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Underwriter in IPOs
Thomas J. Chemmanur
†
and
Karthik Krishnan
‡
Current version: August 17, 2011
†
Professor of Finance, Carroll School of Management, Boston College, 440 Fulton Hall, Chestnut Hill, MA 02467.
Email: chemmanu@bc.edu. Phone: (617) 5523980. Fax: (617) 5520431.
‡
Assistant Professor of Finance, College of Business, Northeastern University, 414C Hayden Hall, 360 Huntington
Ave., Boston, MA 02115. Email: k.krishnan@neu.edu. Phone: (617) 3734707, Fax (617) 3738798
For helpful comments and discussions, we thank Douglas Cook, Iraj Fooladi, Elena Loutskina, Gang Hu, and
seminar participants at Boston College, Babson College, Dalhousie University, the 2008 FIRS conference, the 2008
European Finance Association annual meetings, the 2007 Financial Management Association annual meetings, and
the 2007 Eastern Finance Association annual meetings. Thomas Chemmanur acknowledges summer support from
the Carroll School of Management at Boston College.
Heterogeneous Beliefs, IPO Valuation, and the
Economic Role of the Underwriter in IPOs
Abstract
Several theoretical papers have argued that the valuation of equity will reflect the beliefs of the most
optimistic investors and be at a premium over intrinsic value when investors subject to short sale constraints
have heterogeneous priors. We test the above theories by analyzing the effect of IPO underwriter reputation
on the heterogeneity in investor beliefs and consequently on equity valuation in IPOs. We propose a “market
power” hypothesis, postulating that highreputation underwriters are able to attract a greater number of
higher quality market participants (such as institutional investors, analysts, and comanaging underwriters) to
the IPOs backed by them, thereby yielding higher IPO valuations by increasing the heterogeneity in investor
beliefs. We empirically distinguish the above hypothesis from the “certification hypothesis,” which implies
that highreputation underwriters are associated with IPOs priced closer to intrinsic value. We find that
equity in highreputation underwriter backed IPOs are priced higher and further away from intrinsic value
compared to lowreputation underwriter backed IPOs; this result is robust to controlling for endogenous
matching between highreputation underwriters and higher quality issuers using instrumental variables and
regression discontinuity analyses. We show that the above relationship between underwriter reputation and
market valuation is driven by the greater heterogeneity in investor beliefs and greater participation by
institutional investors and highreputation comanaging underwriters that characterize highreputation
underwriter backed IPOs. Overall, our results support the market power hypothesis and contradict the
certification hypothesis.
JEL classification: G24
Keywords: Investment banks, Underwriter reputation, IPOs
1
Introduction
Starting with Miller (1977), the effect of heterogeneity in investor beliefs on the valuation of equity
has been the subject of considerable debate among financial economists. In particular, formalizing Miller’s
(1977) intuition, Harrison and Kreps (1978) and Morris (1996) have shown that the equity of firms will
reflect the valuation of the most optimistic investors (and will sell at a premium over their fundamental
value) when investors subject to short sale constraints have heterogeneous prior beliefs (see also Duffie,
Garleanu, and Pederson (2002) and Chen, Hong, and Stein (2002)). Given that firms going public have a
very sparse track record publicly available to investors, the equity of IPO firms are likely to be characterized
by a higher degree of heterogeneity in investor beliefs and therefore provide a particularly appropriate
context to test the implications of heterogeneous beliefs and behavioral theories of equity valuation. Existing
empirical analyses of such theories have been primarily in nonIPO settings (see, e.g., Chen, Hong, and Stein
(2002) and Diether, Malloy, and Scherbina (2002)). The objective of this paper is to extend the above
literature to the IPO setting by analyzing the role of heterogeneity in investor beliefs under short sale
constraints on the valuations of the equity of firms going public. In particular, we empirically analyze the
implications of these theories on the role of the underwriter in the valuation of the equity of firms going
public, both in the IPO and in the immediate secondary market.
Underwriters have a particularly important role to play in IPO valuation. This is because, first, they
set the IPO offer price after ascertaining the views of investors on their valuation of the IPO through the book
building process. Second, participation by a highly reputable underwriting syndicate may affect the beliefs of
at least some investors about the future prospects of the IPO firm. We therefore focus on the economic role
of the underwriter in affecting the heterogeneity in investor beliefs faced by IPO firms, which in turn, will
affect the valuation of equity in the IPOs that they underwrite. The economic role of the underwriter in IPOs
has become a particularly relevant topic of study in light of the recent empirical evidence that the relationship
between underwriter reputation and IPO underpricing has reversed. While earlier evidence documented that
IPOs underwritten by highreputation investment banks were characterized by a smaller extent of
underpricing, more recent evidence indicates that IPOs underwritten by highreputation underwriters are
characterized by greater underpricing: see, e.g., Beatty and Welch (1996), Loughran and Ritter (2004), and
Cooney, Carter, Dark, and Singh (2001) who find that the average underpricing has gone from being smaller
for highreputation underwriters in the 1980s to being larger for highreputation underwriters in the 1990s.
This is consistent with a parallel debate in the venture capital literature. For instance, Francis and Hasan
(2001) use data from the 1990s and find that IPOs of firms backed by venture capitalists are underpriced
more than those not backed by venture capitalists, in contrast with the findings of prior literature that uses
data from the 1980s.
In order to incorporate the role of the underwriter in the Miller (1977) setting, we conjecture that
underwriters are motivated to obtain high valuations for the equity of firms they take public by making use of
2
their longterm relationships with various participants in the IPO market (institutional investors, analysts, and
comanaging underwriters). These relationships enable them to attract greater participation by these market
players in the IPOs of firms backed by them, leading to higher valuations for the equity of these firms (both
in the IPO and in the secondary market).
1
Participation by highreputation underwriters and by a larger
number of other highquality market participants (i.e. highreputation comanagers and a larger number of
institutional investors and analysts) may make retail investors more optimistic about the IPO firm’s
prospects. For example, Welch (1992) shows that later investors in a firm’s IPO will optimally ignore their
private information and buy shares in the IPO after becoming more optimistic about the IPO firm’s prospects
if they observe strong demand from earlier investors for these shares.
2
Such higher optimism of retail
investors increases the heterogeneity in investor beliefs, which in turn may lead to higher valuations, both in
the IPO and in the immediate aftermarket, based on arguments made by Miller (1977) and others discussed
earlier. In summary, the greater heterogeneity in investor beliefs regarding firms whose IPOs are
underwritten by highreputation underwriters (relative to firms whose IPOs are underwritten by low
reputation underwriters) will lead to higher valuations of these firms in the IPO as well as in the immediate
secondary market.
3
We will refer to the above hypothesis as the “market power” hypothesis.
4
The above hypothesis contrasts with the prevailing view that the underwriter acts as a “certifying”
intermediary who produces information about the intrinsic value of the firm in an IPO market characterized
by asymmetric information between firm insiders and outsiders. Since information production is costly (and
therefore characterized by moral hazard), underwriters have a shortterm incentive to sell the equity of firms
they take public at a price higher than their intrinsic value. However, underwriters have reputation at stake
with investors, mitigating this moral hazard problem in information production, thereby inducing them to
price equity in IPOs consistent with intrinsic value (see, e.g., Chemmanur and Fulghieri (1994)). This means
1
Underwriters may be motivated to obtain high valuations for the IPO firm for two reasons. First, their gross spread
revenue per share is proportional to the IPO offer price. Second, successfully obtaining high IPO proceeds will increase
the underwriter’s reputation with subsequent issuers leading to higher future revenues.
2
Consistent with this, in their survey of the diffusion of interest among institutional and retail investors, Shiller and
Pound (1989) found that 44% of investors who bought shares in a firm’s IPO did so because someone they knew
ofbought stock in the company. Further, various other papers have found evidence consistent with the idea that, unlike
large and institutional investors, retail investors’ trades are motivated by analyst recommendations and other sources of
information that may grab their attention, even if such sources do not benefit them in the long run. For example,
Malmendier and Shantikumar (2007) find that small investors follow analyst recommendations literally, even if analysts
are affiliated with an underwriter; whereas larger traders discount analyst recommendations. Barber and Odean (2008)
find that individual investors are more likely to be net buyers in attention getting stocks, unlike professional investors.
3
We are assuming here that the increase in the heterogeneity in investor beliefs is symmetric about the mean level of
investor beliefs about the firm. In such a setting, it can be shown using a formal theoretical model that the beliefs of the
marginal investor about the firm going public and therefore the valuation of the firm’s equity in the IPO and in the
immediate secondary market will be increasing in the heterogeneity in investor beliefs. While, due to space limitations,
we will not present a formal theoretical analysis here, the above results will follow from a model along the lines of
Bayar, Chemmanur, and Liu (2010).
4
This paper primarily focuses on the role of the lead underwriter in IPOs. Through the rest of the paper, we refer to lead
underwriters in an IPO as underwriters and explicitly refer to comanaging underwriters (comanagers) wherever
necessary.
3
that the certification hypothesis has implications dramatically different from the market power hypothesis for
the pricing of IPOs: while the certification hypothesis implies that highreputation underwriters price equity
in IPOs backed by them closer to intrinsic value due to their concern for preserving reputation in the IPO
market, the market power hypothesis implies that highreputation underwriters would price this equity higher
and further away from intrinsic value.
In order to make the market power hypothesis more precise and understand the relationship between
the IPO and the first day secondary market share valuations of IPOs underwritten by high and low
reputation underwriters, we study the following economic environment. Consider an IPO market populated
by both retail and institutional investors, and where a firm’s IPO may be underwritten by either a high
reputation or a lowreputation underwriter. Underwriters care about both the initial offer price and the first
day closing secondary market share price of the IPO firm, maximizing a weighted average of the two. Thus,
an underwriter chooses the offer price (OP) and (implicitly) the secondary market price (SMP) to maximize:
5
γ
1
(.)OP + γ
2
(.)SMP, (1)
where the weights γ
1
(.)
and γ
2
(.) are decreasing functions of OP and SMP, respectively.
6
Further, the γ
1
(.) and
γ
2
(.) functions are the same for high and lowreputation underwriters. For the reasons discussed earlier,
assume that, for a given extent of underpricing, the heterogeneity in investor beliefs about the IPO firm’s
prospects and therefore secondary market share valuations will be greater if the IPO is backed by a high
reputation underwriter rather than by a lowreputation underwriter. Further, assume that either a high or a
lowreputation underwriter can generate greater participation by institutional investors (and other high
quality market players) in the IPO by underpricing to a greater extent, since such underpricing will serve to
compensate these market players for their participation in the IPO.
7
Finally, we assume that participation by
a larger number of such market players will further increase the heterogeneity in investor beliefs, and
therefore the secondary market valuation, of the firm going public.
5
In practice, the variables explicitly chosen by the underwriter will be the IPO offer price and the extent of participation
by highquality market players which, in turn, will determine the extent of heterogeneity in investor beliefs and thereby
secondary market stock valuation. As we explain below, the extent of participation by highquality market players will
be determined by the reputation of the underwriter and the extent of underpricing.
6
The rationale for assuming such an objective function is that underwriters care about the both the IPO as well as the
secondary market price of the firm’s equity. Underwriters care about the firm’s IPO price since they receive a fraction
of gross IPO proceeds as compensation. Underwriters also care about the IPO firm’s shortrun secondary market price
because they are committed to engaging in price support activities if this price falls below a certain threshold level, and
also because their reputation with future issuers will be damaged if the stock price of firms whose IPOs they underwrite
languishes in the secondary market. Our results will remain qualitatively unchanged even if we allow the weights γ
1
(.)
and γ
2
(.) to depend on additional IPO parameters such as the fraction of equity sold by insiders in the IPO: see
Chemmanur (1993) for a similar objective function.
7
This assumption that institutional investors are important beneficiaries from IPO underpricing is consistent with the
evidence that there is a significant amount of flipping of IPO shares by institutional investors to retail investors both in
the first few days of trading in secondary market shares (Aggarwal (2003)) and the subsequent months (Chemmanur,
Hu, and Huang (2010)). It is also consistent with the evidence that institutional investors make significant abnormal
profits from selling their IPO share allocations soon after the IPO (Chemmanur, Hu, and Huang (2010)).
4
In the above setting, we can show the following. First, for a given level of IPO underpricing, the
secondary market share price of a firm whose IPO is backed by a highreputation underwriter will be greater
than if it were backed by a lowreputation underwriter. The intuition here is that highreputation underwriters
face a steeper demand curve for shares than lowreputation underwriters due to the greater heterogeneity in
retail investor beliefs associated with highreputation underwriter backed IPOs. Second, highreputation
underwriters will underprice IPOs to a greater extent than lowreputation underwriters. The intuition here is
that, since a lowreputation underwriter backed IPO receives lower secondary market valuations than a high
reputation underwriter backed IPO (for the reasons discussed earlier), the offer price of a lowreputation
underwriter backed IPO will be lower than that of a highreputation underwriter backed IPO for the same
extent of underpricing. This means that a lowreputation underwriter will underprice IPO shares to a smaller
extent than a highreputation underwriter, given that the weight the lowreputation underwriter places on the
IPO offer price in his objective function will be higher for a lower offer price. Third, even after underpricing
IPOs to a greater extent, highreputation underwriters will set the offer prices of IPOs backed by them at a
higher level than lowreputation underwriters (for reasonable model parameter values). The intuition here is
that, as the highreputation underwriter underprices to a greater extent (in order to attract greater institutional
investor participation and thus obtain a higher secondary market price), the offer price chosen by him
becomes lower as a consequence. A lower offer price increases the weight placed on the offer price in the
underwriter’s objective function, while a higher secondary market price (arising as a result of greater IPO
underpricing) will decrease the weight placed on the secondary market price in this objective function. The
equilibrium IPO offer price arising from the above tradeoff will be higher for a highreputation underwriter
backed IPO than for a lowreputation underwriter backed IPO.
8,9
We now specify the testable predictions arising from the market power and the certification
hypotheses. We develop these testable predictions in terms of IPO valuation ratios (i.e., the ratio of primary
and secondary market IPO stock valuations relative to their intrinsic value) rather than IPO underpricing.
This is because underpricing simply reflects the price rise of a firm’s equity from the IPO offer price to the
first day closing price in the secondary market, so that it is affected not only by the price of the equity in the
IPO, but also by the first day closing price of the equity in the secondary market.
10
8
Recall that, even for the same γ
1
(.) and γ
2
(.) functions, the weight placed on the secondary market price in the
objective function of a low reputation underwriter will be greater than that in the objective function of a high reputation
underwriter, since the secondary market share valuation (for a given level of IPO underpricing) will be lower for the
low reputation underwriter, thus inducing him to optimally set a lower offer price.
9
Throughout the above discussion, we assume that the equilibrium offer price emerging from the above tradeoff faced
by high and lowreputation underwriters is below the maximum possible IPO valuation that is achievable by the firm.
This maximum possible IPO valuation will depend on the heterogeneity in investor beliefs in the IPO market, which in
turn will be a function of underwriter reputation and participation by other high quality market players like institutional
investors and analysts.
10
For underpricing to be a meaningful measure in any study of the economic role of underwriters in IPOs, one has to
make the crucial (and rather strong) assumption that the closing price of a firm’s stock on the first day of secondary
5
We use three sets of measures in our empirical analysis. The first measure we study is the ratio of the
valuation placed on the firm in the IPO (valuation at the offer price (OP)) to its intrinsic value (IV).
11
The
implications of the market power hypothesis discussed above suggest that the ratio of the IPO firm value to
intrinsic value will be larger for highreputation underwriter backed IPOs than for lowreputation
underwriter backed IPOs (H1A). On the other hand, if the role of the underwriter in IPOs is that of
certification, one would expect highreputation underwriter backed IPOs to be priced closer to intrinsic value
than lowreputation underwriter backed IPOs, so that this ratio will be closer to one for highreputation
underwriter backed IPOs (H1B).
The second measure we study is the ratio of the valuation placed on a firm at the close of the first
trading day in the secondary market (SMP) to its intrinsic value (IV). The implications of the market power
hypothesis discussed above suggest that this ratio will be higher for the IPOs of highreputation underwriter
backed firms than for the IPOs of lowreputation underwriter backed firms (H2). Of course, one would
expect that the valuation difference between highreputation underwriter backed and lowreputation
underwriter backed IPOs to go down over time as hard information about the operating performance of the
IPO firm becomes available to investors (due to which the heterogeneity in investor beliefs associated with
the reputation of the IPO underwriter dissipates over time). We therefore study the ratio of secondary market
valuation to intrinsic value at the end of one year, two years, and three years after the IPO. The market power
hypothesis predicts that price to intrinsic value ratio of IPOs backed by highreputation underwriters and
lowreputation underwriters should converge to each other and towards unity in the years after the IPO
(H3A). On the other hand, given that firm value is now determined by the equity market (once the firm’s
shares start trading in the secondary market), the certification hypothesis predicts that the secondary market
price to intrinsic value ratio will not change over time subsequent to the IPO (H3B).
The third set of measures relate to the relationship between underwriter reputation and the
heterogeneity in investor beliefs about the IPO firm. Under the market power hypothesis, we expect the
market trading is not affected by underwriter reputation and always equals the intrinsic value of that stock. Clearly, it is
difficult to assume that, in a setting with heterogeneous beliefs and short sale constraints, the price of an IPO firm’s
equity at the close of the first day secondary market trading will equal its intrinsic value (little information regarding the
future performance of the IPO firm is released between the time the IPO offer price is set and the close of trading on the
first day). The empirical literature on the long run underperformance of IPOs (see, e.g., Ritter (1991)) also indicates that
the closing price of an IPO firm’s equity is not equal to its intrinsic value. This literature suggests that, if investors buy
IPO shares at the first trading day closing price and hold them for one to three years, they are likely to earn inferior
returns compared to similar investments in the equity of firms which have been public for some time. Apart from the
above evidence provided by academic studies, it is easy to see from casual observation that the opening day secondary
market price of IPO shares is significantly different from intrinsic value during some periods. One example is the
internet bubble period of 19992000, where a number of IPOs were priced far above their intrinsic value, only to climb
much higher on the first day of trading in the secondary market. It seems obvious (at least in hindsight) that while these
IPOs were highly underpriced (in the sense that their initial returns were very large), they were also significantly
overvalued (relative to intrinsic value).
11
We calculate intrinsic value using multiple methodologies, such as relative valuation using a comparable firm based
on simple matching and propensity score matching (e.g., Purnanandam and Swaminathan (2004)), as well as using a
discounted cash flow method based on Ohlson’s (1990) residual income valuation model.
6
heterogeneity in investor beliefs to be greater for IPOs backed by highreputation underwriters (H4). Clearly,
the greater the heterogeneity in investor beliefs, the higher the valuation of the firm’s equity in the secondary
market (H5). Greater market participation by institutional investors and more reputable comanaging
underwriters will increase the heterogeneity in investor beliefs and should also be positively related to the
secondary market price to intrinsic value ratio (H6). We would also expect that any heterogeneity in investor
beliefs associated with underwriter reputation would dissipate over time subsequent to the IPO (H7) and such
decreases in heterogeneous beliefs will be associated with the decreases in the IPO firm’s stock market value
to intrinsic value ratio (H8). We summarize these testable predictions in Appendix 1.
We find that equity in highreputation underwriter backed IPOs are priced higher and further away
from intrinsic value compared to lowreputation underwriter backed IPOs. One potential explanation for this
result is that it reflects endogenous matching between highreputation underwriters and higher quality issuing
firms, based on unobservable valuerelevant firm characteristics not captured by our valuation methodology.
We use various strategies to control for such endogenous matching between underwriters and issuers. First,
we split our sample into hot and cold IPO markets. Prior literature finds that hot IPO market issuers are of the
same or lower quality than cold IPO market issuers (see, e.g., Helwege and Liang (2004) and Ritter (1991)).
Given the results in the prior literature, the endogenous matching argument would suggest that the valuation
difference between IPOs backed by highreputation underwriters and lowreputation underwriters would be
the same or lower in hot IPO markets than in cold IPO markets. On the other hand, if underwriters with high
reputation find it easier to manipulate investor beliefs in hot markets (when investors are already optimistic;
e.g., Helwege and Liang (2004)), then the relation between underwriter reputation and IPO valuation should
be even more positive in hot markets than in cold markets. We find evidence consistent with the latter
conjecture, that is, the association between underwriter reputation and IPO valuation is more positive in hot
IPO markets than in cold IPO markets, consistent with the idea that highreputation underwriters are able to
more easily manipulate investor beliefs in hot IPO markets.
Second, we exploit the discontinuous nature of NYSE listing requirements for assets to control for
any endogeneity between underwriter reputation and IPO valuation in a regression discontinuity framework.
Finally, we use instrumental variables analysis to correct for the endogeneity between underwriter reputation
and IPO valuation (we discuss the instruments we use in section IV.C.4). We find that, even after controlling
for any such endogeneity using the three methods discussed above, highreputation underwriter backed firms
are associated with higher IPO and secondary market valuations. Thus, our result is robust to correction for
endogenous selection between highreputation underwriters and firms. We then show that the above
relationship between underwriter reputation and postIPO secondary market valuation is associated with
greater heterogeneity in investor beliefs and greater participation by institutional investors, analysts, and
7
highreputation comanaging underwriters that characterize highreputation underwriter backed IPOs.
12
Further, we find that the valuation of IPO stocks converge towards their intrinsic value and the heterogeneity
in investor beliefs decline over the three years after the IPO. Finally, the above decline in IPO stock
valuation over the long run is associated with the decline in the heterogeneity in investor beliefs over the
same time period. Overall, our results support the market power hypothesis and reject the certification
hypothesis.
What do our empirical results tell us about the effect of heterogeneous beliefs among investors (in
the presence of short sale constraints) on IPO valuation and the role of underwriters in IPOs? First, consistent
with the heterogeneous beliefs theory of Miller (1977) and Morris (1996), a greater extent of heterogeneity in
investor beliefs is associated with higher IPO stock valuations. Second, highreputation underwriters are able
to build reputation with issuers by obtaining higher equity valuations for shares sold in the IPO and in the
immediate secondary market. Third, the mechanism through which highreputation underwriters are able to
obtain higher IPO valuations is by generating greater participation by higher quality market players such as
highreputation comanaging underwriters and institutional investors, and by obtaining greater analyst
coverage for IPOs backed by them.
13
This, in turn, changes the sentiment of retail investors in the IPO
market to become more optimistic about the future prospects of these firms, thus increasing the heterogeneity
in investor beliefs and resulting in higher firm valuations.
Fourth, the above pricing behavior by highreputation underwriters may not damage their reputation
with institutional investors, since the valuation of equity in firms backed by highreputation underwriters
becomes even higher (and commands an even higher premium over shares in IPOs backed by lowreputation
underwriters) in the first few days of secondary market trading. Since there is considerable evidence
indicating that there is a significant amount of flipping of IPO shares by institutional investors to retail
investors both in the first few days of trading in the secondary market shares (Aggarwal (2003)) and in the
subsequent months (Chemmanur, Hu, and Huang (2010)), institutional investors may in fact be able to make
higher profits by buying shares in IPOs backed by highreputation underwriters (despite their higher IPO
valuations) by selling them at even higher valuations to retail investors. Finally, the above indicates that the
investors who are least well off from participating in IPOs backed by highreputation underwriters are retail
investors, who, consistent with the well documented longterm underperformance of IPOs (Ritter (1991)),
may be purchasing heavily overvalued shares of equity when they invest in IPOs in the secondary market.
Further, such retail investors are worse off investing in shares backed by highreputation underwriters
12
In unreported tests, we also analyze the relationship between the firm valuation ratio at the IPO and the heterogeneity
in investor beliefs as well as market participants and find results similar to those reported for the postIPO secondary
market. However, our analysis of the secondary market valuation is more appropriate since our independent variables in
this analysis are measured exante relative to the dependent variable (i.e., postIPO secondary market valuation).
13
In unreported tests, and consistent with our expectations, we also find that IPOs backed by higher reputation
underwriters are also associated with greater participation by high quality market players such as institutional investors,
analysts, and more reputable comanaging underwriters.
8
relative to investing in IPOs backed by lowreputation underwriters, since the former are priced higher and
further away from intrinsic value.
The rest of the paper is organized as follows. Section I discusses the related literature. Section II
describes the data and the sample selection methodology. Section III outlines the empirical methodology
used in the paper. Section IV describes the empirical results on IPO underpricing and valuation. Section V
describes our results on heterogeneity in investor beliefs in IPOs. Section VI describes our multivariate
analysis of the mechanisms that may drive the effect of underwriter reputation on the market valuation ratios
of IPO firms and section VII concludes.
I. Relation to the Existing Literature
The evidence provided by the prior literature (e.g., Beatty and Welch (1996), Loughran and Ritter
(2004), and Cooney, Carter, Dark, and Singh (2001)) indicates that highreputation underwriters are also
associated with higher IPO underpricing (i.e., a larger amount of money left on the table) during the 1990s.
We reconcile our results that highreputation underwriters obtain higher IPO and secondary market
valuations with those in the abovementioned literature by noting the following. First, as documented by
Purnanandam and Swaminathan (2004), IPOs can be underpriced and overvalued relative to intrinsic value at
the same time provided that the immediate secondary market price can deviate from intrinsic value (since
underpricing merely captures the initial return from the IPO offer price to the first day closing price in the
secondary market). Second, the money left on the table by underwriters may be a mechanism through which
they share value with market players such as institutional investors and analysts and thus attract participation
by them to the IPOs they underwrite. Thus, highreputation underwriters may leave a greater extent of money
on the table to attract greater participation by these market players, thereby enabling IPO firms to obtain
higher market valuations, both in the IPO and the secondary market. Consistent with this argument,
Chemmanur, Hu, and Huang (2010) document that institutional investors sell a large fraction of their IPO
allocations by the end of the first month after the IPO and capture much of the money left on the table on
these shares. In a similar vein, Aggarwal, Krigman, and Womack (2002), and Cliff and Denis (2004) have
shown that IPOs that leave more money on the table are associated with greater analyst coverage.
In addition to the theoretical and empirical literature (discussed earlier) on the effect of
heterogeneous beliefs among investors on equity valuation, this paper is also related to the broader literature
on the role of financial intermediaries in IPOs: see, e.g., Chemmanur, Loutskina, and Tian (2008) who study
the role of venture backing in IPOs, and conclude that venture capitalists perform a marketing rather than a
certifying role. They, however, do not study the role of underwriter reputation in IPOs. Our paper is also
related to Cook, Kieschnick, and Van Ness (2006), who argue that investment bankers try to promote IPOs to
9
induce sentiment investors to buy the stock.
14
While they show that preoffer publicity is related to
investment bank compensation and IPO underpricing, they do not study the role of underwriter reputation in
IPOs or its impact on the heterogeneity in investor beliefs about the firm’s prospects. Further, our paper is
related to Aggarwal, Krigman, and Womack (2002), who analyze the role of underpricing and analyst
research in determining insider sales around lockup periods. While their paper relates underpricing to analyst
coverage and insider sales at lockup period, our paper analyzes how underwriter reputation affects IPO and
first day closing secondary market valuations. Our paper is also related to the broader theoretical on IPOs
(see Allen and Faulhaber (1989), Chemmanur (1993), Grinblatt and Hwang (1989) and Welch (1989) for
theoretical models of IPO underpricing) and the going public decision (see, e.g., Chemmanur and Fulghieri
(1999)), as well as the empirical literature on the going public decision (see, e.g., Chemmanur, He, and
Nandy (2010) and see Ritter and Welch (2002) for a review of the IPO literature).
15
II. Data and Sample Selection
The initial sample is obtained from the SDC Platinum New Issues database and consists of 7780
IPOs issued between 1980 and 2000. Out of this sample, only 5276 firms are present on the CRSP and
Compustat datasets. As is common in the IPO literature, we remove IPOs of ADRs, nonordinary shares,
REITs, closed end fund shares or unit offerings.
16
We also remove firms with offer price of IPO less than $5,
as well as firms with missing data for assets which leaves us with 3737 IPOs in the sample period.
Panel A of Table I shows the descriptive statistics for our IPO sample. The IPOs in our sample have
a median asset size of $21.07 million, median EBITDA of $3.01 million, and median proceeds from IPO of
about $29 million. Venture capital firms back about 45% of the all the IPO firms in the sample. The mean
underpricing (21%) and the median underpricing (7%) for our sample are consistent with the numbers
reported in Loughran and Ritter (2004) (mean underpricing of 18.7% and median underpricing of 6.3%). We
also provide summary statistics for our measures of heterogeneous beliefs and underwriter market share
(used to measure underwriter reputation).
For further analysis, we need to impose additional filters depending on the intrinsic value calculation
methodology. This further decreases the size of the sample for which we can calculate intrinsic value ratios.
The next section describes these valuation methodologies in detail.
14
See also Ho, Huang, Lin, and Lin (2010), who document that, prior to their offerings, IPO firms tend to report higher
earnings and disclose inflated earnings forecasts in an attempt to manage news coverage around the IPO. Further, Chan
(2010) studies individual versus institutional trades in IPO stocks and documents that IPO stocks’ opentoclose returns
are positively related to small trade participation, small trade purchases, and small trade order imbalance, but only in the
case of hot IPO samples.
15
Houge, Loughran, Suchanek, and Yan (2001) study the relationship between the long term performance of IPOs and
investor uncertainty and the divergence of investor opinion about the firm’s IPO. In contrast, our focus here is on the
effect of heterogeneous beliefs on IPO valuation, and the impact of the underwriter on the above variables.
16
We do not rely only on SDC classification to identify ADRs, nonordinary shares, REITs, and closed end funds.
Instead, we use share codes from CRSP to implement this filter.
10
III. Methodology
A. Intrinsic Value Calculations
To calculate intrinsic value, we follow a methodology similar to the one in Chemmanur, Loutskina,
and Tian (2008) and Purnanandam and Swaminathan (2004). We compute three measures of intrinsic value.
The first measure uses the market valuation of a comparable firm based on similar industry, size, and
EBITDA/sales ratio to that of the IPO firm. The second method uses the market value of a comparable firm
based on a propensity score based matching approach. The final method is a discounted cash flow approach
using Ohlson’s (1990) residual income valuation method. A detailed overview of the three methods follows.
1. The Basic Comparable Firm Approach
The first approach that we use to estimate the intrinsic value of IPO companies is a matching
technique based on finding an industry peer with comparable Sales and EBITDA profit margin
(EBITDA/Sales). This approach is similar to the one followed in Chemmanur, Loutskina, and Tian (2008),
Purnanandam and Swaminathan (2004), and Bhojraj and Lee (2002). We first remove the IPO firms that
have negative or missing sales and EBITDA values in Compustat, which leaves us with 2724 firms. To
obtain candidate firms to match, we use all the Compustat firms that have been public for at least three years
prior to the IPO date and exclude ADRs, foreign company stocks, REITS, nonordinary shares, closed end
funds, and firms with stock price less than $5 at IPO date. The remaining Compustat firms are divided into
48 industry portfolios based on Fama and French (1997) industry classifications. For each year, we divide
each industry portfolio into three portfolios based on sales and then separate each sales portfolio into three
portfolios based on EBITDA profit margin (EBITDA/Sales). This procedure gives us nine portfolios for each
industryyear. If there are less than 3 firms in any of the industryyearsalesEBITDA margin portfolio, we
then do a 2 by 2 sort on sales and EBITDA/sales. If this sort is not sufficient, we then consider only one
portfolio per industryyear. For each IPO firm, an appropriate comparable firm is then chosen from the
corresponding yearindustrySalesEBITDA margin portfolio having the closest sales value to the sales of the
IPO firm. We then estimate the offer price to intrinsic value and secondary market price to intrinsic value
ratios of the IPO firms based on the price multiples of their comparable firms as follows.
(2)
g Outstandin Shares x Price
Sales Fiscal Year Prior
Sales Fiscal Year Prior
g Outstandin Shares x Price Offer
Comparable Comparable
Comparable
IPO
IPO IPO


