Journal of Banking & Finance 33 (2009) 335–346

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Journal of Banking & Finance

journal homepage: www.elsevier.com/locate/jbf

An analysis of the liquidity benefits provided by secondary markets

Tomas Mantecon a,*,1, Percy Poon b
a
Department of Finance, Insurance, Real State and Law, College of Business, University of North Texas, 1167 Union Circle, Denton, TX 76201, USA
b
Department of Finance, College of Business, University of Nevada, Las Vegas, 4505 Maryland Parkway, Las Vegas, NV 89154-6008, USA

a r t i c l e i n f o a b s t r a c t

Article history: Listing shares in liquid secondary markets either to facilitate acquisitions or to diversify owner’s personal
Received 11 March 2008 wealth are among the most important reasons for firms to go public [Brau, J.C., Fawcett, S.E., 2006. Initial
Accepted 17 August 2008 public offerings: An analysis of theory and practice. Journal of Finance 61, 399–436]. We contend that the
Available online 26 August 2008
expected benefits derived from the liquidity provided by secondary markets are relevant for understand-
ing important decisions made in preparation for an IPO. We hypothesize that the potential losses caused
JEL classification: by an IPO failure induce firms that benefit more from going public to hire more reputable underwriters
G24
and to adopt more conservative pricing policies. We use several proxies for the benefits firms derive from
G32
post-IPO liquidity. The results indicate that firms that benefited more from liquidity were taken public by
Keywords: more prestigious underwriters and exhibited substantially larger levels of price revisions and underpric-
IPO ing. Post-IPO liquidity is also important for understanding the decision to retain the lead underwriter in
Liquidity subsequent SEOs.
Ó 2008 Elsevier B.V. All rights reserved.

1. Introduction of their equity holdings in the secondary market (Corwin et al.,

The liquidity provided by secondary markets is an important
determinant of the decision to go public. Creating a public market
for a firm’s shares either to conduct acquisitions or to diversify the
owner’s personal wealth is among the most important reasons
firms go public (Brau and Fawcett, 2006). Because stock liquidity
is positively related to firm value (Amihud and Mendelson, 1986;
Becker-Blease and Donna, 2006), liquidity following an initial pub-
lic offering (IPO) increases the value of the stock held by the firm’s
owners as well as the value of the stock used as currency in acqui-
sitions. We contend that these liquidity benefits provided by sec-
ondary markets are important for understanding the decisions
made by firms preparing for IPOs and subsequent seasoned equity
offerings (SEOs).
The benefits derived from liquid public markets likely affect the
choice of underwriter. Habib and Ljungqvist (2001) argue that
managers who sell shares in IPOs and suffer greater wealth dilution
because of underpricing have incentives to hire more reputable
underwriters. In the same spirit, private firms that benefit more
from the liquidity provided by a public market should hire more
reputable underwriters who can reduce the probability of IPO
withdrawal (Dunbar and Foerster, 2008) and improve the liquidity
* Corresponding author. Tel.: +1 940 891 6905.
E-mail addresses: tomas.mantecon@unt.edu (T. Mantecon), Percy.Poon@unlv.
edu (P. Poon).
1
The majority of this work was done while the author was at the University of
Nevada, Las Vegas.
2004; Lewellen, 2006).
The rents derived from post-IPO liquidity are also likely to affect
IPO pricing. Edelen and Kadlec (2005) argue that a more aggressive
pricing strategy reduces dilution but increases the probability of
IPO failure. We focus on two potential rents derived from listing
shares in public equity markets. First, Brau and Fawcett (2006) find
that the acquisition rate increases following IPOs, probably be-
cause private firms with a limited operating history suffer from se-
vere adverse selection problems and may find it prohibitively
costly to access debt or private equity which hampers their ability
to undertake acquisitions. We hypothesize that these firms should
follow pricing strategies that minimize the chances of IPO failure.
Second, the value of the portfolios of insiders who have signifi-
cant wealth tied to their firms is reduced by the restricted alien-
ability of the residual claims in privately held corporations (Fama
and Jensen, 1983). Consistent with liquidity benefits, Bodnaruk
et al. (2007) find that underpricing is negatively associated with
the level of portfolio diversification for owners of IPO firms in Swe-
den. We extend Bodnaruk et al. (2007) analysis by examining a
sample of IPOs in the United States, which allows the findings from
Sweden to be generalized. In addition, the amount of wealth own-
ers have invested in their firms depends on firm-specific character-
istics that also affect underpricing. We examine this potential
endogeneity, which clouds the interpretation of the relationship
between underpricing and the wealth owners have in their firms.
To contrast the hypotheses in this paper, we constructed a
sample of firms that went public in the United States from 1996
to 2003. The results show that firms that use more stock in

