Chapter 3

IPO Anomalies
Academic research into firms that have gone public has focused mainly on the study of
two anomalies Firstly, the shares of firms that have gone public are generally offered to
investors at prices that, on an average, are considerably lower than the price that they
trade at in the immediate aftermarket Following Ibbotson (1975) and Ritter (1984),
numerous researchers have found that m different countries and at different points in
time, the phenomenon of the underpncmg of IPOs is a generalised phenomenon
Secondly, and more recently, different studies have analysed the long-run performance of
IPOs Such an analysis has revealed that investors who have purchased shares of IPO
firms in the aftermarket at the listing day price, especially closing price on the listing day,
and held them for definite period of time, have incurred losses compared to those who
have invested m the stocks of seasoned or non-issumg firms {cited in Alvarez and
Gonzalez (2005))

3.1 Underpricing of IPOs:

Underpncmg of IPOs is measured as the difference between the issue pnce or offenng
pnce and the closing pnce on the first trading day when the IPO gets listed on the stock
exchange Empmcal work shows that underpncmg of IPOs is a well-documented
phenomenon for almost every equity market While the magnitude of underpncmg or
initial return may vary over time and as a function of firm charactenstics, however, it
shows no sign of declining Empmcal evidence indicates that IPOs of common stock
generate large short-run returns, on an average, for investors fortunate enough to
purchase the stock at the offenng pnce Ever since Ibbotson (1975) first ngorously
documented the large underpncmg of IPOs, it has puzzled researchers (cited in Welch
(1989)) Such persistent and systematic underpncmg of IPO issues is an obvious puzzle
for those who otherwise believe in efficient financial markets, and this apparent violation
of market efficiency has received considerable attention from researchers Ibbotson et al
(1988) report an average initial return of 16 4 percent for IPOs made dunng 1960 to 1987
m the U S (cited in Chemmanur (1993)) Ritter (1984) note that, m the U S , dunng the
15-month penod which started from January 1980, the mean return on IPOs of common
stock purchased at the offenng pnce and sold at the closing bid pnce on the first day of
public trading was 48 4 percent m contrast to a mean return of 16 3 percent dunng the
remainder of the 6-year penod 1977-82 Loughran and Ritter (2004) note that dunng the
whole decade of the 1980s the average first day return on IPOs m the U S was 7 percent
They further document that average first-day return doubled to almost 15 percent dunng

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1990-1998, before jumping to 65 percent during the internet bubble years of 1999-2000
and then reverting to 12 percent dunng 2001-2003 Promoters of issuing companies or
their underwaters seem unconcerned about situations of extreme underpncmg, even
though it results m substantial loss of issue proceeds to the issuers Ragman et al (2001)
report that issuing firms do not view large amounts of money left on the table, where the
money left on the table is defined as the first-day pace gam multiplied by the number of
shares sold and the first-day pace gam is computed as the difference between the offeang
pace and the closing pace on the first-trading day, as an important consideration in
choosing underwaters for a follow-on offeang They report that for 15 IPOs with first
day returns m excess of 60 percent that subsequently conducted follow-on offeangs, all
15 retained the lead underwater from the IPO {cited in Loughran and Ritter (2002))
Loughran and Ritter (2002) report that, dunng the penod 1990-1998, companies going
public in the U S have left more than $27 billion on the table If these shares were sold at
the closing market pace on the listing day, rather than the offer pace, the proceeds of the
offeangs would have been higher by an amount equal to the money left on the table
Alternatively, the same proceeds could have been raised by selling fewer shares, resulting
in less dilution of the pre-issue shareholders The investors' profits m these cases come
out of the pocket of the issuing company and its pre-issue shareholders The average IPO
duang the same peaod has left $9 1 million on the table The $27 billion amount of
money left on the table duang the same peaod is twice as large as the $13 billion fees
paid to the investment bankers and this underpaying represents a substantial indirect cost
to the issuing firms Further, these same companies generated profits of approximately $8
billion in the year before going public, which means that the amount of money left on the
table represents more than three years of aggregate profits In some specific cases the
numbers are still extreme For example, m the case of the EPO of Netscape which went
public in August 1995 with Morgan Stanley as the lead underwater, 5 million shares
were sold to investors at $28 00 per share With a closing market pace of $58 25 on the
first trading day, $151 million was left on the table
The following table reports vaoous studies conducted by researchers about IPO
underpacmg m different capital markets of the world

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 Table 3.1: International Evidence of IPO Underpricing
Country Study Sample Period Sample Initial Return
Size (%)
Australia Finn and Higham (1988) 1966-1978 93 29 20
Belgium Mamgart and Rogiers (1992) 1984-1990 28 13 70
Brazil Aggarwaletal (1993) 1980-1990 62 78 50
Canada Jog and Riding (1987) 1971-1983 100 1100
Canada Jog and Snvastava (1996) 1971-1992 254 740
Chile Aggarwaletal (1993) 1982-1990 19 16 30
Finland Kelohaqu (1993) 1984-1992 91 14 40
France Jenkinson and Mayer (1988) 1986-1987 11 25 10
France Husson and Jacquillat (1990) 1983-1986 131 4 00
Germany Uhlir (1989) 1977-1987 97 21 50
Germany Ljungqvist (1997) 1970-1993 180 9 20
Hong Kong Dawson (1987) 1978-1983 21 13 80
Hong Kong McGuinness (1993) 1980-1990 80 17 60
India Sehgal and Singh (2007) 1992-2001 438 99 20
Japan Dawson and Hiraki (1985) 1979-1984 106 51 90
Japan Jenkinson (1990) 1986-1988 48 54 70
Japan Kanebo and Pettway (1994) 1989-1993 37 12 00
Malaysia Dawson (1987) 1978-1983 21 166 00
Mexico Aggarwaletal (1993) 1987-1990 44 2 80
Netherlands Wessels (1989) 1982-1987 46 5 10
New Zealand Vos and Cheung (1992) 1979-1991 149 28'80
Smgapore Dawson (1987) 1978-1983 39 39 40
Smgapore Koh and Walter (1989) 1973-1987 66 27 00
\ Sweden Rydqvist (1993) 1970-1991 213 39 00
Switzerland Kunz and Aggarwal (1994) 1983-1989 42 35 80
Taiwan Chen (1992) 1971-1990 168 45 00
UK Jenkinson and Mayer (1988) 1979-1987 20 22 20
UK Levis (1993) 1980-1988 712 14 30
US Ritter (1987) 1977-1982 664 14 80
US Aggarwal and Rivoli (1990) 1977-1987 1,598 10 70
US Ritter (1991) 1975-1984 1,526 14 30
Sources Aggarwaletal (1993)
Alvarez and Gonzalez (2005)
Sehgal and Singh (2007)

