Public Information, IPO Price Formation, and Long-Run Returns: Japanese Evidence

33 Pages Posted: 17 May 2006

See all articles by Kenji Kutsuna

Kenji Kutsuna

Osaka City University

Janet Kiholm Smith

Claremont McKenna College - Robert Day School of Economics and Finance

Richard L. Smith

University of California, Riverside - Anderson Graduate School of Management

Date Written: May 22, 2006

Abstract

We use a sample of JASDAQ IPOs to study the effects of public information on offer price formation, initial returns, and long-run returns. Underwriters begin reporting anticipated offer prices of Japanese IPOs at an earlier point than in the US. The observable portion of the price formation process begins with an original price that is established before the roadshow, continues through establishment of the filing range, and concludes with the offer price. Neither price adjustment - from the original price to the midpoint of the range, or from the midpoint to the offer price - fully reflects public information from as long as four months before the IPO. As in the US, price adjustments are asymmetric. Prices adjust more fully in response to negative than to positive public information. It appears that adjustments are limited by an implicit agreement between the issuer and the underwriter that originates before marketing of the offer begins. The agreement reflects an expectation that the offer price will be based on the relative market values of public companies up to four months before the IPO. We find that one-year aftermarket returns are significantly lower when initial returns are high. Initial returns under-adjust relative to public information that is revealed before the IPO and the under-adjustment is substantially reversed in the aftermarket. The evidence connects the implicit contracting theory with the argument that offer prices are based partly on expected value at the time of early price discussions. As a result, it can explain episodes of substantial underpricing that are sustained over periods of several months. The paper also documents that over-allotment options affect price formation by enabling issuers to select significantly narrower filing ranges and to price more fully, so that initial returns are lower.

Keywords: IPO price formation, partial adjustment, underpricing, public information, long-run returns, over-allotment options

JEL Classification: G24, G32, G14, G28

Suggested Citation

Kutsuna, Kenji and Smith, Janet Kiholm and Smith, Richard L., Public Information, IPO Price Formation, and Long-Run Returns: Japanese Evidence (May 22, 2006). Available at SSRN: https://ssrn.com/abstract=902661 or http://dx.doi.org/10.2139/ssrn.902661

Kenji Kutsuna

Osaka City University ( email )

3-3-138, Sugimoto
Sumiyoshi-ku
Osaka 558-8585
Japan

Janet Kiholm Smith (Contact Author)

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
909-607-3276 (Phone)

Richard L. Smith

University of California, Riverside - Anderson Graduate School of Management ( email )

Riverside, CA 92521
United States
951-827-3554 (Phone)

HOME PAGE: http://www.agsm.ucr.edu/

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