.

\



.

\

= 
.

\

x
IV
OP
Sales
(3)
g Outstandin Shares x Price
Sales Fiscal Year Prior
Sales Fiscal Year Prior
g Outstandin Shares x Price Closing Day First
Comparable Comparable
Comparable
IPO
IPO IPO


.

\



.

\

= 
.

\

x
IV
SMP
Sales
11
(4)
g Outstandin Shares x Price
EBITDA Fiscal Year Prior
EBITDA Fiscal Year Prior
g Outstandin Shares x Price Offer
Comparable Comparable
Comparable
IPO
IPO IPO


.

\



.

\

= 
.

\

x
IV
OP
EBITDA
(5)
g Outstandin Shares x Price
EBITDA Fiscal Year Prior
EBITDA Fiscal Year Prior
g Outstandin Shares x Price Closing Day First
Comparable Comparable
Comparable
IPO
IPO IPO


.

\



.

\

= 
.

\

x
IV
SMP
EBITDA
(6)
g Outstandin Shares x Price
Earnings Fiscal Year Prior
Earnings Fiscal Year Prior
g Outstandin Shares x Price Offer
Comparable Comparable
Comparable
IPO
IPO IPO


.

\



.

\

= 
.

\

x
IV
OP
Earnings
(7)
g Outstandin Shares x Price
Earnings Fiscal Year Prior
Earnings Fiscal Year Prior
g Outstandin Shares x Price Closing Day First
Comparable Comparable
Comparable
IPO
IPO IPO


.

\



.

\

= 
.

\

x
IV
SMP
Earnings
Here, OP/IV is the offer price to intrinsic value ratio and SMP/IV is the first day closing secondary
market price to intrinsic value ratio for the IPO stock. Offer price of the IPO stock is obtained from the SDC
Platinum database. Shares outstanding is the number of shares outstanding immediately after the IPO for IPO
stocks and the number of shares outstanding on the day closest to the IPO day for the comparable firm. The
shares outstanding data and the market prices are obtained from the CRSP daily files. Earnings, Sales, and
EBITDA data are obtained from the annual Compustat files. Based on this procedure, we are able to
successfully find matching firms for 2655 IPO firms.
2. Propensity Score Based Comparable Firm Approach
The propensity score based approach of obtaining comparable firms has significant advantages over
the basic comparable firm approach. First, the propensity score based approach allows us to match on a
larger set of parameters than the basic matching method. Second, it allows us to control for a possible
endogeneity bias in our intrinsic value calculations.
To expand a bit more on the endogeneity issue, it is possible that highreputation underwriters have
information about the future performance of firms and therefore select firms that they expect to perform
better in the future. This could potentially bias our intrinsic value calculations. To correct for this, we include
three year expost average growth in sales, average growth in cost of goods sold, and average growth in
selling and general expenses in the propensity score model. These variables allow us to control for the
underwriter’s private information regarding improvements in future sales as well as cost efficiency of the
firm.
17
Following Chemmanur, Loutskina, and Tian (2008), we make use of the “nearestmatch” version of
the propensity score based matching approach similar to Dehejia and Wahba (1999, 2002). We run the same
filters for the set of candidate and IPO firms as we did in the basic comparables approach. For each fiscal
17
We explicitly control for endogenous matching between underwriters and firms in section IV.C using instrumental
variables and regression discontinuity analyses.
12
year, we then run a probit model for the set of all IPO and nonIPO firms where the dependent variable takes
on the value 1 if the firm is an IPO firm and 0 if it is not. The independent variables in the regression are
sales, EBITDA to sales ratio, net income to sales ratio, the average three year expost growth in sales, the
average three year expost growth in cost of goods sold, and the average three year expost growth rate in
selling and general expenses. We then obtain the predicted value of the probabilities from the probit model
and match the IPO firm with a nonIPO firm having the closest predicted probability to that of the IPO firm,
while keeping the restriction that the comparable firm must be in the same industry as the IPO firm. Finally,
offer price and secondary market price to intrinsic value ratios are calculated as before using equations (2)
through (7). Based on this procedure, we are able to successfully find matching firms for 2277 IPO firms.
3. Discounted Cash Flow Valuation Method
We also use the discounted cash flow method to compute the intrinsic value of IPO firms. The most
significant benefit of the discounted cash flow method is that we do not have to restrict the sample of firms to
have positive earnings or net income. However, we do require that firms have earnings data for at least 2
years after the IPO date. Intrinsic values computed using this method allows us to check the robustness of the
results from the comparables approach.
The specific model we follow to compute the intrinsic value of the firm is similar to Ohlson (1990).
The intrinsic value of the firm is computed as follows:
The last term is the discounted terminal value of the stock. B
i
is the book value of the issuer in year i
after the IPO, EPS
i
is the earnings per share in year i after IPO. EPS and book value data are obtained from
COMPUSTAT. We assume a constant required return of 13%. We do our calculations with two values of
terminal growth rates, g=0 and g=5% to check the robustness of our results. In doing intrinsic value
calculations, we set terminal value equal to 0 if it is negative under the assumption that managers are unlikely
to continue negative NPV projects to perpetuity. Finally, we only use firms that have positive intrinsic values
for our valuation ratio calculations. Based on this procedure, we are able to compute intrinsic value and
valuation ratios for 2112 firms using the 0% terminal growth rate and 2113 firms using the 5% terminal
growth rate.
18,19,20
18
One firm that had a positive intrinsic value under a 5% growth rate assumption has a negative intrinsic value under a
0% growth rate assumption.
19
There is a potential survivorship bias induced by this methodology since we are using actual future EPS of an IPO
firm. However, surviving firms are likely to have higher intrinsic values. Therefore, keeping the IPO valuation constant,
a survivorship bias should reduce the difference between offer price and the intrinsic value, thus biasing our results
against finding overvaluation of IPOs. Further and more importantly, while a survivorship bias can bias intrinsic value,
(8)
) ( * ) 1 (
1
*
2
) * ( ) * (
) 1 (
*
1 2 0 1 0 1


.

\

÷ +
÷ + ÷
+
+
÷
+ =
g r r
B r EPS B r EPS
r
B r EPS
B IV
o
13
B. Underwriter Reputation Measurement
Our main test variable is underwriter reputation. We use two different market share based measures
for underwriter reputation. The first is the based on Megginson and Weiss (1991) and is calculated as the
total market share of the lead underwriter in the IPO market over the entire sample period. The second
measure is based on the market share of the lead underwriter over a rolling 12 month period prior to the IPO
issue date (e.g., Cooney, Carter, Dark, and Singh (2001)). The market share for a given time period is
calculated as the ratio of total proceeds issued by the underwriter in that period to the total size of the IPO
market in that period. If more than one underwriter acts as a lead underwriter for an issue, we split the
proceeds from that offering equally between each of the lead underwriters to calculate their individual market
share. We then take the average of the market shares of all the lead underwriters of the issue to calculate the
lead underwriter syndicate rank for that issue. We only report results using the Megginson and Weiss (1991)
ranking measure in this paper for brevity (MW ranking from here on). However, all our tests are conducted
using both ranking methods and the results are qualitatively similar when we use the 12 month rolling
rankings.
We also measure the reputation of comanaging underwriters in IPOs in a similar manner. We
calculate the average market share of the comanaging underwriter group for each IPO as a measure of
reputation. The market share for each underwriter who acts as a comanaging underwriter is calculated as the
total proceeds in all IPOs for which the underwriter acts as a comanaging underwriter (IPO proceeds are
split equally among all comanaging underwriters if there is more than one) divided by total IPO proceeds
within the sample period. As with lead underwriters, we also calculate 12 month rolling rankings for co
managing underwriters and conduct all tests using this ranking method.
We use both binary and continuous specifications of underwriter reputation for our tests. The binary
highreputation dummy takes the value 1 if the underwriter reputation is higher than the median of the
sample and 0 otherwise. We only report tests based on the binary version of underwriter reputation variable
to ensure continuity with the univariate comparisons. However, all our multivariate tests are replicated using
it is unlikely to bias the IPO and secondary market valuation of a firm for a given intrinsic value. That is, a survivorship
bias requires that underwriters value IPOs without any regard to intrinsic value, which is unlikely. Since our analysis
focuses on the valuation of a firm in the IPO and the immediate postIPO aftermarket relative to intrinsic value, a
survivorship issue is less likely to affect our results. In addition, since we also conduct our analysis with the comparable
firm methodology, which is less likely to be affected by a survivorship bias, we believe that our results are not driven by
such biases.
20
We also conduct our tests using an expanded specification :
) ( * ) 1 (
1
*
2
) * ( ) * (
) 1 (
*
) 1 (
*
2
2 3 1 2
2
1 2 0 1


.

