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J. of Multi. Fin. Manag. 18 (2008) 180–196

Underpricing versus gross spread: New evidence

on the effect of sold shares at the time of IPOs
Salim Chahine ∗
The Suliman S. Olayan School of Business, American University of Beirut, Lebanon
Received 15 June 2006; accepted 4 August 2007
Available online 19 August 2008

Abstract
This paper sheds light on the impact of initial owners’ decisions to reduce underpricing at the time of initial
public offerings (IPOs). Using a sample of 172 French IPOs, empirical findings indicate that the larger the
percentage of primary and secondary shares sold, the higher the gross spread paid by initial owners, which
reduces underpricing. Above a certain level of primary shares sold, however, underpricing increases. In
contrast with prior research on US IPOs, initial owners endogenously determine the fraction of primary
and secondary shares sold. When a firm goes public in the Nouveau Marché, the market for high-growth
firms, initial owners are more concerned about the signalling effect of the sale of their secondary shares than
the dilutive effect of primary shares. Therefore, they pay a larger gross spread in offerings with a higher
participation ratio in order to reduce underpricing.
© 2007 Elsevier B.V. All rights reserved.

JEL classification: G2

Keywords: Gross spread; Underpricing; Primary shares; Secondary shares; Initial public offering

1. Introduction

One of the most critical issues facing initial owners as they begin to move towards an initial
public offering (IPO) is how to limit underpricing. Yeoman (2001) argues that IPO firms incurring
a higher gross spread (i.e. the difference between the offer price to the general public and the price

∗ Tel.: +961 1 374374; fax: +961 1 750214.

E-mail address: salim.chahine@aub.edu.lb.

1042-444X/$ – see front matter © 2007 Elsevier B.V. All rights reserved.
doi:10.1016/j.mulfin.2007.08.001
 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196 181

received by issuing firms) have lower underpricing. Habib and Ljungqvist (2001) demonstrate
the existence of a negative association between the marketing costs of IPOs and underpricing.
Both papers, however, use US data where IPO firms traditionally issue a significant proportion of
primary shares. Consequently, they ignore potential signalling, and therefore exclude the endoge-
nous choice of the fraction of sold shares as part of the minimization problem (Leland and Pyle,
1977).
This research focuses on one of the largest European IPO markets: the French market, where
IPOs are more diverse in nature than those in the US, and even includes pure secondary offerings
(Huyghebaert and Van Hulle, 2006). The French model of corporate governance is characterized
by the poor legal protection of minority shareholders (La Porta et al., 1998) and the prevalence of
manager-owners in French IPOs (Roosenboom and Schramade, 2006). As a result, institutional
aspects of French IPOs may provide an opportunity to develop a more general analysis of signalling
strategies in the context of public listings. More specifically, initial owners’ decisions at the time
of IPOs may signal the level of managerial opportunism and firm value. Underpricing and gross
spreads may therefore be affected by the endogenous determination of the percentage and the type
of shares sold, whether primary or secondary. A higher percentage of secondary or primary shares
sold may have a negative signalling effect, causing a potential non-linearity in the relationship
with underpricing.
This paper contributes to the IPO literature in the following respects. First, it includes a sample
of 172 issues from 1997 to 2000 going public with a book-building procedure where underwriters
and their fees play a significant role in the price discovery process.1 The research shows that
costly actions undertaken by initial owners to limit underpricing should relate to the gross spread
paid (management fees, selling concessions, and underwriting fees2 ) rather than focus on the
marketing costs.
Second, this paper considers the existence of simultaneous relationships among the gross
spread, the percentage of primary shares sold, i.e. dilution factor, and the percentage of sec-
ondary shares sold, i.e. participation ratio, which capture the joint determination of all three
variables by initial owners. Empirical tests show support for the signalling hypothesis. There
is an endogenous relationship where the larger the fraction of primary and secondary shares
sold, the higher the gross spread and the lower the underpricing. This is more significant for
issues with a larger fraction of secondary shares sold, where initial owners seem to be concerned
about their loss of wealth through underpricing. Interestingly, the increase in the dilution fac-
tor above a certain threshold offsets the gross spread effect and causes investors to require a
higher compensation in the aftermarket, i.e. a greater underpricing. Since more diluted issues
are accompanied with fewer secondary shares sold, pre-IPO owners are more complacent about
high first-day returns (see also Giudici and Roosenboom (2006) in European New Markets).
This suggests that initial owners try to reduce underpricing in issues with larger participa-
tion ratios, whereas they are not overly concerned about leaving money on the table in more

1 While a small number of firms (7) went public using a fixed-price offering from 1997 to 2000, there were 48 IPOs

using an auction procedure. Derrien and Womack (2003) show that there are significant differences in the price discovery
process between French auction and book-building procedures. While the former mechanism is “market driven”, the latter
is likely to depend on the market power of underwriters (pp. 57–58). They argue that the two procedures require different
organizational structures (team size and advertisement practices), which may cause some underwriters to specialize in one
of the two IPO mechanisms. As such, I expect significant differences in the nature of fees required in each mechanism,
which justifies focusing on book-built IPOs.
2 The information on promotion costs is rarely given in France. This information was found for 32 IPOs between 1997

and 2000. It shows an average promotion cost of D 148.205, 1.34% of the gross proceeds.
182 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

dilutive offerings where they participate less. The increase in the number of primary shares
sold at the time of IPOs may thus explain the high underpricing levels of the late 1990s in
France.3
Finally, in addition to a small number of large firms and/or state-owned enterprises directly
going public in the Premier Marché, most French firms go public in either the Second Marché (SM)
or the Nouveau Marché (NM). As in the NYSE, the SM includes both hi-tech and non-hi-tech
firms. It was created in 1983 to cater to the various financial needs of medium-sized and mature
firms. The NM, on the other hand, was established in 1996 following the NASDAQ model, to
provide access to financing sources for relatively young, risky, and hi-tech firms (Chahine, 2007).
This paper thus complements prior research and investigates the differences in the behaviour of
initial owners in both markets. It shows that both the participation ratio and the dilution factor
affect the gross spread and underpricing in the SM; however, pre-IPO owners in the NM are
mainly affected by the signalling effect of selling secondary shares on underpricing. As IPOs
in this market are usually related to capital needs for investment purposes, initial owners are
more likely to pay a higher gross spread for offerings with a larger participation ratio to reduce
underpricing.
The paper is organized as follows: Section 2 conducts a literature overview and presents testable
hypotheses; Section 3 presents the database and research method; Section 4 shows empirical results
and Section 5 presents conclusions.

