IPO Price Formation and Analyst Coverage

Abstract

Given important market and regulatory changes over the past two decades, we re-examine the relation between IPO pricing and coverage by sell-side stock analysts. Our design builds on the well-documented finding of the partial adjustment phenomenon, in that the IPO offer price revision following the road show is highly predictive of the first-day return. We provide new insights to the literature on IPO analyst coverage / recommendations. With respect to coverage, we find no evidence to suggest that the decisions of affiliated analysts vary with IPO pricing. As for unaffiliated analysts, our results indicate that their coverage decisions are driven much more so by the offer price revision than by the return on the first-trading day. We interpret this as consistent with the view that unaffiliated analysts consider institutional investor demand revealed during book-building as an important input into their decision of whether to cover an IPO issuer. With respect to recommendations, our findings suggest that, for IPOs after the JOBS Act of 2012, lead underwriters appear to bring on co-managers that seemingly pre-commit to provide favorable recommendations; particularly, for IPOs that do not experience an increase in their offer price after the road show or an increase in their share price on the first trading day.

Keywords: analyst coverage, IPOs, partial adjustment, price revision, underpricing

JEL Classification: G24, G32, M13, M41