\

÷ +
÷ + ÷
+
+
÷
+
+
÷
+ =
g r r
B r EPS B r EPS
r
B r EPS
r
B r EPS
B IV
o
The results obtained with this measure of intrinsic value are qualitatively similar as the ones reported in the paper.
14
the continuous market share variables. The results obtained using the continuous variables are similar to the
results reported in this paper.
C. Proxies for Heterogeneous Beliefs
We argue that highreputation underwriters elicit more market participant interest and this in turn is
able to induce higher levels of heterogeneity in retail investor beliefs. This, in conjunction with short sale
constraints, is able to obtain higher valuations for IPOs. To examine the relationship between underwriter
reputation and heterogeneous beliefs, we identify proxies for heterogeneous beliefs. We motivate our proxy
using the model of Harris and Raviv (1993), who argue that when heterogeneous beliefs are higher in the
market, there is more trading between agents and this should be empirically measurable. A number of
empirical papers in the finance literature (see, e.g., Kandel and Pearson (1995)) as well as the accounting
literature (see, e.g., Bamber (1987) and Bamber, Barron, and Stober (1997)) have used trading activity as a
proxy for heterogeneous beliefs among investors. The three market based proxies that we use are daily
volume (defined as the log of the price of the stock multiplied by the number of shares traded in that day),
daily turnover (defined as the ratio of the number of shares of the IPO stock traded in that day to the number
of shares of that stock outstanding on that day), and the number of trades in a given day. The first two
proxies are also used in Chemmanur, Loutskina, and Tian (2008). We add the number of trades as it is also
representative of the trading activity for the stock. We obtain the weekly and monthly values of these
variables by averaging the daily values over time. To control for possible liquidity effects, we also use
adjusted values of the statistics described above. The adjusted values are calculated as the value of the
variable minus the average monthly value of the same variable after three years. The data for calculating the
proxies of heterogeneous beliefs is obtained from the CRSP database.
IV. IPO Underpricing and Valuation
A. IPO Underpricing in the 1980s and 1990s
Panel B of Table I shows how underpricing and underpricing differences between high and low
reputation underwriters have evolved over time. In the table, the “80s period” includes IPOs from 1980 to
1989, the “90s period’ includes IPOs from 1990 to 1998 and the “90s including bubble period” includes IPOs
issued between 1990 and 2000. The above results indicate that the underpricing difference between higher
and lowreputation underwriter backed IPOs has clearly flipped from the 80s to the 90s. The difference in
underpricing between higher and lowreputation underwriter backed IPOs increases from an average of 
1.5% in the 80s to 7.6% in the 90s. The median underpricing difference increases from 0.14% (not
statistically significant) in the 80s to about 4.2% in the 90s. This effect is also documented in Loughran and
Ritter (2004) who find that the average underpricing has gone from being lower for highreputation
underwriter backed IPOs in the 1980s to being higher for highreputation underwriter backed IPOs in the
15
1990s.
21
The above trend highlights our motivating question of the economic role of the underwriter in IPOs.
One of the secondary objectives of this paper is to test whether IPO valuation and the economic role of the
underwriter in an IPO was fundamentally different in the 1980s and 1990s using alternative measures of the
economic role of the underwriter (such as IPO valuation relative to intrinsic value).
B. Univariate Results on Valuation
The univariate tests for primary and secondary market valuation ratios are reported in Tables 2, 3,
and 4. The tables list valuations over the same time periods as the underpricing trend reported in Table I for
ease of comparison. Table II reports the comparisons using the basic comparable firm approach. Based on
the sales multiple, highreputation underwriters obtain a median offer price of about 1.57 times the intrinsic
value for the stock of the IPO firm while lowreputation underwriters get a statistically significantly lower
offer price of about 1.52 times the intrinsic value in the 80s. The results are similar for first day closing
secondary market prices where highreputation underwriters obtain a median offer price that is 1.65 times the
intrinsic market value while lowreputation underwriters obtain a median offer price that is 1.58 times the
intrinsic value in the 80s. The differences are even more stark for the 90s period: here the median offer price
valuation ratio for IPOs backed by highreputation underwriters is 0.36 higher than that for IPOs backed by
lowreputation underwriters. Further, the median first day closing secondary market price valuation ratio for
IPOs backed by highreputation underwriters is 0.46 higher than the median valuation ratios for IPOs backed
by lowreputation underwriter in the 1990s. These differences are highly statistically and economically
significant. The results are also similar for the 90s including the bubble period, where highreputation
underwriter backed IPOs have higher median offer price valuation ratios and first day closing secondary
market price valuation ratios than lowreputation underwriter backed IPOs. The results obtained above hold
when we use valuation ratios based on EBITDA and earnings multiples.
22
Table III shows that the results are similar when we use the propensity score based comparable firm
approach. This method controls for the possibility that highreputation underwriters could potentially select
better firms and therefore bias the basic comparable method results. For the sales multiple based valuation,
there is a statistically significant difference of 0.28 between the median offer price valuation ratios of high
and lowreputation underwriter backed IPOs and 0.32 between the median first day closing secondary market
price ratios of high and lowreputation underwriter backed IPOs. The results based on valuation ratios using
21
Carter, Dark, and Singh (1998) and Megginson and Weiss (1991) document a negative relationship between
underwriter reputation and IPO underpricing using data from 1980s.
22
To test whether clustering around industry and year can affect the standard errors in our univariate analysis, we
calculate the Somers’ D clustered statistic and the 90% confidence intervals for the HodgesLehmann clustered median
difference test for all the univariate results presented here. Our results do not change qualitatively. Similarly, all
subsequent multivariate tests on valuations are conducted with and without clustering on industry as well as the year of
issue. Our results are robust to clustering the standard errors.
16
other multiples are qualitatively similar although the statistical significance using the EBITDA multiple is
weaker. Finally, we use the discounted cash flow approach to value the IPO stocks in Table IV. The reported
results are generally consistent with the results above and corroborate our hypothesis that highreputation
underwriters obtain higher primary and secondary market valuations for their clients.
We show in subsequent sections that our valuation ratios are higher for highreputation underwriters
in multivariate tests as well as in tests that control for endogenous matching between underwriters and firms.
Overall, our empirical results indicate that highreputation underwriters are able to obtain higher valuations
in both the primary and the secondary markets for their clients, consistent with our hypotheses (H1A) and
(H2). The results in this section are consistent with the idea that the underwriter’s primary goal is to get the
highest possible valuation for their clients and that highreputation underwriters are better at obtaining these
higher valuations. Moreover, these valuation results are consistent across the 1980s and 1990s in the sense
that highreputation underwriters obtain higher valuations than lowreputation underwriters in both these
time periods. In contrast, the underpricing results are not consistent in the 1980s and 1990s.
C. Multivariate Results and Endogenous Matching between Underwriter Reputation and Firms
1. OLS Regressions in the Full Sample.
Panel A of Table V reports the results from the OLS regression of the log of our offer price to
intrinsic value ratio and the log of the first day closing secondary market price to intrinsic value ratio. We
control for firm size, whether or not the firm is backed by a venture capitalist, and the fraction of the firm
sold in the IPO. In addition, we control for industry and year fixed effects. In these regressions, we use both
the dummy and the log of the continuous version of underwriter reputation. The OLS model confirms our
univariate results that highreputation underwriters are associated with higher valuations, both in the IPO and
the immediate postIPO secondary market. In particular, we find that IPOs backed by highreputation
underwriters (based on the highreputation dummy) are associated with a 37.5% increase in the offer price
valuation ratio and a 44.6% increase in the secondary market price valuation ratio. Similarly, a one standard
deviation increase in the underwriter reputation is associated with a 30% increase in the offer price valuation
ratio and with in the secondary market price to valuation ratio.
In terms of the control variables, we find that IPOs of larger firms are associated with lower
valuations. Further, IPOs of firms backed by venture capitalists are associated with higher valuations,
consistent with expectations. IPOs of firms selling larger fraction of equity are associated with lower
valuations, consistent with investors viewing sales of higher stakes in the firm with greater apprehension.
2. IPO Valuation by Underwriters in Hot and Cold IPO Markets.
In this section, we test whether the association between underwriter reputation and the valuation of
IPO stocks changes depending on whether the IPO market is hot or cold. If all that is happening is that high
17
reputation underwriters systematically pick better firms based on underlying and unobservable quality, then
the association between underwriter reputation and valuation of IPO stocks during hot IPO markets should
not be different from that in cold IPO markets (see below for further explanation). If, on the other hand, high
reputation underwriters have greater ability to obtain higher valuation by making investors optimistic, then
they should obtain even higher valuations than lowreputation underwriters in hot IPO markets, when
investors can be more easily manipulated.
We rely on an important assumption for this test. We assume that higher quality firms are equally or
less likely to conduct IPOs in hot markets than in cold markets. Various empirical papers have demonstrated
this. For example, Helwege and Liang (2004) find no difference either in the characteristics such as size,
growth potential, and industry or in the postIPO operating performance of firms whose IPOs are issued in
hot markets relative to those whose IPOs are issued in cold markets. Ritter (1991) finds that longrun IPO
stock return underperformance is actually higher in high volume years (consistent with IPOs issued in hot
markets underperforming relative to those issued in cold markets).
The assumption that the quality of firms is not different between hot and cold markets allows us to
keep the effect of any endogenous matching between underwriters and firms on valuation constant across hot
and cold IPO markets. Further, the possibility that hot IPO market firms’ quality may be worse than cold IPO
market firms’ quality, on average, predicts that the incremental effect of underwriter reputation on IPO
valuation will be lower in hot IPO markets compared to cold IPO markets (based on the endogenous
matching conjecture). On the other hand, if highreputation underwriters can obtain higher valuation for the
IPOs that they back by manipulating investor sentiment, then we expect that the effect of underwriter
reputation on IPO valuation will be higher in hot IPO markets compared to cold IPO markets. This is because
highreputation underwriters will find it easier to manipulate retail investor beliefs in hot markets, when
investors tend to be more optimistic. Evidence from Helwege and Liang (2004) is consistent with this
argument.
We define hot IPO markets by using the three month moving averages of the number of IPOs prior
to the sample IPO. Specifically, if the average number of IPOs in the three months prior to the sample IPO is
greater than the sample median, we categorize the IPO to be issued in a hot market, and vice versa. Panel B
of Table V reports the results of the OLS regressions of the IPO valuation ratios split by hot and cold IPO
markets. We find that while underwriter reputation has positive coefficient estimates in both hot and cold
IPO markets, the coefficient estimate on underwriter reputation is significantly higher in hot markets than in
cold markets. Economically, a one standard deviation in underwriter reputation has a 18% higher association
with the IPO offer time valuation ratio in hot markets compared to that in cold markets. Similarly, based on
the highreputation underwriter dummy we find a 22% higher association between underwriter reputation
and valuation in hot IPO markets relative to cold IPO markets.
18
In summary, we find evidence that the positive association between underwriter reputation and IPO
valuations is consistent with the manipulation of investor beliefs by IPO underwriters, consistent with
hypotheses (H1A) and (H2).
3. Endogenous Matching between Underwriter Reputation and Firms: Regression Discontinuity
Analysis
In this section, we analyze the causal effect of underwriter reputation on IPO valuation using a
regression discontinuity (RD) analysis. In particular, we use the “fuzzy” RD technique discussed in Van der
Klaauw (2002) and Angrist and Lavy (1999). Identification in a fuzzy RD technique comes from a
discontinuous jump in the expected probability of treatment. Van der Klaauw (2002) and Angrist and Lavy
(1999) analyze the effect of jumps in continuous treatment variables on their variables of interest. We use the
twostage approach discussed in the papers above to implement our RD analysis.
We estimate the following model:
j j j j
z x y c o  + + = (9)
where, z
j
is the potentially endogenous treatment variable. The fuzzy RD approach requires a variable (we
will call it the assignment variable) S
j
such that z
j
experiences a jump at a known point S
0
. Note that, unlike
an instrumental variables approach, S
j
can be correlated with the error variable, ε
j
. The restriction required for
identification is that no other effect causes a jump in y
j
at S
j
= S
0
. The regression discontinuity can then be
implemented with a twostage approach. We first estimate,
j j j j
S S S f z q ¸ + > + = } { 1 . ) (
0
. (10)
where, f(S
j
) is a continuous function of S
j
, 1{S
j
≥ S
0
} is an indicator function that equals 1 if S
j
≥ S
0
, and η
j
is
an error term. We augment the second stage equation with the conditional expectation E(z
j
 S
j
), which is
calculated as the predicted value from (10). The second stage model is then:
j j j j j j
u S S z E x y + + + = . )  ( . ì o  . (11)
We use a piecewise quadratic functional form for f(S). Specifically, f(S) = ¢
1
S
+ ¢
2
S
2
+ ¢
11
(S – S
0
).
1{S
j
≥ S
0
} + ¢
11
(S – S
0
)
2
. 1{S
j
≥ S
0
}.
The standard errors in the second stage are bootstrapped to account for
generated regressors. This approach is analogous to an instrumental variables approach, with the
discontinuity 1{S
j
≥ S
0
} serving as the identifying instrument.
We exploit the discontinuity arising from NYSE listing requirements for net tangible assets from the
sample period 1980 to 1997. NYSE required $16 million in assets for listing till 1983, $18 million from 1984
to 1994, and $40 million from 1995 to 1997 for a company to list on the exchange. After that, NYSE listings
did not have restrictions based on assets.
23
Therefore, to account for the changes in the NYSE listing
23
See Anderson and Dyl (2008) and Cowan, Carter, Dark, and Singh (1992).
19
requirements over time (using the sample from 1980 to 1997), our assignment variable S
j
, is defined as log
normalized level of assets, i.e.,
S
j
=log(
Pì¡m usscts
N¥SL ussct Iìstìng ¡cquì¡cmcnts
)
Our identification strategy depends on the idea that firms that are larger than the listing requirement
for NYSE, i.e., S
j
≥0, will be more likely to list on the NYSE.
24
Evidence in prior literature shows that NYSE
listings are related to higher liquidity and more visibility and investor recognition for the firm (Kadlec and
McConnell (1994), Grammatikos and Papaioannou (1986)), thus reducing the necessity of a highreputation
underwriter. Thus, while the endogeneity argument would predict that underwriter reputation is positively
related to firm size (to the extent that firm quality is correlated to size), this relation would reverse in a
discontinuous manner at the point where the firm becomes eligible to list on the NYSE; since highreputation
underwriters’ services, such as creating liquidity and investor recognition are, to some extent, substituted by
the NYSE listing.
We show a graphical analysis of the discontinuity. Figure 1 graphs kernel weighted mean smoothing
estimations between underwriter reputation (measured as the log of underwriter market share) and the
normalized size variable. The graph clearly indicates that there is a sudden decline in the underwriter
reputation at 0, as expected, thus supporting our identification strategy.
The results of the regression discontinuity analysis are reported in Table VI. Consistent with our
expectation, the coefficient estimate on the jump point indicator (i.e., 1{Norm. Size >0}) is statistically
significant and negative in the first stage regression, indicating that there is a downward jump in the
propensity in the underwriter reputation at the point where a firm becomes eligible to list on the NYSE based
on assets. In the second stage, we find that the coefficient estimate on the predicted underwriter reputation
from the first stage is positive and statistically significant. Thus, after controlling for the selfselection
between firms and reputed underwriters using the regression discontinuity approach, we find that high
reputation underwriters are linked to higher valuations, both in the IPO and the first day closing secondary
market, which is consistent with (H1A) and (H2).
One concern with the assignment variable may be that firms may be able to manipulate their size
levels to comply with NYSE requirements. McCrary (2008) argues that such active sorting may undermine
the identification requirements of the regression discontinuity design. To rule out this concern, we
graphically and statistically analyze the density function of the normalized size variable around the cutoff
point (i.e., at S
j
=0). Visual analysis of the graph indicates no upward jump of S
j
at the cutoff point. We then
conduct the statistical test recommended in McCrary (2008) to ensure that our identification strategy is valid.
24
NYSE also has other restrictions for firms to be eligible for listing. Some listing requirements such as total market
value of shares can be directly influenced by underwriters, due to which such variables are unsuitable as candidates to
obtain a discontinuity for our analysis. In addition, income requirements are more complicated and based on different
levels of required income levels in one, two, and three years prior to the IPO, which makes analysis less tractable.
20
The test is implemented as a Wald test of the null hypothesis that the discontinuity in the density function of
the assignment variable is zero at the cutoff point. The test does not find a statistically significant jump in the
density function of the assignment variable S
j
at the cutoff point, i.e., S
j
= 0, thereby validating our
identification strategy.
25,
26
4. Endogenous Matching between Underwriter Reputation and Firms: Instrumental Variables
Analysis
We use instrumental variables analysis to demonstrate the causal effect of underwriter reputation on
IPO valuation using instrumental variables methodology. We use two instruments to satisfy exclusion
restrictions. The first instrument is the location concentration of the underwriter used in the IPO. This is
defined as the Herfindahl index of the amount of IPOs underwritten by the lead underwriter across different
states, measured over five years prior to the sample IPO. IPO underwriters that concentrate on fewer
geographic locations are less likely to gain large market shares, and we expect a negative relation between
this variable and underwriter reputation.
27
The second instrument that we use is the availability of
underwriters that have experience in the industry of the firm, based on FamaFrench industries. This variable
is the unique count of underwriters that have underwritten IPOs in the same industry as the IPO firm in the
past five years. More underwriters with experience in the industry of the firm increases the bargaining power
of the firm that may reduce the cost of hiring a highreputation underwriter.
28
Thus, we expect this
instrument to be positively correlated with underwriter reputation.
The results of our IV analyses, implemented as a two stage least squares model (using the continuous
version of underwriter reputation) and a treatment effects model (using a binary version of underwriter
reputation), are reported in Table VII. We report the results of the first and the second stage models
separately. The standard errors in the second stage are corrected for the estimation error from the first stage
(Maddala (1983)). In the first stage of the two stage least squares model, we find that, consistent with our
25
The estimator for this test is calculated in two steps. First, one obtains a finely gridded histogram. Second, one
smoothes the histogram using local linear regressions separately on either side of the cutoff point. The test statistic is
based on the estimates of the density function from local linear regressions from the two sides of the cutoff point.
26
Another concern with our identification strategy is that NYSE listed firms may have higher valuations if NYSE
listing itself provides greater investor recognition and reduces information asymmetry for the firm going public.
However, since the eligibility for NYSE listing is negatively related to the propensity of using a higher reputation
underwriter in Table VI, such an effect would diminish the effect of the predicted underwriter reputation on IPO
valuation, thus biasing the results against finding a positive relation between underwriter reputation and IPO valuation.
27
An argument against such an instrument is that perhaps by localizing, underwriters are able to specialize in their local
areas, and thus can obtain higher valuation through better certification. We, therefore, split our sample into quartiles
based on the location concentration variable and analyze the difference in the valuation of IPOs relative to intrinsic
value of the highest and the lowest quartile and do not find a statistically significant difference between these two
groups. In addition, to control for the possibility that any other firm related statespecific effect may be contained in this
variable, we control for the fixed effects of the state in which the sample IPO firms are located.
28
As before, the instruments for multiple lead underwriters in an IPO underwriting syndicate are the average values of
the instrument across all the lead underwriters.
21
expectations, underwriter location concentration is negatively related to underwriter reputation. The first
stage Fstatistic is 274.92 and highly statistically significant at the 1% level, and the partial Rsquared is
23.2% suggesting that our instruments are significant predictors of underwriter reputation (Staiger and Stock
(1997), Stock and Yogo (2005)).
29
As expected, underwriter location concentration is negatively associated
with underwriter reputation and industry underwriter availability is positively associated with underwriter
reputation. Since we have two instruments, we are able to conduct the test of overidentifying restrictions and
are unable to rule out the null hypothesis that our instruments are exogenous.
We find that, after controlling for the endogenous selection of reputable underwriters using two stage
least squares analysis, highreputation underwriters are associated with higher valuations, both in the IPO
and the immediate postIPO secondary market. Our results for the treatment effects model remain similar to
those from the two stage least squares model. Thus, using IV analyses, we find the same results as in the
previous two subsections, namely IPO underwriter reputation has a positive causal impact on the valuation
of the stock in IPOs that they back, consistent with hypotheses (H1A) and (H2).
.
D. Dynamics of Valuation Ratios
We analyze how valuation ratios of IPO stocks evolve over time over a period of one, two, and three
years after the IPO date. To do this we calculate the intrinsic value of IPO stocks using the valuation
methodologies discussed above for one, two, and three years after the IPO and calculate the ratios in each of
these periods. For the comparable firms approaches (both the basic and propensity score based comparable
firm approaches), we find a new matched firm every year for one, two, and three years after the IPO date.
Table VIII reports the dynamics for the sales and earnings multiple based valuation ratios for both
the basic comparable firm and the propensity score based comparable firm approaches. The table lists the
valuation ratios at offer time, the first day closing, one, two, and three years after the IPO. The dynamics for
the propensity score based price ratios are graphed in Figure 2. We find two interesting patterns of valuation
ratios over time that significantly support our hypotheses and our intrinsic valuation methodology. First, the
median valuation ratios decrease over time for both high and lowreputation underwriter backed IPOs and
move towards unity. Consider, for example, the sales multiple based ratio dynamics for the propensity score
based comparable firm approach in Panel B. The ratio decreases from 1.823 at offer time to 1.295 at three
years after the IPO date for highreputation underwriter backed IPOs. For the lowreputation underwriters
backed IPOs, the ratio decreases from 1.393 at the offer time to 1.088 at three years after the IPO date. We
find similar declines in valuation ratios for the earnings multiple based ratio. Further, the analysis obtains
similar results even when we use the basic comparable firm approach. Given that the effect of the
29
The F statistic is for the test of the joint significance of the coefficient estimates on the two instruments in the first
stage. The partial Rsquare measures the correlation between the endogenous variable and instruments after partialing
out the effect of the other exogenous variables.
22
underwriter diminishes over time and that our valuation measures are not biased, this is the convergence
pattern one would expect to see over time. This gives credibility to our valuation methodology since one
would expect that the effect of underwriters on valuations fades over time and the valuations of IPOs
converge towards their intrinsic values.
Another aspect of the valuation dynamics is that the difference in valuation ratios between high and
lowreputation underwriter backed IPOs is decreasing over time after the IPO. For example, for the sales
multiple based ratio dynamics using the propensity score based approach, the difference in valuation between
high and lowreputation underwriter backed IPOs starts from 0.43 at the IPO date, then increases to 0.663 at
the closing of the first trading day, and then decreases to 0.206 by the third year. For the earnings multiple
based ratio dynamics using the propensity score based approach, the pattern is similar: the valuation
difference between high and lowreputation underwriter backed IPOs first increases from 0.232 at the IPO
date to 0.382 at the closing of the first trading day, and then decreases to a very small and statistically
insignificant value of 0.061 at the end of three years. This convergence in valuation further supports the idea
that the effect of underwriter reputation on valuation diminishes over time.
In summary, we document the dynamics of valuation ratios of IPO stocks over a time period of three
years after the IPO. We find that the valuation ratios of IPOs decrease over time towards 1. We also find that
the valuation ratios for high and lowreputation underwriter backed IPOs converge towards each other
indicating that the effect of underwriter reputation diminishes over time. The above results provide evidence
consistent with hypothesis (H3A). The results obtained in this section also provide credibility to our
valuation methodology.
V. Heterogeneous Beliefs in IPOs
A. Heterogeneous Beliefs
Now we test whether highreputation underwriters associated with higher levels of heterogeneity in
investor beliefs about the IPO firm’s future prospects. This, in conjunction with short sale constraints, is
hypothesized to obtain higher prices for the IPO firm’s equity in the primary and the immediate postIPO
secondary markets.
Panels A, B, and C of Table IX report regressions with dependent variables as log of adjusted first
day volume, log of adjusted first day turnover, and log of adjusted first day number of trades, respectively.
30
The multivariate results are consistent with our expectations. The coefficient estimate on high underwriter
reputation dummy is positive and significant even after controlling for size, venture capital backing, number
of analysts estimating earnings, number of institutions, percentage institutional holdings, number of co
managing underwriters, comanaging underwriter reputation, and year and industry dummies. Interestingly,
30
We also conduct the same tests with unadjusted values and the results are qualitatively similar.
23
the coefficient on the highreputation dummy decreases as we add more market participant variables. The
coefficients on number of analysts, number of institutions, percentage institutional holdings, number of co
managers, and comanaging underwriter reputation variables are generally statistically significant and
positive. In Panel A, the coefficient on the underwriter reputation dummy is 0.255 in specification (4) and
this corresponds to a 29% increase in the adjusted volume. This result indicates that highreputation
underwriters are associated with higher dispersion in investors’ beliefs. We see similar results in the adjusted
first day turnover regressions in Panel B of Table IX. Here, we get a coefficient of 0.133 on the underwriter
reputation dummy. The results for adjusted number of trades are similar to the results described above and
are reported in Panel C of Table IX. We also find that institutional investor, analyst, and reputable co
managing underwriter participation is positively related to high heterogeneity in investor beliefs, consistent
with greater heterogeneity in investor beliefs being related to high quality market participants.
In summary, we find evidence consistent with a positive association between highreputation
underwriters and higher dispersion of beliefs among investors. The evidence in this section is therefore
consistent with hypothesis (H4).
B. The Dynamic Pattern in Heterogeneous Beliefs
We argue that highreputation underwriters are able to induce significantly higher dispersion in the
beliefs of investors. We also conjecture that the effect of underwriter reputation may disappear over time. To
test this hypothesis, we study the dynamic pattern in our heterogeneous beliefs proxies over time. We obtain
the heterogeneous beliefs variables for one, two, and three years after the IPO date. The methodology used
for calculating the variables is the same as the one used for the IPO period.
Table X reports the dynamic pattern for our proxies of heterogeneous beliefs. We find that adjusted
volume, adjusted turnover, and the adjusted number of trades all decrease for both high and lowreputation
underwriter backed IPO stocks for the three years after the issue date.
31
This is consistent with the idea that
the heterogeneity in investor beliefs about the IPO stock decreases over time. The above results are also
consistent with the results on the dynamics of IPO valuations over time reported in section IV.D, i.e.,
valuation premiums for IPO stocks decline over time. For instance, the median adjusted volume comes down
from 39.31 at the IPO date to a statistically insignificant value of 0.001 at the end of three years for high
reputation underwriter backed IPO stocks. A similar pattern is observed for median adjusted volume of low
reputation underwriter backed IPOs.
We also find that the difference in heterogeneous beliefs between high and lowreputation
underwriter backed IPO stocks diminishes over time. The difference in adjusted volume between high and
lowreputation underwriter backed IPOs decreases from 31.85 in year 0 to a statistically insignificant and
31
The results for the unadjusted values of our heterogeneous beliefs proxies are qualitatively similar.
24
economically small value of 0.002 in year 3. Similarly, the difference in median turnover between high and
lowreputation underwriter backed IPOs is the highest at time 0 at about 6.5% and comes down to an
economically small value of 0.01 % by the end of year 3. We find similar patterns for median adjusted
number of trades.
In summary, we find evidence indicating that the heterogeneity in investor beliefs decreases over
time and that the difference in the heterogeneity in investor beliefs between high and lowreputation
underwriter backed IPO stocks (which is high at the time of the IPO) also decreases over time. This is
consistent with the idea that the effect of underwriter reputation fades over time.
VI. Multivariate Analysis of the Effect of Underwriter Reputation on Secondary Market Valuations
and the Role of Market Participants and Heterogeneous Beliefs
A. The Relationship between Heterogeneous Beliefs and Market Participants on IPO Secondary
Market Valuation
We now conduct multivariate analysis of the effect of underwriter reputation on secondary market
valuations and directly link the increase in the extent of participation by various market players in the IPO
