Why Has Ipo Underpricing Changed over Time?

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Why Has IPO Underpricing Changed Over Time? Tim Loughran and Jay Ritter* lu the l9SOs. the average first-day rcliirn on inilial public offerings (IPOs) was 7%, The average firsl-day return doubled to almost I5 ' ' 'i during 1990-1998. before jumping to 65% during Ihe internet bubble years of 1999-2000 and then reverting la / i % during 2001-2003. We attribute much of the higher underpricing during the bubble period to a changing issuer objective function. We argue that in the later periods there wav less focus on maximizing IPO proceeds due to an increased emphasis on research coverage. Furthermore, allocations of hot IPOs to the personal brokerage accounts oj issuing firm executives created an incentive to seek rather than avoid…show more content…
(Money on the table is the change between the offer price and the first closing market price, multiplied by the number of shares sold.) The hypothesized reasons for the increased acquiescence are reduced chief executive officer (CEO) ownership, fewer IPOs containing secondary shares, increased ownership fragmentation, and an increased frequeney and size of "friends and family" share allocations. These changes made issuing firm decision-makers less motivated to bargain for a higher offer price. The realignment of incentives hypothesis is similar to the changing risk composition hypothesis in that it is changes in the characteristics of ownership, rather than any nonstationarities in the pricing relations, that are associated with changes in average underpricing. It differs from the changing risk composition hypothesis, however, in that underpricing is not determined solely by the investor demand side of the market. In our empirical work, we find little support for the realignment of ineentives hypothesis as an explanation for substantial changes in underpricing. We find no relation between the inclusion of secondary shares in an IPO and underpricing. And although CEO fractional ownership was lower during the internet bubble period, the CEO dollar ownership (the market value of the CEO 's holdings) was substantially higher, resulting in increased incentives to avoid underpricing. Furthermore, it is possible that changes in

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