“Why New Issue are Underpriced?” and “IPO and Underwriter Reputation”

“Why New Issue are Underpriced?” and“IPO and Underwriter Reputation” Diniloisvina Sumsun Gezy Megalitta Novy Yana

Why New Issue are Underpriced? Kevin ROCK Journal of Financial Economics 1986

Introduction

Model Assumption

Demand for New Issue

Implication-Uninformed Investor

Implication-Issuer

Conslusion

Initial Public Offerings and Underwriter Reputation Richard Carter, Steven Manaster Journal of Finance 1990

Literature Review • IPO returns are required by uninformed investors as compensation for the risk of trading against superior information (Rock, 1986) • Empirical regulity of IPO underpricing (Louge 1973; Ibboston 1975; Miller and Reilly 1987)

Research Question • What is the correlation between prestigious underwriter with low risk offering?

Main Result • Prestigious underwriter are associated with lower risk offerings • With less risk there is less intensive to acquire information and fewer informed investors • Consequently, prestigious underwriter are assosiated with IPO that have lower returns

Model Assumption • A1 There are three time periods

A2 There are two markets, a primary market and a secondary market • A3 Differences in issuing firms • A4 Investor are risk neutral • A5 Informed investors, do not have sufficient wealth • A6 All IPO are oversubscribe • A7 Critical for the model’s development, in the nature of the asymmetric information in the primary market

Empirical test for the model • Investor’s Choice

Empirical test for the model

Empirical test for the model B. The Uncertain and Underwriter Reputation

Empirical test for the model C. The matching of Underwriters and Issuing Firm • The foregoing model predicts that the price run-up for issuing firms will be less for underwriters with greater prestige. Implicit in the model is the supposition that investment banking firms choose to develop reputations and that issuing firms will employ underwriters with a reputation appropriate for the a level of their IPO. Reputation development and maintenance are exogenous to our model. In this section, we provide an intuitive explanation of the role played by reputation in the matching of investment bankers and issuing firms.

DATA • Data Description • The Underwriter Reputation Variable

Methods and Result • Hypothesis Tests : The Variance of Possible Firm Values • Hypothesis Test : Price Run-Up

Summary and Conclusion We have presented an empirically testable model of initial public offerings of equity. The model is consistent with the work of Rock (1986). He argued that IPO price run-up compensates uninformed investors for the risk of trading against superior information. The extend this theory to suggest that the greater the proportion of informed capital participating in an IPO, the greater theequilibrium price run-up. Because investors have scarce resources to invest in information acquisition, they will specialize in acquiring information for the most risky investments. With a migration of informed capital to the IPOs with the largest dispersion in possible secondary market values, these will experience the greatest price run-up.

Thank you for your attention

“Why New Issue are Underpriced?” and “IPO and Underwriter Reputation”