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Initial Public Offerings

Initial Public Offerings. papers by: Loughran and Ritter FM (2004) Brau and Fawcett JF (2006). Initial Underpricing. average underpricing of 18% varies over time in late 70s and early 80s in early to mid 90s huge in late 90s and 2000 relative to all other times. Reasons for Underpricing.

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Initial Public Offerings

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  1. Initial Public Offerings papers by: Loughran and Ritter FM (2004) Brau and Fawcett JF (2006)

  2. Initial Underpricing • average underpricing of 18% • varies over time • in late 70s and early 80s • in early to mid 90s • huge in late 90s and 2000 relative to all other times

  3. Reasons for Underpricing • asymmetric information • between underwriter and issuer • between issuers and potential buyers • between informed and uninformed investors • protection against future litigation • marketing function • increase ownership base • facilitate questionable practices • prospect theory Brau and Fawcett (JF 2006)

  4. Expectations and Explanations of Underpricing • Brau and Fawcett (2006) • CFOs asked to indicate on 5-pt scale “To what extent did the following lead to the level of underpricing expected?” (expected an average of 10%) • “to compensate investors for taking risk of IPO” – 3.47 • “underwriters underprice to incur favor of institutional investors” – 3.20 • “to ensure a wide base of owners” – 3.17 • “to increase the post-issue trading volume of the stock” – 3.14

  5. Signaling • number of papers that suggest certain actions send good/bad signals relative to the quality of the firm/offer • selling insider shares • selling large portion of firm • using prestigious underwriters • using reputable accounting firm • having backing of VC firm • signal firm quality using underpricing • insiders committing to long lockup period signal firm quality • history of strong earnings signals future strong performance

  6. Signaling • Brau and Fawcett (2006) – What type of signal do the following actions convey to investors regarding the value of a firm going public? • strong historical earnings – 4.51 • using top IB – 4.21 • insiders commit to long lockup – 3.99 • using a big 4 acctg firm – 3.91 • large first day price jump – 3.77

  7. Advantages of Underpricing to Underwriter • compensation • underwriter discretion • the good & • the bad

  8. Timing of IPOs / Underwriter Selection • theories on timing • take advantage of attractive stock prices / bull markets • attractiveness of IPO market • firms at a certain point in there growth cycle and need external equity to grow • CFOs – take into account market and industry stock returns (Brau and Fawcett) • CFOs – select underwriters based on overall reputation, quality of research department, and industry expertise • also some on institutional investor base

  9. Reasons for Going Public • motivations suggested by theory • cost of capital (M&M) • allow insiders to cash out of firm • facilitate takeover activity • serve as strategic moves • broaden ownership base of firm • capture first-mover advantage • increase publicity or reputation of firm • analyst coverage

  10. CFO survey on Motivation for Going Public • “How important were/are the following motivations for conducting an IPO?” • IPO serves to create public shares for use in future acquisitions – 3.56 (59% agree) • establishment of market price or value for the firm (only other to receive support from more than 50% of CFOs) • Why do some firms decide not to go public?

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