In India also, cases of heavy underpncmg of IPOs have not been uncommon Following
table reports some of the IPOs with underpncmg of more than 100 percent on the listing
day for the penod 2000-2011 Listing day underpncmg is computed from the offenng
pnce to the closing pnce on the listing day not adjusted for the market return

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 Table 3.2: IPOs in India with 100 or more than 100 percent underpricing for the
period 2000-2011
EPO Period of Issue Issue Price Closing Price on Percentage of
Listing Day underpricing
(Rs.) (Rs.)
Tantia 27-03-2006 to 31-03-2006 50 220 00 340 00
Bumpur Cement 28-11-2007 to 03-12-2007 12 46 35 286 25
F C S Software 22-08-2005 to 26-08-2005 50 179 10 258 20
Everonn Education 05-07-2007 to 11-07-2007 140 478 45 241 75
Nissan Copper 04-12-2006 to 08-12-2006 39 128 80 230 26
Baron Infotech 17-04-2000 to 20-04-2000 10 32 20 222 00
Allied Computers 19-10-2007 to 23-10-2007 12 37 70 214 17
Vivimed Lad 09-07-2005 to 13-07-2005 70 218 35 211 93
Dishman Pharma 29-03-2004 to 07-04-2004 175 542 00 209 71
Geometric Software 28-01-2000 to 02-02-2000 300 850 00 183 33
Religare Enterprises 29-10-2007 to 01-11-2007 185 521 70 182 00
PTC India 01-03-2004 to 08-03-2004 16 44 65 179 06
Vishal Retail 11-06-2007 to 13-06-2007 270 752 20 178 59
Dynacon Systems 21-07-2000 to 28-07-2000 30 81 25 170 83
Cambridge Tech 29-12-2006 to 09-01-2007 38 99 95 163 03
Aishwarya Telecom 15-04-2008 to 17-04-2008 35 90 85 159 57
Nitin Fire Protection 15-05-2007 to 18-05-2007 190 484 10 154 79
Birla Pacific 20-06-2011 to 23-06-2011 10 25 35 153 50
Nandan Exim 12-05-2005 to 20-05-2005 20 50 20 151 00
ICRA 20-03-2007 to 23-03-2007 330 797 60 141 70
Edserv Softsystem 05-02-2009 to 09-02-2009 60 137 55 129 25
Educomp Solutions 19-12-2005 to 22-12-2005 125 285 35 128 28
Indus Networks 27-01-2000 to 31-01-2000 20 44 80 124 00
MIC Electronics 30-04-2007 to 08-05-2007 150 335 65 123 77
Mundra Port 01-11-2007 to 07-11-2007 440 961 70 118 57
Dwankesh Sugars 29-11-2004 to 03-12-2004 65 133 55 105 46
IDFC 15-07-2005 to 22-07-2005 34 69 55 104 56
TV 18 Broadcast 15-01-2007 to 18-01-2007 250 510 10 104 04
Career Point 16-09-2010 to 21-09-2010 310 632 35 103 98
Fmeotex Chemical 23-02-2011 to 25-02-2011 70 140 90 10129
Avon Weighing 09-06-2008 to 12-06-2008 10 20 OQ 100 00
Source Business Line various issues

3.2 Theories of IPO Underpricing

Numerous theoretical explanations have been offered for the large initial returns received
by investors on new common stock For the most part, these explanations focus on why
underwriters might choose to (deliberately) underprice IPO shares Majority of the
theories explaining IPO underpricing are based on the notion of information asymmetry

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3.2.1 Adverse Selection Theory
Rock (1986) constructs a model for the underpricing of IPOs The model depends upon
the existence of a group of investors whose information is superior to that of the firm as
well as to that of all other investors This group of informed investors consists of outside
investors who have better knowledge about the prospective cash flow than does the
entrepreneur The second type, uninformed outside investors lack special knowledge
about the firm’s future cash flow Informed investors know the quality of an issue and
naturally subscribe only to good issues Uninformed investors cannot distinguish between
‘good’ and ‘bad’ issues, and so suffer from winner’s curse In other words, if new issue
shares are pnced at their expected value, these privileged, informed investors crowd out
the others when good issues are offered and they withdraw from the market when bad
issues are offered As a result, the uninformed investors are likely to be allocated a
disproportionate share of ‘bad’ issues, to which informed investors do not subscribe This
information asymmetry may lead to a ‘lemons problem’, where the uninformed investors
end up primarily with the less successful IPOs In other words, uninformed investors are
allocated greater quantities m overpriced IPOs and smaller quantities m underpriced
IPOs Therefore, the offering firm must price the shares at a discount m order to
guarantee that even the uninformed mvestors participate m the issue
Thus, the implications of Rock’s model of IPO underpricing is that to induce the
uninformed mvestors to take part m the offerings, it is necessary for the issuer and
underwriter to sell the issue at a price below that warranted by its intrinsic quality 1 e
underpricing is then needed to attract uninformed mvestors In other words, to keep the
uninformed mvestors m the market, issuers and underwriters have to offer additional
premium m the form of underpricing to both the types of investors As the winner’s curse
increases m proportion to the fraction of informed mvestors with whom good issues are
shared, so does the necessary amount of underpricing
In the U S , Rock’s (1986) winner’s curse theory is tested indirectly under the assumption
that institutional investors are better informed Michaely and Shaw (1994) show that in
IPOs with small participation of institutional investors, underpricing is smaller since the
investors know they do not have to compete with informed mvestors Aggarwal et al
(2002) use data on the proportion of the issue that is allocated to institutional investors
and retail mvestors They find that institutional mvestors receive a larger proportion of
new issues in IPOs that are more underpriced and earn more than retail mvestors,
avoiding ‘lemons’ in the IPO market Amihud et al (2003) test Rock’s (1986) theory of