2. Overview of literature and hypotheses

Habib and Ljungqvist (2001) demonstrate that the loss of wealth caused by underpricing is
positively related to the percentages of secondary and primary shares sold, as well as the level
of uncertainty. As a result, initial shareholders who participate more in offerings and suffer more
from the dilution of their retained shares may try to minimize their wealth losses. To do so,
they pay higher promotion costs to attract uninformed investors and reduce underpricing. Hence,
underpricing is negatively related to the promotion cost. This is consistent with Yeoman (2001)
who develops a “net proceeds maximization theory,” and shows the existence of a trade-off
between gross spread and underpricing.
Furthermore, Habib and Ljungqvist (2001) report a negative association between underpricing
and both the primary and secondary shares sold at the time of IPOs. They argue that the higher
the number of existing shares sold (i.e. the participation ratio) and shares newly created (i.e. the
dilution factor), the greater the incentives of initial owners to limit underpricing by increasing the
gross spread.
Loughran and Ritter (2002) use the prospect theory, whereby they predict that IPOs with a
larger percentage of sold shares should have less underpricing as issuers bargain harder for higher
offer prices. They argue that reducing underpricing by increasing the offer price results in higher
fees; therefore, underpricing depends on the gross spread paid as well as both the primary and
secondary shares sold. Similarly, Ljungqvist and Wilhelm (2003) show a negative association

3 This is in contrast with recent evidence in US IPOs where Dolvin and Jordan (2005) argue that the higher underpricing

level during the late 1990s was driven by the increase in the pre-IPO owners retained wealth relative to the gross proceeds
(i.e. economic overhang). While the economic overhang has roughly tripled and reached 8.84 in 1999–2000 in the US,
the economic overhang in France was significantly lower (4.19 on average), and was not different from that calculated in
prior periods (e.g. 4.33 from 1996 to 1998). This may suggest that firm valuations during the late 1990s were not high
enough to reduce the number of offered shares by pre-IPO owners.
 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196 183

between underpricing and both the dilution factor as well as the participation ratio. Building on
this prior research, I expect that:
Hypothesis 1. Initial underpricing is negatively related to the gross spread.
Hypothesis 2. Initial underpricing is negatively related to the dilution factor.
Hypothesis 3. Initial underpricing is negatively related to the participation ratio.
The signalling literature, however, predicts that the percentage of shares offered sends a signal
about firm value. IPO firms with a higher retained ownership by initial shareholders have fewer
agency problems (Jensen and Meckling, 1976) and lower asymmetric information between insid-
ers and outsiders (Leland and Pyle, 1977). Share retention may thus be used by managers to signal
the true value of their firms, as supported by Klein (1996). Accordingly, the increase in the number
of primary and secondary shares sold may lead investors to require higher underpricing, which
offsets the effect of the gross spread. First, the increase in the number of secondary shares sold may
increase ex ante uncertainty, leading to higher underpricing. Second, as the earnings-per-share
decrease with the number of primary shares sold, investors may require greater compensation,
i.e. higher underpricing. Hence:
Hypothesis 4. There is a quadratic relationship between underpricing and the number of primary
and secondary shares sold. Underpricing first decreases, and then increases with the number of
primary and secondary shares sold.
Ritter (1991) argues that initial shareholders may want to benefit from the IPO’s market val-
uation error. He suggests that the number of shares sold by initial owners increases with market
overvaluation. Moreover, the ex ante uncertainty may lead firms to go public in periods where
there are windows of opportunity (Loughran and Ritter, 1995), during which initial shareholders
can raise capital on favorable terms. A window of opportunity is often related to either the level
of information asymmetry (Bayless and Chaplinsky, 1996) or to investors’ optimism (Loughran
and Ritter, 1995). Both ex ante uncertainty and/or positive market conditions may thus affect
the decisions made by initial owners at the time of IPOs. The hypothesized relationships should
therefore consider the joint estimation of the gross spread, the dilution factor, and the participation
ratio.4

3. Database and research method

French IPO firms do not have mandatory requirements to disclose the costs of their offerings.
As a result, this paper focuses on IPOs for which information about the gross spread and new/old
shares offered was found in prospectuses, yearly balance sheets, and through surveys of firms.
The studied sample includes 172 of the 211 book-built IPOs in France from 1997 to 2000. It
focuses on small and medium-sized firms listed in the Nouveau Marché and the Second Marché.
Stock price information is taken from the Euronext database.
Initial underpricing is the main dependent variable in this study. It reflects the amount of money
left on the table during the first day of trading, equal to the first-day return. Underpricing relates
to primary explanatory variables and a number of control variables.

4 Huyghebaert and Van Hulle (2006) investigate the existence of a trade-off between the size of the primary and

secondary portion. They argue that the offering size of secondary shares may increase if the primary portion is relatively
small. It may also decrease in order to curb adverse selection costs when the primary portion is already large or vice versa.
184 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

3.1. Primary explanatory variables

There are three primary explanatory variables of this research which are calculated as follows:
the gross spread is equal to the percentage difference between the offer price and the price paid to
the issuing firm; the dilution factor is equal to the number of new shares sold as a percentage of
pre-IPO outstanding shares; the participation ratio is equal to the number of existing shares sold
as a percentage of pre-IPO outstanding shares.

3.2. Control variables

Consistent with previous studies, empirical tests control for three sets of variables related to
firm characteristics, underwriter reputation, and market momentum.

