Ch. 7: IPO Underpricing 417
6.3.1. Testable implications and evidence
Ljungqvist and Wilhelm (2005)use the structure suggested byLoughran and Ritter’s
(2002)behavioral perspective to test whether the CEOs of recent IPO firms makesub-
sequentdecisions consistent with a behavioral measure of their perception of the IPO’s
outcome. Specifically, they investigate whether CEOs deemed ‘satisfied’ with the un-
derwriter’s performance according to Loughran and Ritter’s story are more likely to
hire their IPO underwriters to lead-manage later seasoned equity offerings. Controlling
for other known factors, IPO firms are less likely to switch underwriters for their SEO
when they were deemed ‘satisfied’ with the IPO underwriter’s performance. Underwrit-
ers also appear to benefit from behavioral biases in the sense that they extract higher
fees for subsequent transactions involving ‘satisfied’ decision-makers.
While these tests suggest there is explanatory power in the behavioral model, they do
not speak directly to whether deviations from expected utility maximization determine
patterns in IPO initial returns. More work is needed.
- Concluding remarks
The empirical IPO literature is now fairly mature. We know that IPOs are underpriced
in virtually all countries and that the number of companies going public and the extent
of underpricing fluctuate over time. There is a large body of theoretical work explaining
IPO underpricing, and most theories have been subjected to rigorous empirical testing.
Broadly speaking, the empirical evidence supports the view that information frictions
(including agency conflicts between the issuing company and its investment bank) have
a first-order effect on underpricing. Specifically,
- The bulk of underpricing-related gains accrue to informed (or at least institutional)
investors; uninformed (or at least retail) investors earn little or no excess returns from
investing in IPOs. - In the cross-section, underpricing increases in the ex ante uncertainty surrounding a
firm’s valuation. - There is ample evidence suggesting that some investors are informed and that their
information influences the investment bank’s choice of offer price.
At the same time, the enormous variation in the extent of underpricing over time
raises doubt in some people’s mind whether information-based explanations on their
own can account for the huge amounts of money left on the table in hot markets, such
as the internet bubble of 1998–2000.
Against this background, vigorous debate continues between two broad views of what
causes underpricing: theBenveniste and Spindt (1989)perspective which emphasizes
the necessity of underpricing if the underwriter is to efficiently extract pricing-relevant
information from better informed investors and thereby maximize the issuer’s expected
proceeds, and the agency view commonly associated with Jay Ritter’s work which
stresses the self-interested nature of investment banks. The sometimes strident tone of