Investor Horizon Clientele and IPO Underpricing
50 Pages Posted: 16 Sep 2009 Last revised: 3 Sep 2014
Date Written: October 16, 2010
We study how the heterogeneity in investment horizons of institutional investors affects the IPO market. We document the fact that short-term investors prefer more liquid stocks than long-term investors do and that IPO stocks are very liquid in the after-market. On this premise, we argue that short-term investors should have a higher reservation price than long-term investors for IPO stocks. However, given the limited supply of short-term investors, the underwriter still prices the issue at the reservation price of long-term investors. Rationing causes the unsatisfied demand of short-term investors to express itself in the secondary market. This generates a positive relationship between short-term investor demand and both underpricing and trading at the IPO. We test this intuition by constructing a geography-based measure of “local short-term demand”, which captures the cross-sectional variations in regional investor horizon clienteles. Consistent with our hypotheses, we find that local short-term demand is strongly positively related to IPO underpricing and after-market trading volume and that the fraction of IPO holdings by short-term investors after the IPO is significantly higher than certain benchmarks. Our results are consistent with the view that investor base heterogeneity affects asset returns.
Keywords: institutional investors, investor horizon clientele, proximity investing, short-term investor fraction, IPOs, Amihud illiquidity, underpricing
JEL Classification: G24, G28
Suggested Citation: Suggested Citation