0378-4266/$ - see front matter Ó 2008 Elsevier B.V. All rights reserved.
doi:10.1016/j.jbankfin.2008.08.008
336 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346
acquisitions announced three years after an IPO were 25% more
likely to hire high-quality underwriters and exhibited 56% greater
underpricing. CEOs with more wealth tied to their firms were 14%
more likely to hire reputable underwriters and exhibited 36%
greater underpricing. These results are robust to different specifi-
cations and to the estimation method. The findings also show a po-
sitive association between the use of stock in post-IPO acquisitions
and the wealth CEOs have invested in their firms, with price revi-
sions. These findings indicate that the expected liquidity provided
by secondary markets is an important factor in choosing a lead
underwriter as well as in the pricing of IPOs.
The results also indicate that the positive association between
underwriter reputation and underpricing in the 1990s (e.g., Ho-
berg, 2007) disappears when controlling for the effect of endogene-
ity among the benefits firms obtain from going public, the choice of
the underwriter, and underpricing. This result suggests that the po-
sitive association between underwriter prestige and underpricing
occurs because firms that benefited more from going public hired
more prestigious underwriters and were content with greater
underpricing.
We further examined the rents firms derived from post-IPO
liquidity by analyzing SEOs conducted after the IPO. We used the
decision by CEOs to sell shares in SEOs as an indication of their
preference for liquidity. This proxy for liquidity preference pro-
vides further evidence that post-IPO liquidity affects the choice
of underwriter and IPO pricing polices: firms in which CEOs sold
shares in an SEO were taken public by more prestigious underwrit-
ers and exhibited higher levels of underpricing.
Finally, we investigated the importance of liquidity by examin-
ing the decision to retain the lead underwriter in post-IPO SEOs.
Ljungqvist and Wilhelm (2005) argue that managerial satisfaction
with underwriters does not depend on underpricing but on the in-
creases in owners’ perceived wealth. We add to this analysis by
proposing that some managers are satisfied with underwriters
when the IPO provides the expected liquidity for their holdings.
Consistent with the importance of post-IPO liquidity to managers,
the results show that CEOs who invested high levels of wealth in
their firm but encountered low levels of post-IPO liquidity were
less likely to retain the same underwriter in the SEO.
In summary, this paper contributes to the existing literature by
providing further evidence of the benefits provided by liquid sec-
ondary markets and its relevance to understand important deci-
sions taken by firms in preparation to their IPO. The findings
suggest that firms engaged in conservative pricing policies hired
more reputable underwriters in order to increase liquidity of the
firm’s shares. Disappointing post-IPO liquidity is also important
to the understanding of the decision to retain underwriters in sub-
sequent SEOs.
The rest of the article is organized as follows. Section 2 presents
the literature review and hypotheses. Section 3 discusses the sam-
ple construction, sample characteristics, and variables definitions.
Section 4 presents the ordinary least squares (OLS) cross-sectional
regression analysis. Section 5 analyzes the decision to retain
underwriters in SEOs. Section 6 concludes.
2. Literature review and hypotheses
2.1. The underwriter choice
Habib and Ljungqvist’s (2001) model predicts that the choice of
underwriter depends on the rents owners derive from an IPO.2 We
add to this analysis by examining the benefits managers derive from
2 these managers hire more prestigious underwriters and engage
Alavi et al. (in press) find evidence consistent with Habib and Ljungqvist’s (2001)
for a sample of Australian IPOs.
the liquidity provided by the public market for their shares. Brau and
Fawcett (2006) survey IPO firm CFOs, who reported that one of the
main reasons they go public is to create a public market for their
shares. Brau and Fawcett (2006) find that the acquisition rate in-
creases following IPOs, probably because private firms have limited
access to external financing. We hypothesize that firms with more to
gain from going public have greater incentive to hire prestigious
underwriters, which can reduce the probability of IPO withdrawal
(Dunbar and Foerster, 2008) and improve the post-IPO liquidity
(Corwin et al., 2004; Lewellen, 2006).
A similar argument can be made when the owners of private
firms have high levels of personal wealth in their firms because
the liquidity provided by secondary markets enhances the value
of their equity holdings. To test our hypotheses we require infor-
mation on ownership and compensation about a firm’s main exec-
utives. We focus on the CEO as the main decision maker in a firm
who arguably has the most influence over the pricing policy (i.e.,
Lowry and Murphy, 2007) and the person for whom we consis-
tently have ownership and compensation information.
Hypothesis 1. Firms that go public to create currency for future
acquisitions and firms managed by CEOs with high levels of wealth
tied to the equity value of their firms will hire more reputable
underwriters.
2.2. IPO pricing and its effect on underpricing
Edelen and Kadlec (2005) argue that firms follow a pricing pol-
icy that maximizes the expected surplus of taking a company pub-
lic: higher prices reduce the amount of money left on the table but
increase the probability of IPO failure. As argued previously, liquid
public markets may be important for IPO firms to create currency
for acquisitions. In the spirit of Edelen and Kadlec (2005), these
firms should be more conservative in establishing an offer price.
We also contend that the benefits for liquidity should be more
relevant when the owners have millions of dollars of paper wealth
that cannot be converted into liquid assets. Consistent with this
view, Bodnaruk et al. (2007) find that IPOs in the Stockholm stock
exchange (SSE) exhibit greater levels of underpricing when diversi-
fication of the owner’s portfolio is lower. We extend this analysis to
the US market. In addition, CEOs who value post-IPO liquidity may
favor larger first-day returns if underpricing increases stock liquid-
ity after the IPO (Booth and Chua, 1996). Consistent with this
hypothesis, Zheng and Li (2008) report that underpricing is used
to attract nonblock institutional shareholders, which improves
post-IPO liquidity.
Hypothesis 2. Underpricing will be positively associated with the
amount of equity used in post-IPO acquisitions and with the
wealth a CEO has tied to the value of firm equity.
2.3. Seasonal equity offerings
The amount of wealth CEOs invested in the firm as a proxy for
the benefits of going public has an important drawback. Namely,
we should consider the degree of diversification of their portfolios.
Bodnaruk et al. (2007) minimize this shortcoming by using specific
information about the portfolios of IPO firm owners in the SSE, but
they lack complete information about the owner’s total wealth. We
argue that CEOs who sell additional shares in subsequent SEOs
indicate a greater preference for liquidity, and we use this as an
alternative proxy for the benefits CEOs derive from going public.
Following an argument similar to Hypothesis 2, we propose that
in conservative pricing policies.
 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346
Hypothesis 3. Firms in which CEOs sell additional shares in an SEO
will be taken public by more prestigious underwriters and will be
associated with larger underpricing.
Krigman et al. (2001) report that the decision to switch under-
writers in subsequent SEOs is not related to the level of underpric-
ing. Ljungqvist and Wilhelm (2005) find evidence that managers
were more inclined to retain the same underwriter when the IPO
rendered an unexpected change in wealth. Our main hypothesis
is that CEOs value the post-IPO liquidity of their equity holdings.
Thus, CEOs who value more liquidity should retain the same
underwriter in the SEO when they are satisfied with the post-IPO
liquidity of their equity holdings.
Hypothesis 4. The likelihood of switching underwriters in sub-
sequent SEOs will be higher when CEOs with high levels of wealth
tied to their firm face low post-IPO liquidity of their equity
holdings.
3. Sample construction, variable definitions, and sample
descriptive statistics
3.1. Sample construction
From the SDC Global New Issues database (SDC), we collected a
sample of 1,715 IPOs that went public from June 1, 1996 to Decem-
ber 31, 2003.3 We retrieved all the necessary information from SDC
and from the prospectus. Information on underwriter reputation and
the founding date of the company was obtained from the Jay R. Ritter
Web page. Prices used to compute first-day returns and bid–ask
spreads were obtained from the center for research in security prices
(CRSP) database. We required two years of accounting information
before the IPO and compensation information for the CEOs for firms
to be included in the final sample, which resulted in 1343 IPO firms
with complete information for all variables.
3.2. Variable definitions
Table 1 presents the definitions and descriptive statistics for the
variables in this study.
3.2.1. Measures of post-IPO acquisition activity and CEO equity
holdings
The variables stock used in acquisitions and cash used in acqui-
sitions measure the amount of stock and cash used in acquisitions
within three years following the IPO. This Information was ob-
tained from the SDC Mergers and Acquisitions database. We used
CUSIPs, SDC company identifiers, company IRS numbers, and com-
pany names to match this sample with the sample of IPOs. Of the
total sample, 615 IPO firms (45.79%) engaged in acquisitions of as-
sets or corporations within three years following the IPO.
Bodnaruk et al. (2007) had detailed information about the com-
position of the portfolios of owners of firms that went public in the
SSE. We lack such specific information in our sample. However, we
expect that for a given level of investor wealth and portfolio diver-
sification, CEOs with more wealth tied to their firm’s equity value
benefit more from going public because the value of their equity
holdings is diminished by the lack of liquidity of their investments.
From each company’s prospectus we found the number of shares
and options owned by the CEO. Following Bergstresser and Philip-
3
We selected June 1996 as the starting date because after this date all companies
filed their prospectus electronically. The original sample consisted of 1827 IPOs. We
deleted 112 firms for various reasons: 42 lacked the original prospectus, 27 were
equity carve-outs, 21 REITS, 19 sold units, 16 were a combination of stocks and
warrants, 7 were incorporated overseas, 4 were SEOs, 1 was an IPO of senior notes, 1
was the sale of preferred stock, and 1 was an IPO of a joint venture firm.
337
pon (2006) we computed the variable ONEPCT which measures the
dollar value of a CEO’s stock and options holdings in percentage
terms:
ONEPCTi;t ¼ 0:01ðOffer Pricei;t  Sharesi;t þ Optionsi;t
 ðOffer Pricei;t  Exercise Pricei;t ÞÞ:
We then normalized this variable by CEO total compensation to
obtain a measure of the importance of equity compensation rela-
tive to total CEO compensation and used this measure as a proxy
for the benefits a CEO derives from the liquidity provided by the
secondary market:4
Incentive Ratioi;t ¼ ONEPCTi;t =ðONEPCTi;t þ Salaryi;t þ Bonusi;t Þ:
3.2.2. Proxies for informational uncertainties
Investors should demand higher returns for IPOs of firms with
more valuation uncertainty. Firms with less collateral, firms that
are younger, and firms with a limited operating history and nega-
tive earnings suffer from more valuation uncertainty. These firm
characteristics are measured by the following variables: assets,
the natural log of total assets before the IPO; age, the number of
months from the founding date to the date of the first filing of
the IPO; and ROA, the return on assets.
Valuation uncertainty is also higher for firms with a larger pro-
portion of firm value derived from growth opportunities relative to
assets in place. As a measure of growth opportunities, we esti-
mated Tobin’s Q (Smith and Watts, 1992). Firms with more R&D
are more growth based on intangibles creating more valuation
uncertainty (Aboody and Lev, 2000). We computed R&D as the ra-
tio of R&D to total revenues before the IPO. We used the list of
Internet firms on the Jay R. Ritter Web page and in Appendix D
in Loughran and Ritter (2004) to compute the indicator variable
Tech-Internet to account for the difficulty to value firms in these
industries.
3.2.3. Proxies for post-IPO liquidity
Bid–ask spreads are a commonly accepted measure of liquidity
and important determinants of asset returns (Amihud and Mendel-
son, 1986; Brennan and Subrahmanyam, 1996; Chan et al., 2008).
We computed Liquidity B–A, the average relative bid–ask spread:
(ask–bid)/(ask + bid)/2. We also used Liquidity Volume, the ratio
of daily trading volume to the total number of shares outstanding,
as a proxy for liquidity. Because Atkins and Dyl (1997) indicate that
NASDAQ trading volume is roughly double-counted compared to
the NYSE, we divided by 2 the trading volume of NASDAQ firms.5
4. Analysis of the choice of underwriter and underpricing
4.1. Univariate analysis
To test Hypotheses 1 and 2 we used the median statistic to par-
tition the sample into high and low levels of incentive ratio and
stock used in acquisitions. We performed separate analyses for
the acquisitions announced one, two, and three years after the
4
Bergstresser and Philippon (2006) point out that this measure assumes the delta
of the options equals 1, and they use the Black–Scholes formula (B-S) to correct for
potential errors. We often lacked information on the inputs required by B-S but most
options were deeply in the money, and the error incurred in assuming the delta is 1
should not significantly affect our results. The average (median) exercise price of the
options is $2.466 ($0.175) whereas the average (median) offer price is $12.839
($12.000).
5
We used one year of information starting one month after the IPO to compute the
measures of liquidity. We replicated the analysis estimating these variables from the
month after the IPO to one month before the first SEO prospectus and obtained results
qualitatively identical.
338 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346

