Investor interest, trading volume, and the choice of IPO mechanism in France Salim Chahine *
American University of Beirut, The Suliman S. Olayan School of Business, Bliss Street, P.O.Box: 11-0236, Beirut, Lebanon Received 3 February 2004 Available online 7 November 2005
Abstract This paper investigates the relationship between underpricing and investor interest level prior to and after the IPO date. Empirical tests show a significant 3-day buy-and-hold abnormal return of 19.15%. It is positively related to the share demand-to-offer ratio in the pre-market period and to trading volume in the aftermarket. Despite a high initial underpricing for some book-built issues, the book-building procedure allows for more effective pricing and a lower divergence of opinion among investors in the aftermarket than the auction-like procedure. D 2005 Elsevier Inc. All rights reserved. JEL classification: G24; G28; G32 Keywords: IPO mechanisms; Underpricing; Share demand-to-offer ratio; Trading volume
1. Introduction The price setting process for initial public offerings (IPOs) is one of the most puzzling phenomena in finance. Prior empirical studies propose that investors participate in initial public offerings at an offer price lower than their own value expectations. Accordingly, there is international evidence about a significant positive abnormal return at the IPO date, usually called undepricing (Loughran, Ritter, & Rydqvist, 1994). The stimulation of investor interest is a central issue in the success of an IPO. Firms looking to attract investors thus have to accept underpricing when going public. Within this framework,
* Tel.: +961 1 374374x3722. E-mail address: firstname.lastname@example.org. 1057-5219/$ - see front matter D 2005 Elsevier Inc. All rights reserved. doi:10.1016/j.irfa.2005.10.002
S. Chahine / International Review of Financial Analysis 16 (2007) 116–135
this paper investigates the relationship between initial underpricing and investor interest according to the choice of the IPO mechanism in the French market. The existence of different IPO mechanisms in the Paris stock market raises questions related to the attractiveness of these mechanisms to investors and to the price discovery process. IPOs in the French market may be issued using one of the following procedures: a fixed-price offer (called Offre a Prix Fixe), an ` auction-like procedure (called Offre a Prix Minimal), and a book-building mechanism ` (Placement Garanti). While more attractive auction-like issues may be transformed into fixed-price offers, book-building procedures may be accompanied by a tranche to individual investors. In accordance with the chosen IPO procedure, underwriters are differentially informed about investor interest in offerings. Therefore, this paper supposes that an efficient selling mechanism should (1) attract enough investors so as to avoid the risk of failure of the issue and (2) reduce underpricing and divergence of opinion among investors in the aftermarket. Hence, it proposes to gauge the pre-IPO investor interest level by the share demand-to-offer ratio in the pre-market period. It also considers trading volume as a proxy for divergence of opinion among investors in the aftermarket (Beaver, 1968; Karpoff, 1986).1 This study uses 305 of the 335 French IPOs from 1996 to 2000, thus complementing prior comparative research among IPO mechanisms. Derrien and Womack (2003) use a sample of 264 French IPOs and analyze the ability of IPO mechanisms to control for market momentum from 1992 to 1998. They show that auction-like procedures allow underwriters to better control market momentum and lead to lower underpricing than other selling mechanisms in bhotQ and bcoldQ issues. At least two reasons may lead to differences in this study’s results versus those of Derrien and Womack (2003). First, this study focuses on the period following the creation of the...