“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

Introduction

Model Assumption

Demand for New Issue

Implication-Uninformed Investor

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

Time Period Event

0 Issuing firm contract with marketing underwriters to sell their IPO on a “firm commitment” basis in the primary market

1 The underwriter sells the IPO in the primary market

2 The shares of the IPO trade in secondary market

A2 There are two markets, a primary market and a secondary marketA3 Differences in issuing firmsA4 Investor are risk neutralA5 Informed investors, do not have sufficient wealthA6 All IPO are oversubscribeA7 Critical for the model’s development, in the nature of the asymmetric information in the primary market

Empirical test for the model

A. 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