3.2.1. Firm characteristics

The underpricing regression includes a set of control variables related to firm characteristics:
firm size, industry membership, loss dummy, company age, sales revenue growth, venture capital
ownership, and the percentage of greenshoe options. Firm size is equal to the natural logarithm
of the total assets, LAsset, and is used as a proxy for risk (Giudici and Roosenboom, 2006).
Hi-tech IPOs are more likely to be risky and to have higher underpricing than non-hi-tech IPOs; a
hi-tech dummy is thus included. It is equal to 1 if a company belongs to the hi-tech industry, zero
otherwise. The age of the issuing firms is also considered since younger firms are presumed to be
riskier. LAge is the natural logarithm of the number of years from the creation of the company to
the date of the prospectus. A loss dummy is used as a proxy for the level of ex ante uncertainty of
the IPO firm (see Bhagat and Rangan, 2004). It is equal to 1 if the firm had a net loss in the year
prior to the IPO date, and zero otherwise. In line with Huyghebaert and Van Hulle (2006), sales
revenue (SR) growth is added to proxy for the effect of growth opportunities on firm value. It is
calculated over a 3-year period, using the sales revenue of the year prior to the IPO date and the
expected sales over a 1- and 2-year period following the IPO date, as provided in the prospectuses.
The aftermarket standard deviation is another proxy for risk (Barry et al., 1991). It precludes
the price support period which may occur shortly after the IPO date, and is equal to the daily
standard-deviation of IPO returns over months 2–13. An NM market dummy – equal to 1 if
Nouveau Marché, zero otherwise – is included to control for differences between the Nouveau
Marché (NM) and the Second Marché (SM) (Chahine, 2007).
Furthermore, this study controls for the certification role played by venture capitalists
(Megginson and Weiss, 1991). VC ownership is equal to the post-IPO venture capitalist own-
ership as a percentage of outstanding shares. It also considers the effect of greenshoe options,
which allow the underwriters to buy additional shares from issuers in order to meet excess demand
(Aggarwal, 2000). Greenshoe option is equal to the number of stocks in the greenshoe option
agreement as a percentage of the total number of offered stocks.

3.2.2. Underwriter reputation

Prior research shows that more prestigious investment banks use their reputational capital
to reduce IPO underpricing (Carter and Manaster, 1990). More recently, Cooney et al. (2001)
have documented that this negative association flipped in the 1990s. Loughran and Ritter (2002)
propose an agency explanation where underwriters pursue their own interests by charging lower
gross spreads, thereby leaving more money on the table (i.e. higher underpricing). Underwriter
ranking is calculated based on Loughran and Ritter’s (2004) methodology. Underwriters are ranked
 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196 185

from one to nine (less prestigious to more prestigious, respectively), based on their cumulative
market shares from 1996 to 2000.5

3.2.3. Market conditions

The third set of variables controls for the effect of market conditions on pricing IPO shares
(Ljungqvist and Wilhelm, 2003). The regression adds the Market return calculated based on the
Société des Bourses Françaises (SBF) 250 market index buy-and-hold return over the 3-month
period prior to the IPO date. It also includes the market volatility, i.e. the standard deviation of
the SBF 250 market index return over the 3-month period prior to the IPO date. A bubble period
dummy equal to 1 if the IPO occurs in 1999–2000, zero otherwise, and is also used to control
for changes in the behaviour of investors, underwriters, and issuers during hot-issue periods. The
regression also includes (1) the number of issues in the year prior to the IPO year period, pre-IPO
issues number, and (2) the growth rate of the industrial production, in volume, IP growth rate,
calculated at the time of the issue.
Finally, consistent with the information revelation hypothesis (Hanley, 1993), the underpricing
regression includes the price revision in the pre-IPO period. Price revision, in percentage, is
calculated based on the mid-point of the initial price range of book-built IPOs.
Therefore, building on prior research, the underpricing regression is as follows:
underpricing = β0 + β1 gross spread + β2 dilution factor + β3 participation ratio
+ β4 price revision + β5 underwriter ranking + β6 SR growth
+ β7 hi-tech + β8 LAge + β9 loss dummy + β10 LAsset
+ β11 aftermarket standard deviation + β12 NM market dummy
+ β13 VC ownership + β14 greenshoe option + β15 bubble period dummy
+ β16 pre-IPO issue number + β17 IPO growth rate + β18 market return
+ β19 market volatility (1)

The gross spread, however, may be simultaneously related to the level of both the dilution
factor and the participation ratio. A three simultaneous equation system is first used to reduce
the bias encountered in single-equation OLS estimation, and to investigate the interdependencies
among the gross spread, the dilution factor, and the participation ratio. This is followed by further
analysis which examines their relationships with underpricing.6
The implementation of a simultaneous equation analysis requires the identification of at least
one instrument that affects one dependent variable but not others. The selection of instruments
is guided by economic consideration and relates to prior research in the IPO literature. Since
there is no theoretical prediction that the gross proceeds affects the fractions of primary and
secondary shares sold, I consider this as an instrumental variable for the gross spread. In line with
Ritter (1987), the natural logarithm of the gross proceeds, LProceeds calculated at the offer price,

5 Foreign underwriters are ranked according to results in Loughran and Ritter (2004).
6 Since prior research argues that underpricing and spread are jointly determined (e.g. Yeoman, 2001), I used a four
simultaneous equation system. This confirms the existence of a trade-off between underpricing and gross spread, but fails
to show evidence of the existence of any simultaneous association between underpricing and both the dilution factor and
the secondary ratio.
186 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

controls for the economies of scale effect. I also use Debt mix, the ratio of bank loan-to-total debt,
as an instrumental variable for the primary shares sold. According to Pagano et al. (1998), as an
IPO increases outside competition to issuing firms’ bankers, it reduces the cost of credit. Debt mix
is therefore positively related to the primary shares sold, but is unlikely to affect the secondary
portion (Huyghebaert and Van Hulle, 2006). Finally, I use concentration, the ownership percentage
of shareholders owning at least 5% of the shares before the IPO, as an instrumental variable for
the secondary shares sold. As financial markets provide managerial disciplining, initial owners
may be concerned about the increase in the adverse selection cost related to offering a larger
percentage of secondary shares. There is a negative association between concentration and the
fraction of secondary shares sold (Huyghebaert and Van Hulle, 2006).