and heterogeneity in investor beliefs about the IPO stock induced by underwriter reputation to the IPO
valuation. We expect to see a positive coefficient on the high underwriter reputation dummy after controlling
for size, venture backing, fraction of the firm sold in the IPO, and year and industry effects. We also expect
to see that as we add comanaging underwriter and institutional investor variables, the coefficient on the high
underwriter reputation dummy should diminish, since we expect that underwriter reputation should affect
secondary market valuations through these channels. The coefficient on the high underwriter reputation
dummy should decrease further as we add proxies for heterogeneous beliefs of investors, consistent with our
conjecture that highreputation underwriters’ positive effect on valuations may be driven by heterogeneity in
investor beliefs.
Table XI reports the results of our multivariate regressions with the log of first day closing secondary
market price to intrinsic value ratio as the dependent variable. As expected, the coefficient on the high
reputation dummy in regression specification (1) is statistically significant and positive. The coefficient on
highreputation dummy for offer price ratio in specification (1) is 0.369 which corresponds to a 44.6 percent
increase in the secondary market valuation ratios for highreputation underwriter backed IPOs as compared
to lowreputation underwriter backed IPOs. Further, the coefficient on the highreputation dummy decreases
as we add the market participant and heterogeneous beliefs proxies.
The coefficients on the number of institutional investors participating in the IPO and the percentage
institutional holdings are also positive and significant. The coefficient on institutional investor holdings in
specification (3) is 0.229 and statistically significant at the 1 percent level. From this coefficient, we infer
that a 1% increase in institutional investor holdings increases the secondary market valuation ratio by 25.7
25
percent. Further, comanaging underwriter reputation also has an economically meaningful impact on
secondary market valuation ratios. The positive and statistically significant coefficient of 0.230 on co
manager reputation in specification (6) corresponds to an increase in the secondary market valuation ratio of
25.86 percent when the comanaging underwriter reputation increases by 1 percent. Thus, we find that
participation by various market players has an economically meaningful impact on IPO secondary market
valuations. Further, as we add more market participant variables to the regression equations, the statistical
and economic significance of the coefficient on the underwriter reputation dummy decreases. This indicates
that underwriters’ effect on valuations may be partly driven by the participation of more and higher quality
market participants.
The analysis also indicates that the effect of the heterogeneous beliefs proxies on the secondary
market valuations is statistically significant and positive. The coefficient on adjusted first day volume in
specification (9) is 0.323 and statistically significant at the 1 percent level. This coefficient corresponds to a
38.1 percent increase in the secondary market valuation ratio for a 1 percent increase in the adjusted first day
volume. Thus, the association between heterogeneous beliefs of investors on the IPO stock’s secondary
market valuations is economically significant. Moreover, adding the proxies for heterogeneous beliefs in the
regression equations leads to a further reduction in the statistical and economic significance of the coefficient
on the underwriter reputation dummy. This suggests that the positive association between highreputation
underwriters and secondary market valuations is driven by the greater heterogeneity in investor beliefs
associated with highreputation underwriter backed IPOs.
Overall, our multivariate analysis of secondary market valuations is consistent with the hypothesis
that highreputation underwriters’ ability to obtain higher valuations is driven by more market participants
and higher levels of heterogeneity in investor beliefs. These results are consistent with hypotheses (H2),
(H5), and (H6).
B. Relationship between Long Run Changes in Heterogeneous Beliefs and IPO Stock Valuation
We also analyze whether the long run declines in IPO market valuation (that we found in Table VIII)
and the long run decline in heterogeneous beliefs of investors (that we found in Table X) are related to each
other. In particular, our arguments suggest that heterogeneity in investor beliefs is associated with higher
market valuations. A finding that changes in heterogeneity in investor beliefs over the long run are associated
with changes in the market value to intrinsic value ratios of the IPO firm’s stock would provide additional
evidence to support the above conjecture.
32
We conduct this analysis in two different ways. First, we regress
the difference in secondary market price to intrinsic value ratios on the change in the daily adjusted measures
of heterogeneity in investor beliefs. As in the prior section, we use exante measures of heterogeneous beliefs
32
We are grateful to the anonymous referee for suggesting this analysis.
26
to predict the expost market value to intrinsic value ratio. Second, we regress the level of secondary market
ratio on the level of daily adjusted measures of heterogeneity in investor beliefs and firm fixed effects. Both
tests analyze how the changes in secondary market to intrinsic value ratios over time are related to the
changes in heterogeneity in investor beliefs. Whereas the first test directly analyzes these changes, the second
test analyzes the time variation in the market value to intrinsic value ratio and measures of heterogeneous
beliefs by controlling for crosssectional variation (i.e., firmspecific variation) by using firm fixed effects.
Table XII reports the results of both the analyses described above. Note that we reshape the data to a
panel format for these tests. Thus, we have the IPO day closing, one year, two year, and three year post IPO
valuation ratio and heterogeneous beliefs data as separate observations for each firm (which allows us to use
firm fixed effects). In other words, the observation is at the firmevent year level, where the event year is 0
for the IPO year, 1 for the year after the IPO year, and so on. The empirical results, in both the difference
regressions and the fixed effects regressions are broadly consistent with our conjecture that the changes in
heterogeneity in investor beliefs are positively related to the changes in secondary market value to intrinsic
value ratios of the IPO firm’s stock over the three year period after the IPO. As a result, the declines in
heterogeneous beliefs over time are associated with the declines in IPO valuation ratios.
The results in this section provide additional support to our conjecture that IPO stock valuations are
indeed associated with heterogeneity in investor beliefs. Since the heterogeneous beliefs measures are ex
ante (i.e., measured prior to the valuation date), the results above show that greater heterogeneity in investor
beliefs is associated with greater valuations, and further, as the heterogeneity in investor beliefs decreases
after the IPO date, the market value to intrinsic value ratio also decreases.
VII. Conclusion
Several theoretical papers have argued that the valuation of equity will reflect the beliefs of the most
optimistic investors and be at a premium over intrinsic value when investors subject to short sale constraints
have heterogeneous priors. We test the above theories by analyzing the effect of IPO underwriter reputation
on the heterogeneity in investor beliefs and consequently on equity valuation in IPOs. We propose a “market
power” hypothesis, postulating that highreputation underwriters are able to attract a greater number of
higher quality market participants (such as institutional investors, analysts, and comanaging underwriters) to
the IPOs backed by them, thereby yielding higher IPO valuations by increasing the heterogeneity in investor
beliefs. We empirically distinguish the above hypothesis from the “certification hypothesis,” which implies
that highreputation underwriters are associated with IPOs priced closer to intrinsic value.
We find that equity in highreputation underwriter backed IPOs are priced higher and further away
from intrinsic value compared to lowreputation underwriter backed IPOs; this result is robust to controlling
for endogenous matching between highreputation underwriters and higher quality issuers using instrumental
variables and regression discontinuity analyses. We show that the above relationship between underwriter
27
reputation and market valuation is driven by the greater heterogeneity in investor beliefs and greater
participation by institutional investors and highreputation comanaging underwriters that characterize high
reputation underwriter backed IPOs. Our results support the market power hypothesis and contradict the
certification hypothesis. Further, unlike results based on IPO underpricing, the evidence based on our
measures indicates that the economic role of the underwriter remains the same across the 1980s and the
1990s.
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Appendix 1: Summary of Empirical Predictions
Variable(s) of Interest Empirical Predictions
Offer price to intrinsic value
ratio
H1A: Market power Hypothesis Highreputation underwriter backed IPOs will have
higher offer price to intrinsic value ratios than lowreputation underwriter backed IPOs.
H1B: Certification Hypothesis Highreputation underwriter backed IPOs will have offer
price to intrinsic value ratios closer to 1 than lowreputation underwriter backed IPOs.
Secondary market price to
intrinsic value ratio
H2: Highreputation underwriter backed IPOs will have higher first day closing
secondary market price to intrinsic value ratios than lowreputation underwriter backed
IPOs.
Market price to intrinsic
value ratios over time
H3A: Market power Hypothesis Over the long run, the stock price to intrinsic value
ratios of higher and lowreputation underwriter backed IPOs should converge towards
each other and towards unity.
H3B: Certification Hypothesis Over the long run, the stock price to intrinsic value ratios
should not change.
Heterogeneous beliefs
associated with the IPO firm
stock
H4: Highreputation underwriter backed IPO stocks will have more heterogeneity in
investor beliefs compared to lowreputation underwriter backed IPO stocks.
Heterogeneous beliefs,
market player participation,
and IPO valuation
H5: Higher levels of heterogeneous beliefs will be associated with higher first day closing
secondary market price to intrinsic value ratios for IPO stocks.
H6: Higher Participation by market players will be associated with higher first day
closing secondary market price to intrinsic value ratios for IPO stocks.
Changes in Heterogeneous
Beliefs and IPO valuation
over time
H7: Heterogeneity in investor beliefs will decrease over time over the long run.
H8: Decreases in heterogeneous beliefs will be associated with decreases in secondary
market price to intrinsic value ratio over the long run.
Table I. Summary Statistics and Underpricing Trend in the 1980s and the 1990s
This table reports the descriptive statistics for a sample of IPOs. IPOs with an offer price below $5.00 per share, unit offers, REITs, closedend funds, banks and S&Ls, and ADRs are excluded. Total
Proceeds (in $ millions) and venture backed dummy are as reported in SDC. Assets (in $ millions) and EBITDA (in $ millions) are as reported in Compustat for the fiscal year prior to the IPO date.
Underpricing is the percentage change in stock price from the offer price to the closing value at the end of the first trading day. Offer price data is from SDC while first day closing prices are obtained
from CRSP. Daily volume is calculated as log (number of shares traded during the first trading day multiplied by price). Daily turnover calculated as the first day turnover. Daily number of trades
calculated as the first day number of trades. The adjusted values of the volume, turnover, and number of trades variables are calculated by subtracting from them the average monthly value of that
statistic calculated 3 years after the IPO date. Panel A reports descriptive statistics for the full IPO sample; Panel B reports the time trend of underpricing for the sample. “80s” time period corresponds to
issues that are placed between 1980 and 1989, “90s” time period corresponds to issues placed between 1990 and 1998, and “90s incl. bubble” time period corresponds to issues placed between 1990 and
2000. “Highreputation underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the sample. “Lowreputation underwriter” stands for IPOs whose
lead underwriting syndicate has reputation rank lower than the median. The ranking is calculated as the average market share of the lead underwriting syndicate over the sample period based on
Megginson & Weiss (1991). Data are from SDC Platinum, CRSP, and Compustat. The statistical significances are for the ttest for the differences for the equality of means and the WilcoxonMann
Whitney ranksum test for the equality of medians of two subsamples.
Panel A. Summary statistics
Assets EBITDA
Total
Proceeds
Venture
Backed
Underpricing
Adj. Daily
Volume
Adj. Daily
Turnover
Adj. Daily
Number of
trades
Underwriter
Market
Share
High
reputation
Underwriter
Mean 229.22 29.13 67.65 0.54 0.29 102.30 23.27 4097.93 0.045
Median 30.99 4.31 42.00 0.11 39.31 19.76 840.76 0.024
Std. Dev. 1088.41 169.12 86.54 0.50 0.57 252.44 18.81 8787.63 0.039
Count 1842 1842 1831 1842 1842 1385 1385 966 1842
Low
Reputation
Underwriter
Mean 41.89 5.47 26.36 0.35 0.13 28.16 17.03 1605.01 0.003
Median 14.62 2.42 17.5 0.05 7.46 13.24 322.55 0.002
Std. Dev. 165.95 22.41 30.94 0.48 0.32 87.14 15.79 4651.67 0.003
Count 1895 1895 1894 1895 1895 1340 1341 859 1895
Mean diff. 187.33*** 23.66*** 41.29*** 0.19*** 0.16*** 74.14*** 6.24*** 2492.92*** 0.042***
Median diff. 16.37*** 1.89*** 24.5*** 0.06*** 31.85*** 6.52*** 518.21*** 0.022***
Total Mean 134.23 17.13 46.66 0.45 0.21 65.84 20.20 2924.55 0.023
Median 21.07 3.01 29.00 0.07 18.34 16.29 548.50 0.009
Std. Dev. 778.77 120.37 67.77 0.50 0.47 193.61 17.66 7251.39 0.035
Count 3737 3737 3725 3737 3737 2725 2726 1825 3737
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Panel B. Underpricing trend over time
Time period
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s Mean 0.071 0.086 –0.015*
Median 0.023 0.025 –0.001
Count 304 682
90s Mean 0.182 0.106 0.076***
Median 0.104 0.062 0.042***
Count 1148 1027
90s incl. bubble Mean 0.336 0.156 0.180***
Median 0.137 0.070 0.067***
Count 1538 1213
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table II. The Valuation of IPOs Backed by High and Lowreputation Underwriters using the Basic
Comparable Firm Approach
This table reports the crosssectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing secondary
market price to intrinsic value (SMP/IV) for IPOs. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales,
market pricetoEBITDA, or market pricetoearnings ratios of an industry peer. The industry peer is a comparable publicly traded firm in the
same Fama and French (1997) industry as the IPO firm and has the closest sales and EBITDA profit margin (EBITDA/ Sales) in the preIPO
fiscal year. “Highreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the
sample. “Lowreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median. The
rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss
(1991). “80s” time period corresponds to issues that are placed between 1980 and 1989, “90s” time period corresponds to issues placed between
1990 and 1998, and “90s incl. bubble” time period corresponds to issues placed between 1990 and 2000. For median ratios, the statistical
significances correspond to the sign test for median OP/ IV (or SMP/IV) equal to 1. For differences, the statistical significances are for Wilcoxon
MannWhitney rank sum test for the equality of medians of two subsamples. The IPOs are from SDC Platinum and all other data are from CRSP
and Compustat.
Sales multiple
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s median 1.565*** 1.519*** 0.046** 1.650*** 1.577*** 0.073**
count 244 611 244 611
90s median 1.588*** 1.224*** 0.364*** 1.772*** 1.313*** 0.459***
count 904 716 904 716
90s incl. bubble median 1.670*** 1.264*** 0.406*** 1.923*** 1.349*** 0.574***
count 1037 763 1037 763
EBITDA multiple
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s median 1.503*** 1.215*** 0.289*** 1.608*** 1.341*** 0.267***
count 233 588 233 588
90s median 1.549*** 1.211*** 0.338*** 1.749*** 1.297*** 0.452***
count 854 657 854 657
90s incl. bubble median 1.632*** 1.247*** 0.385*** 1.840*** 1.345*** 0.495***
count 975 699 975 699
Earnings multiple
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s median 1.518*** 1.315*** 0.203*** 1.664*** 1.347*** 0.316***
count 209 541 209 541
90s median 1.634*** 1.178*** 0.455*** 1.876*** 1.269*** 0.607***
count 621 522 621 522
90s incl. bubble median 1.700*** 1.237*** 0.463*** 1.940*** 1.305*** 0.635***
count 685 555 685 555
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table III. The Valuation of IPOs Backed by High and Lowreputation Underwriters using the
Propensity Score Based Comparable Firm Approach
This table reports the cross sectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing secondary
market price to intrinsic value (SMP/IV) for IPOs. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales,
market pricetoEBITDA, or market pricetoearnings ratio of an industry peer. The industry peer is a comparable publicly traded firm in the
same Fama and French (1997) industry as the IPO firm and which has the closest propensity score value based on sales, operating margin
(EBITDA/ Sales), profit margin (Net Income/ Sales), sales growth, cost of goods sold growth, and selling and general expenses growth. “High
reputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the sample. “Low
reputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median. The rankings are
calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). “80s”
time period corresponds to issues that are placed between 1980 and 1989, “90s” time period corresponds to issues placed between 1990 and 1998,
and “90s incl. bubble” time period corresponds to issues placed between 1990 and 2000. For median ratios, the statistical significances
correspond to the sign test for median OP/ IV (or SMP/IV) equal to 1. For differences, the statistical significances are for WilcoxonMann
Whitney rank sum test for the equality of medians of two subsamples. The IPO data is from SDC Platinum and all other data are from CRSP
and Compustat.
Sales multiple
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s median 1.839*** 1.556*** 0.283** 2.000*** 1.676*** 0.324**
count 200 440 200 440
90s median 1.728*** 1.21*** 0.518*** 2.073*** 1.358*** 0.716***
count 703 636 703 636
90s incl. Bubble median 1.900*** 1.312*** 0.588*** 2.322*** 1.43*** 0.891***
count 917 720 917 720
EBITDA multiple
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s median 1.449*** 1.289*** 0.159* 1.487*** 1.319*** 0.168*
count 161 360 161 360
90s median 1.287*** 1.171** 0.115 1.464*** 1.241*** 0.223
count 505 434 505 434
90s incl. Bubble median 1.288*** 1.178*** 0.11 1.500*** 1.252*** 0.248**
count 582 458 582 458
Earnings multiple
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s median 1.37*** 1.266*** 0.104 1.535*** 1.378*** 0.157
count 143 326 143 326
90s median 1.451*** 1.127* 0.323** 1.73*** 1.236** 0.494***
count 360 353 360 353
90s incl. Bubble median 1.488*** 1.136** 0.352*** 1.822*** 1.282*** 0.54***
count 407 371 407 371
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table IV. The Valuation of IPOs Backed by High and Lowreputation Underwriters using the
Discounted Cash Flow Approach
This table reports the cross sectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing secondary
market price to intrinsic value (SMP/IV) for IPOs. The intrinsic value is the fair value of the IPO firm estimated using the residual income model
of Ohlson (1990) with a constant discount rate of 13%. “5% growth” represents the aggregate sample of IPOs across years where IVs are
calculated under the assumption of 5% indefinite earnings growth after year 3, “0% growth” represents the aggregate sample of IPOs across years
where IVs are calculated under the assumption of no earnings growth after year 3. “Highreputation Underwriter” stands for IPOs whose lead
underwriting syndicate has reputation rank higher than the median for the sample. “Lowreputation Underwriter” stands for IPOs whose lead
underwriting syndicate has reputation rank lower than the median. The rankings are calculated as the average market share of the lead
underwriting syndicate over the sample period based on Megginson & Weiss (1991). “80s” time period corresponds to issues that are placed
between 1980 and 1989, “90s” time period corresponds to issues placed between 1990 and 1998, and “90s incl. bubble” time period corresponds
to issues placed between 1990 and 2000. For median ratios, statistical significances correspond to the sign test for median OP/ IV (or SMP/IV)
equal to 1. For differences, statistical significances are for WilcoxonMannWhitney rank sum test for the equality of medians of two sub
samples. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat.
Growth = 0%
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s median 2.190*** 1.898*** 0.292** 2.438*** 2.031*** 0.406**
count 151 381 151 381
90s median 2.575*** 2.236*** 0.338** 2.949*** 2.432*** 0.517***
Count 705 634 705 634
90s incl. Bubble Median 2.825*** 2.377*** 0.449*** 3.220*** 2.614*** 0.607***
Count 863 717 863 717
Growth = 5%
OP/IV SMP/IV
High
reputation
Underwriter
Low
reputation
Underwriter
Difference High
reputation
Underwriter
Low
reputation
Underwriter
Difference
80s Median 1.986*** 1.756*** 0.231* 2.145*** 1.902*** 0.242*
Count 151 381 151 381
90s Median 2.426*** 2.149*** 0.277 2.727*** 2.349*** 0.378**
Count 705 634 705 634
90s incl. Bubble Median 2.607*** 2.323*** 0.283** 3.071 2.565 0.507
Count 863 718 863 718
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table V. IPO Valuation for High and Lowreputation Underwriter Backed IPOs
This table reports the result of OLS regressions where the dependent variables are the log of ratio of offer price to intrinsic value and the log of the ratio of the first trading day closing secondary market
price to intrinsic value for IPOs. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales ratio of an industry peer. The industry peer is a comparable publicly traded
firm in the same Fama and French (1997) industry as the IPO firm and has the closest sales and EBITDA profit margin (EBITDA/ Sales) in the preIPO fiscal year. The independent variables are:
Underwriter reputation, based on the log of the market share of the IPO underwriter; Underwriter reputation dummy, which takes the value 1 if the market share of the lead underwriter is greater than
the sample median, and 0 otherwise; Size, which is the log of assets of the IPO firm; VC backing dummy; the fraction of firm sold, calculated as the number of shares sold in IPO as fraction of number of
shares outstanding; industry fixed effects; and year fixed effects. Panel A reports the regression results for the overall sample. Panel B reports the regression results for the sample split by hot and cold
IPO markets. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat. Robust tstatistics and zstatistics are reported in parentheses in Panels A and B, respectively.
Panel A: IPO valuation (full sample)
Offer price to intrinsic value
ratio
Offer price to intrinsic
value ratio
Secondary market price to
intrinsic value ratio
Secondary market price to
intrinsic value ratio
Underwriter reputation (continuous) 0.129*** 0.146***
(10.682) (11.438)
Underwriter reputation dummy 0.319*** 0.369***
(7.281) (8.078)
Size –0.238*** –0.184*** –0.271*** –0.211***
(–12.565) (–10.134) (–13.673) (–11.215)
VC Backing 0.171*** 0.216*** 0.182*** 0.232***
(3.856) (4.803) (3.937) (4.939)
Fraction of firm sold –1.555*** –1.575*** –1.701*** –1.722***
(–7.742) (–7.817) (–9.626) (–9.789)
Constant 2.437*** 1.000*** 2.898*** 1.266***
(8.774) (4.601) (10.464) (5.591)
Adj. RSquared 0.207 0.187 0.210 0.214
Observations 2655 2655 2655 2655
Panel B: IPO Valuation in Hot and Cold IPO Markets
Offer price to intrinsic
value ratio
Offer price to intrinsic
value ratio
Secondary market price to
intrinsic value ratio
Secondary market price to
intrinsic value ratio
Hot
market
Cold
market
Diff Hot
market
Cold
market
Diff Hot
market
Cold
market
Diff Hot
market
Cold
market
Diff
Underwriter reputation (continuous) 0.146*** 0.076*** 0.07** 0.164*** 0.088*** 0.076**
Underwriter reputation dummy
(11.058) (3.875) (2.500) (10.150) (3.757) (2.360)
0.349*** 0.178** 0.171* 0.401*** 0.217*** 0.184*
Size
(6.868) (2.206) (1.790) (7.592) (2.596) (1.860)
–0.245*** –0.223*** –0.182*** –0.191*** –0.277*** –0.266*** –0.206*** –0.230***
VC backing
(–9.102) (–6.445) (–8.705) (–5.725) (–8.805) (–7.238) (–9.545) (–6.560)
0.167*** 0.183 0.213*** 0.217*** 0.179*** 0.193 0.230*** 0.231***
Fraction of firm sold
(3.808) (1.460) (4.041) (2.720) (3.843) (1.439) (4.181) (2.738)
–1.821*** –1.177*** –1.831*** –1.198*** –1.987*** –1.300*** –1.997*** –1.323***
Constant
(–12.189) (–4.747) (–12.910) (–4.212) (–11.722) (–6.412) (–14.283) (–6.330)
1.669*** 1.448*** 0.724*** 0.760** 2.237*** 1.689*** 1.172*** 0.891***
(8.594) (3.069) (3.655) (2.471) (10.338) (3.517) (5.840) (2.949)
Adj. Rsquared 0.216 0.203 0.192 0.194 0.248 0.227 0.220 0.217
Observations 1959 696 1959 696 1959 696 1959 696
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table VI. Endogenous Matching between Underwriter Reputation and Firm Quality:
Regression Discontinuity Analysis
This table reports the result of a regression discontinuity analysis. The dependent variables are: underwriter reputation in the first
stage, and the ratio of offer price and the immediate post IPO secondary market price to intrinsic value ratio in the second stage. The
independent variables in the first stage are: 1{Norm. Size>cutoff} which is a dummy variable that is 1 if the normalized assets of the
IPO firm is greater than the cutoff required for NYSE listing, where the normalized assets is the log of the ratio of assets of the firm
divided by the NYSE listing cutoff for a given year; Norm. Size; Norm. Size
2
; 1{Norm. Size>0}x(Norm. Size – 0); 1{Norm.
Size>0}x(Norm. Size – 0)
2
; fraction of firm sold in the IPO firm; and the VC backing dummy. Underwriter reputation is calculated as
the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). The
independent variables in the second stage are the predicted underwriter reputation from the first stage; Norm. size; fraction of firm
sold in the IPO firm; and the VC backing dummy. Year and industry fixed effects are included in every specification. Robust t
statistics are reported in parentheses for the first stage regression and bootstrapped zstatistics are reported in parentheses in the second
stage regressions.
First stage Second stage
Underwriter
reputation
(Continuous)
Offer price to
intrinsic
value ratio
Secondary
market price
to intrinsic
value ratio
1{Norm. Size>0}
–0.334**
Underwriter reputation
0.323** 0.308**
(–2.196)
(2.575) (2.293)
Norm. Size
0.941***
Norm. Size
–0.374*** –0.385***
(4.800)
(–4.203) (–4.018)
Norm. Size
2
–0.009
(–0.150)
1{Norm. Size>0}x(Norm. Size – 0)
0.206
(0.908)
1{Norm. Size>0}x(Norm. Size – 0)
2
–0.123*
(–1.880)
Fraction of firm sold
–0.479***
Fraction of firm sold
–1.386*** –1.535***
(–2.640)
(–5.435) (–6.279)
VC backing
0.733***
VC backing
0.020 0.050
(9.015)
(0.175) (0.406)
Constant
–5.595***
Constant
2.778*** 2.818***
(–13.191)
(3.647) (3.451)
Observations 2154 Observations 2154 2154
Adj .Rsquared 0.357 Adj. Rsquared 0.158 0.174
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table VII. Endogenous Matching between Underwriter Reputation and Firm Quality: IV
Analysis
This table reports the results of two stage least squares model and treatment effects estimations. The dependent variables the second
stage of the two stage least squares models and the treatment effects models are the log of the ratio of offer price to intrinsic value and
the log of the ratio of the secondary market price to intrinsic value. The intrinsic value is the fair value of the IPO firm computed
based on market pricetosales ratio of an industry peer. The industry peer is a comparable publicly traded firm in the same Fama and
French (1997) industry as the IPO firm and has the closest sales and EBITDA profit margin (EBITDA/ Sales) in the preIPO fiscal
year. The 2SLS and the treatment effects models estimate two stages. The first stage (selection stage) dependent variables are the
underwriter reputation dummy (in the treatment effects model) and the log of the underwriter IPO market share (in the two stage least
squares model). The independent variables are: Underwriter location concentration, which is the state level concentration of the
underwriters IPO business and is measured as the Herfindahl index of the amount of IPOs underwritten by the lead underwriter in
various states, calculated over a five year period prior to the sample IPO; Industry underwriter availability, which is the number of
unique underwriters that conduct business in the same industry as the IPO firm, measured over five years prior to the sample IPO;
Size, which is the log of assets of the IPO firm; VC backing dummy; the fraction of firm sold, calculated as the number of shares sold
in IPO as fraction of number of shares outstanding; industry fixed effects; and year fixed effects. Firm state effects are included in the
2SLS and the treatment effects models. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat. Robust t
statistics are reported in parentheses.
Two stage least squares Treatment effects model
First Stage:
Underwriter
Reputation
Second Stage:
Offer price to
intrinsic value
ratio
Second Stage:
Secondary
market price to
intrinsic value
ratio
First Stage:
Underwriter
reputation
dummy
Second Stage:
Offer price to
intrinsic value
ratio
Second Stage:
Secondary
market price to
intrinsic value
ratio
Underwriter reputation
(continuous)
0.087*** 0.105***
(3.057) (3.472)
Underwriter reputation
dummy
0.429*** 0.536***
(3.204) (3.852)
Size 0.511***
–0.211*** –0.245***
0.374*** –0.208*** –0.243***
(23.010)
(–8.011) (–8.852)
(13.201) (–9.093) (–10.250)
VC Backing 0.556***
0.186*** 0.205***
0.473*** 0.176*** 0.190***
(8.620)
(3.881) (4.108)
(6.695) (3.476) (3.612)
Fraction of firm sold –0.488***
–1.497*** –1.616***
–0.490*** –1.478*** –1.590***
(–3.700)
(–7.052) (–8.947)
(–2.885) (–13.872) (–14.362)
Underwriter location concentration –2.992]*** –2.132***
(–23.360) (–13.76)
Industry underwriter availability 0.003** 0.003*
(2.040) (1.940)
Constant –2.807***
1.083*** 1.723***
5.723 0.314 0.781
(–5.170)
(3.204) (4.936)
(0.008) (0.310) (0.742)
Adj. Rsquared 0.504 0.222 0.255
Wald Chi. Sq. 1208.08 1323.56
Observations 2318 2318 2318 2318 2318 2318
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table VIII. Dynamics of Market Valuation for IPOs Backed by High and Lowreputation
Underwriters
This table presents the ratio of offer price (OP/IV) and secondary market price to intrinsic value (SMP/ IV) for IPOs over time. The
dataset contains IPOs. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales , market priceto
EBITDA ratio, or market pricetoearnings ratio of an industry peer. For the basic matching approach, the industry peer is a
comparable publicly traded firm generated by the basic comparable firm approach. For the propensity score approach, the industry
peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and which has the closest
propensity score value based on sales, operating margin (EBITDA/ Sales), profit margin (Net Income/ Sales), sales growth, cost of
goods sold growth, and selling and general expenses growth. OP/IV is the ratio of offer price to estimated intrinsic value of the IPO
stock. SMP/IV “t” is the ratio of the closing price on the secondary market in year t after IPO to the estimated intrinsic value of the
IPO stock at year t. “Highreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than
the median for the sample. “Lowreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank
lower than the median. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample
period based on Megginson & Weiss (1991). For median ratios, statistical significances correspond to the sign test for median OP/ IV
(or SMP/IV) equal to 1. For differences, the statistical significances are for WilcoxonMannWhitney rank sum test for the equality of
medians of two subsamples. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat.
Basic Comparable Firm Valuation Dynamics
Sales Multiple Earnings Multiple
High
reputation
Underwriter
Low
reputation
Underwriter
Difference High
reputation
Underwriter
Low
reputation
Underwriter
Difference
OP/IV 1.616*** 1.303*** 0.313*** 1.632*** 1.274*** 0.358***
SMP/IV 0 1.870*** 1.368*** 0.502*** 1.873*** 1.325*** 0.549***
SMP/IV 1 1.442*** 1.206*** 0.236*** 1.387*** 1.072* 0.315***
SMP/IV 2 1.186*** 1.009*** 0.177*** 1.203 1.047 0.156***
SMP/IV 3 1.118*** 0.904*** 0.214*** 1.195 1.086 0.109*
Propensity Score Based Comparable Firm Valuation Dynamics
Sales Multiple Earnings Multiple
High
reputation
Underwriter
Low
reputation
Underwriter
Difference High
reputation
Underwriter
Low
reputation
Underwriter
Difference
OP/IV 1.823*** 1.393*** 0.43*** 1.455*** 1.223*** 0.232***
SMP/IV 0 2.183*** 1.521*** 0.663*** 1.715*** 1.333*** 0.382***
SMP/IV 1 1.523*** 1.188*** 0.335*** 1.197*** 1.157*** 0.041
SMP/IV 2 1.495*** 1.212*** 0.284*** 1.277*** 1.15** 0.126
SMP/IV 3 1.295*** 1.088 0.206*** 1.142 1.081 0.061
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table IX. Heterogeneous Beliefs About IPOs Backed by High and Lowreputation
Underwriters: Multivariate Tests
This table reports the results of regression analysis of heterogeneous belief proxies. The dependent variables are: Adjusted daily
volume, log of adjusted daily turnover, and log of adjusted daily number of trades. Daily volume is calculated as log (number of
shares traded during the first trading day multiplied by price). Daily turnover calculated as the log of first day turnover. Daily number
of trades calculated as the log of first day number of trades. The adjusted values of the statistics are calculated by subtracting from
them the average monthly value of that statistic calculated 3 years after the IPO date. The independent variables are the underwriter
