Endorsing Legitimacy to Avoid IPO Underpricing When Markets for Technology Fail

Abstract

Bringing institutional theory and the signalling effect of patents in the debate, we investigate how to mitigate IPO underpricing in different appropriability regimes. Empirical evidence remains that in the industry with a transparent link between R&D expenditures and value appropriation, the level of R&D expenditures does not even have a negative impact on IPO underpricing and a venture's patent stock effectively mitigates investors' concerns of its future prospect. Conversely, when the link between innovations and future returns is unclear, the endorsing legitimacy is extremely prevalent, especially for high-tech IPOs. Post hoc analysis shows that it does decrease the level of IPO underpricing caused by innovation-based information asymmetry, proxied by the R&D expenditures. The result extends information asymmetry theory by considering institutional prospective and by contextualizing firm information. It also contributes to institutional theory by showing how this theory contributes most to our understanding of firm behaviour in the absence of well functioning markets (e.g., market for technology).