Monitoring as a motivation for IPO underpricing (original) (raw)

2004, The Journal of Finance

Abstract

Brennan and Franks (1997) and Stoughton and Zechner (1998) provide contrasting arguments for why monitoring considerations create incentives for managers to underprice their firms' IPOs (initial public offerings). Like Smart and Zutter (2003), we examine these arguments using a sample of U.S. IPOs. However, we find evidence that the determinants of initial returns, institutional shareholdings, and post-IPO likelihood of acquisition are not consistent with these arguments. Thus, we conclude that monitoring considerations are not important determinants of IPO underpricing. EVIDENCE THAT THE PRICES OF UNSEASONED NEW ISSUES of common stock (IPOs) in early secondary market trading are substantially higher, on average, than their offer prices has evoked an extensive literature trying to explain such underpricing. While prior literature has tended to focus on uncertainty/asymmetric information stories for such underpricing (e.g., Rock (1986) and Benveniste and Spindt (1989)), recent literature has suggested that post-IPO ownership considerations are also important. More specifically, this literature has suggested that monitoring considerations create incentives for managers to underprice their firm's stock in its first public offering. Brennan and Franks (1997), for example, argue that insiders have an incentive to underprice the IPO of their firm's stock in order to ensure its wide distribution, thereby reducing the likelihood of being monitored or removed by new shareholders, particularly institutional shareholders. Brennan and Franks call their hypothesis the reduced monitoring hypothesis. Consistent with their hypothesis, for a sample of 69 U.K. IPOs during 1986 to 1989, they find that: (1) Smaller applicants are allocated a larger share of oversubscribed/underpriced issues, and (2) the size and amount of subsequent outside large shareholdings are inversely related to the firm's degree of IPO underpricing. 1

Loading...

Loading Preview

Sorry, preview is currently unavailable. You can download the paper by clicking the button above.

References (27)

  1. Aggarwal, Reena, 2000, Stabilization activities by underwriters after initial public offerings, Jour- nal of Finance 55, 1075-1103.
  2. Ang, James, and James Brau, 2002, Firm transparency and the costs of going public, Journal of Financial Research 25, 1-17.
  3. Asquith, Dan, Jonathan Jones, and Robert Kieschnick, 1998, Evidence on price stabilization and underpricing in early IPO returns, Journal of Finance 53, 1759-1773.
  4. Beatty, Randolph, and Jay Ritter, 1986, Investment banking, reputation, and the underpricing of initial public offerings, Journal of Financial Economics 15, 213-232.
  5. Bebchuk, Lucian, 2002, Asymmetric information and the choice of corporate governance arrange- ments, Harvard Law and Economics Discussion Paper number 398.
  6. Benveniste, Lawrence, and Paul Spindt, 1989, How investment bankers determine the offer price and allocation of new issues, Journal of Financial Economics 24, 343-361.
  7. Brennan, Michael, and Julian Franks, 1997, Underpricing, ownership and control in initial public offerings of equity securities in the UK, Journal of Financial Economics 45, 391-413.
  8. Clarke, Richard, 1989, SICs as delineators of economic markets, Journal of Business 62, 17- 32.
  9. Cook, Douglas, Sherry Jarrell, and Robert Kieschnick, 2003, U.S. IPO cycles: The role of uncertainty, divergent investor opinion and short-sale constraints, Working paper, University of Texas at Dallas.
  10. Crutchley, Claire, Jacqueline Garner, and Beverly Marshall, 2002, An examination of board sta- bility and the long-term performance of initial public offerings, Financial Management 31, 63-90.
  11. Demsetz, Harold, and Kenneth Lehn, 1985, The structure of corporate ownership: Causes and consequences, Journal of Political Economy 93, 1155-1177.
  12. Field, Laura, 1999, Control considerations of newly public firms: The implementation of anti- takeover provisions and dual class shares before the IPO, Working paper, Penn State Univer- sity.
  13. Field, Laura, and Jonathan Karpoff, 2002, Takeover defenses of IPO firms, Journal of Finance 57, 1857-1889.
  14. Field, Laura, and Dennis Sheehan, 2000, Underpricing in IPOs: Control, monitoring, or liquidity?, Working Paper, Penn State University.
  15. Gompers, Paul, and Andrew Metrick, 2000, Institutional investors and equity prices, Quarterly Journal of Economics 116, 229-259.
  16. Habib, Michel, and Alexander Ljungqvist, 1998, Underpricing and IPO proceeds: A note, Economic Letters 61, 381-383.
  17. Hanley, Kathleen, 1993, The Underpricing of initial public offerings and the partial adjustment phenomenon, Journal of Financial Economics 34, 231-250.
  18. Hanley, Kathleen, A. Arun Kumar, and Paul Seguin, 1993, Price stabilization in the market for new issues, Journal of Financial Economics 34, 177-197.
  19. Loughran, Tim and Jay Ritter, 2003, Why has IPO underpricing increased over time?, Working paper, University of Florida.
  20. Miller, Edward M., 1977, Risk, uncertainty, and divergence of opinion, Journal of Finance 32, 1151-1168.
  21. Palepu, Krishna, 1986, Predicting takeover targets: A methodological and empirical analysis, Jour- nal of Accounting and Economics 8, 3-35.
  22. Papke, Leslie, and Jeffrey Wooldridge, 1996, Econometric methods for fractional response variables with an application to 401(k) plan participation rates, Journal of Applied Econometrics 11, 619-632.
  23. Ritter, Jay, 1984, The "Hot" issue market of 1980, Journal of Business 57, 215-240.
  24. Rock, Kevin, 1986, Why new issues are underpriced?, Journal of Financial Economics 15, 187-212.
  25. Smart, Scott, and Chad Zutter, 2003, Control as a motivation for underpricing: A comparison of dual-and single-class IPOs, Journal of Financial Economics 69, 85-110.
  26. Stoughton, Neal, and Josef Zechner, 1998, IPO-mechanisms, monitoring and ownership structure, Journal of Financial Economics 49, 45-77.
  27. Tukey, John W., 1960, A survey of sampling from contaminated normal distributions, in Ingram Olkin ed.: Contributions to Probability and Statistics (Stanford University Press, Stanford, CA).