4. Empirical results

4.1. Descriptive statistics

Descriptive statistics in Table 1 exhibit an average gross spread of 7.5% (a median value of
7.1%), which is consistent with prior results in the US. The first-day return is equal to 22.7% on
average, and is positively skewed when compared to its median value of 9.80%.
The quality ranking of underwriters is equal to 3.62, which is lower than prior results in
Benveniste et al. (2003) showing an average rank of 6.88 for US IPOs from 1985 to 2000. This
reflects the existence of a large number of less prestigious underwriters in the French market.
Moreover, the price revision during the pre-IPO period is positive and equal to 2.8% on average
(72.7% of sample firms are priced above the mid-point of the initial price range).
The average (median) amount raised is D 20.88 m (D 12.44 m), and is equal to 27.65% of the
market capitalization, on average. Much of the amount raised represents a capital increase: on
average, initial owners sell only 8.8% of their shares (i.e. the participation ratio), while increasing
shares outstanding by 26.3% (i.e. the dilution factor). Moreover, 16 of the 172 IPOs (9.3%) are
purely secondary offerings, and 53 IPOs, 30.8% of the sample, are purely primary offerings. The
remaining IPO firms combine primary and secondary offerings.
The average issuer in the sample is more likely to belong to the hi-tech industry (64%), be
young in age (11.65 years), have an average asset size of D 34.66 m, and an average bank loans-to-
total debt ratio of 25.2%. While IPO firms exhibit an average increase in sales of 70.1%, 37.2% of
them have negative net income. IPOs in the study have an average aftermarket standard deviation
of 4.3%.7 The average block-holder’s ownership is equal to 88.9%, which is consistent with prior
results in other European markets (Huyghebaert and Van Hulle (2006) in Belgium and Pagano et
al. (1998) in Italy).
Table 1 also shows that 74.4% of sample IPOs go public in the Nouveau Marché, which
is consistent with prior research in France (Derrien and Womack, 2003). Venture capitalists
(VC) own 12% of IPO firms, on average. This low VC shareholding per IPO is consistent with
recent evidence of a less mature VC market in France compared to Anglo-Saxon countries. The
percentage of greenshoe options is equal to 5.1% on average, which is significantly lower than
prior results in the US (an average of 11.48% in Aggarwal, 2000).

7 Further investigations indicate an average standard deviation of 1.32% for the SBF 250 market index over months

2–13 following each IPO. This is significantly lower than the aftermarket standard deviation of IPOs in the studied sample
(p = 5%).
 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196 187

Table 1
Summary statistics
Variable Mean Median Standard deviation

Offering characteristics
Gross spread 0.075 0.071 0.031
Underpricing 0.227 0.098 0.393
Underwriter ranking 3.616 3.000 2.923
Price revision 0.028 0.046 0.063
Firm characteristics
Gross proceeds (D million) 20.88 12.44 23.75
Participation ratio 0.088 0.063 0.103
Dilution factor 0.263 0.250 0.169
Hi-tech dummy 0.640 1.000 0.482
Total asset (D million) 34.660 12.414 72.338
Age 11.65 10.00 14.11
Loss dummy 0.372 0.000 0.485
SR growth 0.701 0.376 1.083
Debt mix 0.252 0.238 0.221
Concentration 0.889 0.918 0.111
Aftermarket standard deviation 0.043 0.039 0.018
NM market dummy 0.744 1.000 0.438
VC ownership 0.120 0.059 0.148
Greenshoe option 0.051 0.000 0.064
Market conditions
Market return 0.105 0.085 0.134
Market volatility 0.013 0.012 0.003
Bubble period dummy 0.488 0.000 0.502
Pre-IPO issue number 65.33 56.00 22.37
IP growth rate (%) 0.049 0.042 0.023

The sample includes 172 IPOs in the Nouveau Marché and the Second Marché over the period 1997–2000. The mean,
median, and standard deviation are calculated for studied variables. Gross spread is the difference between the offer price
to the general public and the price received by issuing firms. Underpricing is the first-day return. Underwriter ranking
is calculated inline with Loughran and Ritter (2004) methodology, where underwriters are ranked from one to nine, less
prestigious to more prestigious investment banks (respectively) based on their cumulative market shares from 1996 to
2000. Price revision is the percentage of price change between the mid-point of the price range and the offer price. Gross
proceeds is calculated at the offer price in millions of euros. The dilution factor is the number of primary sold shares
in percentage of initial shares. The participation ratio is the number of secondary sold shares in percentage of initial
shares. Hi-tech dummy is equal to 1 if hi-tech, zero otherwise. Total asset is in D million, and is equal to the total asset
value during the last year prior to the IPO. Age is calculated as the number of years from the creation of the firm to
the date of the prospectus. Loss dummy is equal to 1 if the firm has a negative net income during the last year prior to
the IPO, zero otherwise. SR growth is calculated over a 3-year period around the IPO date using the sales revenue of
the year prior to the IPO date and the expected sales over a 1- and 2-year period following the IPO date, as provided
in the prospectuses. Debt mix is the ratio of bank loan-to-total debt in the year prior to the IPO. Concentration is the
ownership percentage of shareholders owning at least 5% of the shares before the IPO. The aftermarket standard deviation
is calculated over a 1-year period following the closing price at the end of the first month of trading. NM market dummy is
a dummy variable which is equal to 1 if Nouveau Marché, zero otherwise. VC ownership is equal to the post-IPO venture
capitalists ownership in percentage of outstanding shares. Greenshoe option is equal to the number of stocks announced
in the greenshoe option agreement in percentage of the total number of offered stocks. Market return is the SBF 250
buy-and-hold return calculated over a 3-month period prior to the IPO date. Market volatility is the standard deviation of
daily return of the SBF 250 index over a 3-month period prior to the IPO date. Bubble period dummy is equal to 1 if the
IPO occurs in 1999–2000, zero otherwise. Pre-IPO issue number is the number of issues in the year previous to the IPO
year period, and IP growth rate (%) is the growth rate of the industrial production, in volume, calculated at the time of the
issue.
188 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

Market condition variables show that firms usually go public following periods of positive
market momentum; there is an average buy-and-hold market return of 10.5% over a 3-month
period prior to the IPO date. Descriptive statistics indicate that 48.8% of firms went public during
the hot-issue period (1999–2000). They finally show that the number of IPOs during the year
prior to the IPO date is equal to 65.33 IPOs, and the industrial production growth rate is positive
and equal to 4.9% on average.

