Academic journal article Global Business and Management Research: An International Journal

Voluntary and Involuntary Underpricing in IPOs

Academic journal article Global Business and Management Research: An International Journal

Voluntary and Involuntary Underpricing in IPOs

Article excerpt

Introduction

The empirical study of positive average initial returns in IPOs has been well documented. Although many theoretical and empirical studies were interested in the underpricing phenomenon, few have examined the deliberate price discount. Benveniste and Spindt (1989) developed a hypothesis that the offer price must be set low (at a discount) in order to compensate institutional investors who reveal positive information during the bookbuilding phase. Benveniste et al (2003) integrated the Benveniste and Spindt's (1989) hypothesis in their initial return model. They expect that lower percentage discounts (the total cost of information production) on average is spread across a larger group of firms, and a relatively smooth discount distribution across grouped firms. Barry (1989), Brennan and Franks (1997) and Habib and Ljungqvist (2001) discussed the difference between underpricing and wealth losses. They found that underpricing represents a significant portion of entrepreneurial wealth losses in IPOs. To set the offer price, underwriters voluntarily discount the fair value (Roosenboom, 2012). In the Tunisian IPO prospectus, this price discount is indicated. In our sudy, we decompose total underpricing into voluntary and involuntary underpricing. We define voluntary underpricing as the deliberate price discount obtained from the prospectus. It is calculated as the difference between the subscription price and the fair value estimate as measured by the IPO firm, divided by the fair value estimate (Roosenboom, 2012). It is an entrepreneurial voluntary wealth loss in IPOs. Involuntary underpricing is defined as the difference between the closing price and the fair value estimate, divided by the fair value estimate. It is an entrepreneurial involuntary wealth loss in IPOs. It is similar to the fund's premium (Barclay et al, 1993).

Chowdhry and Sherman (1996) argue that when the offer price is set before the consummation of the offering, the IPOs will be more underpriced. They observe that in many countries, larger underpricing is associated with large levels of oversubscription. They also argue that when the offer price is set many days before the end of the subscription period, there is a possibility that much information about the aggregate investors' demand becomes public before the end of this period. Such information is crucial in determining the initial price in the secondary market. When all investors know that the offer price is too low, a large oversubscription will be observed. However, when all investors know that the offer price is too high, the issue will fail. Benveniste and Busaba (1997) suggest that fixed price mechanism is the most capable of generating demand cascades. Biais et al (2002) argue that the IPO price is highly adjusted when the aggregate demand is strong. In Tunisia, the fixed price mechanism is the most in use.

Several studies treated the relation between the underwriter reputation and the IPO returns. Baron (1982) argues that underpricing is explained by the asymmetric information between the issuer and the investment banker who is better informed than the issuer. Booth and Smith (1986) developed a theory of the underwriter's role in certifying the pricing of equity. They argue that a decrease in value followed by either positive abnormal or normal returns from subscription price to first closing price is expected. They also argue that the more costly external certification is, the more probably the stock is to be issued at a discount. Carter and Manaster (1990) and Habib and Ljungqvist (2001) find a negative relationship between IPO returns and underwriter reputation. However, Loughran and Ritter (2004), Loureiro (2010) and Lowry et al (2010) argue that there is a positive relationship between IPO returns and underwriter reputation.

Ben slama et al (2011) and Kanoun and Taktak (2013) examine the relationship between underpricing and discount. Roosenboom (2012) and Jeribi and Jarboui (2014) examine the deliberate price discount level. …

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