Table 1
Variables description and descriptive sample statistics

Variable Variable Definitions Mean Max (Min) Std. Dev.

(Median)
Panel A: Firm characteristic before the IPO
Age (years) Number of years from the founding date to the date of the first S-1 or SB2 filing 10.88 (6.00) 145.00 16.37
(0.00)
Assets ($000) Total assets 85,232 4,333,527 242,170
(24,400) (0.26)
ROA (%) Earnings before interest, taxes, depreciation, and amortization divided by total assets 4.43 32.14 1.03
(2.23) (193.47)
Tobin’s Q Expected market value of equity plus the book value of debt and divided by the total value of assets. The 11.36 (7.77) 348.49 10.68
expected value of equity was estimated as the product of the expected price per share times the (0.25)
expected shares outstanding after the offer
R&D Ratio of R&D expenditures to total sales 0.6858 89.43 (0.00) 2.2713
(0.0514)
Tech-Internet Indicates whether the firm is in the technology or Internet sectors 0.6033 1.00 (0.00) 0.4984
(1.00)
Panel B: IPO information, venture capital investments, and underwriter reputation
Expected Proceeds Total expected proceeds from the IPO 77.90 3,519.00 128.26
($mill) (52.30) (4.12)
Insider Ownership Percentage ownership by directors and officers before the IPO 63.09 100.00 26.47
(%) (64.70) (0.00)
Secondaries ($mill) Value of the shares sold by insiders at the IPO 5.78 (0.00) 351.00 27.08
(0.00)
VC Investment Total dollars invested by all funds in all rounds of financing until the IPO 1.79 (1.29) 10.39 (0.00) 1.91
($mill)
Under Reputation Carter and Manaster (1990) measure of underwriter reputation 7.60 (8.10) 9.1 (1.10) 1.99
Panel C: Method of payment in post-IPO acquisitions and the value of CEO’s ownership
LnStock Used in Amount of stock ($ mill) used in post-IPO acquisitions 56.34 (9.07) 906.61 122.59
Acquisitions (0.00)
Cash Used in Amount of cash ($ mill) used in post-IPO acquisitions 20.95 (0.00) 700.40 58.04
Acquisitions (0.00)
Incentive Ratio (%) Ratio of CEO equity compensation to total CEO compensation, computed as in Bergstresser and 41.99 0.99 (0.00) 27.06
Philippon (2006) (39.21)
Panel D: Price revisions and underpricing
Price Revisions (%) Percentage change between the midpoint in the indicative original filing range and the offer price 4.67 (0.00) 220.00 28.44
(60.00)
Underpricing (%) Percentage change between the offer price and the closing price the first-day of trading 36.71 697.50 67.74
(13.64) (43.27)
Panel E: Post-IPO liquidity
Liquidity B-A Average relative bid–ask spread: (ask–bid)/((ask + bid)/2) 0.0279 0.3246 0.0247
(0.0215) (0.0011)
Liquidity Volume Daily trading volume divided by the shares outstanding 0.0089 0.0883 0.0083
(0.0064) (0.0006)

The sample consists of 1,343 firms that went public from June 1, 1996 to December 23, 2003.

IPO. The results reported in Table 2 are consistent with Hypothesis 4.2.1. The choice of the underwriter
1. Firms that used more stock in acquisitions and were managed by To test Hypothesis 1 we estimated the parameters in the follow-
CEOs with more wealth tied to equity holdings are associated with ing model:
more prestigious underwriters. In results not reported we found
that firms that used high levels of stock in acquisition were 25% Under Reputation ¼ d0 þ d1 Assets þ d2 ROA þ d3 Age
more likely to hire high-quality underwriters. Similarly, CEOs with þ d4 Tobin’s Q þ d5 RD
high levels of incentive ratio were 14% more likely to hire reputa-
ble underwriters. þ d6 Tech-Internet þ d7 CEO Ownership
Supporting Hypothesis 2, the average underpricing is nearly 4 þ d8 VC Investment
times larger for firms that used more stock in post-IPO acquisi-
þ d9 CEO Is the Founder
tions. The average (median) underpricing was 88.96% (48.25%)
for firms that used more stock in acquisitions in the year following þ d1 LnExpected Proceeds
the IPO. These figures are significantly larger than the mean (med- þ d11 LnSecondaries þ d12 Dilution
ian) underpricing equal to 29.54% (11.86%) for the remaining IPOs
þ d13 Participation þ d14 IncentiveRatio
firms. The average (median) underpricing was 36.16% (14.23%)
greater for firms in which the CEO had high values of equity hold- þ d15 LnStock Used in Acquisitions
ings, measured around incentive ratio. þ d16 LnCash Used in Acquisitions þ r: ð1Þ

4.2. OLS regression analysis
In this section we test Hypotheses 1 and 2 using OLS regression
analysis to control for factors that affect the choice of underwriter
and underpricing.
Table 3 reports the results, which support Hypothesis 1. We
considered acquisitions announced one year after the IPO (Model
4), two years after the IPO (Model 5), and three years after the
IPO (Model 6). The coefficient of LnStock Used in Acquisitions is
consistently positive and statistically significant (p < 0.01), as is
 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346 339

