analyzes the pricing performance of new equity issues by companies which came to the new issue market and sought a listing on the Stock Exchange of Singapore during the period 1975–84. We find that the new equity issues in Singapore are more underpriced than those in the U.S., the U.K. and Australia. It appears that the greater underpricing is due largely to more conservative pricing policies followed by underwriters in Singapore. This results in greater losses suffered by the existing shareholders of the issuing companies.