reputation dummy, size (log of total assets), the VC backing dummy, fraction of firm sold calculated as the number of shares sold in
IPO as fraction of number of shares outstanding, number of unique analysts that estimate earnings (“Number of analysts”), number of
institutional investors participating in the IPO, percentage share of IPO held by institutional investors, the number of comanaging
underwriters in the IPO, and the comanaging underwriter reputation dummy. Year and industry fixed effects are included in every
specification. The underwriter reputation dummy takes the value 1 if the lead underwriting syndicate has a ranking value greater than
the median for the sample and 0 otherwise. The rankings are calculated as the average market share of the lead underwriting syndicate
over the sample period based on Megginson & Weiss (1991). Robust tstatistics are reported in parentheses.
Panel A: Adjusted Daily Volume
(1) (2) (3) (4)
Underwriter reputation
Dummy
0.400*** 0.533*** 0.379*** 0.255***
(8.119) (10.393) (7.718) (5.157)
Size 0.043** 0.177*** 0.028 0.011
(2.545) (8.899) (1.564) (0.600)
VC backing 0.064 0.005 0.053 0.006
(1.459) (0.089) (1.206) (0.139)
Fraction of firm sold –0.098** 0.003 –0.100** –0.124**
(–2.071) (0.059) (–2.106) (–2.502)
Number of analysts
estimating earnings
0.026*** 0.113*** 0.021** 0.016*
(2.781) (12.210) (2.234) (1.693)
Number of institutions 0.039*** 0.038*** 0.037***
(12.742) (12.569) (13.004)
Percentage institutional
holding
0.127*
(1.860)
Num. of comanaging
underwriters
0.089***
(3.133)
Comanaging
underwriter reputation
0.253***
(5.778)
Constant
1.058*** 1.519*** 1.187*** 2.249***
(4.939) (7.044) (5.431) (8.178)
Observations 2143 2143 2143 1828
Adjusted Rsquared 0.678 0.574 0.68 0.671
Panel B: Adjusted Daily Turnover
(1) (2) (3) (4)
Underwriter reputation
Dummy
0.205*** 0.237*** 0.198*** 0.133***
(6.249) (7.250) (6.049) (3.901)
Size –0.121*** –0.088*** –0.126*** –0.132***
(–9.817) (–7.347) (–9.823) (–10.199)
VC backing 0.079** 0.060* 0.076** 0.057*
(2.459) (1.777) (2.348) (1.750)
Fraction of firm sold 0.833*** 0.863*** 0.832*** 0.798***
(22.978) (23.733) (22.917) (20.090)
Number of analysts
estimating earnings
0.003 0.026*** 0.002 –0.002
(0.653) (5.234) (0.365) (–0.409)
Number of institutions 0.010*** 0.010*** 0.009***
(7.396) (7.255) (7.273)
Percentage institutional
holding
0.057*
(1.818)
Num. of comanaging
underwriters
0.027
(1.331)
Comanaging
underwriter reputation
0.083***
(2.673)
Constant 6.048*** 6.156*** 6.087*** 6.450***
(39.675) (41.139) (39.556) (36.199)
Observations 2143 2143 2143 1828
Adjusted Rsquared 0.462 0.441 0.463 0.467
Panel C: Adjusted Daily Number of Trades
(1) (2) (3) (4)
Underwriter reputation
Dummy
0.255*** 0.407*** 0.236*** 0.160***
(4.472) (6.537) (4.082) (2.607)
Size –0.006 0.078*** –0.014 –0.019
(–0.268) (2.931) (–0.616) (–0.778)
VC backing –0.021 –0.011 –0.033 –0.071
(–0.367) (–0.174) (–0.601) (–1.196)
Fraction of firm sold –0.112* –0.112 –0.112* –0.126*
(–1.759) (–1.578) (–1.769) (–1.835)
Number of analysts
estimating earnings
0.040*** 0.099*** 0.035*** 0.030***
(3.599) (8.528) (3.051) (2.657)
Number of institutions 0.034*** 0.033*** 0.032***
(14.068) (13.692) (13.240)
Percentage institutional
holding
0.009
(0.197)
Num. of comanaging
underwriters
0.087**
(2.174)
Comanaging underwriter
reputation
0.217***
(4.188)
Constant 4.789*** 4.889*** 4.111*** 4.218***
(19.932) (16.282) (17.997) (11.976)
Observations 1494 1494 1494 1316
Adjusted Rsquared 0.717 0.659 0.718 0.714
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table X. The Dynamics of Heterogeneous Beliefs About IPOs Backed by High and Lowreputation Underwriters
This table presents the daily adjusted volume, adjusted turnover, and adjusted number of trades over time from the IPO date to three years after the IPO. “Highreputation Underwriter” stands for IPOs whose
underwriting syndicate has a reputation rank higher than the median for the sample. “Lowreputation Underwriter” stands for IPOs whose underwriting syndicate has a reputation rank lower than the median. The
rankings are calculated as average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). For median ratios, statistical significances correspond to the
Wilcoxon signtest for median equal to 0. For differences, the statistical significances are for Wilcoxon MannWhitney rank sum test for the equality of medians of two sub samples. respectively. The IPO data
is from SDC Platinum and all other data are from CRSP and I/B/E/S.
Adj. Volume Adj.Turnover Adj.Number of trades
Time
after
IPO
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
High
reputation
Underwriter
Low
reputation
Underwriter
Difference
0 Median 39.306*** 7.456*** 31.849*** 19.7557*** 13.2371*** 6.5186*** 840.758*** 322.55*** 518.208***
count 1385 1340 1385 1341 966 859
1 Median 0.021** 0.003* 0.018* –0.078*** –0.0731*** –0.0048 –12.545*** –4.19*** –8.355***
count 1395 1368 1401 1388 1061 1065
2 Median 0.002 0.004*** –0.003 –0.0821*** –0.0607*** –0.0213** –9.509*** –3.286*** –6.223***
count 1413 1426 1416 1446 1080 1157
3 Median –0.001 0 –0.002 –0.0688*** –0.0619*** –0.0069** –5.093*** –1.952*** –3.141***
count 1421 1440 1424 1463 1098 1198
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table XI. Valuation ratios in IPOs Backed by High and Lowreputation Underwriters: Multivariate Tests
This table reports the results of our regression analysis of overvaluation. The dependent variable is the log of first trading day closing secondary market price to intrinsic values ratio (SMP/IV). The valuations
ratios are generated by the basic comparable firm approach using the sales price multiple. The independent variables are the underwriter reputation dummy, the log of assets of the IPO firm, the VC backing
dummy, fraction of firm sold calculated as the number of shares sold in IPO as fraction of number of shares outstanding, number of unique analysts estimating EPS for the firm in the first year after the IPO,
percentage share of IPO held by institutional investors, number of institutional investors participating in the IPO , adj. first day volume, adj. first day turnover, adj. first day number of trades, the number of co
managing underwriters in the IPO, and the comanaging underwriter reputation dummy. Year and industry fixed effects are included in every specification. The underwriter reputation dummy takes the value 1 if
the lead underwriting syndicate has a ranking value greater than the median for the sample and 0 otherwise. The rankings are calculated as the average market share of the lead underwriting syndicate over the
sample period based on Megginson & Weiss (1991). Robust tstatistics are reported in parentheses.
(1) (2) (3) (4) (5) (6) (7) (8 (9)
Underwriter reputation dummy 0.369*** 0.231*** 0.329*** 0.219*** 0.154*** 0.155*** 0.149*** 0.063 0.012
(8.078) (4.763) (6.743) (4.486) (2.737) (2.743) (2.793) (0.891) (0.231)
Size –0.211*** –0.341*** –0.255*** –0.349*** –0.370*** –0.369*** –0.304*** –0.303*** –0.370***
(–11.215) (–15.989) (–12.784) (–16.203) (–14.493) (–14.295) (–11.689) (–8.163) (–15.229)
VC backing –1.722*** –1.803*** –1.696*** –1.804*** –1.803*** –1.802*** –2.401*** –1.680*** –1.934***
(–9.789) (–8.704) (–9.121) (–8.694) (–7.164) (–7.166) (–10.363) (–7.505) (–11.089)
Fraction of firm sold 0.232*** 0.200*** 0.174*** 0.193*** 0.130** 0.130** 0.200*** 0.195*** 0.175***
(4.939) (4.253) (3.467) (4.083) (2.356) (2.356) (3.667) (2.941) (3.303)
Percentage institutional holding 0.229***
(3.364)
Number of institutions 0.020*** 0.020*** 0.018*** 0.018*** 0.017*** 0.016*** 0.006***
(8.555) (8.264) (7.672) (7.658) (6.668) (4.907) (2.800)
Num. of comanaging underwriters 0.048* –0.007 0.045 0.117*** 0.027
(1.649) (–0.203) (1.399) (3.096) (0.873)
Comanaging underwriter reputation 0.230*** 0.230***
(4.124) (4.125)
Adj. first day turnover 0.196***
(5.074)
Adj. first day number of trades 0.237***
(5.597)
Adj. first day volume 0.323***
(11.038)
Constant 1.266*** 1.260*** 1.353*** 1.261*** 1.229*** 1.233*** 0.329 –2.267*** –4.148***
(5.591) (5.161) (5.203) (5.163) (3.678) (3.667) (1.038) (–5.403) (–8.548)
Observations 2655 2367 2367 2367 1768 1768 1786 1047 1755
Adjusted Rsquared 0.214 0.289 0.245 0.29 0.31 0.309 0.303 0.351 0.352
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Table XII. Changes in Valuation Ratio of IPO stocks with Measures of Heterogeneous Beliefs during the
Three Years after the IPO
This table reports the results of panel data regressions where the dependent variables are changes in log of secondary market price to intrinsic value ratio
(in specifications (1), (2), and (3)) and the log of secondary market price to intrinsic value (in specifications (4), (5), and (6)). The valuation ratios are
generated by the basic comparable firm approach using the sales price multiple. The independent variables are yearly changes in and the levels of adj. first
day volume, adj. first day turnover, and adj. first day number of trades; the log of assets of the IPO firm; the VC backing dummy; and fraction of firm sold
calculated as the number of shares sold in IPO as fraction of number of shares outstanding. Year fixed effects are included in every specification. Industry
fixed effects are included in specifications (1), (2), and (3); and firm fixed effects are included in specifications (4), (5), and (6). Robust tstatistics are
reported in parentheses.
Change in log of secondary market price
to intrinsic value ratio:
Difference regressions
Log of Secondary market price to
intrinsic value ratio:
Firm fixed effects regressions
(1) (2) (3) (4) (5) (6)
Change in adj. daily turnover 0.063*
(1.890)
Change in adj. daily volume 0.162**
(2.016)
Change in adj. number of trades 0.112*
(1.874)
Adj. daily turnover 0.128***
(3.225)
Adj. daily volume 0.393***
(4.486)
Adj. daily number of trades 0.257***
(3.759)
Size 0.020 0.026** –0.012 –0.216*** –0.230*** –0.190***
(1.623) (2.178) (–0.621) (–5.819) (–7.711) (–4.532)
VC backing –0.004 –0.005 0.014
(–0.141) (–0.192) (0.438)
Fraction of firm sold 0.310*** 0.321*** 0.236**
(4.111) (4.356) (2.411)
Constant –0.114 –0.178 –0.177 1.105*** 1.180*** 0.998***
(–0.478) (–0.754) (–1.323) (6.733) (9.099) (5.823)
Firm fixed effects Y Y Y
Industry fixed effects Y Y Y
Year fixed effects Y Y Y Y Y Y
Observations 5099 5036 3434 7391 7342 5136
Adjusted Rsquared 0.017 0.017 0.019 0.41 0.409 0.388
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.
Figure 1. Discontinuity of the Treatment (Underwriter Reputation) when
Normalized Size=0.
Figure 2. Dynamics of Sales and Earnings Based Valuation Ratios Using
Propensity Score Based Comparable Firm Approach
Heterogeneous Beliefs, IPO Valuation, and the Economic Role of the Underwriter in IPOs
Abstract Several theoretical papers have argued that the valuation of equity will reflect the beliefs of the most optimistic investors and be at a premium over intrinsic value when investors subject to short sale constraints have heterogeneous priors. We test the above theories by analyzing the effect of IPO underwriter reputation on the heterogeneity in investor beliefs and consequently on equity valuation in IPOs. We propose a “market power” hypothesis, postulating that highreputation underwriters are able to attract a greater number of higher quality market participants (such as institutional investors, analysts, and comanaging underwriters) to the IPOs backed by them, thereby yielding higher IPO valuations by increasing the heterogeneity in investor beliefs. We empirically distinguish the above hypothesis from the “certification hypothesis,” which implies that highreputation underwriters are associated with IPOs priced closer to intrinsic value. We find that equity in highreputation underwriter backed IPOs are priced higher and further away from intrinsic value compared to lowreputation underwriter backed IPOs; this result is robust to controlling for endogenous matching between highreputation underwriters and higher quality issuers using instrumental variables and regression discontinuity analyses. We show that the above relationship between underwriter reputation and market valuation is driven by the greater heterogeneity in investor beliefs and greater participation by institutional investors and highreputation comanaging underwriters that characterize highreputation underwriter backed IPOs. Overall, our results support the market power hypothesis and contradict the certification hypothesis.
JEL classification: G24 Keywords: Investment banks, Underwriter reputation, IPOs
Introduction Starting with Miller (1977), the effect of heterogeneity in investor beliefs on the valuation of equity has been the subject of considerable debate among financial economists. In particular, formalizing Miller’s (1977) intuition, Harrison and Kreps (1978) and Morris (1996) have shown that the equity of firms will reflect the valuation of the most optimistic investors (and will sell at a premium over their fundamental value) when investors subject to short sale constraints have heterogeneous prior beliefs (see also Duffie, Garleanu, and Pederson (2002) and Chen, Hong, and Stein (2002)). Given that firms going public have a very sparse track record publicly available to investors, the equity of IPO firms are likely to be characterized by a higher degree of heterogeneity in investor beliefs and therefore provide a particularly appropriate context to test the implications of heterogeneous beliefs and behavioral theories of equity valuation. Existing empirical analyses of such theories have been primarily in nonIPO settings (see, e.g., Chen, Hong, and Stein (2002) and Diether, Malloy, and Scherbina (2002)). The objective of this paper is to extend the above literature to the IPO setting by analyzing the role of heterogeneity in investor beliefs under short sale constraints on the valuations of the equity of firms going public. In particular, we empirically analyze the implications of these theories on the role of the underwriter in the valuation of the equity of firms going public, both in the IPO and in the immediate secondary market. Underwriters have a particularly important role to play in IPO valuation. This is because, first, they set the IPO offer price after ascertaining the views of investors on their valuation of the IPO through the book building process. Second, participation by a highly reputable underwriting syndicate may affect the beliefs of at least some investors about the future prospects of the IPO firm. We therefore focus on the economic role of the underwriter in affecting the heterogeneity in investor beliefs faced by IPO firms, which in turn, will affect the valuation of equity in the IPOs that they underwrite. The economic role of the underwriter in IPOs has become a particularly relevant topic of study in light of the recent empirical evidence that the relationship between underwriter reputation and IPO underpricing has reversed. While earlier evidence documented that IPOs underwritten by highreputation investment banks were characterized by a smaller extent of underpricing, more recent evidence indicates that IPOs underwritten by highreputation underwriters are characterized by greater underpricing: see, e.g., Beatty and Welch (1996), Loughran and Ritter (2004), and Cooney, Carter, Dark, and Singh (2001) who find that the average underpricing has gone from being smaller for highreputation underwriters in the 1980s to being larger for highreputation underwriters in the 1990s. This is consistent with a parallel debate in the venture capital literature. For instance, Francis and Hasan (2001) use data from the 1990s and find that IPOs of firms backed by venture capitalists are underpriced more than those not backed by venture capitalists, in contrast with the findings of prior literature that uses data from the 1980s. In order to incorporate the role of the underwriter in the Miller (1977) setting, we conjecture that underwriters are motivated to obtain high valuations for the equity of firms they take public by making use of
1
their longterm relationships with various participants in the IPO market (institutional investors, analysts, and comanaging underwriters). These relationships enable them to attract greater participation by these market players in the IPOs of firms backed by them, leading to higher valuations for the equity of these firms (both in the IPO and in the secondary market).1 Participation by highreputation underwriters and by a larger number of other highquality market participants (i.e. highreputation comanagers and a larger number of institutional investors and analysts) may make retail investors more optimistic about the IPO firm’s prospects. For example, Welch (1992) shows that later investors in a firm’s IPO will optimally ignore their private information and buy shares in the IPO after becoming more optimistic about the IPO firm’s prospects if they observe strong demand from earlier investors for these shares.2 Such higher optimism of retail investors increases the heterogeneity in investor beliefs, which in turn may lead to higher valuations, both in the IPO and in the immediate aftermarket, based on arguments made by Miller (1977) and others discussed earlier. In summary, the greater heterogeneity in investor beliefs regarding firms whose IPOs are underwritten by highreputation underwriters (relative to firms whose IPOs are underwritten by lowreputation underwriters) will lead to higher valuations of these firms in the IPO as well as in the immediate secondary market.3 We will refer to the above hypothesis as the “market power” hypothesis.4 The above hypothesis contrasts with the prevailing view that the underwriter acts as a “certifying” intermediary who produces information about the intrinsic value of the firm in an IPO market characterized by asymmetric information between firm insiders and outsiders. Since information production is costly (and therefore characterized by moral hazard), underwriters have a shortterm incentive to sell the equity of firms they take public at a price higher than their intrinsic value. However, underwriters have reputation at stake with investors, mitigating this moral hazard problem in information production, thereby inducing them to price equity in IPOs consistent with intrinsic value (see, e.g., Chemmanur and Fulghieri (1994)). This means
Underwriters may be motivated to obtain high valuations for the IPO firm for two reasons. First, their gross spread revenue per share is proportional to the IPO offer price. Second, successfully obtaining high IPO proceeds will increase the underwriter’s reputation with subsequent issuers leading to higher future revenues. 2 Consistent with this, in their survey of the diffusion of interest among institutional and retail investors, Shiller and Pound (1989) found that 44% of investors who bought shares in a firm’s IPO did so because someone they knew ofbought stock in the company. Further, various other papers have found evidence consistent with the idea that, unlike large and institutional investors, retail investors’ trades are motivated by analyst recommendations and other sources of information that may grab their attention, even if such sources do not benefit them in the long run. For example, Malmendier and Shantikumar (2007) find that small investors follow analyst recommendations literally, even if analysts are affiliated with an underwriter; whereas larger traders discount analyst recommendations. Barber and Odean (2008) find that individual investors are more likely to be net buyers in attention getting stocks, unlike professional investors. 3 We are assuming here that the increase in the heterogeneity in investor beliefs is symmetric about the mean level of investor beliefs about the firm. In such a setting, it can be shown using a formal theoretical model that the beliefs of the marginal investor about the firm going public and therefore the valuation of the firm’s equity in the IPO and in the immediate secondary market will be increasing in the heterogeneity in investor beliefs. While, due to space limitations, we will not present a formal theoretical analysis here, the above results will follow from a model along the lines of Bayar, Chemmanur, and Liu (2010). 4 This paper primarily focuses on the role of the lead underwriter in IPOs. Through the rest of the paper, we refer to lead underwriters in an IPO as underwriters and explicitly refer to comanaging underwriters (comanagers) wherever necessary.
1
2
In order to make the market power hypothesis more precise and understand the relationship between the IPO and the first day secondary market share valuations of IPOs underwritten by high. assume that either a high. will determine the extent of heterogeneity in investor beliefs and thereby secondary market stock valuation.and lowreputation underwriters.)OP + γ2(. 5 3 .and lowreputation underwriters. the γ1(. and Huang (2010)).7 Finally. respectively.) and γ2(. In practice. Thus.that the certification hypothesis has implications dramatically different from the market power hypothesis for the pricing of IPOs: while the certification hypothesis implies that highreputation underwriters price equity in IPOs backed by them closer to intrinsic value due to their concern for preserving reputation in the IPO market. Underwriters care about the firm’s IPO price since they receive a fraction of gross IPO proceeds as compensation. Hu.) to depend on additional IPO parameters such as the fraction of equity sold by insiders in the IPO: see Chemmanur (1993) for a similar objective function. As we explain below.) are decreasing functions of OP and SMP. of the firm going public.) and γ2(. for a given extent of underpricing. assume that.or a lowreputation underwriter can generate greater participation by institutional investors (and other highquality market players) in the IPO by underpricing to a greater extent. an underwriter chooses the offer price (OP) and (implicitly) the secondary market price (SMP) to maximize:5 γ1(. and where a firm’s IPO may be underwritten by either a highreputation or a lowreputation underwriter. Hu.6 Further. Further. For the reasons discussed earlier. we assume that participation by a larger number of such market players will further increase the heterogeneity in investor beliefs. the extent of participation by highquality market players will be determined by the reputation of the underwriter and the extent of underpricing. and therefore the secondary market valuation. maximizing a weighted average of the two. the variables explicitly chosen by the underwriter will be the IPO offer price and the extent of participation by highquality market players which. the heterogeneity in investor beliefs about the IPO firm’s prospects and therefore secondary market share valuations will be greater if the IPO is backed by a highreputation underwriter rather than by a lowreputation underwriter. the market power hypothesis implies that highreputation underwriters would price this equity higher and further away from intrinsic value. in turn. we study the following economic environment.) functions are the same for high. It is also consistent with the evidence that institutional investors make significant abnormal profits from selling their IPO share allocations soon after the IPO (Chemmanur.)SMP. since such underpricing will serve to compensate these market players for their participation in the IPO. Underwriters also care about the IPO firm’s shortrun secondary market price because they are committed to engaging in price support activities if this price falls below a certain threshold level. and also because their reputation with future issuers will be damaged if the stock price of firms whose IPOs they underwrite languishes in the secondary market. and Huang (2010)). Underwriters care about both the initial offer price and the first day closing secondary market share price of the IPO firm. 6 The rationale for assuming such an objective function is that underwriters care about the both the IPO as well as the secondary market price of the firm’s equity. 7 This assumption that institutional investors are important beneficiaries from IPO underpricing is consistent with the evidence that there is a significant amount of flipping of IPO shares by institutional investors to retail investors both in the first few days of trading in secondary market shares (Aggarwal (2003)) and the subsequent months (Chemmanur. Our results will remain qualitatively unchanged even if we allow the weights γ1(. (1) where the weights γ1(.) and γ2(. Consider an IPO market populated by both retail and institutional investors.
the weight placed on the secondary market price in the objective function of a low reputation underwriter will be greater than that in the objective function of a high reputation underwriter. The intuition here is that. the ratio of primary and secondary market IPO stock valuations relative to their intrinsic value) rather than IPO underpricing. since the secondary market share valuation (for a given level of IPO underpricing) will be lower for the low reputation underwriter. highreputation underwriters will set the offer prices of IPOs backed by them at a higher level than lowreputation underwriters (for reasonable model parameter values).e. which in turn will be a function of underwriter reputation and participation by other high quality market players like institutional investors and analysts. The intuition here is that. one has to make the crucial (and rather strong) assumption that the closing price of a firm’s stock on the first day of secondary 8 4 . This means that a lowreputation underwriter will underprice IPO shares to a smaller extent than a highreputation underwriter. the offer price of a lowreputation underwriter backed IPO will be lower than that of a highreputation underwriter backed IPO for the same extent of underpricing. First. even for the same γ1(. while a higher secondary market price (arising as a result of greater IPO underpricing) will decrease the weight placed on the secondary market price in this objective function. The equilibrium IPO offer price arising from the above tradeoff will be higher for a highreputation underwriter backed IPO than for a lowreputation underwriter backed IPO.) functions. thus inducing him to optimally set a lower offer price. for a given level of IPO underpricing. highreputation underwriters will underprice IPOs to a greater extent than lowreputation underwriters.) and γ2(. The intuition here is that highreputation underwriters face a steeper demand curve for shares than lowreputation underwriters due to the greater heterogeneity in retail investor beliefs associated with highreputation underwriter backed IPOs. This is because underpricing simply reflects the price rise of a firm’s equity from the IPO offer price to the first day closing price in the secondary market. the secondary market share price of a firm whose IPO is backed by a highreputation underwriter will be greater than if it were backed by a lowreputation underwriter.8. we can show the following. we assume that the equilibrium offer price emerging from the above tradeoff faced by high. since a lowreputation underwriter backed IPO receives lower secondary market valuations than a highreputation underwriter backed IPO (for the reasons discussed earlier). Second. given that the weight the lowreputation underwriter places on the IPO offer price in his objective function will be higher for a lower offer price.. as the highreputation underwriter underprices to a greater extent (in order to attract greater institutional investor participation and thus obtain a higher secondary market price).9 We now specify the testable predictions arising from the market power and the certification hypotheses. A lower offer price increases the weight placed on the offer price in the underwriter’s objective function.10 Recall that. even after underpricing IPOs to a greater extent. the offer price chosen by him becomes lower as a consequence. This maximum possible IPO valuation will depend on the heterogeneity in investor beliefs in the IPO market. so that it is affected not only by the price of the equity in the IPO. 9 Throughout the above discussion. We develop these testable predictions in terms of IPO valuation ratios (i. Third.In the above setting.and lowreputation underwriters is below the maximum possible IPO valuation that is achievable by the firm. but also by the first day closing price of the equity in the secondary market. 10 For underpricing to be a meaningful measure in any study of the economic role of underwriters in IPOs.
11 The implications of the market power hypothesis discussed above suggest that the ratio of the IPO firm value to intrinsic value will be larger for highreputation underwriter backed IPOs than for lowreputation underwriter backed IPOs (H1A). The second measure we study is the ratio of the valuation placed on a firm at the close of the first trading day in the secondary market (SMP) to its intrinsic value (IV). where a number of IPOs were priced far above their intrinsic value. they were also significantly overvalued (relative to intrinsic value). one would expect that the valuation difference between highreputation underwriter backed and lowreputation underwriter backed IPOs to go down over time as hard information about the operating performance of the IPO firm becomes available to investors (due to which the heterogeneity in investor beliefs associated with the reputation of the IPO underwriter dissipates over time). The market power hypothesis predicts that price to intrinsic value ratio of IPOs backed by highreputation underwriters and lowreputation underwriters should converge to each other and towards unity in the years after the IPO (H3A).We use three sets of measures in our empirical analysis. 11 We calculate intrinsic value using multiple methodologies. Clearly. Ritter (1991)) also indicates that the closing price of an IPO firm’s equity is not equal to its intrinsic value. and three years after the IPO.g. we expect the market trading is not affected by underwriter reputation and always equals the intrinsic value of that stock.. if investors buy IPO shares at the first trading day closing price and hold them for one to three years. The empirical literature on the long run underperformance of IPOs (see.g. It seems obvious (at least in hindsight) that while these IPOs were highly underpriced (in the sense that their initial returns were very large). such as relative valuation using a comparable firm based on simple matching and propensity score matching (e. Of course. given that firm value is now determined by the equity market (once the firm’s shares start trading in the secondary market). they are likely to earn inferior returns compared to similar investments in the equity of firms which have been public for some time. in a setting with heterogeneous beliefs and short sale constraints. On the other hand. The implications of the market power hypothesis discussed above suggest that this ratio will be higher for the IPOs of highreputation underwriter backed firms than for the IPOs of lowreputation underwriter backed firms (H2). The first measure we study is the ratio of the valuation placed on the firm in the IPO (valuation at the offer price (OP)) to its intrinsic value (IV). it is difficult to assume that. Purnanandam and Swaminathan (2004)). Under the market power hypothesis. so that this ratio will be closer to one for highreputation underwriter backed IPOs (H1B). the certification hypothesis predicts that the secondary market price to intrinsic value ratio will not change over time subsequent to the IPO (H3B). it is easy to see from casual observation that the opening day secondary market price of IPO shares is significantly different from intrinsic value during some periods. Apart from the above evidence provided by academic studies. one would expect highreputation underwriter backed IPOs to be priced closer to intrinsic value than lowreputation underwriter backed IPOs. only to climb much higher on the first day of trading in the secondary market. The third set of measures relate to the relationship between underwriter reputation and the heterogeneity in investor beliefs about the IPO firm. This literature suggests that. On the other hand. as well as using a discounted cash flow method based on Ohlson’s (1990) residual income valuation model.. 5 . One example is the internet bubble period of 19992000. if the role of the underwriter in IPOs is that of certification. e. We therefore study the ratio of secondary market valuation to intrinsic value at the end of one year. two years. the price of an IPO firm’s equity at the close of the first day secondary market trading will equal its intrinsic value (little information regarding the future performance of the IPO firm is released between the time the IPO offer price is set and the close of trading on the first day).
Finally. our result is robust to correction for endogenous selection between highreputation underwriters and firms. based on unobservable valuerelevant firm characteristics not captured by our valuation methodology.4). even after controlling for any such endogeneity using the three methods discussed above. We find that. Helwege and Liang (2004)). First. the higher the valuation of the firm’s equity in the secondary market (H5). we use instrumental variables analysis to correct for the endogeneity between underwriter reputation and IPO valuation (we discuss the instruments we use in section IV.heterogeneity in investor beliefs to be greater for IPOs backed by highreputation underwriters (H4). we exploit the discontinuous nature of NYSE listing requirements for assets to control for any endogeneity between underwriter reputation and IPO valuation in a regression discontinuity framework. consistent with the idea that highreputation underwriters are able to more easily manipulate investor beliefs in hot IPO markets. highreputation underwriter backed firms are associated with higher IPO and secondary market valuations. if underwriters with highreputation find it easier to manipulate investor beliefs in hot markets (when investors are already optimistic. We use various strategies to control for such endogenous matching between underwriters and issuers.g. the association between underwriter reputation and IPO valuation is more positive in hot IPO markets than in cold IPO markets. then the relation between underwriter reputation and IPO valuation should be even more positive in hot markets than in cold markets. Second. Thus.. e. we split our sample into hot and cold IPO markets. and 6 . that is. We find that equity in highreputation underwriter backed IPOs are priced higher and further away from intrinsic value compared to lowreputation underwriter backed IPOs. We summarize these testable predictions in Appendix 1. Prior literature finds that hot IPO market issuers are of the same or lower quality than cold IPO market issuers (see. Greater market participation by institutional investors and more reputable comanaging underwriters will increase the heterogeneity in investor beliefs and should also be positively related to the secondary market price to intrinsic value ratio (H6). We then show that the above relationship between underwriter reputation and postIPO secondary market valuation is associated with greater heterogeneity in investor beliefs and greater participation by institutional investors. analysts. We find evidence consistent with the latter conjecture. One potential explanation for this result is that it reflects endogenous matching between highreputation underwriters and higher quality issuing firms.g. e. On the other hand.. the greater the heterogeneity in investor beliefs. We would also expect that any heterogeneity in investor beliefs associated with underwriter reputation would dissipate over time subsequent to the IPO (H7) and such decreases in heterogeneous beliefs will be associated with the decreases in the IPO firm’s stock market value to intrinsic value ratio (H8). Helwege and Liang (2004) and Ritter (1991)). the endogenous matching argument would suggest that the valuation difference between IPOs backed by highreputation underwriters and lowreputation underwriters would be the same or lower in hot IPO markets than in cold IPO markets.C. Clearly. Given the results in the prior literature.
