Do the underwriters efficiently set first-trade prices in IPOs?

Lena Chua Booth

Abstract


While there is extensive literature documenting the discrepancy between IPO offer prices and their respective closing prices on the first day, few had examined the relationship between the offer, first-trade, and the first-day closing prices of IPOs. We examine the IPO trading return on the first day (opening price-to-closing price) to determine whether investment banks are efficient in setting the first-trade prices. We also examine when final offer price is set relative to when trading starts as a proxy for level of oversubscription. We find that open-to-close return is positive and significant. It is negatively related to the offer-to-open return, even after controlling for issue characteristics and market conditions. This is particularly prominent during the bubble period when laddering agreements were arguably widespread. These findings suggest the possibility of substitution between lower offer-to-open return for higher open-to-close return in the secondary market. We also find that high ranked underwriters are more conservative in setting of the first-trade price relative to the closing price in first-day trading. They tend to leave more return to the secondary market investors even after controlling for our measures of difficulty in setting the offer price. Overall, these results suggest that information learned in the book-building process is important in explaining the first trading day returns.


Keywords


First-trade; Initial public offerings (IPOs); Laddering; Partial adjustment; Underpricing.

Full Text:

PDF

References


Barry, C. and Jennings, R., 1993. The opening price performance of initial public offerings of common stock. Financial Management, 22: 54-63. http://dx.doi.org/10.2307/3665965

Beatty, Randolph P. and Jay Ritter, 1986. Investment banking, reputation and underpricing of initial public offerings. Journal of Financial Economics, 15: 213-232. http://dx.doi.org/10.1016/0304-405X(86)90055-3

Booth, James R. and Richard Smith, 1986. Capital raising, underwriting and the certification hypothesis. Journal of Financial Economics, 15: 261-281. http://dx.doi.org/10.1016/0304-405X(86)90057-7

Bradley, D.J. and B.D. Jordan, 2002. Partial adjustment to public information and IPO underpricing. Journal of Financial and Quantitative Analysis, 37(4): 595-617. http://dx.doi.org/10.2307/3595013

Carter, Richard B., Frederick H. Dark and Ajai K. Singh, 1998. Underwriter reputation, initial returns, and the long-run performance of IPO stocks. Journal of Finance, 53: 285-311. http://dx.doi.org/10.1111/0022-1082.104624

Carter, Richard and Steven Manaster, 1990. Initial public offerings and underwriter reputation. Journal of Finance, 45: 1045-1067. http://dx.doi.org/10.1111/j.1540-6261.1990.tb02426.x, http://dx.doi.org/10.1111/j.1540-6261.1990.tb02426_3.x, http://dx.doi.org/10.1111/j.1540-6261.1990.tb02426_1.x, http://dx.doi.org/10.1111/j.1540-6261.1990.tb02426_2.x.

Chemmanur, T. J. and P. Fulghieri, 1994. Investment bank reputation, information production and financial intermediation. Journal of Finance, 49: 57-79. http://dx.doi.org/10.1111/j.1540-6261.1994.tb04420.x

Griffin, John M., Jeffrey H. Harris and Selim Topaloglu, 2007. Why are IPO investors net buyers through lead underwriters? Journal of Financial Economics, 85: 518-55. http://dx.doi.org/10.1016/j.jfineco.2005.12.005

Hanley, K. W. 1993. Underpricing of initial public offerings and the partial adjustment phenomenon. Journal of Financial Economics, 34: 231-250. http://dx.doi.org/10.1016/0304-405X(93)90019-8

Hao, Q., 2007. Laddering in initial public offerings. Journal of Financial Economics, 85: 102-122. http://dx.doi.org/10.1016/j.jfineco.2006.05.008

Loughran, Tim, and Jay R. Ritter, 2004. Why has IPO underpricing increased over time? Financial Management, 33(3): 5-37.

Ritter, Jay R. and Ivo Welch, 2002. A review of IPO activity, pricing, and allocations. Journal of Finance, 57: 1795-1828. http://dx.doi.org/10.1111/1540-6261.00478

Smith, Clifford, 1986. Investment banking and the capital acquisition process." Journal of Financial Economics, 15: 3-29. http://dx.doi.org/10.1016/0304-405X(86)90048-6




DOI: http://dx.doi.org/10.18533/jefs.v2i05.143

Article Metrics

Metrics Loading ...

Metrics powered by PLOS ALM

Refbacks

  • There are currently no refbacks.
';



Copyright (c) 2014 Lena Chua Booth

.............................................................................................................................

Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 International License.

.............................................................................................................................

If you find difficulties in submitting manuscript please forward your doc file to support@journalofeconomics.org. Our support team will assist you in submission process and other technical matters. Please note that documents uploaded by yourself are reviewed more quickly than replies by e-mail.

In order to get notifications on inbox please add  this domain journalofeconomics.org in your email safe list.

.............................................................

ISSN 2379-9463(Print)
ISSN 2379-9471(Online)

...........................................................