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 adverse selection by which informed investors choose to participate m underpriced IPOs,
uninformed investors receive larger allocation of overpriced IPOs and m equilibrium,
uninformed investors should earn zero initial return Study finds that underpricing is
negatively related to the rate of allocation to subscribers, consistent with the existence of
adverse selection However, the mean initial return earned by uninformed investors is
negative which is because they lose on overpriced offers while apparently their
allocations in underpriced offers are too small This is inconsistent with Rock’s (1986)
prediction that m equilibrium, uninformed investors should earn zero initial return and
therefore, Amihud et al (2003) suggest that IPOs are overpriced from the point of view
of uninformed investors
Findings of the work of Carter and Manaster (1990) are consistent with Rock who argues
that IPO underpricing compensates uninformed investors for the risk of trading against
superior information In their model, consistent with Rock, Carter and Manaster show
that the greater the proportion of informed investor capital participating in an IPO, the
greater is the equilibrium underpricing Because investors have scarce resource to invest
in information acquisition, they will specialise m acquiring information for the most risky
investments Since informed investor capital migrates to the highly uncertain IPOs, the
underpricing and subsequent price run-up for these firms are greater As the price run-up
is injurious to the issuing firm, low dispersion firms will attempt to reveal their low nsk
characteristics to the market They do this by selecting prestigious underwriters
• Prestigious underwriters, to maintain their reputation, market IPOs of only low dispersion
firms As a result, a signal in the form of underwriter reputation is provided to the market
Empirical test supports the model of Carter and Manaster Specifically, a significant
negative relation is found between underwriter prestige and the price run-up variance for
the IPOs that they try to market A significant negative relation is also found between
prestige and the magnitude of the IPO price run-up
However, Chowdhry and Nanda (1996) develop an alternative to Rock’s winner’s curse
theory of IPO underpricing Their argument is that uninformed investors can be
compensated ex post by underwriters buying back shares at the offer price m aftermarket
trading By this stage, some of the information possessed by informed investors becomes
public through the level of subscription of the issue and aftermarket trading The
advantage of such ex post compensation over ex ante compensation through underpricing
is that with ex post compensation, it is mainly the uninformed investors who benefit
With ex ante compensation (underpncmg), however, all investors, including the informed

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receive benefits in the form of a lower offer price An offer to buy back shares at the
issue price is equivalent to giving a put option to investors The put option is valuable to
the uninformed investors It is less valuable to informed investors, because the informed
bid only when they expect the true share price to be larger than the offer price
3.2.2 Signalling Theory
One implication of Rock’s (1986) model is that greater underpricing will result for firms
that informed investors identify as having good quality The signalling models m Allen
and Faulhaber (1989), Welch (1989), and Gnnblatt and Hwang (1989) suggest that m
order to signal their good quality, IPO firms are intentionally underpriced In these
models, the IPO firm itself knows its prospects better The firms with most favourable
prospects find it optimal to signal their type by underpricing their initial issue, because
they can expect to recoup the cost of underpricing m subsequent seasoned issues through
better price Welch (1989) develops a model which strongly suggests that IPO firms
pursue a multiple issue strategy when they choose both the price and the proportion of the
firm they offer at their IPO The reason why IPO underpricing results in a higher
seasoned offering price is because of information asymmetry between firm owners and
investors High-quality firm owners can signal their superior information to investors
because their marginal cost of underpricing is lower than the marginal cost of
underpricing for low-quality firm owners To imitate high-quality firms, low-quality
firms would not only have to incur the signalling costs but also expend the resources to
imitate the observable real activities and attributes of high-quality firms The market may
discover the true quality between the IPO and seasoned offering and therefore, force an
imitating firm to bear some of the imitation expenses whose only purpose was to deceive
investors Higher signalling costs then increase the attractiveness of low-quality firms’
alternative - revealing themselves as low-quality firms Overall, the underpricing of high-
quality firms at the initial public offering adds sufficient signalling costs to these
imitation expenses of low-quality firms and makes the expected gain from imitation
negative Thus, low-quality firms abandon the imitation strategy and voluntarily reveal
their quality These arguments imply that low-quality firms do not underprice their IPOs
as much as do high-quality firms, so investors correctly perceive underpricing as a signal
of the firm’s quality
However, Michaely and Shaw (1994) completely reject the signalling theory of IPO
underpricing They find little support for the models suggesting that firms underprice to
signal their quality or because they intend to return to the market with secondary security
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issues Instead, they find that firms that underprice more have weaker future earnings
performance, fewer dividend initiations and smaller dividends, and less frequent trips to
the market with secondary equity and debt issues They claim that their results suggest
several guidelines first, firms that go public should not underprice their offering because
they may be considering subsequent securities issues There is no need to underprice to
‘go back to the well’ Second, firms issued by more reputable investment banks are
required to leave less money on the table than firms issued by less reputable investment
banks All else being equal, therefore, issuing firms should have an incentive to use
prestigious investment banks This incentive is reinforced by the findings of the study
that shares issued by more reputable investment banks perform significantly better in the
long run Chemmanur (1993) argues that owner-managers of high quality firms will
underprice the IPO to induce investors to produce information about the firm The more
information that is produced, the more likely it is that a high quality firm is revealed to be
high quality, allowing the firm to sell shares m a secondary offering at prices closer to the
firm’s true value Spiess and Pettway (1997) empirically test Chemmanur’s (1993) model
but find no evidence that firms recover the cost of an underpriced IPO m either higher
seasoned offering proceeds or m greater wealth for the firm’s owners through sale of
shares m follow-on seasoned offerings (cited in Aggarwal et al (2002))
Hill and Wilson (2006) develop an entirely different signalling theory of IPO
underpricing They evaluate two alternative but non-mutually exclusive mechanisms
which are likely to underpin the relationship between anticipated value gams on flotation
and underpricing They are

l) Since issuing company directors anticipate gams on flotation, they are inclined to
provide mvestors with positive returns at the IPO Where new investors are
given large returns, issuing company directors are given a more positive
reception to the rigours of managing a listed company, from which they derive
non-monetary utility In addition, such positive returns provide a pool of
goodwill from which issuing companies will hope to benefit at future SEOs
Further, there is evidence to suggest that underpricing at the IPO improves
post IPO value by encouraging increased following of the firm by analysts
(Chemmanur (1993)) Directors benefit from this increased value via a
reduction m the threat of takeover They also gam monetarily where they
retain shares m the firm

95
 n) Underwriters have an incentive to underprice since the gams from underpricing,
that is, the long run profits from the repeat business of key clients, outweigh
the losses, that is, the lost commission at the IPO which is dependent on gross
proceeds

