Chapter 11: VC investment timing and IPO pricing
Traditional theories of initial public offering (IPO) underpricing assume market efficiency and treat the first-day closing price as the correct value of the IPO, which implies that IPOs are on average deeply underpriced at the offer. For example, Rock (1986) proposes a winner’s curse interpretation whereby underpricing is necessary to induce uninformed investors to participate in the offering. Benveniste and Spindt (1989) link underpricing to truth-telling of investors in the book-building process. In both cases, firms with high information asymmetry require larger underpricing to either attract uninformed investors to participate in the offer or to encourage more information revelation. Booth and Smith (1986) develop a certification hypothesis, whereby underwriters can reduce information asymmetry during the IPO process by certifying that the issue price is consistent with insider information about the firm’s earnings prospects.
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