Table 2
Univariate analysis

Under reputation Underpricing

Incentive ratio Low levels of Incentive Ratio 7.29 19.53%
(8.10) (8.69%)
High levels of Incentive Ratio 7.96 55.69%
(8.10) (22.92%)
t-test (Wilcoxon) 6.58*** 10.71***
(6.73)*** (9.99)***
Acquisition with stock one year after the IPO Low levels of Stock Used in Acquisition 7.49 29.54%
(8.10) (11.86%)
High levels of Stock Used in Acquisition 8.43 88.96%
(9.10) (48.25%)
t-test (Wilcoxon) 8.77*** 11.54***
(6.41)*** (9.51)***
Acquisition with stock two years after the IPO Low levels of Stock Used in Acquisition 7.47 29.22%
(8.10) (11.76%)
High levels of Stock Used in Acquisition 8.47 82.52%
(9.10) (40.91%)
t-test (Wilcoxon) 10.78*** 11.01***
(7.13)*** (9.37)***
Acquisition with stock three years after the IPO Low levels of Stock Used in Acquisition 7.46 29.21%
(8.10) (11.76%)
High levels of Stock Used in Acquisition 8.46 79.62%
(9.10) (38.07%)
t-test (Wilcoxon) 7.27*** 8.10***
(6.05)*** (7.76)***

This table compares the means and medians (in parentheses) of the variables Under Reputation, Price Revisions, and Underpricing for high and low levels (defined by the
medians) of the variables Incentive Ratio and LnStock Used in Acquisitions defined in Table 1. The table also reports t-values for the t-test of difference in means and the z-
scores of the Wilcoxon test of difference in medians (in parentheses).
* ** ***
, , Indicate statistical significance at the 10%, 5%, and 1% levels, respectively.

the coefficient of Incentive Ratio (at the 5% level or better). For the
sake of completeness, in Model 4 we included LnONEPCT, the nat-
ural log of ONEPCT. The coefficient of this variable is also positive
and statistically significant (p < 0.01).
Other results are consistent with the prior literature. VC Invest-
ment is associated with more reputable investment banks (Bradley
and Jordan, 2002; Lee and Wahal, 2004) and Proceeds, Secondaries,
and Participation Ratio are also positive (Habib and Ljungqvist,
2001).
4.2.1.1. An alternative explanation for positive association between the
reputation of the lead underwriter and the amount of stock used in
acquisitions. The positive association between underwriter reputa-
tion and the amount of stock used in acquisitions could also be ex-
plained if most prestigious investment banks underwrite high-
quality IPO firms. These higher quality firms should engage in more
stock acquisitions following IPOs because they enjoy higher valua-
tion in the aftermarket.6 We explored this alternative hypothesis by
analyzing whether more reputable underwriters were associated
with higher quality firms and whether firm quality explains the re-
sults in Table 3. It can be argued that stock and operating perfor-
mance reflect observable and unobservable characteristics related
to firm quality. Thus, we use different measures of post-IPO firm per-
formance as proxies for firm quality. The results of this analysis are
not presented here because of space limitations but are available
from the authors upon request.
Carter et al. (1998) find better long-run stock performance for
firms taken public by more reputable underwriters. This result sug-
gests that higher quality investment banks underwrote better IPOs
and that investors underestimated the true value of these firms at
time of the IPO. We computed excess holding period returns (HPR)
using Fama and French’s (1993) three-factor regression model of
6
We are thankful to an anonymous referee for suggesting this alternative
explanation.
monthly excess returns.7 We also used different measures of oper-
ating performance. First, we used the methodology in Barber and
Lyon (1996) to compute the Adjusted Performance and Abnormal
Performance of ROA and return on sales. We also estimated the
industry-adjusted Growth in Sales for each of the three years follow-
ing the IPO.8
To determine whether more reputable underwriters took public
firms of a higher quality, we first computed the correlation be-
tween Under Reputation and the one-, two-, and three year HPR.
The Pearson correlation coefficients were positive in each period
but not statistically significant, indicating that firms taken public
by more reputable underwriters did not exhibit superior stock per-
formance. We also estimated the correlation between Under Repu-
tation and each measure of operating performance. The results
indicate that operating performance was positively associated with
underwriter quality (significant at the 10% level or better, depend-
ing on the measure used), but only for the year following the IPO.
No significant association was found in years 2 and 3. Taken to-
gether, the results fail to show a clear relation between different
proxies of firm quality and underwriter reputation in our sample.
To further determine whether firm quality could explain the po-
sitive association between the reputation of the lead underwriter
and the amount of stock used in acquisitions, we included each
performance measure sequentially in each model in Table 3. The
coefficient of LnStock Used in Acquisitions is of similar magnitude
7
We assumed that IPOs were bought at the closing price the day after the IPO and
sold one, two, or three years after the purchase, or when they were delisted.
8
Adjusted Performance is the difference between a firm’s operating performance
and the median operating performance of the remaining firms in the same industry,
defined by the two-digit SIC code. Abnormal Performance was computed as the
difference between each firm’s performance and expected performance. Growth in
sales was computed as the difference between the firm’s growth in sales and the
median growth in sales for the remaining firms in the same two-digit SIC codes. We
did not analyze growth in earnings because 60% of the sample exhibited negative
values of EBITDA.
340 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346

Table 3
The determinants of the lead underwriter’s reputation

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Intercept 5.7022*** 5.5884*** 6.5355*** 5.6433*** 5.6460*** 5.6627***
(8.75) (8.47) (9.49) (8.39) (8.43) (8.45)
Assets 1.0263*** 0.9987*** 0.9603*** 0.9911*** 0.9846*** 0.9808***
(25.99) (24.99) (23.74) (24.23) (24.09) (24.09)
ROA 0.1158*** 0.1094*** 0.1052*** 0.1065*** 0.1059*** 0.1059***
(4.75) (4.44) (4.17) (4.25) (4.25) (4.25)
Age 0.0009*** 0.0009*** 0.0008*** 0.0009*** 0.0009*** 0.0008***
(4.00) (3.82) (3.63) (3.59) (3.65) (3.66)
Tobin’s Q 0.0582*** 0.0534*** 0.0519*** 0.0527*** 0.0527*** 0.0526***
(10.36) (9.18) (8.92) (9.09) (9.12) (9.12)
R&D 0.0093 0.0116 0.0078 0.0154 0.0144 0.0150
(0.47) (0.58) (0.40) (0.78) (0.71) (0.74)
Tech-Internet 0.5379*** 0.4770*** 0.4538*** 0.4275*** 0.4466*** 0.4083***
(6.00) (5.10) (4.98) (4.56) (4.44) (4.35)
VC Investment 0.2030*** 0.2100*** 0.2195*** 0.2042*** 0.2338*** 0.2038***
(6.66) (6.80) (7.22) (6.67) (6.63) (6.65)
CEO Is the Founder 0.0330 0.2211 0.0548 0.0236 0.0334 0.0311
(0.41) (0.25) (0.64) (0.27) (0.39) (0.36)
LnExpected Proceeds 0.3019*** 0.3132*** 0.3059*** 0.3362*** 0.3476*** 0.3554***
(4.23) (4.29) (4.35) (4.54) (4.66) (4.62)
LnSecondaries 0.1385*** 0.1363*** 0.1391*** 0.1473*** 0.1438*** 0.1445***
(4.32) (4.23) (4.33) (4.59) (4.50) (4.53)
Dilution Ratio 0.0013 0.0015 0.0013 0.0017 0.0018 0.0019
(1.01) (1.07) (0.99) (1.25) (1.27) (1.27)
Participation Ratio 0.0086*** 0.0085*** 0.0083*** 0.0082*** 0.0079*** 0.0080***
(4.73) (4.69) (4.77) (4.60) (4.30) (4.15)
Incentive Ratio 0.0052*** 0.0045*** 0.0045** 0.0045**
(2.97) (2.58) (2.55) (2.55)
LnONEPCT 0.1359***
(4.33)
LnStock Used in Acquisitions 0.1050*** 0.0991*** 0.1010***
(4.59) (4.88) (5.15)
LnCash Used in Acquisitions 0.0349 0.0184 0.0152
(0.96) (0.63) (0.58)
Obs. 1,343 1,343 1,343 1,343 1,343 1,343
Adj. R2 0.4470 0.4477 0.4572 0.4541 0.4554 0.4565
F-value (p-value) 69.10*** 63.04*** 64.51*** 56.09*** 57.08*** 57.32***
(<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001)

