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Investor sentiment and short run IPO anomaly: a behavioral explanation of underpricing

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par Ines Mahjoub
Institut des Hautes Etudes Commerciales - Mastère de Recherche 2010

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I-2-2\ Theory asserting informational symmetry and IPO market efficiency:

I use the main characteristic of Initial Public Offerings, «risk» related to technological or valuation uncertainty and I use many measures:

Ø The issuing firm size reflects the valuation uncertainty risk: Ln (sales), Ln (assets).

Ø The issue risk, a dummy variable taking a value of one if the firm operates in a risky industry and zero otherwise, a variable reflecting technological risk which induces a valuation uncertainty.

Ø The age of the issuing firm: Ln (1+age) (age is number of years since the firm's founding date to the date of going public and the date of introduction in IPO market).

Ø I use also some financial data as proxies for valuation uncertainty risk: firm profitability and ROA.

Almost the empirical studies introducing risk find a positive relation between risk and underpricing: Riskier firms set a low offer price to incite investors to participate in the IPO market and to buy the IPO risky shares, and a high offer price will dissuade them. However, a study of Bartov, Mohanram and Seethamraju (2003) reports that there is no correlation between risk and underpricing. This finding refutes the prior researches and results about the suitability of the risk as an explanation to the underpricing anomaly. And I use this variable with many measures to verify if risk can be considered as a relevant explanation to short run IPO anomaly.

I use another determinant of the symmetric information theory: the issue size calculated as the natural logarithm of the net expected proceeds. Previous researches report a negative and statistically significant relation between size and offer price, so we can talk about a positive and significant relation between issue size and underpricing (Cornelli, Goldreich and Ljungqvist (2004)). Other researches find a negative relation between issue size and underpricing, explaining this by the fact that sizable firms are generally less risky than those making smaller issues, then issuers can bargain a higher offer price conducting a lower level of underpricing.

I also introduce the issuer bargaining power as a variable in the theory asserting the informational transparency and lucidity, with three proxies to have an idea about the ownership structure: insiders' ownership, institutional ownership and blockholders' ownership prior to the offering.

The main result found in the earlier studies, the greater is the ownership concentration, the greater is the issuing firm's bargaining power, the higher is the offer price and the lower is the first-day return and vice-versa. But Loughran and Ritter (2004) argue that this argument has little support as an explanation for underpricing.

I introduce another control variable «Time dummy»: a dummy variable taking the value of 1 if the IPO date is after July 2007, and zero otherwise. This variable is used to control the beginning of financial crisis period and its impact on underpricing.

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