The empirical results of the study provide support for the hypothesised role of the
underwater and the issuing company directors m the pacing decision
3.2.3 Agency Theory
Baron (1982) offers an agency-based explanation for underpacing In his model, the
underwaters are assumed to be better informed with regard to the demand for the issuing
firm’s securities than the issuing firms themselves The model implies that the more
uncertain the issuing firm is about its true market pace, the greater the demand for the
underwriter’s pricing advice Compensation for this supeaor knowledge of the state of
the market is made by allowing the underwater to offer the shares at a pace below the
equilibaum pace, thereby reducing the probability of the offer being undersubscabed
Thus, the higher the level of uncertainty, the more problematical is the pacing, and hence
the higher is the discount In fact, Baron’s Agency theory of underpacing is also based on
information asymmetry, m which the issuer is less informed, but relative to its
underwater, not relative to investors Baron assumes that the value of a new issue is
affected by market demand and the investment banker’s selling effort In his model, the
investment banker is better informed about the market demand than the issuer, but his
distabution effort is unobservable To address this moral hazard, the optimal contract sets
the issue’s offering pace below its ‘true value’, defined as the equilibaum offeang pace
when the investment banker expends his best effort
Muscarella and Vetsuypens (1989) test Baron’s model by examining the IPOs of
investment bankers who marketed their own secuaties Since the issuer and the lead
underwater are the same, there should be no information asymmetry and hence a lower
degree of underpacing should be found when compared with other IPOs where the
underwater and the issuer are not the same Their findings do not lend support to Baron’s
model, since the results show that self-underwotten IPOs were significantly more
underpaced than the offeangs m which the issuing banker did not serve as the lead
manager

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3.2.4 Information Cascade or Herding Theory
Welch (1992) advocates the theory of information cascades by which uninformed
investors set their own demand after having observed the demand of others/informed
investors When IPO shares are sold sequentially, later potential investors can learn from
the purchasing decisions of earlier investors This can lead rapidly to ‘cascades’ m which
subsequent investors optimally ignore their private information and imitate earlier
investors Although rationing m this situation gives rise to a winner's curse, it is
irrelevant The model predicts that (1) Offerings succeed or fail rapidly (2) Demand can
be so elastic that even nsk-neutral issuers underprice to completely avoid failure (3)
Issuers with good inside information can price their shares so high that they sometimes
fail (4) An underwriter may want to reduce the communication among investors by
spreading the selling effort over a more segmented market Consistent with the
Information Cascade theory, Amihud et al (2003) find that investors either subscribe
overwhelmingly to new issues, which results m very small allocations, or largely abstain
so that the issue is undersubscribed and subscribers received full allocation, with very
few cases m between Thus, the study finds support for the information cascade theory
where underpricing is a means to create a cascade of high demand that will ensure the
success of the offering
3.2.5 Litigation Risk Theory
In the U S , Sections 11 and 12 of the Securities Act of 1933 allow the subscribers of
IPOs to sue the issuers if the aftermarket trading prices of IPO shares is far below the
offering price Because litigation is costly, managers have incentives to insure against
such costs One way to effectively insure against these costs is to lower the probability of
being sued For this reason, all firms and their underwriters conduct due diligence prior to
the IPO, i e they investigate all aspects of the firm’s business, finance, management, and
projections and discuss their findings in the IPO prospectus However, it is not feasible to
foresee every future event, and there are obvious limits to what can be incorporated into a
prospectus A second way to lower the probability of being sued is to decrease the
potential damages that plaintiffs can recover Alexander (1993) emphasises that the
amount of the expected settlement reward is a major determinant of the probability of
being sued For this reason, underpricing is a particularly attractive form of insurance
Unlike other forms of insurance that firms can purchase, underpricing lowers the
potential damages that plaintiffs can recover, and thus reduces plaintiffs’ incentives to
bring a lawsuit against the firm (cited in Lowry and Shu (2002))
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Further, Ibbotson (1975) and Time (1988) argue that underpricing represents a form of
insurance against future litigation The issuer and the underwriter agree to set the offer
price below the expected market value of the securities because this decreases probability
of future litigation as well as the amount of damages m the event of lawsuit Consistent
with this, Time (1988) finds that the initial returns of a sample of IPOs prior to the
Securities Act of 1933 are significantly lower than those of a sample of firms that went
public after this Act was implemented {cited in Lowiy and Shu (2002))
The findings of Lowry and Shu (2002) suggest that under the litigation risk hypothesis,
initial returns can be related to the probability of a lawsuit along two dimensions First,
firms with higher litigation risk or legal exposure tend to underprice their offerings by a
significantly greater amount, suggesting that firms use underpricing as a form of
insurance against future litigation Second, consistent with the effectiveness of
underpricing as a form of insurance, study finds that underpricing decreases the expected
litigation costs by reducing lawsuit probability implying that litigation is a decreasing
function of initial returns However, the findings of Drake and Vetsuypens (1993) do not
lend support for the Litigation risk theory of IPO underpricing, study documents that
underpricing of IPOs is not a very efficient way of avoiding future lawsuits
3.2.6 Partial Adjustment Theory
The essence of the Benvemste and Spmdt’s (1989) partial adjustment theory of IPO
underpricing is that underwriters must reward investors for truthfully revealing their
private demand for an issue when book-buildmg is used, as in the U S When an
underwriter learns'that an issue is m high demand, the offer price is raised, but not to full
market value The result is that the offer price only partially adjusts to the pnvate
information, with the rest of the adjustment coming in the form of underpricing, which
compensates the supplier of information Apart from Benvemste and Spmdt (1989),
Benvemste and Wilhelm (1990), and Spatt and Snvastava (1991) argue that the common
practice of ‘book-buildmg’ allows underwriters to obtain information from informed
investors With book-building, a preliminary offer price range is set, and then
underwriters and issuers go on a ‘road show’ to market the company to prospective
investors This road show helps underwriters to gauge demand as they record ‘indications
of interest’ from potential investors If there is strong demand, the underwriter will set a
higher offer price, but not to the extent of full market value If potential investors know
that showing a willingness to pay a higher price will result in a higher offer price, there
would not be any motivation for them to register strong demand for the issue Therefore,

98
these informed investors must be offered something m return To induce these investors
to truthfully reveal that they want to purchase shares at a higher price, underwriters must
offer them some' combination of more EPO allocations and underpricing when they
indicate a willingness to purchase shares at a high price (cited in Ritter and Welch
(2002))