The dependent variable is Under Reputation, the Carter and Manaster (1990) measure of underwriter reputation. The variables LnStock Used in Acquisitions and LnCash Used
in Acquisitions are the natural log of (1 + Stock Used in Acquisitions) and the natural log of (1 + Cash Used in Acquisitions), respectively. In Model 4 we considered acquisitions
one year after the IPO, in Model 5 acquisitions two years after the IPO, and in Model 6 acquisitions three years after the IPO. The independent variables are defined in Table 1
with the exceptions of LnONEPCT, the natural log of the variable ONEPCT. LnSecondaries and LnExpected Proceeds are, respectively, the natural log of (1 + Secondaries) and
Expected Proceeds. Dilution Factor is the fraction of pre-flotation shares sold in the IPO. Participation Ratio is the proportion of shares sold by the insiders. The t-values
reported in absolute values in parentheses were computed using the Huber–White–Sandwich estimator of variance that produces consistent standard errors.
* ** ***
, , Statistical significance at the 10%, 5%, and 1% levels, respectively.

and statistical significance to the results reported here. Thus, the
results of this alternative analysis continue supporting Hypothesis
1 in the article.
4.2.2. Underpricing
To test Hypothesis 2 we estimated the following model:
Underpricing ¼ g0 þ g1 Assets þ g2 ROA þ g3 Age
þ g4 Tobin’sQ þ g5 RD þ g6 Tech-Internet
þ g7 CEO Ownership þ g8 VC Investment
þ g9 CEO Is the Founder
þ g1 LnExpected Proceeds
þ g11 Market Return þ g12 Bubble
þ g13 Incentive Ratio
þ g14 LnStock Used in Acquisitions
þ g15 LnCash Used in Acquisitions
þ g16 Price Revisions þ u:
5). Consistent with Hypothesis 2, LnStock Used in Acquisitions and
Incentive Ratio are consistently and positively associated with
Underpricing.
These results suggest that managers who value the liquidity
provided by secondary markets adopted conservative policies,
which resulted in larger underpricing. We included two variables
to control for the effect of contemporaneous market conditions:
Market Return is the CRSP value-weighted index return in the 15
trading days before the IPO (Loughran and Ritter, 2002), and Bub-
ble, which equals 1 for IPOs in 1999 or 2000, accounts for the
extraordinary levels of underpricing during the Internet bubble
(Ljungqvist and Wilhelm, 2003). In line with prior evidence, con-
temporaneous market conditions and firms in the Internet industry
are associated with higher underpricing. Other results are also con-
sistent with prior evidence. The positive coefficient of Price Revi-
sions in Model 5 is consistent with Hanley (1993) and the
reputation of the lead underwriter is positively associated with
underpricing (Loughran and Ritter, 2004; Hoberg, 2007).
ð2Þ 4.3. Endogeneity analysis

The results are reported in Table 4. We performed separate analyses In this section we examine the potential endogeneity between
for acquisitions announced one year after the IPO (Model 3), two CEO ownership and underpricing. This problem may be worrisome
years after the IPO (Model 4), and three years after the IPO (Model because prior literature suggests that valuation uncertainty influ-
 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346 341

Table 4
The determinants of underpricing

Model 1 Model 2 Model 3 Model 4 Model 5

Intercept 0.5401***
0.4980*** 0.3895*** 0.3636*** 0.3789***
(3.02) (2.83) (2.68) (2.48) (5.59)
Assets 0.0204 0.0191 0.0151 0.0141 0.0153
(1.43) (1.35) (1.30) (1.23) (1.34)
ROA 0.0011 0.0007 0.0013 0.0010 0.0011
(0.12) (0.08) (0.20) (0.17) (0.20)
Age 0.0001 0.0001 0.0001 0.0001 0.0001
(0.19) (0.72) (1.11) (0.99) (0.94)
Tobin’s Q 0.0016 0.0015 0.0001 0.0001 0.0001
(0.66) (0.65) (0.03) (0.06) (0.02)
R&D 0.0001 0.0012 0.0014 0.0027 0.0027
(0.01) (0.21) (0.27) (0.56) (0.57)
Tech-Internet 0.1247*** 0.0952*** 0.0329 0.0317 0.0302
(5.17) (3.80) (1.61) (1.54) (1.45)
VC Investment 0.0181* 0.0168* 0.0038 0.0034 0.0037
(1.71) (1.62) (0.44) (0.39) (0.42)
Under Reputation 0.0450*** 0.0379*** 0.0215*** 0.0215*** 0.0160***
(6.04) (5.18) (3.33) (3.32) (3.34)
CEO Is the Founder 0.0534** 0.0568** 0.0228 0.0247 0.0228
(2.04) (2.17) (1.07) (1.14) (1.05)
LnExpected Proceeds 0.1185*** 0.1072*** 0.0671*** 0.0640*** 0.0648***
(5.91) (5.43) (4.08) (3.80) (3.88)
Market Return 0.0226*** 0.0227*** 0.0091*** 0.0089*** 0.0089***
(6.38) (6.51) (2.92) (2.82) (2.79)
Bubble 0.3210*** 0.3162*** 0.1914*** 0.1973*** 0.2021***
(10.03) (10.02) (6.99) (7.21) (7.35)
Incentive Ratio 0.0040*** 0.0036*** 0.0010** 0.0010** 0.0010**
(6.48) (6.05) (2.11) (2.06) (2.10)
LnStock Used in Acquisitions 0.0478*** 0.0453*** 0.0352*** 0.0303***
(4.65) (3.70) (3.54) (3.35)
LnCash Used in Acquisitions 0.0098 0.0102 0.0161* 0.0122
(1.07) (0.96) (1.84) (1.55)
Price Revisions 1.4359*** 1.4382*** 1.4431***
(13.06) (13.09) (13.11)
Obs. 1,343 1,343 1,343 1,343 1,343
Adj. R2 0.2929 0.3130 0.5229 0.5198 0.5180
F-value–(p-value) 25.46*** 23.48*** 36.41*** 36.24*** 36.22***
(<0.001) (<0.001) (<0.001) (<0.001) (<0.001)

The dependent variable in the models is Underpricing. The variables LnStock Used in acquisitions and LnCash Used in Acquisitions are the natural log of (1 + Stock Used in
Acquisitions) and the natural log of (1 + Cash Used in Acquisitions), respectively. In Model 3 we considered acquisitions one year after the IPO, in Model 4 acquisitions two
years after the IPO, and in Model 5 acquisitions three years after the IPO. The independent variables are defined in Table 1 with the exceptions of LnExpected Proceeds, which
is the natural log of Expected Proceeds. Market Return is the return of the CRSP value-weighted index in the 15 trading days before the IPO. Bubble equals 1 if the company
went public in 1999 or 2000. The remaining independent variables are defined in Table 1. The t-values reported in absolute values in parentheses were computed using the
Huber–White–Sandwich estimator of variance that produces consistent standard errors.
*,**,***
Statistical significance at the 10%, 5%, and 1% levels, respectively.