4.2. Selling activity and IPOs costs

4.2.1. Gross spread and initial owners decision-making at the time of IPOs
Table 2 presents the results of the dilution factor, the participation ratio, and the gross spread
regressions. Specifically, models (1)–(3) include the ordinary least squares (OLS) regressions of
each one of these three variables, respectively. Models (4)–(6) present the two-stage least squares
(2SLS) estimation of the simultaneous equations system, and also determine the nature of the
trade-off among these variables. All models in Table 2 exhibit considerable explanatory power
with adjusted R2 ranging from 24.6% to 40.8%.
The OLS regression run for the dilution factor in model (1) indicates a negative association
with the participation ratio (p = 1%), but shows no relationship with the gross spread. In line with
Huyghebaert and Van Hulle (2006), the dilution factor increases with the percentage of bank loans
in the total debt (p = 5%). Firms with a higher dependence on bank loans are more likely to issue
new shares to increase their bargaining power.
The dilution factor is positively related to SR growth and aftermarket standard deviation, but
negatively related to the total asset of IPO firms. This suggests that small size, risky, high-growth
firms are more likely to raise new equity. These firms are usually financially constrained, and are
therefore more likely to issue new shares to finance their growth opportunities. This is consistent
with the positive association between the dilution factor and the NM dummy (p = 5%), where
firms going public are younger, smaller, and hi-tech. Although the positive association between
the dilution factor and the industrial production growth rate may reflect the timing of equity
issuance for investment purposes, it does not clearly show that firms try to benefit from specific
windows of opportunity.
Model (2) exhibits a significantly negative association between the participation ratio and the
gross spread (p = 1%). A closer look at the database shows that firms issuing a higher fraction
of secondary shares are older, larger and have a lower aftermarket standard deviation, which is
consistent with Kim and Weisbach (2005). Hence, initial owners may consider their offerings less
risky, and consequently pay a lower gross spread. This is also confirmed by the negative association
between the percentages of secondary shares and primary shares sold (p = 1%). Driven by either
a need to raise capital or by liquidity motives, initial owners are thus likely to trade-off the nature
of shares sold when preparing for their IPOs.
Consistent with the adverse selection hypothesis, the participation ratio is negatively related
to block-holders’ ownership, i.e. concentration (p = 5%). It increases with underwriter rep-
utation (p = 5%), and it decreases for firms with higher growth opportunities as proxied
by SR growth (p = 5%) and hi-tech firms (p = 5%). Initial owners are likely to partici-
pate more in offerings which follow hot-issue periods (p = 1%), as proxied by the number
of IPOs over the 1 year period prior to the IPO date, and positive economic conditions
(p = 1%), as proxied by the industrial production growth rate. This supports the windows of
opportunity hypothesis where initial owners participate in IPOs following positive market momen-
tum.
Table 2
Gross spread and the effect of secondary and primary sold shares
Dilution OLS (1) Participation OLS (2) Gross spread OLS (3) Dilution 2SLS (4) Participation 2SLS (5) Gross spread 2SLS (6)

Constant 0.298** (0.132) 0.248*** (0.089) 0.231*** (0.064) 0.298** (0.143) 0.109 (0.100) 0.279*** (0.068)
Gross spread −0.035 (0.513) −0.826** (0.325) 0.011 (0.562) 0.021* (0.013)
Participation ratio −0.514*** (0.147) −0.066** (0.031) −0.027 (0.155) 0.022*,a (0.013)
Dilution factor −0.172*** (0.039) 0.000 (0.018) −0.013 (0.078) 0.013*,a (0.008)

S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

Debt mix 0.137** (0.069) 0.137** (0.066)
Concentration −0.150** (0.063) −0.139** (0.066)
LProceeds −0.010*** (0.004) −0.014*** (0.004)
Underwriter ranking 0.207 (0.265) 0.444** (0.204) 0.056 (0.056) −0.071 (0.272) 0.514** (0.223) 0.044 (0.056)
SR growth 0.020** (0.010) −0.019** (0.009) −0.001 (0.002) 0.013* (0.008) −0.015* (0.009) 0.000 (0.002)
Hi-tech dummy 0.004 (0.030) −0.041** (0.017) 0.002 (0.005) 0.016 (0.031) −0.045** (0.018) 0.005 (0.005)
LAge 0.002 (0.034) −0.004 (0.022) −0.003 (0.005) 0.001 (0.036) −0.002 (0.024) −0.004 (0.006)
Loss dummy −0.035 (0.028) 0.004 (0.013) 0.001 (0.005) −0.036 (0.030) −0.003 (0.015) 0.002 (0.005)
LAsset −0.017* (0.009) −0.001 (0.006) 0.000 (0.002) −0.019* (0.010) 0.003 (0.006) 0.000 (0.002)
Aftermarket standard 1.704** (0.750) 0.668 (0.413) 0.252** (0.107) 1.493* (0.842) 0.258 (0.484) 0.222** (0.111)
deviation
NM dummy 0.094** (0.036) −0.025 (0.020) 0.020*** (0.007) 0.130*** (0.038) −0.069*** (0.022) 0.025*** (0.007)
VC ownership 0.113 (0.086) −0.010 (0.047) 0.000 (0.015) 0.108 (0.092) −0.027 (0.053) 0.000 (0.014)
Greenshoe option −0.146 (0.205) −0.093 (0.110) 0.003 (0.038) −0.120 (0.216) −0.048 (0.119) 0.012 (0.039)
Pre-IPO issue number 0.000 (0.001) 0.002*** (0.000) 0.000 (0.000) 0.000 (0.001) 0.002*** (0.000) 0.000 (0.000)
IP growth rate 2.011** (0.843) 2.106*** (0.567) 0.300** (0.138) 1.238* (0.736) 1.733*** (0.583) 0.198 (0.156)
Bubble period dummy 0.024 (0.031) 0.023 (0.021) −0.005 (0.007) 0.011 (0.030) 0.035* (0.021) −0.005 (0.007)
Adjusted R2 0.389 0.470 0.411 0.325 0.365 0.385
F-statistic 5.414 10.535 10.930 4.099 9.885 9.312
Prob(F-statistic) 0.000 0.000 0.000 0.000 0.000 0.000

This table includes the regressions run of the dilution factor, the participation ratio and the gross spread for 172 IPOs in the Nouveau Marché and the Second Marché over the
period 1997–2000. Models (1)–(3) contain the OLS regressions of the three variables, whereas models (4)–(6) present the 2SLS regressions controlling for their simultaneous
determination. Standard errors are in parentheses. White heteroskedasticity-consistent standard errors & covariance ***, **, * respectively significant at the 1%, 5%, and 10%
level.
a Significantly different at the 10% level.