Hanley (1993) was the first one to test the implications of the partial adjustment theory of
IPO underpricing She finds that underwriters do not fully adjust their pricing upward to
keep underpricing constant when demand is strong Thus, when underwriters revise the
share price upward from their original estimate m the preliminary prospectus,
underpricing tends to be higher Also, consistent with the information revelation theory of
book-buildmg, Lee et al (1999), and Comelh and Goldreich (2001) show that informed
investors request more, and preferentially receive more, allocations {cited in Ritter and
Welch (2002)) Ljungqvist and Wilhelm (2002) find that institutions that reveal more
valuable information during the registration period are rewarded with higher allocations
when such information is positive, increasing institutional allocations results in offer
prices that deviate more from the pre-marketing price range, constraints on bankers’
discretion reduce institutional allocations and result m smaller price revisions, indicating
diminished information production, and initial returns are directly related to information
production and inversely related to institutional allocations Thus, study notes that
allocation policies favour institutional investors both m the U S and worldwide and,
underpricing is an indirect cost of book-buildmg which reflects a quid pro quo
arrangement with institutional investors whose nonbmdmg bids provide the foundation
for establishing the issuer’s offer price However, Sherman (2000) has noted that the
average level of underpricing required to induce information revelation is reduced if
underwriters have the ability to allocate shares m future IPOs to investors
3.2.7 Managerial Self-dealing Theory
This theory states that IPOs are underpriced m order to benefit the insiders either
immediately after going public or m the long run For example, Ljungqvist and Wilhelm
(2003) find that underpricing is positively related to the proportion of shares offered to
families and friends of company employees, and they interpret this result as reflecting
managerial influence over the offer pnce The study also finds that underpricing is
negatively related to the CEO’s fraction of pre-IPO ownership Because managers
holding significant pre-IPO shares lose from IPO underpricing, this seems consistent with
managerial influence over offer prices Rocholl (2005) finds that top managers in
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approximately 80 percent of German Neuer Markt IPOs are granted IPO options Further,
these IPOs are significantly more underpriced than IPO companies m which no top
executives hold EPO options (cited in Lowry and Murphy (2007)) Lowry and Murphy
(2007) note that m about one-third of U S IPOs between 1996 and 2000 executives
received stock options with an exercise price equal to the IPO offer price rather than a
market-determined price Among firms with such ‘DPO options’, 58 percent of top
executives realise a net benefit from underpricing, the gam from the options exceeds the
loss from dilution of their pre-IPO shareholding However, m their specific study, Lowry
and Murphy find no evidence that U S firms granting EPO options have higher first-day
returns than firms not granting such options These results are inconsistent with the
hypothesis that executives with EPO options take actions to increase the value of these
options by setting especially low offer prices
Aggarwal et al (2002) developed a model that highlights the potential benefits of
substantial underpricing to owner-managers Since owner-managers are typically
discouraged from selling shares at the time of the IPO, their first opportunity to diversify
their wealth is by selling at or after the lock-up expiration. When the lock-up period ends,
insiders (owner-managers) are able to sell shares previously restricted from sale Owner-
managers interested m maximising their personal wealth will focus on the lock-up
expiration share price rather than the IPO offer price The cost of underpricing the IPO is
a secondary consideration The model developed argues that substantial underpricing of
IPOs generates information momentum, which shifts the demand curve for the firm’s
stock outwards By underpricing the issue, the large run-up in the stock price on the first
day attracts interest from research analysts and the media Analysts provide more
recommendations and research reports for the hottest EPOs This enhanced coverage
brings the stock to the attention of more investors, shifting out the demand curve for the
stock The owner-manager then exploits this additional demand when he sells shares at
the expiration of the lock-up period Thus underpricing, even substantial underpricing can
maximise the owner-manager’s wealth Consistent with the model, Aggarwal et al find
that firms m which managers retain more shares and hold more options have greater first-
day underpricing Firms with greater first-day underpricing receive significantly more
recommendations from research analysts in the months leading up to the lock-up
expiration than do firms with less first-day underpricing This increased coverage from
research analysts, especially non-lead underwriter analysts, leads to higher stock prices at
the lock-up expiration Finally, insiders sell more shares m the open market and through

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secondary offerings when there is more non-lead analyst research coverage Boehmer
and Fishe (2001) present a model, m which underpricing generates trading volume, which
benefits the lead underwriter because the lead underwriter is also the dominant market-
maker for the stock However, m their model, there is no direct benefit of underpricing to
the issuing firm {cited in Aggarwal et al (2002))
In a related work, Demers and Lewellen (2003) explore the potential marketing benefit of
going public and of IPO underpricing First, focusing on a sample of internet IPOs, the
study examines the impact of IPO underpricing on website traffic, which is direct
measure of product market performance for internet firms Study finds that web traffic
growth in the month after the IPO is positively and significantly associated with initial
returns, and the effect is economically significant Study interprets these findings as
underpricing attracts media attention and creates valuable publicity for the firm Study
also investigates media reaction to IPO underpricing for a broader sample of IPO firms
The results suggest that the marketing benefits of underpricing extend beyond the internet
sector and the ‘hot issues’ market of the late 1990s
3.2.8 Prospect Theory
Loughran and Ritter (2002) developed ‘Prospect Theory’ explaining why issuers do not
object to large amount of money being left on the table in IPOs The explanation offered
under the theory involves several parts Most IPOs leave relatively little money on the
table The IPOs where a lot of money is left on the table are generally those where the
offer price and market price are higher than had originally been anticipated Thus, the
minority of issuers losing wealth via leaving large amounts of money on the table are
generally simultaneously discovering they are wealthier than they expected to be By
integrating the losses with the gam, they are left happy, even though they have just been
victimised The explanation offered under the theory emphasises the covariance of money
left on the table and changes m the wealth of the issuing firm’s decision makers
The model also explains a second empirical pattern Because offer prices only adjust
partially to public information, first day returns are predictable based on lagged market
returns Because the lagged market returns are correlated for IPOs whose preselling
periods overlap, this generates autocorrelation m the first day returns Theory also offers
an explanation for the IPO underpricing phenomenon Leaving money on the table is an
indirect form of underwriter compensation, because investors are willing to offer quid pro
quos to underwriters to gam favourable allocations on hot deals Underpricing is an
indirect cost to issuers, however, and they accept severe underpricing only when they are
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simultaneously getting good news in the form of unanticipated wealth increases In
general, because issuers do not treat the opportunity cost of underpricing as equivalent to
the same direct costs, underwriters are able to achieve higher total compensation than if
all of the costs borne by issuers were bundled as direct fees