ences both the return demanded by investors and the amount of
wealth CEOs have invested in their firms.
First, compensation for labor is one component of the wealth
CEOs have invested in their firms. Little is known about the deter-
minants of managerial compensation in private firms, but the re-
search on publicly held corporations suggests that CEOs of IPO
firms with more valuation uncertainty receive more equity-based
compensation.9 Second, investment in the firm before the IPO is an-
other component of the wealth CEOs have in their firms. We lack
specific information about this component, but owners should invest
more of their own personal wealth (accepting high levels of idiosyn-
cratic risk) to fund a firm’s growth when their firms have restricted
access to alternative sources of financing. We expect that owners are
forced to invest more of their wealth in firms with higher levels of
valuation uncertainty because these firms suffer from more severe
adverse selection problems, which increase their cost of capital
and hamper their access to external financing (Diamond and Verrec-
chia, 1991; Mantecon, 2008). We also expect CEOs to have greater
investment in their firms when they are also the founders and we in-
cluded the variable CEO Is the Founder, which equals 1 when the CEO
is the founder or cofounder.10
To examine the determinants of CEOs’ equity holdings we esti-
mate the following model:
Incentive Ratio ¼ v0 þ v1 Assets þ v2 ROA þ v3 Age
þ v4 VC Investment þ v5 CEO Ownership
þ v6 Tobin’s Q þ v7 RD
þ v8 CEO Is the Founder þ t: ð3Þ
This analysis suggests that the positive association between under-
pricing and the amount of wealth CEOs have invested in the firm, as
reported in the prior section and suggested by Bodnaruk et al.
(2007), could result because CEOs of firms with more valuation

9
For instance, Smith and Watts (1992) propose that equity incentives are adequate
for firms with more growth options because of the high costs of monitoring managers
and the greater uncertainty associated with measuring performance in these firms
(see also Guay, 1999; Kang et al., 2006).
10
In 608 IPOs (45.27% of the sample), the CEO was a founder or cofounder. We
assigned a value of 1 to CEO Is the Founder in 10 cases in which the CEO is the son of
the founder and in 8 cases in which the CEO provided capital through private equity
funds. In 6 of these 8 events the CEO was a VC investor and in 2 events the CEO bought
the predecessor of the IPO firm.
342 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346

Table 5
Simultaneous equations

Dependent Variables in Models 1–4

(3) Incentive Ratio (1) Under Reputation (4) Price Revisions (2) Underpricing
Intercept 29.4098*** 6.5041*** 0.2175 0.0974
(4.85) (11.07) (1.29) (0.21)
Lag Leverage 1.8551***
(3.93)
Assets 5.1499*** 1.0814*** 0.0346 0.0863
(9.58) (19.97) (1.22) (1.15)
ROA 0.4128 0.1378*** 0.0045 0.0100
(0.66) (3.40) (0.63) (0.15)
Age 0.0157*** 0.0013*** 0.0001 0.0001
(4.14) (4.97) (0.06) (0.95)
Tobin’s Q 0.8930*** 0.0724*** 0.0010 0.0041
(11.86) (9.15) (0.40) (0.70)
R&D 0.0374 0.0435** 0.0010 0.0021
(0.13) (2.29) (0.32) (0.24)
Tech-Internet 12.2262*** 0.6944 0.0699** 0.0488
(8.99) (0.52) (2.22) (0.47)
VC Investment 0.2291*** 0.0093 0.0571***
(7.81) (1.11) (2.65)
Under Reputation 0.0204 0.1231*
(0.78) (1.92)
CEO Is the Founder 13.7502*** 0.4216*** 0.0286 0.2753***
(11.68) (3.04) (0.70) (2.60)
LnExpected Proceeds 0.3899*** 0.0275** 0.0870**
(6.04) (2.32) (2.17)
Market Return 0.0147*** 0.0366****
(8.98) (2.32)
Bubble 0.0999*** 0.4201***
(3.17) (3.23)
LnSecondaries 0.0292***
(4.59)
Dilution Ratio 0.0021***
(2.57)
Participation Ratio 0.0067***
(2.83)
Incentive Ratio 0.0332*** 0.0022 0.0198***
(3.90) (0.81) (2.67)
LnStock Used in Acquisitions 0.0769*** 0.0172*** 0.0766***
(3.07) (3.09) (3.40)
LnCash Used in Acquisitions 0.0124 0.0030 0.0085
(0.43) (0.58) (0.70)
Price Revisions 0.9659
(0.90)
Obs. 1343 1343 1343 1343
Durbin–Wu–Hausman (p-value) 142.49
(<0.001)
v2 (p-value) 508.34*** 1087.23*** 400.19*** 516.68***
(<0.001) (<0.001) (<0.001) (<0.001)

The table presents the 3SLS estimation of the Models 1–4. The variables LnStock Used in Acquisitions and LnCash Used in Acquisitions are the natural log of (1 + Stock Used in
Acquisitions) and the natural log of (1 + Cash Used in Acquisitions), respectively. In this table we consider acquisitions three years after the IPO.
*,**,***
Statistical significance at the 10%, 5%, and 1% levels, respectively.

uncertainty have more wealth tied to their firms. Similarly, the po- Price Revisions ¼ /0 þ /1 Assets þ /2 ROA þ /3 Age
sitive relation between underwriter reputation and underpricing þ /4 Tobin’sQ þ /5 RD þ /6 Tech-Internet
may be rationalized if CEOs with incentives to hire more reputable
underwriters adopt pricing policies that yield greater underpricing. þ /7 CEO Ownership þ /8 VC Investment
The potential for these endogeneities clouds the intuition of the re- þ /9 CEO Is the Founder
sults in this article and the coefficients using OLS regression analy-
þ /1 LnExpected Proceeds
sis may be biased and inconsistent because the endogenous
variables are correlated with the disturbances. To account for the þ /11 Market Return þ /12 Bubble
endogeneity between these relations, we estimated Models 1, 2, þ /13 Incentive Ratio
and 3 using three-stage least squares (3SLS).11 Ljungqvist and Wil-
þ /14 Stock Used in Acquisitions
helm (2003) propose that price revisions and underpricing should
be determined endogenously. Thus, we included the following þ /15 LnCash Used in Acquisitions þ w: ð4Þ
model:
The results are presented in Table 5. The dependent variable in
Model 3 is Incentive Ratio. Consistent with the evidence on public
11
We only report analysis using acquisitions that occurred three years after the IPO
corporations, the coefficients of the proxies for valuation uncer-
to compute LnStock Used in Acquisitions and LnCash Used in Acquisitions, but the tainties are positive, indicating that the proportion of wealth CEOs
results using acquisitions one or two years after the IPO are qualitatively identical. have invested is higher in firms with greater uncertainty. The value
 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346 343

