Issuer Surplus and the Partial Adjustment of IPO Prices To Public Information

Abstract

This study develops and tests a theoretical rationale for the well-documented fact that IPO prices are revised only partially in response to waiting-period market returns. Rational issuers maximize the expected surplus from going public by weighing the probability of deal success against offer proceeds conditional on success. A rise in market valuations during the waiting period increases surplus, causing the issuer to seek a higher success probability. This is achieved by only partially revising the offer price. In addition to explaining other stylized facts; including unconditional underpricing and hot issues markets, several predictions of the model are born out in new empirical tests. For example, the predicted relation between withdrawal probability and waiting-period market returns leads to a sample truncation bias in empirical analyses of IPO pricing. When that bias is taken into account, the often-cited asymmetric response of offer prices to up versus down market returns disappears.