3.3 Underperformance of IPOs

Empirical studies have shown that generally if the IPOs are underpriced m the short ran
(closing price on the listing day being significantly greater than the issue price), m the
long ran (mostly three to five years from listing), the same IPOs underperform when
compared to either the market or the non-issuers Ritter (1991) documents that firms that
went public in the US m the 1975-1984 period have significantly underperformed a set
of comparable firms matched by size and industry from the closing price on the first day
of public trading to their three-year anniversaries The IPOs m their study
underperformed their matching firms by as much as 29 percent excluding first day returns
by the third-year anniversary of their public listing Study further highlights that every
dollar invested in a portfolio of IPOs purchased at the closing market price on the first
day of trading results m a terminal wealth of $1 3447, while every dollar in the matching
firms results m $1 6186, a ratio of only 0 831 Loughran and Ritter (1995) have shown
that companies issuing stock during 1970 to 1990, whether an IPO or SEO, significantly
underperform relative to non-issuing firms for five years after the offering date The
average annual return during the five yearn after issuing was only 5 percent for firms
conducting IPOs, and only 7 percent for firms conducting SEOs The magnitude of this
underperformance was economically important based on the realised returns, an investor
would have had to invest 44 percent more money m the issuers than m non-issuers of the
same size to have the same wealth five years after the offering date, this number is the
same for both IPOs and SEOs Aggarwal and Rivoli (1990) using a sample of IPO firms
that went public during 1977-1987, document an abnormal return of -13 73 percent for
investors purchasing all IPOs in the open market at the close of the first trading day and
holding each for a period of 250 trading days Reilly (1977) finds that IPOs purchased in
early aftermarket trading and held for one year underperform market averages {cited in
Aggarwal and Rivoli (1990))
Similar cases of long ran underperformance of IPOs have been reported outside the U S
as well Uhlir (1989) shows that German IPOs underperformed the market by 7 41
percent excluding first day returns in their first year of trading {cited in Levis (1993))

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Aggarwal et al (1993) find three-year market-adjusted returns of -47 0 percent, -19 6
percent, and -23 7 percent for Brazil, Mexico and Chile, respectively Using a sample of
IPOs listed on London Stock Exchange in 1980 to 1988, Levis (1993) shows that IPOs m
the U K underperform a number of relevant benchmarks in the 36 full months of public
listing following their first day of trading He reports a long run underperformance of -
30 59 percent by the third year after the offer The magnitude of underperformance is
more pronounced when account is taken of the superior performance of smaller
companies during the period 1980-1988 Finn and Higham (1988) report that the one-
year market-adjusted return from the closing price on day one is -6 52 percent for
Australian IPOs {cited in Aggarwal et al (1993)) Alvarez and Gonzalez (2005) study
long run performance of Spanish IPOs made between 1987 and 1997 m event wmdows of
three and five years and report the existence of negative abnormal returns Jaskiewicz et
al (2005), m their study on the long-run IPO performance of German and Spanish
family-owned businesses, show that three years after going public investors, on an
average, realised an abnormal return of -32 8 percent for German and -36 7 percent for
Spanish IPOs However, Brav and Gompers (1997) show that firms that go public do not
perform worse than benchmarks matched on the basis of size and book-to-market ratios
In addition, they show that value weighting IPO returns dramatically reduces the
measured underperformance They argue that weighting returns in event time by the
number of IPOs may overstate underperformance Finally, the following table exhibits
international evidence of long run performance of IPOs m different capital markets

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 Table 3.3: International Evidence of Long Run Underperformance
Country Study Sample Sample Months Long Run
Period Size Performance (%)
Australia Finn and Higham (1988) 1966- 93 - -6 50
Australia Leeetal (1996) 1976- 266 36 -46 50
Austna Aussenegg (1997) 1965- 57 36 -27 30
Brazil Aggarwal etal (1993) 1980- 62 36 -47 00
Canada Kooli and Suret (2003) 1991- 445 36 -16 86
Canada Jog (1997) 1971- 130 36 -35 15
Chile Aggarwal etal (1993) 1982- 28 36 -23 70
Denmark Jakobsen and Sorensen (2001) 1984- 76 60 -30 40
Finland Kelohanu (1993) 1984- 79 36 -21 10
France Leleux and Murzyka (1997) 1987- 56 36 -30 30
France Demen and Womack (2003) 1992- 264 24 -6 30
Germany Schmidt etal (1988) 1984- 32 12 -10 20
Germany Uhlir (1989) 1977- 97 15 -7 40
Germany Wittleder (1989) 1961- 67 12 -4 00
Germany Hanson and Liungqvist (1992) 1978- 162 20 -1 90
Germany Ehrhardt (1997) 1960- 160 36 -5 20
Germany Liungqvist (1997) 1970- 145 36 -12 10
Germany Schlag and Wodnch (2000) 1884- 163 60 -7 80
Hong Kong Dawson (1987) 1978- 21 - -9 30
Hong Kong McGuinness (1993) 1980- 72 36 -18 30
Italy Giudici and Palean (1999) 1985- 84 36 -2 60
Japan Cai and Wei (1997) 1971- 172 - -27 00
Korea Kim etal (1995) 1985- 99 - 91 60
Malaysia Dawson (1987) 1978- 21 - 18 20
New Firth (1997) 1979- 143 36 -10 00
Poland Aussenegg ((1997) 1991- 57 36 20 10
Portugal Almeida and Duque (2000) 1992- 21 12 -13 80
Singapore Dawson (1987) 1978- 39 - -2 70
Smgapore Hm and Mahmood (1993) 1976- 45 36 -9 20
Spam Alvarez and Gonzalez (2005) 1987- 37 36 -27 80
Sweden Loughranetal (1994) 1980- 162 36 1 20
Switzerland Kunz and Aggarwal (1994) 1983- 42 36 -6 10
Switzerland Drobetz and Kammermann 1983- 120 14 -6 80
Turkey Kivmaz(1998) 1990- 138 36 4410
UK Levis (1993) 1980- 712 36 -30 59
U K Leleux and Muzyka (1997) 1987- 220 36 -19 20
U K Brown (1999) 1990- 232 36 -20 10
U K Kurshedetal (1999) 1991- 240 36 -17 80
U K Espenlaub et al (2000) 1985- 588 60 -21 30
U S Reilly (1977) 1972- 486 - -11 60
U S Aggarwal and Rivoli (1990) 1977- 1,598 12 -13 70
U S Ritter (1991) 1975- 1,526 36 -29 10
U S Loughran and Ritter (1995) 1970- 4,753 60 -30 00
Source Aggarwal et al (1993)
Alvarez and Gonzalez (2005)
Jaskiewicz et al (2005)
Sehgal and Singh (2007)