Table 6
An analysis of the shares sold by CEOs in SEOs following the IPO

Dependent Variable: Under Reputation Dependent Variable: Underpricing

(1) (2) (3) (4)
Intercept 5.2878*** 5.6704*** 0.4839*** 0.3662**
(8.81) (8.50) (2.77) (2.52)
Assets 1.0006*** 0.9775*** 0.0193 0.0155
(25.14) (24.19) (1.38) (1.37)
ROA 0.1122*** 0.1075*** 0.0013 0.0017
(4.64) (4.42) (0.15) (0.30)
Age 0.0008*** 0.0008*** 0.0001 0.0001
(3.73) (3.04) (0.79) (1.01)
Tobin’s Q 0.0562*** 0.0521*** 0.0017 0.0001
(10.15) (9.07) (0.72) (0.06)
R&D 0.0145 0.0167 0.0020 0.0019
(0.73) (0.83) (0.35) (0.41)
Tech-Internet 0.4116*** 0.4087*** 0.0094*** 0.0300
(5.01) (4.37) (3.79) (1.44)
VC Investment 0.2009*** 0.2067*** 0.0185* 0.0053
(6.63) (6.72) (1.78) (0.63)
Under Reputation 0.0357*** 0.0196***
(4.87) (3.04)
CEO Is the Founder 0.0057 0.0370*** 0.0597** 0.0255
(0.07) (2.66) (2.29) (1.18)
LnExpected Proceeds 0.1445*** 0.3591*** 0.1038*** 0.0618***
(4.68) (4.69) (5.30) (3.76)
Market Return 0.0089*** 0.0091***
(2.79) (2.91)
Bubble 0.0229*** 0.2075***
(6.64) (7.53)
CEO Sells in SEO 0.3010*** 0.2861*** 0.1356*** 0.1252***
(3.06) (2.91) (2.96) (3.26)
Incentive Ratio 0.0043** 0.0035*** 0.0027***
(2.45) (5.96) (8.54)
LnStock Used in Acquisitions 0.0975*** 0.0915*** 0.0463*** 0.0265***
(3.06) (4.56) (4.13) (2.89)
LnCash Used in Acquisitions 0.0223 0.0170 0.0106 0.0130*
(0.85) (0.65) (1.17) (1.67)
Price Revisions 1.4401***
(13.34)
Obs. 1,343 1,343 1,343 1,343
Adj. R2 0.4595 0.4590 0.3190 0.5231
F-Value (p-value) 59.92*** 54.85*** 38.33*** 35.53***
(<0.001) (<0.001) (<0.001) (<0.001)

The dependent variable in Models 1 and 2 is Under Reputation and in Models 3 and 4 is Underpricing. The variable CEO Sells in SEO equals 1 if the CEO sells shares in the SEO.
The variables LnStock Used in Acquisitions and LnCash Used in Acquisitions are the natural log of (1 + Stock Used in Acquisitions) and the natural log of (1 + Cash Used in
Acquisitions), respectively. In this table we consider acquisitions three years after the IPO. The t-values reported in absolute values in parentheses were computed using the
Huber–White–Sandwich estimator of variance that produces consistent standard errors.
*,**,***
Statistical significance at the 10%, 5% and 1% levels, respectively.

of the Durbin–Wu–Hausman statistic equals 142.49 (p < 0.01),
indicating that OLS estimation is not consistent.12 These results
hints at the presence of endogeneities discussed earlier. However,
the results of Models 1 and 2 are similar to the OLS results in Tables
3 and 4 and continue to support Hypotheses 1 and 2.
The 3SLS estimation of these models yields an important differ-
ence from the OLS analysis reported in Table 4. The coefficient of
Under Reputation is positively related to price revisions and under-
pricing in Table 4, but it is negative, in the 3SLS analysis in Table 5.
This result suggests that the positive association between under-
writer prestige and underpricing occurs because firms that bene-
fited more from going public hired more prestigious
underwriters and were content with greater underpricing.
In Model 4, Price Revisions is positively related to Incentive Ratio
and LnStock Used in Acquisitions. Theory suggests that a conserva-
tive policy could result in either larger or smaller price revisions.
However, in Model 4, Price Revisions is positively related to Incen-
tive Ratio and LnStock Used in Acquisitions, results that suggest
that managers were also conservative in establishing the indicative
price in the prospectus.
5. The analysis of post-IPO SEOs

12
For the system to be identified, the number of endogenous variables in the right-
hand side of each structural equation has to be larger than the number of exogenous
variables in the remaining equations in the system. For motives of identification, we
do not include Ln Secondaries, Participation and Dilution Ratio in models 3 and 4.
Consistent with Habib and Ljungqvist (2001), we find that the variables affect the
underwriter choice, but not underpricing. Also, we did not include Lag Leverage in
models 2, 3 and 4. The rationale for this variable is that John and John (1993) predicts
a negative relationship between the portion of CEO stockholdings and leverage. This
variable was computed with one year lag information and we found no significant
association between this variable and underwriter’s quality, price revisions or
underpricing.
To test Hypotheses 3 and 4, we identified firms that conducted
an SEO within three years after the IPO.13 We obtained a sample of
SEOs from January 1, 1996 to December 31, 2003 from SDC and
13
Krigman et al. (2001) consider a three year period after the IPO, whereas
Ljungqvist and Wilhelm (2005) retain all post-IPO SEOs. We follow Krigman et al.
(2001) to minimize the effect of equity compensation, exercise of options, sale of
equity, and changes in CEOs. Our IPO sample ends December 31, 2003 and our SEO
sample ends December 31, 2006; therefore, all firms in our sample could have
conducted an SEO in three years, ameliorating the chances of sample-selection bias.
344 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346

Table 7
The determinants of the decision to retain the lead underwriter

Liquidity Measured by the Relative Bid–Ask Spread Liquidity Measured by the Relative Trading Volume
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Intercept 1.1111*** 0.6828 0.3368 1.1351** 0.5917** 0.8239
(3.39) (1.22) (0.44) (2.27) (2.46) (1.35)
Underpricing 0.0007 0.0007 0.0034 0.0003 0.0001 0.0001
(0.50) (0.50) (0.26) (0.22) (0.08) (0.00)
Incentive Ratio 0.3468 0.4629 0.5066 0.2178 0.5959 0.6269
(1.05) (0.82) (0.89) (0.65) (1.04) (1.10)
Days from IPO to SEO 0.0010*** 0.0011*** 0.0012*** 0.0013*** 0.0012*** 0.0012***
(3.80) (4.33) (4.03) (4.22) (4.96) (3.70)
CEO Perceived Wealth Gain 0.0387* 0.0307 0.0304 0.0299 0.0382 0.0031
(1.65) (1.14) (1.13) (1.16) (1.64) (1.27)
Liquidity 0.2094*** 0.0580 0.04203 0.1943 0.1943 0.0761
(3.20) (0.54) (0.39) (1.21) (1.15) (0.39)
Under Reputation 0.2094*** 0.1671** 0.2475*** 0.1809***
(4.00) (2.10) (4.97) (2.58)
High Incentive Ratio – Low Liquidity 0.8450** 0.7540**
(2.15) (2.13)
High Incentive Ratio – High Liquidity 0.61218* 0.3408
(1.95) (1.18)
Low Incentive Ratio – Low Liquidity 0.6415** 0.0728
(2.17) (0.33)
High Incentive Ratio – Low Liquidity – High Reputation 0.9672** 0.7286**
Underwriters (2.30) (2.07)
High Incentive Ratio – High Liquidity – High Reputation 0.5472* 0.1806
Underwriters (1.70) (0.52)
Low Incentive Ratio – Low Liquidity – High Reputation 0.5769* 0.2586
Underwriters (1.84) (1.01)
High Incentive Ratio – Low Liquidity – Low Reputation 0.7644 0.6064
Underwriters (1.49) (1.31)
High Incentive Ratio – High Liquidity – Low Reputation 1.0052* 0.4694
Underwriters (1.96) (0.89)
Low Incentive Ratio – Low Liquidity – Low Reputation 0.8116* 0.2929
Underwriters (1.92) (0.86)
Obs. 411 411 411 411 411 411
Pseudo R2 0.1042 0.1584 0.1385 0.1423 0.1533 0.1605
Wald v2 (p-value) 43.16*** 61.83*** 49.74*** 52.85*** 59.46*** 62.58***
(<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001)

