The Pricing of Initial Public Offerings: Tests of Adverse-Selection and Signaling Theories

TLDR

The study tests the empirical implications of several models of IPO underpricing. The study finds that IPOs are not underpriced when investors are certain they will not compete with informed investors, that reputable underwriters reduce underpricing and improve long‑term performance, and that firms that underprice more reissue less and earn less, contradicting signaling models.

Abstract

We test the empirical implications of several models of IPO underpricing. Consistent with the winner's-curse hypothesis, we show that in markets where investors know a priori that they do not have to compete with informed investors, IPOs are not underpriced. We also show that IPOs underwritten by reputable investment banks experience significantly less underpricing and perform significantly better in the long run. We do not find empirical support for the signaling models that try to explain why firms underprice. In fact, we find that (1) firms that underprice more return to the reissue market less frequently, and for lesser amounts, than firms that underprice less, and (2) firms that underprice less experience higher earnings and pay higher dividends, contrary to the models' predictions.