Bigger Pie, Bigger Slice: Liquidity Value and IPO Underpricing

59 Pages Posted: 11 Dec 2018 Last revised: 23 Jun 2020

See all articles by Wei Gao

Wei Gao

Temple University - Department of Finance

Lily Li

Villanova University

Hongda Zhong

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: June 24, 2019

Abstract

Initial public offerings (IPOs) transform private firms into publicly traded ones, thereby
improving liquidity of their shares. Better liquidity increases firm value, which we call
"liquidity value". We use a simple model and hypothesize that issuers and IPO in-
vestors bargain over the liquidity value, resulting in a discounted offer price, i.e., IPO
underpricing. We find supporting evidence that underpricing is positively related to the
expected post-IPO liquidity of the issuer, controlling for firm and deal characteristics
and market conditions. We also explore two regulation changes as exogenous shocks
to issuers' liquidity before and after IPO, respectively. With a difference-in-differences
approach, we find that underpricing is more pronounced with better expected post-IPO
liquidity or lower pre-IPO liquidity.

Keywords: Liquidity, IPO Underpricing, Nash Bargaining Game

JEL Classification: G32, G34

Suggested Citation

Gao, Wei and Li, Lily Yuanzhi and Zhong, Hongda, Bigger Pie, Bigger Slice: Liquidity Value and IPO Underpricing (June 24, 2019). Fox School of Business Research Paper, Available at SSRN: https://ssrn.com/abstract=3286358 or http://dx.doi.org/10.2139/ssrn.3286358

Wei Gao

Temple University - Department of Finance ( email )

Philadelphia, PA 19122
United States

Lily Yuanzhi Li (Contact Author)

Villanova University ( email )

United States

Hongda Zhong

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

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