Probit analysis of the decision to retain the lead underwriter. The dependent variable equals 1 if the lead underwriter is the same in the IPO and in the SEO, and 0 otherwise.
Median values were used to classify the IPO into high and low values of Incentive Ratio and Liquidity and Under Reputation. The independent variables are defined in Table 1.
Days from IPO to SEO is the natural log of the number of days between the IPO and the SEO. CEO Perceived Wealth Gain was estimated as in Ljungqvist and Wilhelm, 2005, p.
1764. The z-values reported in absolute values in parentheses were computed using the Huber–White–Sandwich estimator of variance that produces consistent standard
errors.
*,**,***
Statistical significance at the 10%, 5%, and 1% levels, respectively.

matched this sample of SEOs with the sample of IPOs.14 The final
sample comprises 433 firms, or 32.24% of the sample.
5.1. Analysis of the shares sold in subsequent SEOs, price revisions, and
underpricing
for the hypothesis that CEOs that value liquidity (proxied by their
selling of shares in the SEO) hired more reputable underwriters
and followed conservative pricing policies.
5.2. The decision to retain the lead underwriter in a subsequent SEO

To test Hypothesis 3 we added to Models 1 and 2 the variable
CEOs Sell in SEO, which equals 1 if the CEO sells shares in a subse-
quent SEO and 0 otherwise. The results are presented in Table 6.
The dependent variable in Models 1 and 2 is Under Reputation.
Consistent with Hypothesis 3, the coefficient of CEO Sells in SEO
is positive (0.2861, in Model 2) and statistically significant
(p < 0.01), indicating that firms in which the CEO sold shares in
the SEO were taken public by more prestigious underwriters.
The dependent variable in Models 3 and 4 is Underpricing. The
results support Hypothesis 3: the average IPO firm exhibited
approximately 20% greater underpricing when the CEO sold addi-
tional shares in the SEO. These results provide additional support
To test Hypothesis 4 we followed the steps in Ljungqvist and
Wilhelm (2005) to identify firms that retained the same lead under-
writer in a subsequent SEO. The results show that 320 firms (73.90%
of the sample) retained the same underwriter.15 Table 7 reports the
results of the probit analysis of the following basic model:
Retain Under ¼ p0 þ p1 Underpricing þ p2 Incentive Ratio
þ p3 Days from IPO to SEO
þ p4 CEO Perceived Wealth Gain
þ p5 Liquidity þ p7 Incentive Ratio
 Liquidity þ D: ð5Þ

14
Following Ljungqvist and Wilhelm (2005) we matched the samples by SDC
company identifiers and company name, yielding 466 matching firms. We then
matched by IRS numbers, which added 13 firms. We excluded 13 firms because the
CEO was different in the IPO and SEO and 43 more firms because complete
information was not available for all relevant variables.
15
We accounted for the mergers between lead investment banks. Corwin and
Schultz (2005) list mergers involving sample underwriters for a sample of 1638 IPOs
from January 1, 1997 to June 1, 2002. Because our sample extends to December 31,
2003, we looked in Factiva for mergers after June 1, 2002. We did not find any
additional mergers during this period.
 T. Mantecon, P. Poon / Journal of Banking & Finance 33 (2009) 335–346
The dependent variable, Retain Under, equals 1 if the firm retained
the same underwriter in the SEO and 0 otherwise. Liquidity repre-
sents our two proxies for liquidity. Liquidity is equal to Liquidity
B–A in Models 1–3 and Liquidity Volume in Models 4–6.
We added CEO Perceived Wealth Gain, estimated as in Ljungq-
vist and Wilhelm (2005, p. 1764), because those authors find that
the decision to switch underwriters is associated with the Lough-
ran and Ritter (2002) measure of perceived gains. We also included
Days from IPO to SEO, which is the natural log of the number of
days between the IPO and the SEO. As expected, the results show
that the longer the time between the IPO and the SEO, the less
likely it is that the firm will retain the same underwriter.
The coefficient of Liquidity is positive (0.2094) and significant
(p < 0.01) in Model 1 although it is weaker in Model 4 when liquid-
ity is measured using Liquidity Volume. Thus, post-IPO liquidity is
an important determinant of the decision to retain underwriters.
In Models 2 and 5 we used the median values of Incentive Ratio
and Liquidity to divide the sample into high and low levels of equi-
ty incentives and post-IPO liquidity.16 The coefficient of High Incen-
tive Ratio – Low Liquidity is negative and statistically significant in
Models 2 and 5.17 The results are broadly consistent with Hypothesis
4 and suggest that CEOs were less satisfied with the performance of
their underwriters when they invested high levels of personal
wealth in their firms and encountered low levels of post-IPO liquid-
ity for their equity holdings.
The results reported in Table 2 suggest that CEOs who value
liquidity have greater incentive to hire prestigious underwriters.
Thus, we expect CEOs who hired prestigious underwriters to be
disappointed when post-IPO liquidity was low. To account for this
effect, we used the median values of Incentive Ratio, Underwriter
Reputation, and our proxies for liquidity to divide the sample into
high and low levels of equity incentives, post-IPO liquidity, and
underwriter prestige. The results in Models 3 and 6 show that
the coefficient of High Incentive – Low Liquidity – High Under-
writer Reputation is negative and statistically significant at the
5% level or better. Thus, CEOs were more likely to switch under-
writers when they had high levels of Incentive Ratio and hired rep-
utable underwriters but low levels of post-IPO liquidity.
6. Conclusion
The liquidity provided by secondary markets appears to be a
significant determinant of the decision to go public (Brau and
Fawcett, 2006). We contend that expected liquidity is important
for understanding the policies adopted by firms preparing for an
IPO. Specifically, we examined the choice of underwriter and the
pricing policies of sample firms that went public in the United
States from 1996 to 2003.
We used three proxies for the benefits derived from post-IPO
liquidity: the use of stock in acquisitions, the amount of wealth
CEOs have invested in their firms, and the decision by CEOs to sell
shares in SEOs following an IPO. The results suggest that firms that
had more to gain from going public hired more reputable under-
writers and adopted conservative polices to minimize the probabil-
ity of IPO failure and increase post-IPO liquidity. For instance, firms
that used more stock in acquisitions were 25% more likely to hire
more prestigious underwriters and exhibited 9 times larger price
16
In results not reported, we found that 60% of the firms with high levels of
Incentive Ratio and low levels of Liquidity retained the same underwriter, which
contrasts with 79% of the sample that retained the same underwriter.
17
The variable Low Incentive – Low Liquidity is also negative and significant in
Model 2. However, we tested whether the coefficients of High Incentive Ratio – Low
Liquidity and Low Incentive – Low Liquidity were equal and rejected the null
hypothesis at the 5% level.
345
revisions and 3 times higher underpricing. The analysis using other
proxies for liquidity preferences yielded similar findings. The re-
sults were also robust to different specifications and estimation
methods.
We analyzed the decision to retain the lead underwriter in SEOs
as an additional test of the relevance of liquidity. This analysis indi-
cated that CEOs were more likely to switch underwriters in subse-
quent SEOs when they placed more value on liquidity but
encountered low levels of post-IPO liquidity for their shares.
Taken together, these results highlight the importance of the
liquidity provided by secondary markets in increasing the value
of the stock held by the firm’s owners and in fostering the market
for corporate control by favoring the creation of currency for
acquisitions.
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