Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings

Posted: 17 Nov 2009

See all articles by Ivo Welch

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Date Written: 1989

Abstract

Suggests a model to explain underpricing at the IPO by high-quality firms as a signal to investors at the expense of low-quality firms. In contrast to Rock's (1986) equilibrium model suggesting firms underprice reluctantly, this model follows in the vein of more recent models (Nanda 1989 and Grinblatt & Hwang 1989), suggesting that high-quality firms underprice strategically as a signaling device. Consequently, low-quality firms are forced to either invest in substantial imitation expenses or reveal their quality. Using data from a sample of 1,028 IPO firms from 1977-1982 in Going Public: The IPO Reporter, empirical evidence shows that IPO firms reissue substantially, and moreover that they choose a timing for seasoned offerings (SO) that is related to the IPO. The model implies that firms are eventually compensated for low IPO prices by a higher price at a seasoned offering. High-quality firm owners are able to achieve higher SO prices because their marginal cost of underpricing is less than that incurred by low-quality firms attempting to imitate high-quality firms. Ultimately, strategic underpricing at the IPO is possible because of an information asymmetry between firm owners and investors. (CJC)

Keywords: Seasoned offerings, Signaling, Underpricing, Valuation, Business conditions, Stock offerings, Information asymmetry, Initial public offerings (IPO)

Suggested Citation

Welch, Ivo, Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings (1989). The Journal of Finance, Vol. 44, Issue 2, p. 421-449 1989. Available at SSRN: https://ssrn.com/abstract=1506372

Ivo Welch (Contact Author)

University of California, Los Angeles (UCLA) ( email )

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HOME PAGE: http://www.ivo-welch.info

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