The Indian experience on the study of long run performance of IPOs gives mixed results
In a study on long run performance of Indian IPOs, Sehgal and Singh (2007) report that
long run performance of IPOs m India does not confirm to international evidence
Underperformance reported by the Indian IPOs in their study during the second and the

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third years does not continue till the fifth year subsequent to issue Pandey (2005)
examined the initial returns and long run performance of Indian IPOs following fixed
price and book-building processes Study finds that fixed-priced IT IPOs performed the
worst and all types of IPOs, on an average, underperformed till about two years
subsequent to listing Ghosh (2005) analysed the post-offenng performance of Indian
banking sector IPOs The performance evaluation on the basis of stock returns does not
find significant evidence of undeiperformance for IPOs from the banking sector {cited in
Sehgal and Singh (2007)) Singh and Mittal (2005) studied the long run performance of
500 Indian IPOs offered during 1992-1996 up to three years Their study shows that
Indian IPOs earned excess returns up to six months from the date of listing and thereafter
the returns declined sharply, though remained positive at the end of first year However,
investors who held their investments for a period of 2-3 years expenenced negative
returns {cited in Sehgal and Singh (2007))
It is not uncommon m Indian capital market to observe IPO shares being traded below
their issue price soon after their listing m the aftermarket especially, after periods of
heavy IPO activity For example, during the decade of the 1990s, the years 1993-1997
saw a large number of IPOs hitting the IPO market The following table shows the year-
wise number of public issues (both IPOs and FPOs) during the decade of nineties
Table 3.4: Number of public issues (IPOs, FPOs, and Offer for Sale) and the
Amount Raised from 1989-1990 to 1999-2000 in India
Year Number of Public Issues Amount Raised (Rs. in Crore)
1989-90 186 2,522
1990-91 140 1,450
1991-92 195 1,400
1992-93 526 5,651
1993-94 765 10,824
1994-95 1,336 12,928
1995-96 1,402 8,723
1996-97 684 4,372
1997-98 58 1,132
1998-99 22 504
1999-00 56 2,975
Source Prime Database (2013)

However, many of the companies that went public during this period of heavy IPO
activity, did not trade regularly once they got listed Even the companies that were
trading in the aftermarket were quoting at very low prices, price much below the issue
price According to a study conducted by Capital Market (source Capital Market

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(1997)), of the 210 IPOs that came to the market between 1994 and 1997 at a premium
with an issue size of more than Rs 10 crore, 90 percent of them were trading at an
average 68 percent discount to their offer prices by August 1997 Only 21 IPOs (10
percent) were trading at an average premium of 74 percent to their offer prices Overall,
there was an average 53 percent depreciation (loss of Rs 3,500 crore') When the net
appreciation/depreciation in the respective company’s price as on 14th August 1997 was
calculated compared to their offer price with the appreciation/depreciation m the BSE
Sensex from the issue opening date till 14th August 1997, the net depreciation worked
out to 70 percent 91 percent of the companies with net depreciation had an average 84
percent depreciation In fact, many have depreciated substantially while the Sensex
appreciated, resulting in many cases more than 100 percent depreciation For example,
the issue price of CRB Capital was Rs 100 (issue opened on 31st January 1995) and its
price as on 14th August 1997 was just Rs 2 with a variation in price of -98 percent The
variation m BSE Sensex during the same period was 19 percent with a net variation of -
117 percent m the price of the scrip as compared to BSE Sensex Only 9 percent of the
companies reported an average net appreciation of 69 percent These findings provide
strong evidence that during the period 1993-97 the market sentiment was high and most
of the issuers approached the market at a time when their shares were overvalued The
findings of this study by capital market perfectly coincide with Ritter (1991) who reports
fads and overoptimism as the mam reason for the underperformance of ,EPO firms in the
U S, that went public during the high-volume years of the 1980s
Again during the period 2006-2008, the market sentiment in India was quite high The
bullish trend witnessed in the market during the year 2007 continued till January 2008
The BSE Sensex touched all time high of 21,000 mark m January 2008 The Sensex has
travelled 6,000 points in just about six months, from 15,000 level on July 6, 2007, it
touched 21,000 level on January 8, 2008 (Times of India 09/01/2008) Following this
bullish trend and investor optimism, many blockbuster IPOs came to the market Apart
from getting highly positive response from the mvestor community in the form of
oversubscription, most of these IPOs were issued at the cap price of their price band
January 2008 ended up as a month with heavy IPO activity, with various issuing
companies raising over Rs 13,000 crore through IPOs (BL, 03/02/2008) Following table
lists out the major IPOs that came to the market with relevant information during this
period

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Table 3.5: IPOs in India with subscription of more than 25 times from January 2007
to January 2008
Issue Issue Size (Rs. m Price Band Issue Price Subscription
crore) (Rs.) (Rs) (times)
Religare Enterprises 140 160-185 185 160 56
Future Capital Holdings 491 30 700-765 765 133
Everonn Education 50 00 125-140 140 13147
BGR Energy 438 425-480 480 119 54
Mundra Port 1,771 400-440 440 116
Edelweiss Capital 691 9 725-825 825 111
MmdTree Consult 237 7 365-425 425 103
Simplex Projects 55 5 170-185 185 88 5
Transformers & Rectifiers 139 3 425-465 465 91 3
CCC Ltd 188 7 460-510 510 81 2
Akruti Nirman 360 475-540 540 79
PFC 997 73-85 85 77 24
Zylog Systems 126 330-350 350 76 51
ICRA Ltd 85 18 275-330 330 75
Reliance Power 11,500 405-450 450/430' 73
Omaxe Ltd 551 7 265-310 310 68
PGCIL 2,984 44-52 52 64
Take Solutions 153 675-730 730 63
Central Bank of India 816 85-102 102 62
Ommtech Info 35 90-105 105 61 84
Supreme Infra 37 53 95-108 108 52 8
Idea Cellular 2,440 65-75 75 50
Time Technoplast 123 5 290-315 315 49 55
Global Broadcast 105 230-250 250 48 74
Firstsource Solutions 443 5 54-64 64 47 5
Jyothi Lab 305 620-690 690 45 83
Koutans Retails 146 370-415 415 45 52
Redmgton Ind Ltd 149 5 95-113 113 43 3
Cmemax Ind Ltd 138 26 135-155 155 42 3
Spice Comm 520 3 41-46 46 37 6
Indian Bank 782 77-91 91 32
Barak Valley 23 8 37-42 42 29
Dhanus Tech 113 13 280-295 295 28 47
eClerx Services 101 270-315 315 26 3
Source Business Line various issues
* Retail Investors got a discount ofRs 20

