Issuer Operating Performance and IPO Price Formation

Abstract

We study the relation between issuer operating performance and initial public offering (IPO) price formation from the initial price range to the offer price to the closing price on the first trading day. For a post‐bubble sample of 2001–2013 IPOs, we find that pre‐IPO net income and, in particular, operating cash flow are strongly, positively associated with the revision from the mid‐point of the initial price range to the offer price and that the “partial adjustment phenomenon” concentrates among issuers with the strongest operating performance. As for why publicly observable information helps predict changes in valuation from when the initial price range is set to when the offer price is set, our findings suggest that strong‐performing issuers, especially those offering small slices of ownership, have lower bargaining incentives and are susceptible to the underwriter(s) low‐balling the price range. Overall, our results suggest an important role for accounting information in understanding the pricing of book‐built IPOs and are consistent with the presence of agency problems between issuers and underwriters.

Voluntary Disclosure and Firm Visibility: Evidence From Firms Pursuing an Initial Public Offering

“…The second prediction we develop from Merton's (1987) model is that visibility-enhancing disclosures should positively affect investor demand for the firm's shares. (Lowry and Schwert, 2004;Willenborg et al, 2015).…”

“…This prediction is motivated by visibility-enhancing pre-prospectus disclosures stimulating excess demand from institutional investors during the IPO book-building process. That said, in the presence of underwriters with incentives for a lower initial filing price range prior to a road show (see Loughran and Ritter, 2002;Willenborg et al, 2015) the predicted price improvement implied by Merton (1987) may not be fully incorporated in the initial IPO valuation. Consistent with this idea, some studies find that only a portion of the positive information obtained during the bookbuilding period gets into the offer price (see, Hanley, 1993).…”

“…Related research documents the importance of this post-IPO visibility Mehran and Peristiani (2009). andBharath and Dittmar (2010) find that IPO firms exit public markets when they fail to generate sufficient investor attention subsequent to their IPO.3 In additional tests, we find that firms with more pre-prospectus disclosures display greater wealth revaluations during the IPO process, consistent with recent research suggesting a role for prospect theory in IPO pricing (e.g.,Loughran and Ritter, 2002;Willenborg et al, 2015).…”

Firms in Transition: A Review of the Venture Capital, IPO, and M&A Literature

“…Willenborg et al () study the relationship of operating performance and IPO price formation (that is, pricing and underpricing of book‐built IPOs in the United States from 2001 to 2013). They find that pre‐IPO operating performance helps to explain a “substantial portion” of variation from the initial price range to the final IPO offer price.…”

“…Using a variety of benchmarks and propensity score matching they find that IPO underpricing decreases after mandatory IFRS adoption, and that IPO firms raise more proceeds from foreign (versus domestic) markets after mandatory IFRS adoption. Willenborg et al (2015) study the relationship of operating performance and IPO price formation (that is, pricing and underpricing of book-built IPOs in the United States from 2001 to 2013). They find that pre-IPO operating performance helps to explain a "substantial portion" of variation from the initial price range to the final IPO offer price.…”