Author: Co-Author

In this study, we examine those factors generally considered to impact IPO performance to assess the extent to which investment bankers might utilize this information in determining the spread within which the offering price is likely to be set and in setting the offering price. Interestingly, we find no evidence that the variables investigated are related to either IPO offer price spread or the IPO offer price. The implications of these findings are notable, as they raise the issue of what information might account for investment bankers' valuation decisions, as captured in the offer price spread and offer price. This paper develops and tests two propositions. We demonstrate that there is a monotone relation between the (expected) under pricing of an initial public offering and the uncertainty of investors regarding its value. We also argue that the resulting under pricing equilibrium is enforced by investment bankers, who have reputation capital at stake. An investment banker who cheats on this under pricing equilibrium will lose either potential investors (if it doesn't under price enough) or issuers (if it under prices too much), and thus forfeit the value of its reputation capital. Empirical evidence supports our propositions. In the IPO market, investors coordinate on acceptable IPO price based on the performance of past IPOs, and this generates an incentive for investment banks to produce information about IPO firms. In hot periods, the information produced by investment banks improves the quality of IPO firms, and this allows ex ante low quality firms to go public and increases the secondary market price, thus synchronizing high IPO volumes and high first day returns. When investment banks behave asymmetrically in information production, the “reputations” of investment banks are interpreted as a form of market segmentation to economize on the social cost of information production.