Ipo Underpricing

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IPO Underpricing

IPO underpricing phenomenon is firstly academic documented in 1970s (Stoll and Curley, 1970; Reilly, 1973; Logue, 1973; Ibbotson, 1975). Early findings (exclusively focused on US market) indicate that underpricing is influenced by particular periods (Ibboston and Jaffe, 1975) and particular industry, usually natural resource (oil and gas) industry (Ritter, 1984). However, these findings are challenged by Smith (1986) who claimed that underpricing occurs in the entire period of 1960s-1980s, rather than concentrates in particular periods, and underpricing level exists across all industries with average exceeds 15%. Recent study is more convincible with larger time period and sample observations. Loughran and Ritter (2004) document this ‘underpricing discount’ has averaged around 19% in the US since the 1960s. Nevertheless, underpricing level (i.e. the average first-day return) tends to fluctuate, 21% in the 1960s, 12% in the 1970s, 16% in the 1980s, 15% in 1990-1998 and then exploded to more than 65% in the 1999-2000 internet bubble period, and falling back to 12% in 2001-2008 (reference). Table Empirical studies have extended the scope of research from the US to the whole world. Underpricing is internationally documented, and the level is extremely high in emerging markets. According to (reference)’s research, China (1990-1996, 226, 388%); US (1960-1996, 13308, 15.8%); Japan (1970-1996, 975, 24%). Table. (Reference) provides wider research. France: 3-14%; Australia: 11-30%; Taiwan: 30-47%; Greece: 48-64%; Brazil: 74-78.5%; China: 127-950%. Table Due to its short history with strong government control characteristics, Chinese IPO market draws research interest. The average initial return of IPOs in China during 1999-2002 was 3.3 times the average emerging markets’ initial return (excluding China) and 6.9 times that of developed countries (Reference). Sample size

Sample period
Initial return (%)
Mok and Hui (1998)
87
1990-1993
289.20%
Datar and Mao (1998)
226
1990-1996
388.00%
Su and Fleisher (1999)
308
1990-1995
948.59%
Chen et al. (2000)
277
1992-1995
350.47%
Liu and Li (2000)
781
1991-1999
139.40%
Chi and Padgett (2002)
668
1996-2000
129.16%
Su (2003)
587
1994- 1999
119.38%
Chan et al. (2003)
570
1993-1998
175.40%
Chan et al. (2003)
286
1999-2000
104.70%
Wang (2005)
747
1994-1999
271.90%
Kimbro (2005)
691
1995-2002
132.00%
Li (2006)
314
1999-2001
134.62%
Asymmetric information theory
The cornerstone of this theory is that there is asymmetric information among parties (issuer, underwriter, and investor) in the IPO. Chambers and Dimson (2009) proved that the level of trust between investors, issuers, and underwriters plays a crucial role on the level of IPO underpricing over time in the UK. Asymmetric information leads to ex ante uncertainty among parties. Higher ex ante uncertainty results in higher underpricing. Ritter (1984) raised the changing risk composition hypothesis, which assumes that riskier IPOs will be underpriced by more than less-risky IPOs. Beatty and Ritter (1986) then extend Rock (1986)’s asymmetric information model (winner’s curse) by introducing the ex ante uncertainty about an IPO’s market clearing price. The ex ante uncertainty among investors over the value of firm determines the underpricing level of the IPO (Loughran and Ritter, 2004). The level of underpricing increases with the degree of ex ante uncertainty about the value of the firm (Beatty and Ritter, 1986; Ljungqvist, 2007). Firms with more uncertainty about growth opportunities have higher levels of underpricing than other firms on average (Ritter, 1984; Beatty and Zajac, 1994; Welbourne and Cyr, 1999). Under the scope of asymmetric information theory, there are three models: winner’s curse, principal-agent and signaling. Winner’s curse assumes informed investors have better information. Principal-agent model argues underwriters gain better information. Signaling model...
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