189
190 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

In line with results in models (1) and (2), model (3) shows a significant negative coefficient for
the participation ratio (p = 10%), and no significant association with the dilution factor. Instead,
model (3) brings support to the economies of scale hypothesis and shows a negative association
between the gross spread and the gross proceeds (p = 1%). The gross spread is positively related
to the aftermarket standard deviation used as a proxy for ex ante uncertainty (p = 5%), and to
the Nouveau Marché (NM) market dummy (p = 1%), where IPO firms are usually riskier than in
the Second Marché. There is also evidence of a positive association between gross spread and
industrial production growth rate (p = 1%).
Nevertheless, models (1)–(3) assume that initial owners do not consider their firms’ charac-
teristics, market conditions or the required direct cost of the IPO, i.e. the gross spread, when
determining the number of shares sold. In fact, initial owners may determine the number of sec-
ondary and primary shares sold according to the negotiated gross spread. For example, they may
be reluctant to sell a higher number of their own shares if this increases ex ante uncertainty, and
the gross spread required by underwriters to ensure the offering’s success. A three simultaneous
equation approach assumes that the dilution factor, the participation ratio and the gross spread
behave as if they were endogenous. To test this assumption, a Hausman test is used where the first
stage of a two-stage least square (2SLS) provides an estimate of each endogenous variable by
regressing it on the exogenous variables. The second stage estimates the coefficients by treating
the residual from the first stage as an additional variable. The bias induced by the endogeneity
is significantly different from zero in all three models within the range of 1–10%.8 Since having
valid instruments is not sufficient to generate unbiased 2SLS estimates in finite samples, I refer to
Staiger and Stock (1997) to verify that selected instruments are “strong,” i.e. strongly correlated
with the endogenous first-stage variable. Staiger and Stock (1997) use an instrument strength test,
which requires a greater than 10 F-test for the joint significance of the instruments in the first
stage. Empirical tests confirm the strength of instruments for both participation ratio and gross
spread, but indicate a weak instrument for the dilution factor. As a result, the two-step estimator
for the primary shares sold may lead to imprecise empirical results.
Models (4)–(6) include the 2SLS regressions of the dilution factor, the participation ratio, and
the gross spread using their predicted values from results in models (1)–(3). Model (4) shows
consistent results with model (1) and indicates no significant relationships between the dilution
factor on the one hand, and the participation ratio and gross spread on the other. Model (5),
however, exhibits a positive and significant association between the participation ratio and the
gross spread (p = 10%). In contrast with Huyghebaert and Van Hulle (2006) who find a negative
association between the participation ratio and the dilution factor for a sample of 95 Belgian IPOs,
model (5) shows no association between both variables. Hence, controlling for the simultaneous
determination of the primary and secondary shares sold, initial owners define their fractions

8 To verify the existence of an endogenous relationship between gross spread and participation ratio, a test of the

feedback hypothesis was performed in models (2) and (3) using the secondary shares intended to be sold. Information on
the intended participation ratio was found for 150 IPOs of the studied sample in research notes disclosed by underwriters
in the early stages of pre-IPO periods. The regression run for the intended participation ratio on the gross spread indicates
a positive, but not significant relationship. Although not significant, the difference with results in Table 2 using the actual
number of secondary shares sold suggests that initial owners may rationally adjust their participation in offerings according
to the gross spread level. Moreover, the difference between the actual and intended participation ratio is negatively and
significantly related to gross spread (a correlation coefficient of −28.4% significant at the 5% level). Initial owners learn
about their IPOs during the pre-IPO period and use some techniques, such as over-allotment options, to manage their
participation ratio.
 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196 191

independently. Moreover, it indicates a lower participation ratio in the Nouveau Marché where
IPOs are usually made by hi-tech growth firms looking to raise new equity for investment purposes.
Interestingly, the 2SLS regression run for the gross spread in model (6) shows positive and
significant estimated coefficients for both the dilution factor, and the participation ratio (at the
10% levels). This is consistent with endogeneity existing in both directions between the secondary
shares sold and the gross spread, whereas it is recursive in only one direction between the dilution
factor and the gross spread. Indeed, the dilution factor affects the gross spread, but not vice
versa. This indicates that initial owners endogenously determine the number of secondary shares
sold and the level of gross spread paid to limit underpricing. A t-test for difference shows that the
estimated coefficient for the participation ratio is significantly higher than the estimated coefficient
for the dilution factor (p = 10%). Initial owners are more likely to pay a higher gross spread
for issues including a larger fraction of secondary shares. A 10% increase in the percentage
of primary and secondary shares sold leads the gross spread to increase by 0.13% and 0.22%,
respectively.

4.2.2. Underpricing and initial owners decision-making at the time of IPOs

Models in Table 3 report the coefficients estimated for the 2SLS regression of underpricing
on the gross spread, the dilution factor and the participation ratio using predicted variables in
Table 2 as a first stage. By the standards of IPO literature, the regression in model (7) has high
explanatory power, with an adjusted R2 of 25.6%. Consistent with Hypothesis 1, model (7) shows
the existence of a negative association between the gross spread and underpricing (p = 10%). A
10% increase in the gross spread would lower the initial return by an almost equal percentage of
12.45%.
In line with Hypotheses 2 and 3, model (7) indicates a negative association between underpric-
ing and both the dilution factor and the participation ratio (p = 10%). For every 10% increase in
the percentage of primary and secondary shares sold, initial underpricing decreases by 3.81% and
7.79%, respectively. The effect of secondary shares sold is significantly higher than the effect of
primary shares sold (p = 10%). One explanation is that as secondary offerings are usually related
to liquidity motives, initial owners are more likely to be concerned about the effect of their partici-
pation ratio on IPO pricing. They pay a higher gross spread (model 6), which reduces underpricing
(model 7). Although not reported in Table 3, an interaction variable was added between the gross
spread and the participation ratio in the underpricing regression. This shows a significantly nega-
tive effect of the interaction variable on underpricing (p = 5%); in other words, issues with a larger
fraction of secondary shares and a higher gross spread have lower underpricing.
In terms of control variables, model (7) confirms the partial information revelation hypothesis,
and shows a positive association between initial underpricing and the price revision during the pre-
IPO period (p = 1%). Moreover, underpricing is significantly higher for issues managed by more
prestigious underwriters (p = 10%) and for hi-tech firms (p = 5%). It is also greater for firms with
higher aftermarket standard deviation (p = 10%) and for IPOs in the Nouveau Marché (p = 10%).
Underpricing depends on market conditions, where lower market volatility is usually followed by
higher underpricing (p = 5%).
Model (8) verifies the existence of a non-linear relationship between underpricing and both
percentages of primary and secondary shares sold. It brings partial support to Hypothesis 4 and
shows that underpricing first moves in opposition to the dilution factor and the participation
ratio, and then increases above a certain threshold percentage of primary sold shares (p = 10%).
Since IPO firms issuing a higher fraction of primary shares are both smaller and more risky (see
results in model (1), Table 2), outside investors may require higher compensation, thus increasing
192 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

Table 3
Underpricing, and the non-linear effect of secondary and primary sold shares
Underpricing

2SLS (7) 2SLS (8)

Constant −0.164 (0.397) −0.190 (0.403)

