What IPO Order Flow Reveals about the Role of the Underwriter
International Journal of Managerial Finance, Vol. 5, No. 1, pp. 16-49, 2009
51 Pages Posted: 3 Apr 2009
Date Written: July 3, 2007
IPO underwriter-brokers dominate aftermarket trading but often follow rather than lead in price discovery. This suggests that the underwriter shares a certification, external monitoring, and signaling role with aftermarket brokers, venture capitalists, and founder-owners retaining equity. In this paper we investigate the cross-sectional determinants of the role of the underwriter in aftermarket price discovery. The underwriters' role expands with greater issue uncertainty and diminishes with venture capitalist involvement and greater retention. Issue uncertainty is measured in pages of idiosyncratic risk factors and in the delay between the announcement and completion of the issue. Our first novel result is that verifiable facts are not a substitute for, but a complement to, underwriter certification and advice. Specifically, the underwriter's contribution to price discovery increases with the number of supplier and customer contracts reported in the prospectus. Secondly, the underwriter's role in price discovery declines when the IPO is first in a new technology or product space. These findings indicate that the verification process (not de novo information production) is the key function of the underwriter.
Keywords: Initial public offering, IPO, underwriter, venture capitalist
JEL Classification: G24, G32
Suggested Citation: Suggested Citation