postIPO secondary market valuation). consistent with the well documented longterm underperformance of IPOs (Ritter (1991)). institutional investors may in fact be able to make higher profits by buying shares in IPOs backed by highreputation underwriters (despite their higher IPO valuations) by selling them at even higher valuations to retail investors. What do our empirical results tell us about the effect of heterogeneous beliefs among investors (in the presence of short sale constraints) on IPO valuation and the role of underwriters in IPOs? First. Finally.e. may be purchasing heavily overvalued shares of equity when they invest in IPOs in the secondary market. since the valuation of equity in firms backed by highreputation underwriters becomes even higher (and commands an even higher premium over shares in IPOs backed by lowreputation underwriters) in the first few days of secondary market trading. Third. consistent with the heterogeneous beliefs theory of Miller (1977) and Morris (1996). the above pricing behavior by highreputation underwriters may not damage their reputation with institutional investors. Hu.13 This. Overall. we find that the valuation of IPO stocks converge towards their intrinsic value and the heterogeneity in investor beliefs decline over the three years after the IPO. changes the sentiment of retail investors in the IPO market to become more optimistic about the future prospects of these firms. and Huang (2010)). 13 In unreported tests. thus increasing the heterogeneity in investor beliefs and resulting in higher firm valuations. and consistent with our expectations. However. analysts. Since there is considerable evidence indicating that there is a significant amount of flipping of IPO shares by institutional investors to retail investors both in the first few days of trading in the secondary market shares (Aggarwal (2003)) and in the subsequent months (Chemmanur. and by obtaining greater analyst coverage for IPOs backed by them.highreputation comanaging underwriters that characterize highreputation underwriter backed IPOs. Fourth. in turn. the above indicates that the investors who are least well off from participating in IPOs backed by highreputation underwriters are retail investors. and more reputable comanaging underwriters. Finally.. Second. we also analyze the relationship between the firm valuation ratio at the IPO and the heterogeneity in investor beliefs as well as market participants and find results similar to those reported for the postIPO secondary market. our results support the market power hypothesis and reject the certification hypothesis. our analysis of the secondary market valuation is more appropriate since our independent variables in this analysis are measured exante relative to the dependent variable (i.12 Further. 12 7 . such retail investors are worse off investing in shares backed by highreputation underwriters In unreported tests. we also find that IPOs backed by higher reputation underwriters are also associated with greater participation by high quality market players such as institutional investors. the above decline in IPO stock valuation over the long run is associated with the decline in the heterogeneity in investor beliefs over the same time period. highreputation underwriters are able to build reputation with issuers by obtaining higher equity valuations for shares sold in the IPO and in the immediate secondary market. who. Further. a greater extent of heterogeneity in investor beliefs is associated with higher IPO stock valuations. the mechanism through which highreputation underwriters are able to obtain higher IPO valuations is by generating greater participation by higher quality market players such as highreputation comanaging underwriters and institutional investors.
Consistent with this argument. who argue that investment bankers try to promote IPOs to 8 . Section V describes our results on heterogeneity in investor beliefs in IPOs. and Singh (2001)) indicates that highreputation underwriters are also associated with higher IPO underpricing (i. and conclude that venture capitalists perform a marketing rather than a certifying role.. however. Thus. Our paper is also related to Cook. Aggarwal. thereby enabling IPO firms to obtain higher market valuations. Loutskina.. Section II describes the data and the sample selection methodology. Section I discusses the related literature. Section III outlines the empirical methodology used in the paper. They. as documented by Purnanandam and Swaminathan (2004). and Tian (2008) who study the role of venture backing in IPOs.g. Beatty and Welch (1996). and Cliff and Denis (2004) have shown that IPOs that leave more money on the table are associated with greater analyst coverage.g. both in the IPO and the secondary market. highreputation underwriters may leave a greater extent of money on the table to attract greater participation by these market players.e. e. this paper is also related to the broader literature on the role of financial intermediaries in IPOs: see.. Section VI describes our multivariate analysis of the mechanisms that may drive the effect of underwriter reputation on the market valuation ratios of IPO firms and section VII concludes. We reconcile our results that highreputation underwriters obtain higher IPO and secondary market valuations with those in the abovementioned literature by noting the following. Chemmanur. In a similar vein. IPOs can be underpriced and overvalued relative to intrinsic value at the same time provided that the immediate secondary market price can deviate from intrinsic value (since underpricing merely captures the initial return from the IPO offer price to the first day closing price in the secondary market). The rest of the paper is organized as follows. Relation to the Existing Literature The evidence provided by the prior literature (e. a larger amount of money left on the table) during the 1990s. In addition to the theoretical and empirical literature (discussed earlier) on the effect of heterogeneous beliefs among investors on equity valuation. I.relative to investing in IPOs backed by lowreputation underwriters. do not study the role of underwriter reputation in IPOs. and Womack (2002). Kieschnick. First. since the former are priced higher and further away from intrinsic value. Second. Carter. Section IV describes the empirical results on IPO underpricing and valuation. Krigman. Dark. and Van Ness (2006). Chemmanur. Hu. and Cooney. the money left on the table by underwriters may be a mechanism through which they share value with market players such as institutional investors and analysts and thus attract participation by them to the IPOs they underwrite. Loughran and Ritter (2004). and Huang (2010) document that institutional investors sell a large fraction of their IPO allocations by the end of the first month after the IPO and capture much of the money left on the table on these shares.
3%). and closed end funds.. Further. REITs. but only in the case of hot IPO samples. and small trade order imbalance. He.15 II. we need to impose additional filters depending on the intrinsic value calculation methodology. e. For further analysis.g. We also provide summary statistics for our measures of heterogeneous beliefs and underwriter market share (used to measure underwriter reputation). and Womack (2002). Our paper is also related to the broader theoretical on IPOs (see Allen and Faulhaber (1989). we remove IPOs of ADRs. As is common in the IPO literature. 16 We do not rely only on SDC classification to identify ADRs.01 million. See also Ho.. Instead. Lin.07 million. Suchanek. 14 9 .14 While they show that preoffer publicity is related to investment bank compensation and IPO underpricing. and Nandy (2010) and see Ritter and Welch (2002) for a review of the IPO literature). only 5276 firms are present on the CRSP and Compustat datasets. and median proceeds from IPO of about $29 million. This further decreases the size of the sample for which we can calculate intrinsic value ratios. our focus here is on the effect of heterogeneous beliefs on IPO valuation. our paper analyzes how underwriter reputation affects IPO and first day closing secondary market valuations. as well as firms with missing data for assets which leaves us with 3737 IPOs in the sample period. Panel A of Table I shows the descriptive statistics for our IPO sample. While their paper relates underpricing to analyst coverage and insider sales at lockup period. and the impact of the underwriter on the above variables. our paper is related to Aggarwal. Grinblatt and Hwang (1989) and Welch (1989) for theoretical models of IPO underpricing) and the going public decision (see. Chemmanur and Fulghieri (1999)). REITs.16 We also remove firms with offer price of IPO less than $5. we use share codes from CRSP to implement this filter. Chemmanur. 15 Houge. Data and Sample Selection The initial sample is obtained from the SDC Platinum New Issues database and consists of 7780 IPOs issued between 1980 and 2000. Loughran. they do not study the role of underwriter reputation in IPOs or its impact on the heterogeneity in investor beliefs about the firm’s prospects.g.7% and median underpricing of 6.induce sentiment investors to buy the stock. prior to their offerings. Chan (2010) studies individual versus institutional trades in IPO stocks and documents that IPO stocks’ opentoclose returns are positively related to small trade participation. nonordinary shares. as well as the empirical literature on the going public decision (see. e. Out of this sample. and Yan (2001) study the relationship between the long term performance of IPOs and investor uncertainty and the divergence of investor opinion about the firm’s IPO. Krigman. nonordinary shares. and Lin (2010). In contrast. The mean underpricing (21%) and the median underpricing (7%) for our sample are consistent with the numbers reported in Loughran and Ritter (2004) (mean underpricing of 18. Huang. The IPOs in our sample have a median asset size of $21. who document that. median EBITDA of $3. The next section describes these valuation methodologies in detail. Further. Venture capital firms back about 45% of the all the IPO firms in the sample. IPO firms tend to report higher earnings and disclose inflated earnings forecasts in an attempt to manage news coverage around the IPO. small trade purchases. closed end fund shares or unit offerings. Chemmanur (1993). who analyze the role of underpricing and analyst research in determining insider sales around lockup periods.
III. We compute three measures of intrinsic value. and EBITDA/sales ratio to that of the IPO firm. and Bhojraj and Lee (2002). closed end funds. The first measure uses the market valuation of a comparable firm based on similar industry. The remaining Compustat firms are divided into 48 industry portfolios based on Fama and French (1997) industry classifications. The second method uses the market value of a comparable firm based on a propensity score based matching approach. For each year. REITS. 1. and Tian (2008) and Purnanandam and Swaminathan (2004). and Tian (2008). For each IPO firm. Methodology A. We then estimate the offer price to intrinsic value and secondary market price to intrinsic value ratios of the IPO firms based on the price multiples of their comparable firms as follows. If this sort is not sufficient. Intrinsic Value Calculations To calculate intrinsic value. The Basic Comparable Firm Approach The first approach that we use to estimate the intrinsic value of IPO companies is a matching technique based on finding an industry peer with comparable Sales and EBITDA profit margin (EBITDA/Sales). nonordinary shares. an appropriate comparable firm is then chosen from the corresponding yearindustrySalesEBITDA margin portfolio having the closest sales value to the sales of the IPO firm. foreign company stocks. Purnanandam and Swaminathan (2004). Offer Price IPO x Shares Outstandin g IPO OP Prior Year Fiscal Sales IPO IV Sales Prior Year Fiscal Sales Comparable x Price Comparable x Shares Outstandin g Comparable (2) First Day Closing Price IPO x Shares Outstandin g IPO SMP Prior Year Fiscal Sales IPO IV Sales Prior Year Fiscal Sales Comparable x Price Comparable x Shares Outstandin g Comparable (3) 10 . If there are less than 3 firms in any of the industryyearsalesEBITDA margin portfolio. we use all the Compustat firms that have been public for at least three years prior to the IPO date and exclude ADRs. which leaves us with 2724 firms. We first remove the IPO firms that have negative or missing sales and EBITDA values in Compustat. we then do a 2 by 2 sort on sales and EBITDA/sales. size. The final method is a discounted cash flow approach using Ohlson’s (1990) residual income valuation method. we then consider only one portfolio per industryyear. Loutskina. This procedure gives us nine portfolios for each industryyear. Loutskina. To obtain candidate firms to match. A detailed overview of the three methods follows. This approach is similar to the one followed in Chemmanur. we follow a methodology similar to the one in Chemmanur. and firms with stock price less than $5 at IPO date. we divide each industry portfolio into three portfolios based on sales and then separate each sales portfolio into three portfolios based on EBITDA profit margin (EBITDA/Sales).
To expand a bit more on the endogeneity issue. To correct for this. This could potentially bias our intrinsic value calculations. Propensity Score Based Comparable Firm Approach The propensity score based approach of obtaining comparable firms has significant advantages over the basic comparable firm approach. Earnings. Shares outstanding is the number of shares outstanding immediately after the IPO for IPO stocks and the number of shares outstanding on the day closest to the IPO day for the comparable firm. Based on this procedure. Offer Price IPO x Shares Outstandin g IPO OP Prior Year Fiscal EBITDA IPO IV EBITDA Prior Year Fiscal EBITDA Comparable x Price Comparable x Shares Outstandin g Comparable (4) First Day Closing Price IPO x Shares Outstandin g IPO SMP Prior Year Fiscal EBITDA IPO IV EBITDA Prior Year Fiscal EBITDA Comparable x Price Comparable x Shares Outstandin g Comparable (5) Offer Price IPO x Shares Outstandin g IPO OP Prior Year Fiscal Earnings IPO IV Earnings Prior Year Fiscal Earnings Comparable x Price Comparable x Shares Outstandin g Comparable (6) First Day Closing Price IPO x Shares Outstandin g IPO SMP Prior Year Fiscal Earnings IPO IV Earnings Prior Year Fiscal Earnings Comparable x Price Comparable x Shares Outstandin g Comparable (7) Here. These variables allow us to control for the underwriter’s private information regarding improvements in future sales as well as cost efficiency of the firm. Sales. OP/IV is the offer price to intrinsic value ratio and SMP/IV is the first day closing secondary market price to intrinsic value ratio for the IPO stock. First. For each fiscal We explicitly control for endogenous matching between underwriters and firms in section IV. we make use of the “nearestmatch” version of the propensity score based matching approach similar to Dehejia and Wahba (1999. 2. we include three year expost average growth in sales. The shares outstanding data and the market prices are obtained from the CRSP daily files. average growth in cost of goods sold. Offer price of the IPO stock is obtained from the SDC Platinum database.C using instrumental variables and regression discontinuity analyses. Loutskina. and Tian (2008).17 Following Chemmanur. and average growth in selling and general expenses in the propensity score model. We run the same filters for the set of candidate and IPO firms as we did in the basic comparables approach. 2002). 17 11 . Second. we are able to successfully find matching firms for 2655 IPO firms. and EBITDA data are obtained from the annual Compustat files. it allows us to control for a possible endogeneity bias in our intrinsic value calculations. the propensity score based approach allows us to match on a larger set of parameters than the basic matching method. it is possible that highreputation underwriters have information about the future performance of firms and therefore select firms that they expect to perform better in the future.
We do our calculations with two values of terminal growth rates. net income to sales ratio. Further and more importantly. thus biasing our results against finding overvaluation of IPOs. and the average three year expost growth rate in selling and general expenses. We then obtain the predicted value of the probabilities from the probit model and match the IPO firm with a nonIPO firm having the closest predicted probability to that of the IPO firm. The intrinsic value of the firm is computed as follows: IV Bo EPS1 r * B0 ( EPS1 r * B0 ) ( EPS 2 r * B1 ) 1 * (1 r ) * (r g ) (1 r ) 2 (8) The last term is the discounted terminal value of the stock. The independent variables in the regression are sales. 3.18. In doing intrinsic value calculations. The most significant benefit of the discounted cash flow method is that we do not have to restrict the sample of firms to have positive earnings or net income. However. offer price and secondary market price to intrinsic value ratios are calculated as before using equations (2) through (7). EPS and book value data are obtained from COMPUSTAT. Finally. Bi is the book value of the issuer in year i after the IPO. 18 12 . We assume a constant required return of 13%. EPSi is the earnings per share in year i after IPO. Based on this procedure. the average three year expost growth in cost of goods sold. Based on this procedure. However. Therefore. the average three year expost growth in sales. a survivorship bias should reduce the difference between offer price and the intrinsic value. while a survivorship bias can bias intrinsic value. we are able to successfully find matching firms for 2277 IPO firms. while keeping the restriction that the comparable firm must be in the same industry as the IPO firm. g=0 and g=5% to check the robustness of our results. Intrinsic values computed using this method allows us to check the robustness of the results from the comparables approach. we then run a probit model for the set of all IPO and nonIPO firms where the dependent variable takes on the value 1 if the firm is an IPO firm and 0 if it is not. we are able to compute intrinsic value and valuation ratios for 2112 firms using the 0% terminal growth rate and 2113 firms using the 5% terminal growth rate.20 One firm that had a positive intrinsic value under a 5% growth rate assumption has a negative intrinsic value under a 0% growth rate assumption.year. keeping the IPO valuation constant. surviving firms are likely to have higher intrinsic values. 19 There is a potential survivorship bias induced by this methodology since we are using actual future EPS of an IPO firm. Finally. EBITDA to sales ratio. we set terminal value equal to 0 if it is negative under the assumption that managers are unlikely to continue negative NPV projects to perpetuity. The specific model we follow to compute the intrinsic value of the firm is similar to Ohlson (1990). Discounted Cash Flow Valuation Method We also use the discounted cash flow method to compute the intrinsic value of IPO firms. we only use firms that have positive intrinsic values for our valuation ratio calculations.19. we do require that firms have earnings data for at least 2 years after the IPO date.
That is. As with lead underwriters. Underwriter Reputation Measurement Our main test variable is underwriter reputation. The market share for a given time period is calculated as the ratio of total proceeds issued by the underwriter in that period to the total size of the IPO market in that period. 13 . We only report results using the Megginson and Weiss (1991) ranking measure in this paper for brevity (MW ranking from here on). Carter. we split the proceeds from that offering equally between each of the lead underwriters to calculate their individual market share. a survivorship bias requires that underwriters value IPOs without any regard to intrinsic value. Since our analysis focuses on the valuation of a firm in the IPO and the immediate postIPO aftermarket relative to intrinsic value. a survivorship issue is less likely to affect our results. The binary highreputation dummy takes the value 1 if the underwriter reputation is higher than the median of the sample and 0 otherwise. The first is the based on Megginson and Weiss (1991) and is calculated as the total market share of the lead underwriter in the IPO market over the entire sample period.. 20 We also conduct our tests using an expanded specification : IV Bo EPS1 r * B0 EPS 2 r * B1 ( EPS 2 r * B1 ) ( EPS 3 r * B2 ) 1 * (1 r ) 2 * (r g ) 2 (1 r ) (1 r ) 2 The results obtained with this measure of intrinsic value are qualitatively similar as the ones reported in the paper.g. We then take the average of the market shares of all the lead underwriters of the issue to calculate the lead underwriter syndicate rank for that issue.B. and Singh (2001)). Dark. Cooney. we believe that our results are not driven by such biases. We calculate the average market share of the comanaging underwriter group for each IPO as a measure of reputation. We use both binary and continuous specifications of underwriter reputation for our tests. However. all our tests are conducted using both ranking methods and the results are qualitatively similar when we use the 12 month rolling rankings. We use two different market share based measures for underwriter reputation. The market share for each underwriter who acts as a comanaging underwriter is calculated as the total proceeds in all IPOs for which the underwriter acts as a comanaging underwriter (IPO proceeds are split equally among all comanaging underwriters if there is more than one) divided by total IPO proceeds within the sample period. However. since we also conduct our analysis with the comparable firm methodology. we also calculate 12 month rolling rankings for comanaging underwriters and conduct all tests using this ranking method. We only report tests based on the binary version of underwriter reputation variable to ensure continuity with the univariate comparisons. If more than one underwriter acts as a lead underwriter for an issue. which is unlikely. We also measure the reputation of comanaging underwriters in IPOs in a similar manner. The second measure is based on the market share of the lead underwriter over a rolling 12 month period prior to the IPO issue date (e. In addition. which is less likely to be affected by a survivorship bias. all our multivariate tests are replicated using it is unlikely to bias the IPO and secondary market valuation of a firm for a given intrinsic value.
g.g. This. The first two proxies are also used in Chemmanur. the “90s period’ includes IPOs from 1990 to 1998 and the “90s including bubble period” includes IPOs issued between 1990 and 2000. in conjunction with short sale constraints. To control for possible liquidity effects. IV. Loutskina. we identify proxies for heterogeneous beliefs. We motivate our proxy using the model of Harris and Raviv (1993). The adjusted values are calculated as the value of the variable minus the average monthly value of the same variable after three years. IPO Underpricing in the 1980s and 1990s Panel B of Table I shows how underpricing and underpricing differences between high and lowreputation underwriters have evolved over time. This effect is also documented in Loughran and Ritter (2004) who find that the average underpricing has gone from being lower for highreputation underwriter backed IPOs in the 1980s to being higher for highreputation underwriter backed IPOs in the 14 . and Stober (1997)) have used trading activity as a proxy for heterogeneous beliefs among investors.14% (not statistically significant) in the 80s to about 4. The difference in underpricing between higher and lowreputation underwriter backed IPOs increases from an average of 1. The data for calculating the proxies of heterogeneous beliefs is obtained from the CRSP database. e. The three market based proxies that we use are daily volume (defined as the log of the price of the stock multiplied by the number of shares traded in that day). and the number of trades in a given day. To examine the relationship between underwriter reputation and heterogeneous beliefs. Proxies for Heterogeneous Beliefs We argue that highreputation underwriters elicit more market participant interest and this in turn is able to induce higher levels of heterogeneity in retail investor beliefs. who argue that when heterogeneous beliefs are higher in the market. Bamber (1987) and Bamber. C. The median underpricing difference increases from 0.. Barron. is able to obtain higher valuations for IPOs.5% in the 80s to 7. Kandel and Pearson (1995)) as well as the accounting literature (see. In the table. the “80s period” includes IPOs from 1980 to 1989. The above results indicate that the underpricing difference between higher and lowreputation underwriter backed IPOs has clearly flipped from the 80s to the 90s. we also use adjusted values of the statistics described above. there is more trading between agents and this should be empirically measurable. We add the number of trades as it is also representative of the trading activity for the stock. IPO Underpricing and Valuation A.the continuous market share variables.6% in the 90s.2% in the 90s. e. We obtain the weekly and monthly values of these variables by averaging the daily values over time. daily turnover (defined as the ratio of the number of shares of the IPO stock traded in that day to the number of shares of that stock outstanding on that day). The results obtained using the continuous variables are similar to the results reported in this paper. A number of empirical papers in the finance literature (see.. and Tian (2008).
The results are also similar for the 90s including the bubble period. For the sales multiple based valuation. Our results do not change qualitatively. 22 To test whether clustering around industry and year can affect the standard errors in our univariate analysis. The results based on valuation ratios using Carter. These differences are highly statistically and economically significant. Univariate Results on Valuation The univariate tests for primary and secondary market valuation ratios are reported in Tables 2. This method controls for the possibility that highreputation underwriters could potentially select better firms and therefore bias the basic comparable method results.28 between the median offer price valuation ratios of high and lowreputation underwriter backed IPOs and 0. where highreputation underwriter backed IPOs have higher median offer price valuation ratios and first day closing secondary market price valuation ratios than lowreputation underwriter backed IPOs.1990s. Table II reports the comparisons using the basic comparable firm approach. 21 15 . we calculate the Somers’ D clustered statistic and the 90% confidence intervals for the HodgesLehmann clustered median difference test for all the univariate results presented here. the median first day closing secondary market price valuation ratio for IPOs backed by highreputation underwriters is 0. B. Our results are robust to clustering the standard errors. Dark.36 higher than that for IPOs backed by lowreputation underwriters. all subsequent multivariate tests on valuations are conducted with and without clustering on industry as well as the year of issue.58 times the intrinsic value in the 80s. The results are similar for first day closing secondary market prices where highreputation underwriters obtain a median offer price that is 1.52 times the intrinsic value in the 80s. and Singh (1998) and Megginson and Weiss (1991) document a negative relationship between underwriter reputation and IPO underpricing using data from 1980s. and 4. Further.21 The above trend highlights our motivating question of the economic role of the underwriter in IPOs. there is a statistically significant difference of 0.65 times the intrinsic market value while lowreputation underwriters obtain a median offer price that is 1. The tables list valuations over the same time periods as the underpricing trend reported in Table I for ease of comparison.46 higher than the median valuation ratios for IPOs backed by lowreputation underwriter in the 1990s. One of the secondary objectives of this paper is to test whether IPO valuation and the economic role of the underwriter in an IPO was fundamentally different in the 1980s and 1990s using alternative measures of the economic role of the underwriter (such as IPO valuation relative to intrinsic value). Based on the sales multiple. The differences are even more stark for the 90s period: here the median offer price valuation ratio for IPOs backed by highreputation underwriters is 0.32 between the median first day closing secondary market price ratios of high and lowreputation underwriter backed IPOs. The results obtained above hold when we use valuation ratios based on EBITDA and earnings multiples.57 times the intrinsic value for the stock of the IPO firm while lowreputation underwriters get a statistically significantly lower offer price of about 1.22 Table III shows that the results are similar when we use the propensity score based comparable firm approach. highreputation underwriters obtain a median offer price of about 1. Similarly. 3.
6% increase in the secondary market price valuation ratio. these valuation results are consistent across the 1980s and 1990s in the sense that highreputation underwriters obtain higher valuations than lowreputation underwriters in both these time periods. C. Panel A of Table V reports the results from the OLS regression of the log of our offer price to intrinsic value ratio and the log of the first day closing secondary market price to intrinsic value ratio. Finally. consistent with expectations.other multiples are qualitatively similar although the statistical significance using the EBITDA multiple is weaker. consistent with investors viewing sales of higher stakes in the firm with greater apprehension. we find that IPOs of larger firms are associated with lower valuations. a one standard deviation increase in the underwriter reputation is associated with a 30% increase in the offer price valuation ratio and with in the secondary market price to valuation ratio. the underpricing results are not consistent in the 1980s and 1990s. The OLS model confirms our univariate results that highreputation underwriters are associated with higher valuations. In contrast. If all that is happening is that high 16 . Further. Moreover. we use the discounted cash flow approach to value the IPO stocks in Table IV. consistent with our hypotheses (H1A) and (H2). we test whether the association between underwriter reputation and the valuation of IPO stocks changes depending on whether the IPO market is hot or cold. we use both the dummy and the log of the continuous version of underwriter reputation. We control for firm size. In addition. We show in subsequent sections that our valuation ratios are higher for highreputation underwriters in multivariate tests as well as in tests that control for endogenous matching between underwriters and firms. we control for industry and year fixed effects. Similarly. The reported results are generally consistent with the results above and corroborate our hypothesis that highreputation underwriters obtain higher primary and secondary market valuations for their clients. we find that IPOs backed by highreputation underwriters (based on the highreputation dummy) are associated with a 37. 2.5% increase in the offer price valuation ratio and a 44. and the fraction of the firm sold in the IPO. IPOs of firms backed by venture capitalists are associated with higher valuations. In these regressions. In particular. The results in this section are consistent with the idea that the underwriter’s primary goal is to get the highest possible valuation for their clients and that highreputation underwriters are better at obtaining these higher valuations. In this section. both in the IPO and the immediate postIPO secondary market. IPOs of firms selling larger fraction of equity are associated with lower valuations. In terms of the control variables. Multivariate Results and Endogenous Matching between Underwriter Reputation and Firms 1. Overall. OLS Regressions in the Full Sample. IPO Valuation by Underwriters in Hot and Cold IPO Markets. our empirical results indicate that highreputation underwriters are able to obtain higher valuations in both the primary and the secondary markets for their clients. whether or not the firm is backed by a venture capitalist.