Gross spread −1.245* (0.732) −1.454* (0.853)
Participation ratio −0.779*,a (0.424) −0.769* (0.425)
Dilution factor −0.381*,a (0.196) −0.434* (0.237)
Dilution factor2 0.848* (0.507)
Price revision 1.805*** (0.492) 1.835*** (0.501)
Underwriter ranking 1.014* (0.599) 1.053* (0.603)
SR growth 0.070 (0.063) 0.072 (0.063)
Hi-tech dummy 0.087* (0.051) 0.099* (0.058)
LAge 0.086 (0.079) 0.086 (0.079)
Loss dummy 0.006 (0.056) −0.004 (0.056)
LAsset −0.002 (0.022) −0.001 (0.022)
Aftermarket standard deviation 3.240* (1.952) 3.154* (1.901)
NM dummy −0.119* (0.065) −0.124** (0.064)
VC ownership 0.327 (0.240) 0.314 (0.242)
Greenshoe option −0.260 (0.499) −0.213 (0.518)
Bubble period dummy 0.069 (0.091) 0.065 (0.092)
Pre-IPO issue number 0.002 (0.002) 0.002 (0.002)
IP growth rate 2.944 (2.718) 2.499 (2.756)
Market return 0.029 (0.253) 0.057 (0.256)
Market volatility −19.998** (8.060) −17.623** (8.486)
Adjusted R2 0.256 0.258
F-statistic 2.752 2.630
Prob(F-statistic) 0.000 0.000

White heteroskedasticity-consistent standard errors & covariance ***, **, * respectively significant at the 1%, 5%, and
10% level. This table includes the regressions run of the underpricing for 172 IPOs in the Nouveau Marché and the Second
Marché over the period 1997–2000. Model (7) presents the 2SLS regressions of the underpricing on the gross spread,
the dilution factor, and the participation ratio using their fitted values from Table 2 as a first stage. Model (8) verifies the
existence of non-linear association between underpricing on the one hand, the dilution factor and the participation ratio
on the other. Standard errors are in parentheses.
a Significantly different at the 10% level.

underpricing. Initial owners may also accept to leave more money on the table in issues where
they sell a smaller fraction of their own shares.
Overall, results in Tables 2 and 3 indicate that initial owners are more likely to pay a higher gross
spread for greater percentages of primary and secondary shares sold in order to limit underpricing.
This does not prevent IPO investors from requiring higher underpricing for extremely dilutive
issues. Both tables, however, do not clearly examine the differences in the behaviour of pre-IPO
owners in the Nouveau Marché and the Second Marché.

4.3. Underpricing, gross spread and the effect of the IPO market

Panels A and B in Table 4 include the 2SLS regressions of both gross spread and underpricing
in the Nouveau Marché (NM) and the Second Marché (SM).9 Within each market, the Hausman

9 I am grateful to the anonymous reviewer for suggesting this empirical investigation.

Table 4
The IPO market and the association between underpricing, gross spread, the secondary and primary sold shares
Panel A: Nouveau Marché (N = 124 IPO) Panel B: Second Marché (N = 48 IPOs)

Dilution 2SLS (9) Participation 2SLS Gross spread 2SLS Underpricing 2SLS Dilution 2SLS (13) Participation 2SLS Gross spread 2SLS Underpricing 2SLS
(10) (11) (12) (14) (15) (16)
Constant 0.390** (0.156) −0.033 (0.098) 0.221*** (0.080) −0.271 (0.488) −2.574 (2.328) 1.828 (1.616) 0.494 (0.345) 0.102 (1.824)

S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

Gross spread 0.036 (0.640) 0.076 (0.238) −1.600* (0.925) 0.075 (1.045) 0.020* (0.012) −0.692* (0.395)
Participation ratio −0.037 (0.234) 0.012* (0.007) −0.098* (0.058) −0.034 (0.340) 0.045* (0.025) −0.542* (0.318)
Dilution factor −0.022 (0.054) 0.013 (0.012) −0.494* (0.263) −0.003 (0.167) 0.027* (0.015) −0.387* (0.222)
Debt mix 0.163** (0.087) 0.126* (0.065)
Concentration −0.138** (0.061) −0.193* (0.104)
LProceeds −0.009* (0.005) −0.023*** (0.007)
Price revision 2.100*** (0.545) −0.900 (0.994)
Underwriter ranking −0.183 (0.394) 0.235 (0.212) −0.015 (0.073) 0.908 (0.947) 0.102 (0.438) 0.566* (0.330) 0.229** (0.112) 1.069 (0.872)
SR growth −0.007 (0.014) −0.005 (0.009) −0.001 (0.003) 0.060 (0.068) −0.008 (0.264) −0.286* (0.166) 0.067* (0.039) 0.465 (0.371)
Hi-tech dummy 0.022 (0.042) −0.032 (0.024) 0.004 (0.005) 0.058 (0.078) 0.058 (0.074) −0.015 (0.033) 0.005 (0.014) 0.103 (0.106)
LAge 0.043 (0.043) 0.046** (0.018) −0.005 (0.006) 0.028 (0.097) −0.060 (0.063) −0.125* (0.067) 0.006 (0.015) −0.104 (0.118)
Loss dummy 0.034 (0.031) −0.012 (0.014) 0.000 (0.005) 0.043 (0.070) −0.036 (0.076) 0.032 (0.054) 0.014* (0.008) −0.189 (0.124)
LAsset −0.018* (0.010) 0.008 (0.008) 0.000 (0.002) 0.005 (0.039) −0.017* (0.010) 0.012 (0.010) −0.002 (0.003) −0.010 (0.029)
Aftermarket standard deviation 1.315* (0.753) 0.356 (0.543) 0.288** (0.135) 3.697* (2.112) 0.853 (1.854) −1.079 (1.336) −0.016 (0.411) −4.915 (3.064)
VC ownership 0.189** (0.098) −0.053 (0.052) 0.001 (0.016) 0.424* (0.248) −0.245 (0.296) −0.030 (0.175) 0.012 (0.041) 0.278 (0.368)
Greenshoe option −0.133 (0.262) 0.008 (0.127) 0.012 (0.045) −0.296 (0.663) 0.411 (0.631) −0.126 (0.461) 0.012 (0.089) −1.899** (0.757)
Pre-IPO issue number 0.000 (0.001) 0.002*** (0.000) 0.000 (0.000) 0.002 (0.002) 0.016* (0.010) −0.007 (0.009) 0.000 (0.002) 0.002 (0.010)
IP growth rate 0.981 (0.897) 1.511*** (0.525) 0.173 (0.149) 3.808 (2.973) 3.272* (1.930) −13.109 (14.683) −0.074 (3.229) −1.753 (17.947)
Bubble period dummy 0.006 (0.033) 0.023 (0.023) −0.011 (0.008) 0.113 (0.106) 0.811 (0.625) −0.303 (0.361) 0.004 (0.088) −0.066 (0.441)
Market return −0.275 (0.316) 1.265** (0.502)
Market volatility −27.181** (11.003) 13.091 (14.294)

