IPO Pricing in 'Hot' Market Conditions: Who Leaves Money on the Table?

Abstract

This paper explores the impact of investor sentiment on IPO pricing. Using a model in which the aftermarket price of IPO shares depends on the information about the intrinsic value of the company and investor sentiment, I show that IPOs can be overpriced and still exhibit positive initial return. A sample of recent French offerings with a fraction of the shares reserved for individual investors supports the predictions of the model. Individual investors' demand is positively related to market conditions. Moreover, large individual investors' demand leads to high IPO prices, large initial returns, and poor long-run performance.

Divergence of opinion and initial public offerings

“…This implication is consistent with Ritter (1984) and Derrien (2005) that expectations of investors affect IPO underpricing. Our result can also be compared to previous studies, such as Miller (1977) and Scheinkman and Xiong (2003), on the influence of investor optimism on asset prices.…”

“…Maksimovic and Pichler (2001) argue that technological and competitive risks can affect the timing of IPOs. Welch (1992), Nelson (2002), Ljungqvist et al (2006), and Derrien (2005) use investor sentiment and herd behavior to explain the underpricing phenomenon and hot issue markets. 2 Miller (1977) and Morris (1996) develop the idea of divergent opinions to explain the long-run underperformance of IPOs.…”

“…Among them, Rock (1986) argues that issuers price IPOs at a discount to compensate uninformed investors for the winner's curse problem because informed investors do not participate in bad issues but only in good issues. Derrien (2005) presents a model with information cascade in which institutional participants in an IPO market receive private signals and bullish noise traders raise the aftermarket price on the offer date. 2 Other related theories focusing on the role of investment banks and underwriters are Baron (1982) and Benveniste and Spindt (1989).…”

Political connections and the long-term stock performance of Chinese IPOs

“…The sample firms experienced significantly negative buy-and-hold returns for a few years after their IPOs. In contrast to Chan et al (2004), who adopted the period of January 1993 to December 1998 as a sample period, our sample period allowed us to avoid the hot-market effect on long-term stock performance (Derrien, 2005;Derrien and Womack, 2003;Helwege and Liang, 2004). Consistent with previous studies, Table 3 shows that all of the wealth relatives are lower than one (ranging from 0.63 to 0.72) and the AD-BHRs are negative and significant; both results suggest that Chinese IPOs experienced underperformance after IPO.…”

The influence of the underwriting syndicate on the valuation of Spanish initial public offerings

“…1 Other studies explore the impact of investor sentiment on IPO pricing. Derrien (2005) uses a model in which the aftermarket price of IPO shares depends on the information about the intrinsic value of the company and investor sentiment. With a sample of French offerings, he shows that IPOs can be overpriced and still exhibit positive initial return.…”