Why Do IPO Offer Prices Only Partially Adjust?

Abstract:     
Initial public offerings with upward offer price revisions leave disproportionately high amounts of money on the table. In this study, we investigate the factors that determine the efficiency of IPO offer price adjustment process. We conduct an efficiency analysis by comparing the magnitude of actual offer price revision to the hypothetical complete level of offer price revision for each IPO in our sample. The analysis of 1,122 IPOs with upward price revisions during 1985-2003 indicates that on average only 42% of the change in firm value during the registration period was incorporated into offer prices, with this ratio dropping to 29% during the bubble period of 1999-2000.

We document substantial variation in the efficiency of offer price adjustment across IPOs and over time, and test three hypotheses concerning the incorporation of information into offer prices. Our findings do not support the dynamic information acquisition hypothesis of Benveniste and Spindt (1989). We find substantial inefficiencies in the incorporation of market returns and information spillovers from recent IPOs into the offer prices. In addition, we find that private information revealed during the registration period is incorporated into the offer prices more efficiently than publicly available information. The cross-sectional analysis of the offer price adjustment efficiency reveals that the partial adjustment phenomenon is primarily due to agency problems between the issuing firms and the underwriters, and the magnitude of the offer price revision is strongly related to the relative bargaining powers of the two sides as hypothesized by Loughran and Ritter (2002) and Ljungqvist and Wilhelm (2003). The evidence in our analysis also suggests that the Edelen and Kadlec (2005) tradeoff hypothesis does not fully explain the partial adjustment phenomenon.

Keywords: IPO, offer price adjustment, underpricing, investment banking

JEL Classification: G32, G24, G14, D82

working papers series