Investment Banking, Reputation, and the Underpricing of Initial Public Offerings
Posted: 17 Nov 2009
Date Written: 1986
Abstract
Examines the underpricing of initial public offerings (IPOs) and the impact of this underpricing on investor uncertainty and on the investment bankers who take the firms public. The firms going public lack the credibility to assert that the offering price is below the expected market price because they only go public once. As a result, these firms seek the help of investment bankers who, through their underwriting process, take many firms public. Data used in the analysis were collected from 1,028 firms that went public between 1977 and 1982. Support is shown for the proposition that the greater the investor uncertainty in the value of the stock, the greater the underpricing is expected to be. The results further show that investment bankers who cheat on underpricing equilibrium by underpricing too much or too little are penalized by the market. Three conditions must be met for investment bankers to be willing to strive for underpricing equilibrium. These are: (1) uncertainty as to the market price of the stock when it beings trading, (2) reputation capital of the investment banker that cannot be repaired, and (3) decline in return on reputation capital if investment banker cheats on underpricing. Given these results, it becomes evident that investment bankers enforce the underpricing equilibrium. (SRD)
Keywords: Credibility, Reputation, Uncertainty, Underpricing, Initial public offerings (IPO), Investment bankers, Investors, Investment banks
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