We rely on an important assumption for this test. on average. On the other hand. we categorize the IPO to be issued in a hot market. Ritter (1991) finds that longrun IPO stock return underperformance is actually higher in high volume years (consistent with IPOs issued in hot markets underperforming relative to those issued in cold markets). and vice versa. For example. Specifically. The assumption that the quality of firms is not different between hot and cold markets allows us to keep the effect of any endogenous matching between underwriters and firms on valuation constant across hot and cold IPO markets. then they should obtain even higher valuations than lowreputation underwriters in hot IPO markets. If. on the other hand. highreputation underwriters have greater ability to obtain higher valuation by making investors optimistic. Economically. We find that while underwriter reputation has positive coefficient estimates in both hot and cold IPO markets. Evidence from Helwege and Liang (2004) is consistent with this argument. based on the highreputation underwriter dummy we find a 22% higher association between underwriter reputation and valuation in hot IPO markets relative to cold IPO markets. Various empirical papers have demonstrated this. Similarly. Helwege and Liang (2004) find no difference either in the characteristics such as size. when investors can be more easily manipulated. Further. the coefficient estimate on underwriter reputation is significantly higher in hot markets than in cold markets. the possibility that hot IPO market firms’ quality may be worse than cold IPO market firms’ quality. Panel B of Table V reports the results of the OLS regressions of the IPO valuation ratios split by hot and cold IPO markets. then we expect that the effect of underwriter reputation on IPO valuation will be higher in hot IPO markets compared to cold IPO markets. growth potential. This is because highreputation underwriters will find it easier to manipulate retail investor beliefs in hot markets. a one standard deviation in underwriter reputation has a 18% higher association with the IPO offer time valuation ratio in hot markets compared to that in cold markets. We define hot IPO markets by using the three month moving averages of the number of IPOs prior to the sample IPO.reputation underwriters systematically pick better firms based on underlying and unobservable quality. predicts that the incremental effect of underwriter reputation on IPO valuation will be lower in hot IPO markets compared to cold IPO markets (based on the endogenous matching conjecture). if highreputation underwriters can obtain higher valuation for the IPOs that they back by manipulating investor sentiment. We assume that higher quality firms are equally or less likely to conduct IPOs in hot markets than in cold markets. when investors tend to be more optimistic. and industry or in the postIPO operating performance of firms whose IPOs are issued in hot markets relative to those whose IPOs are issued in cold markets. if the average number of IPOs in the three months prior to the sample IPO is greater than the sample median. 17 . then the association between underwriter reputation and valuation of IPO stocks during hot IPO markets should not be different from that in cold IPO markets (see below for further explanation).
consistent with hypotheses (H1A) and (H2). The second stage model is then: y j x j . 3. Carter. We augment the second stage equation with the conditional expectation E(zj  Sj). we use the “fuzzy” RD technique discussed in Van der Klaauw (2002) and Angrist and Lavy (1999). f(S) = 1{Sj ≥ S0} + 11(S 1S + 2S 2 (11) + 11(S – S0). We estimate the following model: yj xj z j j (9) where. and $40 million from 1995 to 1997 for a company to list on the exchange. and ηj is an error term. Note that. εj. 18 . The regression discontinuity can then be implemented with a twostage approach. NYSE required $16 million in assets for listing till 1983. Van der Klaauw (2002) and Angrist and Lavy (1999) analyze the effect of jumps in continuous treatment variables on their variables of interest. unlike an instrumental variables approach.1{S j S 0 } j .23 Therefore. Identification in a fuzzy RD technique comes from a discontinuous jump in the expected probability of treatment. which is calculated as the predicted value from (10). Specifically. In particular. We use a piecewise quadratic functional form for f(S). – S0)2. The standard errors in the second stage are bootstrapped to account for generated regressors. (10) where. zj is the potentially endogenous treatment variable. Sj can be correlated with the error variable. We first estimate. 1{Sj ≥ S0}. 1{Sj ≥ S0} is an indicator function that equals 1 if Sj ≥ S0. Endogenous Matching between Underwriter Reputation and Firms: Regression Discontinuity Analysis In this section. The fuzzy RD approach requires a variable (we will call it the assignment variable) Sj such that zj experiences a jump at a known point S0.S j u j . We use the twostage approach discussed in the papers above to implement our RD analysis.E ( z j  S j ) .In summary. we find evidence that the positive association between underwriter reputation and IPO valuations is consistent with the manipulation of investor beliefs by IPO underwriters. with the discontinuity 1{Sj ≥ S0} serving as the identifying instrument. We exploit the discontinuity arising from NYSE listing requirements for net tangible assets from the sample period 1980 to 1997. After that. to account for the changes in the NYSE listing 23 See Anderson and Dyl (2008) and Cowan. NYSE listings did not have restrictions based on assets. f(Sj) is a continuous function of Sj. we analyze the causal effect of underwriter reputation on IPO valuation using a regression discontinuity (RD) analysis. z j f ( S j ) . This approach is analogous to an instrumental variables approach. and Singh (1992). Dark. $18 million from 1984 to 1994. The restriction required for identification is that no other effect causes a jump in yj at Sj = S0.
. which makes analysis less tractable.requirements over time (using the sample from 1980 to 1997). In addition. To rule out this concern. we find that highreputation underwriters are linked to higher valuations. at Sj =0). thus reducing the necessity of a highreputation underwriter..e. will be more likely to list on the NYSE.. Grammatikos and Papaioannou (1986)). both in the IPO and the first day closing secondary market. McCrary (2008) argues that such active sorting may undermine the identification requirements of the regression discontinuity design. which is consistent with (H1A) and (H2). to some extent. In the second stage. Thus. Some listing requirements such as total market value of shares can be directly influenced by underwriters. two. Visual analysis of the graph indicates no upward jump of Sj at the cutoff point. substituted by the NYSE listing. We then conduct the statistical test recommended in McCrary (2008) to ensure that our identification strategy is valid. such as creating liquidity and investor recognition are. Consistent with our expectation. i. One concern with the assignment variable may be that firms may be able to manipulate their size levels to comply with NYSE requirements. Sj≥0.e. 24 NYSE also has other restrictions for firms to be eligible for listing. The graph clearly indicates that there is a sudden decline in the underwriter reputation at 0. Thus.e. thus supporting our identification strategy. the coefficient estimate on the jump point indicator (i.e. as expected. this relation would reverse in a discontinuous manner at the point where the firm becomes eligible to list on the NYSE. since highreputation underwriters’ services. indicating that there is a downward jump in the propensity in the underwriter reputation at the point where a firm becomes eligible to list on the NYSE based on assets.24 Evidence in prior literature shows that NYSE listings are related to higher liquidity and more visibility and investor recognition for the firm (Kadlec and McConnell (1994). income requirements are more complicated and based on different levels of required income levels in one. Figure 1 graphs kernel weighted mean smoothing estimations between underwriter reputation (measured as the log of underwriter market share) and the normalized size variable. after controlling for the selfselection between firms and reputed underwriters using the regression discontinuity approach. Sj =log( ) Our identification strategy depends on the idea that firms that are larger than the listing requirement for NYSE.. 1{Norm. we graphically and statistically analyze the density function of the normalized size variable around the cutoff point (i. and three years prior to the IPO. is defined as log normalized level of assets. we find that the coefficient estimate on the predicted underwriter reputation from the first stage is positive and statistically significant. We show a graphical analysis of the discontinuity. while the endogeneity argument would predict that underwriter reputation is positively related to firm size (to the extent that firm quality is correlated to size). our assignment variable Sj. The results of the regression discontinuity analysis are reported in Table VI. Size >0}) is statistically significant and negative in the first stage regression. i. due to which such variables are unsuitable as candidates to obtain a discontinuity for our analysis. 19 .
26 4. This variable is the unique count of underwriters that have underwritten IPOs in the same industry as the IPO firm in the past five years. 27 An argument against such an instrument is that perhaps by localizing.25. consistent with our The estimator for this test is calculated in two steps.e.27 The second instrument that we use is the availability of underwriters that have experience in the industry of the firm. are reported in Table VII.The test is implemented as a Wald test of the null hypothesis that the discontinuity in the density function of the assignment variable is zero at the cutoff point. 26 Another concern with our identification strategy is that NYSE listed firms may have higher valuations if NYSE listing itself provides greater investor recognition and reduces information asymmetry for the firm going public. thus biasing the results against finding a positive relation between underwriter reputation and IPO valuation. Endogenous Matching between Underwriter Reputation and Firms: Instrumental Variables Analysis We use instrumental variables analysis to demonstrate the causal effect of underwriter reputation on IPO valuation using instrumental variables methodology. The standard errors in the second stage are corrected for the estimation error from the first stage (Maddala (1983)). The test statistic is based on the estimates of the density function from local linear regressions from the two sides of the cutoff point. implemented as a two stage least squares model (using the continuous version of underwriter reputation) and a treatment effects model (using a binary version of underwriter reputation). Sj = 0. therefore. However. This is defined as the Herfindahl index of the amount of IPOs underwritten by the lead underwriter across different states. 28 As before. Second. We use two instruments to satisfy exclusion restrictions. underwriters are able to specialize in their local areas. based on FamaFrench industries. since the eligibility for NYSE listing is negatively related to the propensity of using a higher reputation underwriter in Table VI. We report the results of the first and the second stage models separately. we expect this instrument to be positively correlated with underwriter reputation. the instruments for multiple lead underwriters in an IPO underwriting syndicate are the average values of the instrument across all the lead underwriters. thereby validating our identification strategy. i. More underwriters with experience in the industry of the firm increases the bargaining power of the firm that may reduce the cost of hiring a highreputation underwriter. split our sample into quartiles based on the location concentration variable and analyze the difference in the valuation of IPOs relative to intrinsic value of the highest and the lowest quartile and do not find a statistically significant difference between these two groups. one smoothes the histogram using local linear regressions separately on either side of the cutoff point. such an effect would diminish the effect of the predicted underwriter reputation on IPO valuation. The results of our IV analyses. First. and thus can obtain higher valuation through better certification. IPO underwriters that concentrate on fewer geographic locations are less likely to gain large market shares. The first instrument is the location concentration of the underwriter used in the IPO. In addition. In the first stage of the two stage least squares model. and we expect a negative relation between this variable and underwriter reputation. one obtains a finely gridded histogram.. The test does not find a statistically significant jump in the density function of the assignment variable Sj at the cutoff point. 25 20 .28 Thus. We. to control for the possibility that any other firm related statespecific effect may be contained in this variable. we control for the fixed effects of the state in which the sample IPO firms are located. measured over five years prior to the sample IPO. we find that.
We find two interesting patterns of valuation ratios over time that significantly support our hypotheses and our intrinsic valuation methodology. two. 29 21 .823 at offer time to 1. We find that. Consider. We find similar declines in valuation ratios for the earnings multiple based ratio. and three years after the IPO date. The dynamics for the propensity score based price ratios are graphed in Figure 2. namely IPO underwriter reputation has a positive causal impact on the valuation of the stock in IPOs that they back.393 at the offer time to 1. Our results for the treatment effects model remain similar to those from the two stage least squares model. . both in the IPO and the immediate postIPO secondary market. Table VIII reports the dynamics for the sales and earnings multiple based valuation ratios for both the basic comparable firm and the propensity score based comparable firm approaches. consistent with hypotheses (H1A) and (H2). For the lowreputation underwriters backed IPOs. for example. the analysis obtains similar results even when we use the basic comparable firm approach. Stock and Yogo (2005)). For the comparable firms approaches (both the basic and propensity score based comparable firm approaches). underwriter location concentration is negatively related to underwriter reputation. two. Dynamics of Valuation Ratios We analyze how valuation ratios of IPO stocks evolve over time over a period of one. the first day closing. The first stage Fstatistic is 274. two. The partial Rsquare measures the correlation between the endogenous variable and instruments after partialing out the effect of the other exogenous variables.088 at three years after the IPO date. and three years after the IPO date. after controlling for the endogenous selection of reputable underwriters using two stage least squares analysis. D. The table lists the valuation ratios at offer time. Thus. underwriter location concentration is negatively associated with underwriter reputation and industry underwriter availability is positively associated with underwriter reputation. using IV analyses. and three years after the IPO.295 at three years after the IPO date for highreputation underwriter backed IPOs. we find the same results as in the previous two subsections.expectations. and three years after the IPO and calculate the ratios in each of these periods. First. one. Given that the effect of the The F statistic is for the test of the joint significance of the coefficient estimates on the two instruments in the first stage.29 As expected. we are able to conduct the test of overidentifying restrictions and are unable to rule out the null hypothesis that our instruments are exogenous.92 and highly statistically significant at the 1% level. The ratio decreases from 1.2% suggesting that our instruments are significant predictors of underwriter reputation (Staiger and Stock (1997). we find a new matched firm every year for one. two. To do this we calculate the intrinsic value of IPO stocks using the valuation methodologies discussed above for one. Since we have two instruments. the sales multiple based ratio dynamics for the propensity score based comparable firm approach in Panel B. and the partial Rsquared is 23. the median valuation ratios decrease over time for both high and lowreputation underwriter backed IPOs and move towards unity. highreputation underwriters are associated with higher valuations. the ratio decreases from 1. Further.
then increases to 0. This. venture capital backing. The above results provide evidence consistent with hypothesis (H3A). for the sales multiple based ratio dynamics using the propensity score based approach. Panels A.382 at the closing of the first trading day. The results obtained in this section also provide credibility to our valuation methodology. the pattern is similar: the valuation difference between high and lowreputation underwriter backed IPOs first increases from 0. Heterogeneous Beliefs in IPOs A. We find that the valuation ratios of IPOs decrease over time towards 1. number of institutions. we document the dynamics of valuation ratios of IPO stocks over a time period of three years after the IPO. the difference in valuation between high and lowreputation underwriter backed IPOs starts from 0. and log of adjusted first day number of trades. V. This gives credibility to our valuation methodology since one would expect that the effect of underwriters on valuations fades over time and the valuations of IPOs converge towards their intrinsic values.206 by the third year. Heterogeneous Beliefs Now we test whether highreputation underwriters associated with higher levels of heterogeneity in investor beliefs about the IPO firm’s future prospects. B. and C of Table IX report regressions with dependent variables as log of adjusted first day volume. respectively. comanaging underwriter reputation. 22 . is hypothesized to obtain higher prices for the IPO firm’s equity in the primary and the immediate postIPO secondary markets. 30 We also conduct the same tests with unadjusted values and the results are qualitatively similar. We also find that the valuation ratios for high and lowreputation underwriter backed IPOs converge towards each other indicating that the effect of underwriter reputation diminishes over time. In summary. This convergence in valuation further supports the idea that the effect of underwriter reputation on valuation diminishes over time. log of adjusted first day turnover. For example. and then decreases to a very small and statistically insignificant value of 0. this is the convergence pattern one would expect to see over time. Another aspect of the valuation dynamics is that the difference in valuation ratios between high and lowreputation underwriter backed IPOs is decreasing over time after the IPO. percentage institutional holdings.232 at the IPO date to 0. Interestingly.663 at the closing of the first trading day. in conjunction with short sale constraints. number of comanaging underwriters. The coefficient estimate on high underwriter reputation dummy is positive and significant even after controlling for size.30 The multivariate results are consistent with our expectations. number of analysts estimating earnings. and then decreases to 0. and year and industry dummies.underwriter diminishes over time and that our valuation measures are not biased.43 at the IPO date. For the earnings multiple based ratio dynamics using the propensity score based approach.061 at the end of three years.
percentage institutional holdings. and three years after the IPO date. This result indicates that highreputation underwriters are associated with higher dispersion in investors’ beliefs. The difference in adjusted volume between high and lowreputation underwriter backed IPOs decreases from 31. We also conjecture that the effect of underwriter reputation may disappear over time. The methodology used for calculating the variables is the same as the one used for the IPO period. To test this hypothesis.31 This is consistent with the idea that the heterogeneity in investor beliefs about the IPO stock decreases over time. The Dynamic Pattern in Heterogeneous Beliefs We argue that highreputation underwriters are able to induce significantly higher dispersion in the beliefs of investors. and comanaging underwriter reputation variables are generally statistically significant and positive. In summary. The coefficients on number of analysts. We see similar results in the adjusted first day turnover regressions in Panel B of Table IX. The evidence in this section is therefore consistent with hypothesis (H4). We obtain the heterogeneous beliefs variables for one. We also find that the difference in heterogeneous beliefs between high and lowreputation underwriter backed IPO stocks diminishes over time. we study the dynamic pattern in our heterogeneous beliefs proxies over time. In Panel A. valuation premiums for IPO stocks decline over time. i.31 at the IPO date to a statistically insignificant value of 0.255 in specification (4) and this corresponds to a 29% increase in the adjusted volume. number of institutions. A similar pattern is observed for median adjusted volume of lowreputation underwriter backed IPOs. We find that adjusted volume.85 in year 0 to a statistically insignificant and 31 The results for the unadjusted values of our heterogeneous beliefs proxies are qualitatively similar. Here.001 at the end of three years for highreputation underwriter backed IPO stocks. number of comanagers. The results for adjusted number of trades are similar to the results described above and are reported in Panel C of Table IX.D. we find evidence consistent with a positive association between highreputation underwriters and higher dispersion of beliefs among investors. and the adjusted number of trades all decrease for both high and lowreputation underwriter backed IPO stocks for the three years after the issue date. analyst. we get a coefficient of 0.e. The above results are also consistent with the results on the dynamics of IPO valuations over time reported in section IV. two.. the coefficient on the underwriter reputation dummy is 0.133 on the underwriter reputation dummy. consistent with greater heterogeneity in investor beliefs being related to high quality market participants. 23 . Table X reports the dynamic pattern for our proxies of heterogeneous beliefs. We also find that institutional investor. For instance. B. adjusted turnover.the coefficient on the highreputation dummy decreases as we add more market participant variables. the median adjusted volume comes down from 39. and reputable comanaging underwriter participation is positively related to high heterogeneity in investor beliefs.
Multivariate Analysis of the Effect of Underwriter Reputation on Secondary Market Valuations and the Role of Market Participants and Heterogeneous Beliefs A. We also expect to see that as we add comanaging underwriter and institutional investor variables.5% and comes down to an economically small value of 0. the difference in median turnover between high and lowreputation underwriter backed IPOs is the highest at time 0 at about 6. and year and industry effects.7 24 . The coefficient on institutional investor holdings in specification (3) is 0. we find evidence indicating that the heterogeneity in investor beliefs decreases over time and that the difference in the heterogeneity in investor beliefs between high and lowreputation underwriter backed IPO stocks (which is high at the time of the IPO) also decreases over time. the coefficient on the highreputation dummy in regression specification (1) is statistically significant and positive. Table XI reports the results of our multivariate regressions with the log of first day closing secondary market price to intrinsic value ratio as the dependent variable. The coefficient on the high underwriter reputation dummy should decrease further as we add proxies for heterogeneous beliefs of investors. The coefficient on highreputation dummy for offer price ratio in specification (1) is 0. This is consistent with the idea that the effect of underwriter reputation fades over time.369 which corresponds to a 44. since we expect that underwriter reputation should affect secondary market valuations through these channels. From this coefficient. In summary. Further. we infer that a 1% increase in institutional investor holdings increases the secondary market valuation ratio by 25.6 percent increase in the secondary market valuation ratios for highreputation underwriter backed IPOs as compared to lowreputation underwriter backed IPOs. Similarly. venture backing. the coefficient on the high underwriter reputation dummy should diminish. The Relationship between Heterogeneous Beliefs and Market Participants on IPO Secondary Market Valuation We now conduct multivariate analysis of the effect of underwriter reputation on secondary market valuations and directly link the increase in the extent of participation by various market players in the IPO and heterogeneity in investor beliefs about the IPO stock induced by underwriter reputation to the IPO valuation. fraction of the firm sold in the IPO. We find similar patterns for median adjusted number of trades. VI.01 % by the end of year 3. The coefficients on the number of institutional investors participating in the IPO and the percentage institutional holdings are also positive and significant.economically small value of 0. the coefficient on the highreputation dummy decreases as we add the market participant and heterogeneous beliefs proxies. consistent with our conjecture that highreputation underwriters’ positive effect on valuations may be driven by heterogeneity in investor beliefs.229 and statistically significant at the 1 percent level.002 in year 3. We expect to see a positive coefficient on the high underwriter reputation dummy after controlling for size. As expected.
The coefficient on adjusted first day volume in specification (9) is 0. These results are consistent with hypotheses (H2). This indicates that underwriters’ effect on valuations may be partly driven by the participation of more and higher quality market participants. the statistical and economic significance of the coefficient on the underwriter reputation dummy decreases. 25 . comanaging underwriter reputation also has an economically meaningful impact on secondary market valuation ratios. our arguments suggest that heterogeneity in investor beliefs is associated with higher market valuations. In particular.230 on comanager reputation in specification (6) corresponds to an increase in the secondary market valuation ratio of 25. we use exante measures of heterogeneous beliefs 32 We are grateful to the anonymous referee for suggesting this analysis. The positive and statistically significant coefficient of 0. A finding that changes in heterogeneity in investor beliefs over the long run are associated with changes in the market value to intrinsic value ratios of the IPO firm’s stock would provide additional evidence to support the above conjecture.1 percent increase in the secondary market valuation ratio for a 1 percent increase in the adjusted first day volume. The analysis also indicates that the effect of the heterogeneous beliefs proxies on the secondary market valuations is statistically significant and positive. the association between heterogeneous beliefs of investors on the IPO stock’s secondary market valuations is economically significant. (H5). Further. Further. our multivariate analysis of secondary market valuations is consistent with the hypothesis that highreputation underwriters’ ability to obtain higher valuations is driven by more market participants and higher levels of heterogeneity in investor beliefs. First. Thus.32 We conduct this analysis in two different ways. and (H6). B. Moreover.323 and statistically significant at the 1 percent level. Relationship between Long Run Changes in Heterogeneous Beliefs and IPO Stock Valuation We also analyze whether the long run declines in IPO market valuation (that we found in Table VIII) and the long run decline in heterogeneous beliefs of investors (that we found in Table X) are related to each other. adding the proxies for heterogeneous beliefs in the regression equations leads to a further reduction in the statistical and economic significance of the coefficient on the underwriter reputation dummy. Overall.86 percent when the comanaging underwriter reputation increases by 1 percent. we find that participation by various market players has an economically meaningful impact on IPO secondary market valuations. As in the prior section. as we add more market participant variables to the regression equations. This suggests that the positive association between highreputation underwriters and secondary market valuations is driven by the greater heterogeneity in investor beliefs associated with highreputation underwriter backed IPOs. This coefficient corresponds to a 38. we regress the difference in secondary market price to intrinsic value ratios on the change in the daily adjusted measures of heterogeneity in investor beliefs. Thus.percent.
postulating that highreputation underwriters are able to attract a greater number of higher quality market participants (such as institutional investors.. the results above show that greater heterogeneity in investor beliefs is associated with greater valuations. two year. Since the heterogeneous beliefs measures are exante (i. In other words. this result is robust to controlling for endogenous matching between highreputation underwriters and higher quality issuers using instrumental variables and regression discontinuity analyses. We propose a “market power” hypothesis. the second test analyzes the time variation in the market value to intrinsic value ratio and measures of heterogeneous beliefs by controlling for crosssectional variation (i. VII. the observation is at the firmevent year level. We find that equity in highreputation underwriter backed IPOs are priced higher and further away from intrinsic value compared to lowreputation underwriter backed IPOs.to predict the expost market value to intrinsic value ratio. 1 for the year after the IPO year.” which implies that highreputation underwriters are associated with IPOs priced closer to intrinsic value. where the event year is 0 for the IPO year. the declines in heterogeneous beliefs over time are associated with the declines in IPO valuation ratios. and so on. Both tests analyze how the changes in secondary market to intrinsic value ratios over time are related to the changes in heterogeneity in investor beliefs. Whereas the first test directly analyzes these changes.e. we have the IPO day closing. thereby yielding higher IPO valuations by increasing the heterogeneity in investor beliefs. in both the difference regressions and the fixed effects regressions are broadly consistent with our conjecture that the changes in heterogeneity in investor beliefs are positively related to the changes in secondary market value to intrinsic value ratios of the IPO firm’s stock over the three year period after the IPO. and comanaging underwriters) to the IPOs backed by them. firmspecific variation) by using firm fixed effects. one year. as the heterogeneity in investor beliefs decreases after the IPO date. Thus. we regress the level of secondary market ratio on the level of daily adjusted measures of heterogeneity in investor beliefs and firm fixed effects. We show that the above relationship between underwriter 26 . and three year post IPO valuation ratio and heterogeneous beliefs data as separate observations for each firm (which allows us to use firm fixed effects). analysts.e. Second. the market value to intrinsic value ratio also decreases. The empirical results. We empirically distinguish the above hypothesis from the “certification hypothesis. As a result. and further. Conclusion Several theoretical papers have argued that the valuation of equity will reflect the beliefs of the most optimistic investors and be at a premium over intrinsic value when investors subject to short sale constraints have heterogeneous priors. Note that we reshape the data to a panel format for these tests. The results in this section provide additional support to our conjecture that IPO stock valuations are indeed associated with heterogeneity in investor beliefs.. Table XII reports the results of both the analyses described above. measured prior to the valuation date). We test the above theories by analyzing the effect of IPO underwriter reputation on the heterogeneity in investor beliefs and consequently on equity valuation in IPOs.
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Appendix 1: Summary of Empirical Predictions Variable(s) of Interest Offer price to intrinsic value ratio Empirical Predictions H1A: Market power Hypothesis.Over the long run. H7: Heterogeneity in investor beliefs will decrease over time over the long run. H3B: Certification Hypothesis.Highreputation underwriter backed IPOs will have offer price to intrinsic value ratios closer to 1 than lowreputation underwriter backed IPOs. H1B: Certification Hypothesis.Over the long run. H5: Higher levels of heterogeneous beliefs will be associated with higher first day closing secondary market price to intrinsic value ratios for IPO stocks. the stock price to intrinsic value ratios of higher and lowreputation underwriter backed IPOs should converge towards each other and towards unity. H3A: Market power Hypothesis. H8: Decreases in heterogeneous beliefs will be associated with decreases in secondary market price to intrinsic value ratio over the long run. . market player participation.Highreputation underwriter backed IPOs will have higher offer price to intrinsic value ratios than lowreputation underwriter backed IPOs. and IPO valuation Changes in Heterogeneous Beliefs and IPO valuation over time H4: Highreputation underwriter backed IPO stocks will have more heterogeneity in investor beliefs compared to lowreputation underwriter backed IPO stocks. Heterogeneous beliefs associated with the IPO firm stock Heterogeneous beliefs. the stock price to intrinsic value ratios should not change. Secondary market price to intrinsic value ratio Market price to intrinsic value ratios over time H2: Highreputation underwriter backed IPOs will have higher first day closing secondary market price to intrinsic value ratios than lowreputation underwriter backed IPOs. H6: Higher Participation by market players will be associated with higher first day closing secondary market price to intrinsic value ratios for IPO stocks.
