Liquidity Value and IPO Underpricing
61 Pages Posted: 11 Dec 2018 Last revised: 10 Oct 2019
Date Written: June 24, 2019
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 develop a model and hypothesize that issuers and IPO investors bargain over the liquidity value, resulting in a discounted offer price, i.e., IPO underpricing. Consistent with the model, we find that underpricing is positively related to the expected post-IPO liquidity of the issuer. The relation is stronger when firms are financed by venture capital investors, when the underwriter has more bargaining power, or when a smaller fraction of the firm is sold. We also explore two regulation changes as exogenous shocks to issuers’ liquidity before and after IPO, respectively. With a difference-in-difference 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: Suggested Citation