Adjusted R2 0.175 0.255 0.292 0.276 0.154 0.464 0.190 0.214

F-statistic 2.633 6.732 6.675 2.722 2.611 5.530 5.778 2.713
Prob(F-statistic) 0.002 0.000 0.000 0.001 0.002 0.000 0.000 0.001
Panels A and B in this table include the regressions run of the dilution factor, the participation ratio, the gross spread, and underpricing for 172 IPOs in the Nouveau Marché and the Second Marché over the period 1997–2000. Panel A
presents the results for 124 IPOs in the Nouveau Marché, whereas panel B includes the results for 48 IPOs in the Second Marché. Both panels first control for the simultaneous determination of the dilution factor, the participation ratio,
and the gross spread, then use their fitted values in the underpricing regression. Standard errors are in parentheses. White heteroskedasticity-consistent standard errors & covariance ***, **, * respectively significant at the 1%, 5%, and
10% level.

193
194 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196

test of endogeneity between the dilution factor, the participation ratio, and the gross spread shows
significant results within the range of 1–10%.
The regressions of the dilution factor in both the NM and the SM (models (9) and (13), respec-
tively) show no significant association with either the participation ratio or the gross spread.
Similarly, the regression of the participation ratio in model (10) in the NM indicates no relation-
ship with both the dilution factor and the gross spread. On the contrary, the regression of the
participation ratio in model (14) in the SM shows a positive association with the gross spread
(p = 10%). Moreover, the gross spread regressions in both the NM and SM (models (11) and
(15), respectively) show positive and significant estimated coefficients for the participation ratio
(p = 10%). Nevertheless, the gross spread is positively related to the dilution factor in the SM,
but not in the NM. One explanation is that initial owners are less concerned with the effect of the
fraction of primary shares sold in the NM, whereas they try to limit its effect on underpricing in
the SM.
Models (12) and (16) include 2SLS regressions of underpricing in both the NM and the SM.
Both models confirm the existence of a negative association between underpricing and the gross
spread. Interestingly, underpricing is negatively related to the participation ratio as well as the
dilution factor in both the Second Marché and the Nouveau Marché (p = 10%). As IPOs in the
NM are usually young firms with substantial growth opportunities and limited internal cash
generation, they are expected to issue larger fractions of primary shares for investment purposes.
Initial owners of high-growth firms going public in the NM may be less concerned by the dilutive
effect of selling primary shares on underpricing. On the contrary, the issue of existing shares in
these high-growth firms in the NM may cause a significant increase in ex ante uncertainty. Initial
owners are, therefore, more concerned by the resulting loss of wealth, and so pay a higher gross
spread to reduce underpricing.
Overall, models (9)–(16) exhibit various relationships in terms of control variables. Mainly,
initial owners in the SM are more likely to hire more prestigious underwriters when sell-
ing a larger percentage of their own shares. Moreover, the decision to participate in IPOs
in the NM depends on market conditions. The gross spread also increases in the SM in
firms with a negative net income. Finally, there is a positive relationship between underpric-
ing and VC ownership in the NM (p = 10%). This suggests that VCs of high-growth firms
are likely to grandstand and take firms public earlier than more established firms (Gompers,
1996).

4.4. Robustness tests

Part of the listing rules in the Nouveau Marché is that firms should issue at least 50%
new shares, that is, for every existing share being sold, a new share should also be issued.
This raises a problem for empirical modelling, where one cannot assume that the participa-
tion ratio and dilution factor are chosen freely. Since a part of primary shares is “directly”
justified by the offer of secondary shares, further robustness tests are required to control for
the effect of this specific rule using the excess dilution factor (the difference between primary
and secondary shares issued as a percentage of pre-IPO shares outstanding). This represents
the part of the primary shares offered at the discretion of initial owners. A three simulta-
neous equation system is run to investigate the interdependencies among the gross spread,
the excess dilution factor, and the participation ratio. Empirical results indicate no signifi-
cant differences in the main conclusions of Table 4 (Panel A) (the results are available upon
request).
 S. Chahine / J. of Multi. Fin. Manag. 18 (2008) 180–196 195

5. Conclusion

This paper sheds light on the relation between the gross spread, underpricing, and the nature
of shares sold at the time of IPOs in France. Empirical tests show that the gross spread increases
with the percentage of primary (dilution factor), and secondary (participation ratio), shares sold.
Moreover, there is evidence of a trade-off between gross spread and underpricing, where a higher
gross spread is more likely to reduce underpricing. Controlling for firm characteristics and market
conditions, empirical results indicate that the effect of the fraction of secondary shares sold on
both gross spread and underpricing is significantly higher than that of primary shares sold. Initial
owners seem to have more incentive to pay a higher gross spread and reduce underpricing for
secondary share issues.
Empirical findings confirm the signalling role played by the participation ratio and the dilution
factor. Underpricing exhibits a linear relationship with the fraction of secondary shares sold, but
a curvilinear (U-shape) relationship with the percentage of primary shares sold. Underpricing
decreases with the participation ratio, whereas it first decreases, and then increases with the
dilution factor. Since initial owners participate less in more dilutive offerings, they are likely to
be more complacent about high first-day returns.
Further investigation shows significant differences in initial owners’ behaviour according to
the choice of IPO market. In fact, both the dilution factor and the participation ratio are positively
related to the gross spread and negatively related to underpricing in the Second Marché—the
market for more mature and less risky firms. On the contrary, initial owners of IPOs in the
Nouveau Marché – the market for young and high-growth firms – are mainly concerned about
the effect of selling their secondary shares on their wealth loss. While the dilution factor does not
affect IPO costs, the participation ratio positively affects the gross spread, which in turn reduces
underpricing. Further research should thus consider the institutional nature of the IPO market and
its effect on initial owners’ decisions.

Acknowledgements

I am grateful to Michel Habib, Ike Mathur (the editor) and the anonymous referee for their
comments. I would like to thank seminar participants at the European Financial Management
Association meeting, EFMA, Basel, 2004. Thanks also to Anne Noury for her help in collecting
the database.

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