II-2-4\ Underpricing as a substitute of marketing
expenditures:
Habib and Ljungqvist (2001) argue that underpricing is a
substitute for costly marketing expenditures. Using a data set of IPOs from
1991 to 1995, Habib and Ljungqvist report that an extra dollar left on the
table reduces other marketing expenditures by a dollar. On the first sight,
underpricing seems to be just a substitute for marketing expenditures since
both have the same cost, but underpricing is much more interesting.
By going public and by underpricing and leaving money on the
IPO table, issuing firms can achieve a total coverage media and good news in
all media, which can be much more costly if the firm chooses to use publicity
and marketing expenditures, mainly because we can not forget the possibility of
recouping this money left on the IPO table if the firm has the intention to
conduct Seasoned Equity Offerings in the future. So, the issuing firm achieves
a large coverage media and an important publicity without spending anything,
since the money left on the IPO table will be recouped later. By underpricing,
the investors who bought the IPO shares have confidence in the issuing firm,
they are satisfied with the gains they retired from the IPO shares and from
underpricing in the first day of trading. Optimistic about the value of this
firm, these investors will easily accept the price the firm set for its
Seasoned Equity Offerings at a later date. Even if the price is higher than
necessary, they will accept it since they have confidence in this firm, and
then all the money left on the table can be recouped by conducting Seasoned
Equity Offerings in the future. 9
II-2-5\ Internet Bubble:
One popular related explanation for the high and severe
underpricing of 65% during the Internet bubble (1999-2000) for the U.S IPOs, a
peak never reached before in the U.S IPO market, is that underwriters could not
justify a higher offer price on Internet IPOs. Even if these firms have a high
potential of profitability in the recent future and they are operating in a new
but very promising field which will generate high returns later, the
underwriters can not justify this and propose a higher offer price. These firms
are seen as young and operating in a new field which means that their offerings
are risky and they propose risky shares. Proposing a higher offer price will
not be accepted by investors and will make them fear the offerings. The issuing
firms have to propose a low offer price to incite investors to participate in
the offerings even if they are thought to be risky. So, we can say on one hand,
the newly issuing Internet firms are very important and are operating in a very
promising field and then will generate high returns, but all this can not be
justified by their underwriters and they do not find the convincing arguments.
On the other hand, and since they are operating in a new field not very known
and they are very young firms without a history of returns, they are thought to
be risky. So, we are in the same explanation of risk due to valuation
uncertainty which was proved to be ineffective determinant and explanation for
the underpricing anomaly.
So to explain the severe level of underpricing during the
dot-com period, only the inability to justify a higher offer price can be
considered as a possible explanation, but the fact of young and so risky firms
can not be used as a relevant explanation.
9 As a support for IPO as a marketing event,
Chemmanur (1993) proposes that this publicity could generate additional
investor interest, and Demers and Lewellen (2003) suggest that the publicity
could generate additional product market revenue from greater brand
awareness.
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