Daily volume is calculated as log (number of shares traded during the first trading day multiplied by price).37 3737 67. Dev.39 1825 Underwriter Market Share 0.37*** 29. Count Mean Median Std.03 13.84 18. Assets (in $ millions) and EBITDA (in $ millions) are as reported in Compustat for the fiscal year prior to the IPO date.07 778. and number of trades variables are calculated by subtracting from them the average monthly value of that statistic calculated 3 years after the IPO date.79 1341 6. REITs.31 169. Count 134. “Highreputation underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the sample.13 3.50 1842 0.46 87.54 0.29 0.16 7. Daily Number of trades 4097. Panel B reports the time trend of underpricing for the sample.003 0.00 86.41 1842 41. and Compustat.14 1340 74.20 16.47 2.10 level.23 21.22 30. The statistical significances are for the ttest for the differences for the equality of means and the WilcoxonMannWhitney ranksum test for the equality of medians of two subsamples. and ADRs are excluded. “80s” time period corresponds to issues that are placed between 1980 and 1989.19*** 0.5*** 46.76 18. Summary statistics Assets EBITDA Total Proceeds Venture Backed Underpricing Adj.039 1842 0.045 0. Daily turnover calculated as the first day turnover.5 30.45 0. Total Mean Median Std.29 17. banks and S&Ls.42 22.009 0.11 0.00 per share.24 15.41 1895 23.Table I.54 1831 26.024 0.66*** 1.76 8787.05 0.94 1894 41. turnover.21*** 2924.21 0.01 120. **Significant at the 0. Daily Turnover Adj.89*** 17.06*** 0.50 7251. Summary Statistics and Underpricing Trend in the 1980s and the 1990s This table reports the descriptive statistics for a sample of IPOs. Count 229.89 14.29*** 24. Dev.01 level.36 17.48 1895 0.50 3737 ***Significant at the 0.07 0.55 4651.81 1385 17.002 0.34 193. bubble” time period corresponds to issues placed between 1990 and 2000.00 67. closedend funds. Underpricing is the percentage change in stock price from the offer price to the closing value at the end of the first trading day.05 level.77 3737 0.77 3725 0. Panel A.66 2726 Low Reputation Underwriter Mean diff.022*** 0.30 39.13 0.035 3737 Highreputation Underwriter Mean Median Std. “90s” time period corresponds to issues placed between 1990 and 1998.66 29.24*** 6.61 2725 23. IPOs with an offer price below $5.13 4.92*** 518. Median diff.16*** 0. Data are from SDC Platinum. Daily Volume Adj. unit offers.33*** 16. “Lowreputation underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median.52*** 20.47 3737 102.042*** 0.57 1842 0. Total Proceeds (in $ millions) and venture backed dummy are as reported in SDC.62 165. CRSP. and “90s incl. Offer price data is from SDC while first day closing prices are obtained from CRSP.27 19.32 1895 0. Dev.023 0.31 252.55 548.35 0. Daily number of trades calculated as the first day number of trades.65 42.85*** 65. . *Significant at the 0. The ranking is calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).003 1895 0.14*** 31.44 1385 28.63 966 1605. Panel A reports descriptive statistics for the full IPO sample.95 1895 187.12 1842 5.99 1088.01 322. The adjusted values of the volume.67 859 2492.93 840.
070 1213 Difference –0. bubble 0.Panel B.023 304 0.071 0.106 0.015* –0.05 level.156 0.001 90s 0.104 1148 0.180*** 0.062 1027 0. *Significant at the 0. Underpricing trend over time Time period 80s Mean Median Count Mean Median Count Mean Median Count Highreputation Underwriter 0.10 level.025 682 0. .067*** ***Significant at the 0.01 level.086 0.137 1538 Lowreputation Underwriter 0.182 0.336 0. **Significant at the 0.076*** 0.042*** 90s incl.
772*** 904 1.459*** 90s incl. market pricetoEBITDA.338*** 0.700*** 685 Difference 0.347*** 541 1.073** 80s median count median count median count 90s 0.264*** 763 OP/IV Lowreputation Underwriter 1.178*** 522 1. and “90s incl.289*** Highreputation Underwriter 1.840*** 975 Difference 0.Table II.577*** 611 1.463*** 0. The industry peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and has the closest sales and EBITDA profit margin (EBITDA/ Sales) in the preIPO fiscal year.316*** 90s 0.518*** 209 1.341*** 588 1. The Valuation of IPOs Backed by High and Lowreputation Underwriters using the Basic Comparable Firm Approach This table reports the crosssectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing secondary market price to intrinsic value (SMP/IV) for IPOs.565*** 244 1.345*** 699 SMP/IV Lowreputation Underwriter 1.574*** 80s median count median count median count Highreputation Underwriter 1.940*** 685 Difference 0. **Significant at the 0. .495*** 80s median count median count median count Highreputation Underwriter 1.503*** 233 1. or market pricetoearnings ratios of an industry peer.215*** 588 1.749*** 854 1. “Highreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the sample. bubble” time period corresponds to issues placed between 1990 and 2000. the statistical significances are for WilcoxonMannWhitney rank sum test for the equality of medians of two subsamples.385*** 0.632*** 975 Difference 0.406*** 0. bubble EBITDA multiple 0. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales.634*** 621 1.247*** 699 OP/IV Lowreputation Underwriter 1. “80s” time period corresponds to issues that are placed between 1980 and 1989.455*** 0. For median ratios. “90s” time period corresponds to issues placed between 1990 and 1998.10 level.588*** 904 1. For differences.237*** 555 Highreputation Underwriter 1.046** Difference 0.313*** 716 1.01 level.297*** 657 1.664*** 209 1. the statistical significances correspond to the sign test for median OP/ IV (or SMP/IV) equal to 1. *Significant at the 0.224*** 716 1.269*** 522 1. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).650*** 244 1. “Lowreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median.305*** 555 Difference 0.203*** Highreputation Underwriter 1. bubble 0.608*** 233 1. bubble Earnings multiple 0.670*** 1037 OP/IV Lowreputation Underwriter 1.549*** 854 1.315*** 541 1.349*** 763 SMP/IV Lowreputation Underwriter 1.452*** 90s incl.05 level.211*** 657 1.635*** ***Significant at the 0. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat.364*** 0.876*** 621 1.607*** 90s incl.267*** 90s 0.923*** 1037 SMP/IV Lowreputation Underwriter 1. Sales multiple Highreputation Underwriter 1.519*** 611 1.
operating margin (EBITDA/ Sales). For differences.287*** 505 1.500*** 582 Highreputation Underwriter 2. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).378*** 326 1. cost of goods sold growth.728*** 703 1.822*** 407 Difference 0. *Significant at the 0.11 0. bubble” time period corresponds to issues placed between 1990 and 2000.10 level.73*** 360 1.252*** 458 SMP/IV Lowreputation Underwriter 1.288*** 582 Lowreputation Underwriter 1.01 level.289*** 360 1. The IPO data is from SDC Platinum and all other data are from CRSP and Compustat.159* Highreputation Underwriter 1.21*** 636 1.05 level. . the statistical significances are for WilcoxonMannWhitney rank sum test for the equality of medians of two subsamples.157 90s 0.073*** 703 2. “Highreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the sample.488*** 407 Difference 0.535*** 143 1.282*** 371 Difference 0. market pricetoEBITDA.Table III.352*** 0.487*** 161 1. Bubble Earnings multiple 0. and selling and general expenses growth.900*** 917 OP/IV Lowreputation Underwriter 1. For median ratios. Bubble 0.556*** 440 1.464*** 505 1. “90s” time period corresponds to issues placed between 1990 and 1998.104 Highreputation Underwriter 1. “80s” time period corresponds to issues that are placed between 1980 and 1989.241*** 434 1. **Significant at the 0. Bubble EBITDA multiple 0.322*** 917 SMP/IV Lowreputation Underwriter 1.136** 371 Difference 0.000*** 200 2.266*** 326 1. The industry peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and which has the closest propensity score value based on sales. The Valuation of IPOs Backed by High and Lowreputation Underwriters using the Propensity Score Based Comparable Firm Approach This table reports the cross.518*** 0.283** Difference 0.sectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing secondary market price to intrinsic value (SMP/IV) for IPOs.588*** 0.178*** 458 OP/IV Lowreputation Underwriter 1. and “90s incl.168* Difference 0.127* 353 1. profit margin (Net Income/ Sales).236** 353 1.494*** 90s incl.312*** 720 OP/IV Highreputation Underwriter 1.716*** 90s incl.115 0.319*** 360 1.839*** 200 1. the statistical significances correspond to the sign test for median OP/ IV (or SMP/IV) equal to 1. “Lowreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median.37*** 143 1. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales.324** 80s median count median count median count 90s 0.54*** ***Significant at the 0.323** 0.676*** 440 1.449*** 161 1. or market pricetoearnings ratio of an industry peer.358*** 636 1. sales growth.223 90s incl.451*** 360 1.248** 80s median count median count median count Highreputation Underwriter 1.43*** 720 SMP/IV Lowreputation Underwriter 1.891*** 80s median count median count median count 90s 0. Sales multiple Highreputation Underwriter 1.171** 434 1.
“Highreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the sample.Table IV.898*** 381 2.220*** 863 SMP/IV Lowreputation Underwriter 2.338** 0.01 level.sectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing secondary market price to intrinsic value (SMP/IV) for IPOs. “Lowreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median.426*** 705 2. “90s” time period corresponds to issues placed between 1990 and 1998.607*** 863 Difference 0. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).449*** 0.727*** 705 3.071 863 Difference 0.277 0.349*** 634 2.575*** 705 2.825*** 863 OP/IV Lowreputation Underwriter 1. bubble” time period corresponds to issues placed between 1990 and 2000. Bubble 0.438*** 151 2.031*** 381 2.231* Highreputation Underwriter 2.190*** 151 2.292** 0. *Significant at the 0.236*** 634 2.145*** 151 2. “80s” time period corresponds to issues that are placed between 1980 and 1989. Growth = 0% Highreputation Underwriter 2. For median ratios. Bubble Growth = 5% 0.378** 90s incl.10 level.377*** 717 OP/IV Lowreputation Underwriter 1.949*** 705 3.283** 0. and “90s incl.565 718 Difference 80s median count median Count Median Count 0. .517*** 90s incl. The intrinsic value is the fair value of the IPO firm estimated using the residual income model of Ohlson (1990) with a constant discount rate of 13%. “5% growth” represents the aggregate sample of IPOs across years where IVs are calculated under the assumption of 5% indefinite earnings growth after year 3. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat.432*** 634 2. For differences.607*** 80s Median Count Median Count Median Count Highreputation Underwriter 1.406** 90s 0. statistical significances correspond to the sign test for median OP/ IV (or SMP/IV) equal to 1.756*** 381 2.05 level. **Significant at the 0.242* 90s 0.323*** 718 Difference Highreputation Underwriter 2. “0% growth” represents the aggregate sample of IPOs across years where IVs are calculated under the assumption of no earnings growth after year 3.986*** 151 2. The Valuation of IPOs Backed by High and Lowreputation Underwriters using the Discounted Cash Flow Approach This table reports the cross.507 ***Significant at the 0.614*** 717 SMP/IV Lowreputation Underwriter 1.149*** 634 2.902*** 381 2. statistical significances are for WilcoxonMannWhitney rank sum test for the equality of medians of two subsamples.
898*** (10.231*** (2.724*** (3.223*** (–6.210 2655 Secondary market price to intrinsic value ratio 0.323*** (–6.171* (1.757) 0.517) 0.369*** (8.217 696 Adj.181) –1. Panel A reports the regression results for the overall sample.05 level.206) –0.868) –0.167*** (3.805) 0. Panel B reports the regression results for the sample split by hot and cold IPO markets.266*** (–7.722*** (–9.216 1959 –0.437*** (8. which is the log of assets of the IPO firm.596) –0. and 0 otherwise.058) 0.747) 1.213*** (4.281) –0. which takes the value 1 if the market share of the lead underwriter is greater than the sample median.682) –0.237*** (10.545) 0.464) 0.000*** (4.271*** (–13. Size.227 696 0.266*** (5.673) 0. Rsquared Observations ***Significant at the 0.987*** (–11.626) 2.211*** (–11.949) 0. based on the log of the market share of the IPO underwriter.10 level.187 2655 0.330) 0.460) –1. **Significant at the 0. Robust tstatistics and zstatistics are reported in parentheses in Panels A and B.349*** (6.182*** (–8.230*** (–6. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales ratio of an industry peer.07** (2.789) 1.401*** (7.283) 1.238) 0.471) 0.230*** (4.592) –0.669*** (8.215) 0.164*** (10.448*** (3.041) –1.760** (2.102) 0. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat.817) 1.565) 0.217*** (2.840) 0.701*** (–9.705) 0.076** (2.182*** (3.774) 0.177*** (–4.720) –1.214 2655 Panel B: IPO Valuation in Hot and Cold IPO Markets Offer price to intrinsic Offer price to intrinsic Secondary market price to value ratio value ratio intrinsic value ratio Hot Cold Diff Hot Cold Diff Hot Cold Diff market market market market market market Underwriter reputation (continuous) Underwriter reputation dummy Size VC backing Fraction of firm sold Constant –0.575*** (–7. The industry peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and has the closest sales and EBITDA profit margin (EBITDA/ Sales) in the preIPO fiscal year.591) 0.860) 0.560) 0.997*** (–14.937) –1.216*** (4.939) –1.217*** (2.790) –0.277*** (–8.594) 0.212) 0. IPO Valuation for High.831*** (–12.069) 0.856) –1.203 696 0.445) 0. respectively. RSquared Observations Panel A: IPO valuation (full sample) Offer price to intrinsic value Offer price to intrinsic Secondary market price to ratio value ratio intrinsic value ratio 0.319*** (7.689*** (3.171*** (3.910) 0.555*** (–7.439) –1.722) 2.803) –1. *Significant at the 0.655) 0.172*** (5.184* (1.134) 0.300*** (–6.238*** (–12.738) –1.129*** (10.500) 0.742) 2. and year fixed effects.207 2655 0.360) Secondary market price to intrinsic value ratio Hot Cold Diff market market 0.220 1959 0.891*** (2.245*** (–9.Table V.076*** (3.875) 0. the fraction of firm sold.and Lowreputation Underwriter Backed IPOs This table reports the result of OLS regressions where the dependent variables are the log of ratio of offer price to intrinsic value and the log of the ratio of the first trading day closing secondary market price to intrinsic value for IPOs.146*** (11.178** (2.843) –1.078) –0.821*** (–12.189) 1. Underwriter reputation dummy.198*** (–4.193 (1.438) –0.248 1959 –0.192 1959 0.150) 0.194 696 0.601) 0.191*** (–5. Underwriter reputation (continuous) Underwriter reputation dummy Size VC Backing Fraction of firm sold Constant Adj. industry fixed effects. The independent variables are: Underwriter reputation.232*** (4.338) 0.808) –1.725) 0.183 (1.01 level.146*** (11. VC backing dummy.206*** (–9.184*** (–10. .412) 1.179*** (3.088*** (3. calculated as the number of shares sold in IPO as fraction of number of shares outstanding.
size.374*** (–4. Size>0}x(Norm.009 (–0.123* (–1. Size Norm.818*** (3. Rsquared –1. Size 0.479*** (–2.575) –0.020 (0.279) 0.206 (0.451) 2154 0. 1{Norm.647) 2154 0.293) –0.778*** (3. Size2. Size2 1{Norm. Norm. and the ratio of offer price and the immediate post IPO secondary market price to intrinsic value ratio in the second stage.050 (0.733*** (9. Size>0}x(Norm.158 –1.406) 2.10 level. Size – 0) 1{Norm. Size – 0)2 Fraction of firm sold VC backing Constant Observations Adj .174 .191) 2154 0.386*** (–5. Size – 0)2 .150) 0. Underwriter reputation is calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).323** (2. 1{Norm. fraction of firm sold in the IPO firm. Size>cutoff} which is a dummy variable that is 1 if the normalized assets of the IPO firm is greater than the cutoff required for NYSE listing. Size – 0). Robust tstatistics are reported in parentheses for the first stage regression and bootstrapped zstatistics are reported in parentheses in the second stage regressions.015) –5. The independent variables in the first stage are: 1{Norm. fraction of firm sold in the IPO firm.175) 2.203) Secondary market price to intrinsic value ratio 0.640) 0.01 level. Size>0}x(Norm. The independent variables in the second stage are the predicted underwriter reputation from the first stage. Second stage Offer price to intrinsic value ratio Underwriter reputation Norm. Size. The dependent variables are: underwriter reputation in the first stage.800) –0. Size>0} Norm.941*** (4.880) –0. Norm. where the normalized assets is the log of the ratio of assets of the firm divided by the NYSE listing cutoff for a given year.Rsquared ***Significant at the 0. *Significant at the 0. and the VC backing dummy.334** (–2. Endogenous Matching between Underwriter Reputation and Firm Quality: Regression Discontinuity Analysis This table reports the result of a regression discontinuity analysis.357 Fraction of firm sold VC backing Constant Observations Adj.535*** (–6. Size>0}x(Norm. First stage Underwriter reputation (Continuous) 1{Norm.05 level.196) 0.908) –0. and the VC backing dummy.595*** (–13. Norm.018) –0.Table VI. Year and industry fixed effects are included in every specification. **Significant at the 0.435) 0.308** (2.385*** (–4.
Endogenous Matching between Underwriter Reputation and Firm Quality: IV Analysis This table reports the results of two stage least squares model and treatment effects estimations.05 level.429*** (3.723*** (4. and year fixed effects.132*** (–13.947) 0.08 2318 1323.616*** (–8.488*** (–3.010) 0.108) –1. Size. VC backing dummy.310) 0. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat. Rsquared Wald Chi.208*** (–9.374*** (13.940) 5.742) Adj. calculated over a five year period prior to the sample IPO.003** (2.472) Treatment effects model Second Stage: First Stage: Second Stage: Secondary Underwriter Offer price to market price to reputation intrinsic value intrinsic value dummy ratio ratio 0.204) –0.781 (0.087*** 0.885) –2.490*** (–2. industry fixed effects. Observations ***Significant at the 0. 2318 1208.852) 0.992]*** (–23.201) 0.205*** (4. Sq.76) 0.723 (0.473*** (6.186*** (3.222 2318 1.478*** (–13. The independent variables are: Underwriter location concentration.556*** (8. Firm state effects are included in the 2SLS and the treatment effects models.620) –0.01 level.176*** (3.536*** (3.511*** (23.008) 0. The dependent variables the second stage of the two stage least squares models and the treatment effects models are the log of the ratio of offer price to intrinsic value and the log of the ratio of the secondary market price to intrinsic value.612) –1.695) –0. The first stage (selection stage) dependent variables are the underwriter reputation dummy (in the treatment effects model) and the log of the underwriter IPO market share (in the two stage least squares model).057) (3.852) –0.040) –2.10 level.476) –1. The industry peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and has the closest sales and EBITDA profit margin (EBITDA/ Sales) in the preIPO fiscal year.56 2318 .011) 0. Underwriter reputation (continuous) Underwriter reputation dummy Size VC Backing Fraction of firm sold Underwriter location concentration Industry underwriter availability Constant Two stage least squares Second Stage: Second Stage: Secondary First Stage: Offer price to market price to Underwriter intrinsic value intrinsic value Reputation ratio ratio 0.243*** (–10. *Significant at the 0. which is the log of assets of the IPO firm.362) 1.245*** (–8.250) 0.504 2318 –0. Industry underwriter availability.052) –0. Robust tstatistics are reported in parentheses.190*** (3. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales ratio of an industry peer.255 2318 0. calculated as the number of shares sold in IPO as fraction of number of shares outstanding.700) –2.807*** (–5. **Significant at the 0.170) 0.093) 0.360) 0.590*** (–14. The 2SLS and the treatment effects models estimate two stages. which is the number of unique underwriters that conduct business in the same industry as the IPO firm.Table VII.314 (0.211*** (–8. which is the state level concentration of the underwriters IPO business and is measured as the Herfindahl index of the amount of IPOs underwritten by the lead underwriter in various states.204) 0.105*** (3. measured over five years prior to the sample IPO.003* (1.497*** (–7.936) 0.881) –1.872) 0. the fraction of firm sold.083*** (3.
market pricetoEBITDA ratio.10 level.368*** 1.197*** 1.715*** 1.236*** 0. The dataset contains IPOs.333*** 1.295*** Lowreputation Underwriter 1. and selling and general expenses growth. **Significant at the 0.188*** 1.523*** 1.081 Difference Difference OP/IV SMP/IV 0 SMP/IV 1 SMP/IV 2 SMP/IV 3 0.01 level.823*** 2.118*** Lowreputation Underwriter 1. OP/IV is the ratio of offer price to estimated intrinsic value of the IPO stock.495*** 1.382*** 0.455*** 1. “Lowreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median.313*** 0.223*** 1. the industry peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and which has the closest propensity score value based on sales.387*** 1.126 0.212*** 1.05 level. The intrinsic value is the fair value of the IPO firm computed based on market pricetosales . the industry peer is a comparable publicly traded firm generated by the basic comparable firm approach.206*** 1.206*** Highreputation Underwriter 1.041 0.061 ***Significant at the 0.325*** 1.186*** 1. Dynamics of Market Valuation for IPOs Backed by High and Lowreputation Underwriters This table presents the ratio of offer price (OP/IV) and secondary market price to intrinsic value (SMP/ IV) for IPOs over time. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat.663*** 0.15** 1.047 1. For the basic matching approach.442*** 1.904*** Difference Earnings Multiple Highreputation Underwriter 1.284*** 0.632*** 1. SMP/IV “t” is the ratio of the closing price on the secondary market in year t after IPO to the estimated intrinsic value of the IPO stock at year t. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).274*** 1. operating margin (EBITDA/ Sales). “Highreputation Underwriter” stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the sample. or market pricetoearnings ratio of an industry peer.086 Earnings Multiple Lowreputation Underwriter 1.142 0.203 1.156*** 0.072* 1.502*** 0.303*** 1.393*** 1.277*** 1.521*** 1.183*** 1.088 Difference OP/IV SMP/IV 0 SMP/IV 1 SMP/IV 2 SMP/IV 3 0.232*** 0. . For differences.873*** 1.315*** 0. For median ratios.358*** 0.549*** 0.177*** 0.157*** 1.43*** 0. cost of goods sold growth. Basic Comparable Firm Valuation Dynamics Sales Multiple Highreputation Underwriter 1.Table VIII.616*** 1.870*** 1.109* Propensity Score Based Comparable Firm Valuation Dynamics Sales Multiple Highreputation Underwriter 1. For the propensity score approach. the statistical significances are for WilcoxonMannWhitney rank sum test for the equality of medians of two subsamples. sales growth.214*** 0. statistical significances correspond to the sign test for median OP/ IV (or SMP/IV) equal to 1.009*** 0. *Significant at the 0.335*** 0. profit margin (Net Income/ Sales).195 Lowreputation Underwriter 1.
028 (1.671 1.600) 0.187*** (5. fraction of firm sold calculated as the number of shares sold in IPO as fraction of number of shares outstanding.100** (–2. number of unique analysts that estimate earnings (“Number of analysts”).127* (1.Table IX.718) 0.089*** (3.106) 0. Robust tstatistics are reported in parentheses. Daily number of trades calculated as the log of first day number of trades.178) 1828 0.016* (1.038*** (12. The independent variables are the underwriter reputation dummy.545) VC backing 0. the number of comanaging underwriters in the IPO.68 .431) 2143 0.043** (2. Year and industry fixed effects are included in every specification.379*** (7.249*** (8.011 (0.139) –0.569) (4) 0.037*** (13.113*** (12.778) 2.255*** (5. and log of adjusted daily number of trades.058*** (4.071) Number of analysts 0.678 (2) 0.005 (0. Daily turnover calculated as the log of first day turnover.564) 0.400*** (8.157) 0. The underwriter reputation dummy takes the value 1 if the lead underwriting syndicate has a ranking value greater than the median for the sample and 0 otherwise. the VC backing dummy.053 (1.003 (0.210) (3) 0. Panel A: Adjusted Daily Volume (1) Underwriter reputation 0.533*** (10.064 (1.502) 0.044) 2143 0.519*** (7.781) Number of institutions 0.039*** (12.393) 0.899) 0.119) Dummy Size 0. size (log of total assets). and the comanaging underwriter reputation dummy.693) 0.006 (0. Heterogeneous Beliefs About IPOs Backed by High and Lowreputation Underwriters: Multivariate Tests This table reports the results of regression analysis of heterogeneous belief proxies.459) –0.124** (–2. number of institutional investors participating in the IPO.574 1.021** (2.253*** (5. The dependent variables are: Adjusted daily volume.004) 0.234) 0.939) Observations 2143 Adjusted Rsquared 0. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). Daily volume is calculated as log (number of shares traded during the first trading day multiplied by price).059) 0.742) Percentage institutional holding Num.206) –0.098** Fraction of firm sold (–2.026*** estimating earnings (2. percentage share of IPO held by institutional investors. of comanaging underwriters Comanaging underwriter reputation Constant 1.133) 0.089) 0.177*** (8. log of adjusted daily turnover.860) 0. The adjusted values of the statistics are calculated by subtracting from them the average monthly value of that statistic calculated 3 years after the IPO date.
112 (–1.789*** 4.014 (–0.010*** (7.978) Number of analysts 0.027 (1.060* (1.035*** (3.537) Dummy Size –0.090) –0.833*** (22. of comanaging underwriters Comanaging underwriter reputation Constant 4.087** (2.407*** (4.112* (–1.076** (2.673) 6.126*** (–9.931) VC backing –0.071 (–1.616) –0.832*** (22.002 (–0.528) Number of institutions 0.088*** (–7.556) 2143 0.033*** (13.365) 0.033 (–0.917) 0.199) 0.759) (–1.026*** (5.823) 0.205*** (6.099*** estimating earnings (3.234) (3) 0.040*** 0. of comanaging underwriters Comanaging underwriter reputation Constant 6.174) Fraction of firm sold –0. (3) 0.653) Number of institutions 0.133*** (3.463 Panel C: Adjusted Daily Number of Trades (1) (2) Underwriter reputation 0.01 level.599) (8.733) 0.160*** (2.198*** (6.051) 0.121*** (–9.003 estimating earnings (0.009*** (7.472) (6.817) VC backing 0.078*** (–0.010*** (7.139) 2143 0.057* (1.021 –0.348) 0.750) 0.196) –0.347) 0.367) (–0.578) Number of analysts 0.607) –0.019 (–0.273) 0.450*** (36.692) (4) 0.034*** (14.068) Percentage institutional 0.657) 0.659 ***Significant at the 0.126* (–1.057* (1.249) Dummy Size –0.467 6.718 .002 (0.006 0.032*** (13.009 holding (0.462 (2) 0.10 level.863*** (23.197) Num.818) 0.331) 0.255*** 0.441 6. **Significant at the 0.932) (16.011 (–0.976) 1316 0.217*** (4.778) –0.798*** (20.250) –0.05 level.675) Observations 2143 Adjusted Rsquared 0.601) –0.237*** (7.156*** (41.236*** (4.048*** (39.255) (4) 0.901) –0.396) Percentage institutional holding Num.112* –0.111*** (17.199) 1828 0.087*** (39.240) 0.083*** (2.268) (2.777) 0.174) 0.409) 0.714 4.132*** (–10.282) Observations 1494 1494 Adjusted Rsquared 0.079** (2.188) 4.049) –0.769) 0.Panel B: Adjusted Daily Turnover (1) Underwriter reputation 0.218*** (11.835) 0.997) 1494 0. *Significant at the 0.030*** (2.889*** (19.082) –0.459) Fraction of firm sold 0.717 0.
19*** 1065 –3. respectively.MannWhitney rank sum test for the equality of medians of two sub.0688*** 1424 13. The IPO data is from SDC Platinum and all other data are from CRSP and I/B/E/S.456*** 1340 0.355*** 2 –0. Volume Time after IPO Highreputation Underwriter Lowreputation Underwriter Difference Highreputation Underwriter Adj.001 1421 7. **Significant at the 0. “Lowreputation Underwriter” stands for IPOs whose underwriting syndicate has a reputation rank lower than the median.003* 1368 0. The Dynamics of Heterogeneous Beliefs About IPOs Backed by High and Lowreputation Underwriters This table presents the daily adjusted volume. The rankings are calculated as average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).55*** 859 –4.545*** 1061 –9.078*** 1401 –0.306*** 1385 0.758*** 966 –12.223*** 3 –0.0069** –3.5186*** 840.0619*** 1463 6.141*** ***Significant at the 0.021** 1395 0. the statistical significances are for Wilcoxon.0607*** 1446 –0.0731*** 1388 –0.0821*** 1416 –0.7557*** 1385 –0.002 1413 –0.01 level.Number of trades Highreputation Underwriter Lowreputation Underwriter Difference 0 Median count Median count Median count Median count 39. . Adj.samples.0048 –8. and adjusted number of trades over time from the IPO date to three years after the IPO.05 level.0213** –6.Table X.2371*** 1341 –0.003 –0. adjusted turnover. For differences.208*** 1 0.Turnover Lowreputation Underwriter Difference Adj. For median ratios.509*** 1080 –5. “Highreputation Underwriter” stands for IPOs whose underwriting syndicate has a reputation rank higher than the median for the sample.849*** 19.018* –0.002 –0.952*** 1198 518. statistical significances correspond to the Wilcoxon signtest for median equal to 0.093*** 1098 322.286*** 1157 –1.10 level.004*** 1426 0 1440 31. *Significant at the 0.
first day number of trades Adj.694) 0.018*** (7. adj.989) –1.166) 0.743) –0. number of institutional investors participating in the IPO .467) 0.229*** (3.and Lowreputation Underwriters: Multivariate Tests This table reports the results of our regression analysis of overvaluation.941) (9) 0.667) 1768 0.164) 0. Year and industry fixed effects are included in every specification.649) 0.789) 0.309 0.401*** (–10.012 (0.363) 0.175*** (3.155*** (2.304*** (–11.341*** (–15.229) –1.784) –1. *Significant at the 0.163) 2367 0. Robust tstatistics are reported in parentheses. percentage share of IPO held by institutional investors.803*** (–8.203) 2367 0.233*** (3.364) (4) 0.591) 2655 0.245 1.266*** (5.329*** (6.048* (1.722*** (–9.Table XI.215) –1.356) (6) 0.486) –0.704) 0.934*** (–11. first day number of trades.264) 0. the number of comanaging underwriters in the IPO.680*** (–7.017*** (6.038) 1786 0.038) –4.230*** (4.200*** (4.020*** (8.295) –1.149*** (2.939) (2) 0. Valuation ratios in IPOs Backed by High. adj.124) 0.493) –1.803*** (–7.027 (0. adj.203) –1.370*** (–14.007 (–0.31 1. and the comanaging underwriter reputation dummy.195*** (2. first day volume.125) 0.219*** (4.555) 0.096) 0.804*** (–8.303 –2. The independent variables are the underwriter reputation dummy.229*** (3.689) –2.006*** (2.230*** (4.231*** (4.399) 0.349*** (–16.255*** (–12. the log of assets of the IPO firm.658) –0.303) 0.369*** (–14.089) 0.793) –0.370*** (–15. Underwriter reputation dummy Size VC backing Fraction of firm sold Percentage institutional holding Number of institutions Num. first day volume Constant Observations Adjusted Rsquared ***Significant at the 0. of comanaging underwriters Comanaging underwriter reputation Adj.696*** (–9.289 1.260*** (5.907) 0.161) 2367 0.10 level.231) –0.203) 0.267*** (–5.763) –0. number of unique analysts estimating EPS for the firm in the first year after the IPO.01 level.174*** (3.29 1. first day turnover.548) 1755 0. **Significant at the 0.083) (5) 0.016*** (4.121) 0.323*** (11.403) 1047 0.148*** (–8.351 .018*** (7.237*** (5. The valuations ratios are generated by the basic comparable firm approach using the sales price multiple.678) 1768 0.356) (7) 0. fraction of firm sold calculated as the number of shares sold in IPO as fraction of number of shares outstanding.117*** (3.329 (1.163) –1.873) 0.737) –0. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991).130** (2.668) 0.667) (8 0.891) –0.261*** (5.196*** (5.743) –0. first day turnover Adj.672) 0.130** (2.063 (0. The underwriter reputation dummy takes the value 1 if the lead underwriting syndicate has a ranking value greater than the median for the sample and 0 otherwise.05 level.800) 0.154*** (2.211*** (–11. (1) 0.078) –0.802*** (–7.505) 0.597) 0.200*** (3.353*** (5.214 1.074) 0.352 1.303*** (–8.045 (1.193*** (4.232*** (4.369*** (8. the VC backing dummy.253) (3) 0.020*** (8. The dependent variable is the log of first trading day closing secondary market price to intrinsic values ratio (SMP/IV).
178 (–0.190*** (–4.874) 0.180*** (9.105*** (6. first day volume.004 (–0. and fraction of firm sold calculated as the number of shares sold in IPO as fraction of number of shares outstanding.733) Y 1.01 level.321*** (4.411) –0. adj.114 (–0. and (3)) and the log of secondary market price to intrinsic value (in specifications (4).017 Y Y 5036 0. and (6)).409 0.178) –0. Y Y 5099 0.05 level. (5).128*** (3. (2).323) –0.388 Firm fixed effects Industry fixed effects Year fixed effects Observations Adjusted Rsquared ***Significant at the 0.Table XII.257*** (3. and (6).099) Y Y 7342 0.177 (–1.310*** (4.111) –0. **Significant at the 0.41 . The valuation ratios are generated by the basic comparable firm approach using the sales price multiple. Year fixed effects are included in every specification.014 (0. (5). (2). The independent variables are yearly changes in and the levels of adj.393*** (4. the log of assets of the IPO firm.063* (1.823) Y Y 5136 0.016) 0.020 (1.819) –0.623) –0.532) 0.230*** (–7.486) 0. first day turnover. Industry fixed effects are included in specifications (1). daily volume Adj. first day number of trades. Changes in Valuation Ratio of IPO stocks with Measures of Heterogeneous Beliefs during the Three Years after the IPO This table reports the results of panel data regressions where the dependent variables are changes in log of secondary market price to intrinsic value ratio (in specifications (1).005 (–0. *Significant at the 0.998*** (5.012 (–0. the VC backing dummy.112* (1. daily volume Change in adj.162** (2.621) 0. and (3). daily turnover Change in adj.017 Y Y 3434 0. Change in log of secondary market price to intrinsic value ratio: Difference regressions Log of Secondary market price to intrinsic value ratio: Firm fixed effects regressions Change in adj.216*** (–5.141) 0. Robust tstatistics are reported in parentheses.019 Y 7391 0.759) –0. and adj. and firm fixed effects are included in specifications (4).711) 1. daily turnover Adj.754) –0.356) –0.10 level.438) 0. daily number of trades Size VC backing Fraction of firm sold Constant (1) 0.192) 0.890) (2) (3) (4) (5) (6) 0.236** (2.026** (2. number of trades Adj.478) 0.225) 0.
.Figure 1. Discontinuity of the Treatment (Underwriter Reputation) when Normalized Size=0.
Figure 2. Dynamics of Sales and Earnings Based Valuation Ratios Using Propensity Score Based Comparable Firm Approach .
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