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However, with the market crashing m the second half of January 2008, the mood m the
IPO market also has changed Following the negative mood in the market, there was
back-to-back withdrawal of three IPOs m February 2008 - Wockhardt Hospital, Emaar
MGF, and SVEC Construction In the subsequent months also many IPOs either
withdrew from the market or they simply got postponed owing to negative sentiments
Several IPOs lowered their price band or extended the time period for subscription due to
poor response from the investors Investors who had invested in the primary market in the
previous year-and-half had lost money as most of the IPOs were trading below their issue
prices The primary market had witnessed a fall in the number of IPOs from 94 in 2007 to
just 32 till July 2008 Of the 117 IPOs that hit the market between January 2007 and July
2008 and got listed, 81 IPOs were quoting below their issue prices, while only 36 IPOs
were quoting above their issue prices In fact, at one point of time, the situation was even
worse, with 91 IPOs quoting at a discount to their issue prices and just 26 IPOs quoting
above their issue prices Another striking feature was, out of the total amount of
Rs 37,719 crore invested in these 117 IPOs, investors had lost Rs 5,884 crore {source
Dalai Street Investment Journal, (2008a))
The losses suffered by the investors had shaken their confidence in the primary market
The decline in the number of IPOs was a reflection of the depressed sentiments m both
the primary and secondary markets The loss of confidence among investors was
reflected m the lukewarm response generated by new issues m the grey market of
Ahmedabad, which acts as a barometer for investors, merchant bankers and promoters
alike of the prospects of their proposed IPO “The grey market is dull and there is hardly
any activity here these days Most of the new issues command very little or no premium
at all” was the opinion of a grey market operator in Ahmedabad A senior director of
CRISIL said “As m any bull run, euphoria had taken precedence over valuations and as a
result in many cases, the pricing of the issue was on the higher side The recent correction
in the market has brought valuations down to far more reasonable levels” {Dalai Street
Investment Journal, (2008a)) This observation made is consistent with Miller (1977)
who said as the market corrects the overvaluation of securities issued during the bull run,
the prices will fall in the long run {cited in Ritter and Welch (2002))

3.4 Reasons for Underperformance

Researchers have offered various reasons explaining why IPO shares underperform m the
long run To begin with, Miller (1977) assumes that investors have heterogeneous

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expectations regarding the valuations of the IPO firm The most optimistic investors buy
the IPO Over time, as the variance of opinions decreases, the marginal investor’s
valuation will converge towards the mean valuation, and its price will fall This argument
works better when the float is small and not too many investors are required. This is
consistent with the drop in share price at the end of the lock-up period when more shares
become available to the public, as documented by Bradley et al (2001), Field and Hanka
(2001) and Brav and Gompers (2002) Bradley et al (2001) show that the negative effect
is much more pronounced for venture-capital-backed IPOs Typically with these IPOs,
venture capitalists distribute shares to their limited partners on the lock-up expiration
date, and many limited partners immediately sell This shows up not only negative
returns, but exceptionally high volume (cited in Ritter and Welch (2002)) Schultz (2003)
offers a second explanation He argues that more IPOs follow successful IPOs Thus, the
last large group of IPOs would underperform and be a relatively large fraction of the
sample If underperformance is bemg measured weighting each IPO equally, the high-
volume periods carry a larger weight, resulting m underperformance, on an average
Heaton (2002) argues that managers tend 'to be overoptimistic, and thus prone to
overinvestment if the funds are available (cited in Ritter and Welch (2002))
Ritter (1991) explores three possible explanations for the long-run underperformance of
IPO companies in his study risk mis-measurement, bad luck, and fads and over­
optimism To ascertain whether risk mis-measurement could account for the poor long-
run performance, alternative benchmark portfolios are used To distinguish between the
bad luck explanation and the fads and over-optimism explanation, various cross-sectional
and time-senes patterns are documented Finally, the pattern that emerges is that the
underperformance is concentrated among relatively young growth companies, especially
those going public m the high-volume years of the 1980s While this pattern does not rule
out bad luck bemg the cause of the underperformance, it is consistent with a scenario of
firms going public when investors are irrationally overoptimistic about the future
potential of certain industries Loughran and Ritter (1995) report that the degree of
underperformance by issuing companies vanes over time They find that IPOs that occur
m years when there is little IPO activity exhibit no statistically significant
underperformance, whereas companies selling stock dunng high volume penods severely
underperform
Teoh et al (1998) m their study provide evidence that issuers with unusually high
accruals in the IPO year expenence poor stock return performance in the three years
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thereafter IPO issuers in the most ‘aggressive’ quartile of earnings management have a
three year aftermarket stock return of approximately 20 percent less than IPO issuers m
the most ‘conservative’ quartile Study further finds that overoptimism among investors
is the reason for long run underperformance of IPOs Study explores the possible source
for this overoptimism Issuers can report unusually high earnings by adopting
discretionary accounting accrual adjustments that raise reported earnings relative to
actual cash flows If buyers are guided by earnings but are unaware that earnings are
inflated by the generous use of accruals, they could pay too high a price As information
about the firm is revealed over tune by the media, analysts’ reports, and subsequent
financial statements, investors may recognise that earnings are not maintaining
momentum, and the investors may thus lose their optimism Other things equal, the
greater the earnings management at the time of the offering, the larger the ultimate price
correction and consequently, greater underperformance of such stocks m the long run
Hao (2007) offers an entirely different explanation for the long run underperformance of
IPO shares - laddering m IPO Laddering is a practice whereby the allocating underwriter
requires the ladderers to buy additional shares of the issuer in the aftermarket as a
condition for receiving shares at the offer price The buying pressure from laddering
could boost the market price and reduce the underwriter’s expected price support cost in
the aftermarket If there are information momentum effects, whereby positive initial
returns of IPO stocks induce more information production and additional demand, there
is also a greater extent of laddering Laddering also results m a higher offer price being
chosen by the underwriter, if the ladderers are not expected to sell all their shares m the
immediate aftermarket Finally, by boosting the immediate aftermarket price, laddering
contributes to long run underperformance and a negative correlation between short-run
and long-run returns

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