The Effect of Issuer Conservatism on IPO Pricing and Performance

Abstract

Based on a textual analysis of IPO prospectuses, we obtain a number of important findings regarding the relation between the conservatism in prospectuses, IPO pricing, and subsequent operating and stock return performance. First, prospectus conservatism is positively related to underpricing, with the relation more pronounced for technology than non-technology firms. Second, for non-technology IPOs, prospectus conservatism is able to predict the firm’s post-IPO operating performance. Specifically, we find that conservatism is inversely related to the firm’s operating performance for the three years following the IPO. However, this predictability is limited to non-technology IPOs. Finally, we find some evidence that for non-technology IPOs conservatism is inversely related to the firm’s post-IPO abnormal stock return. We conclude that the conservatism contained in an IPO’s prospectus contains useful information about pricing and subsequent operating and stock return performance. Moreover, prospectus conservatism for non-technology IPOs deserves more attention from investors.

Keywords: Initial public offering (IPO), prospectus, conservatism, negative tone, underpricing

JEL Classification: G12, G14, G24