Partial Adjustment to Public Information in the Pricing of IPOs
41 Pages Posted: 15 Mar 2012 Last revised: 20 Sep 2016
Date Written: September 10, 2016
Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a rational explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)'s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This "incentive effect"' receives strong empirical support in a sample of 6,300 IPOs in 1983-2012. Controlling for the incentive effect, the positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is held to be most informative, effectively resolving the predictability puzzle.
Keywords: IPO, underpricing, bookbuilding, public information, partial adjustment
JEL Classification: G24, G32
Suggested Citation: Suggested Citation