Initial Public Offerings: The Origin of Investor Recognition?

Abstract

Merton (1987) argues that, if information is costly, a firm that decreases the information costs of investors can increase its investor recognition and thereby increase its value. I study a key decision that allows a firm to influence its investor recognition, namely, the initial public offering. By selling a larger number of underpriced shares, pre-IPO shareholders can decrease the information costs of IPO investors, increase investor recognition, and thereby increase the value of the shares that they retain after the IPO. My results show that greater compensation for information costs from pre-IPO shareholders to IPO investors is associated with a permanent increase in investor recognition and firm value.

Keywords: Initial public offerings, information costs, investor recognition, value

JEL Classification: G32