Disaggregating the influences on IPO underpricing in the Australian fixed-price setting

Disaggregating the influences on IPO underpricing in the Australian fixed-price setting

This research examines the relationship of initial public offer (IPO) underpricing and intrinsic value in the Australian fixed-price setting. The first stage of the research contains a review of major underpricing theories (asymmetric information, institutional explanations and theories of ownership and control) and relates these theories to the Australian institutional setting. A baseline model of underpricing is developed from analysis of Australian empirical IPO literature. The second stage of the research is the disaggregation of underpricing into mispricing (MP) and misvaluation (MV) components. MP captures the extent of the issuer's influence on underpricing and is measured as the difference between the intrinsic value of an IPO share and its offer price. MV captures the extent of investors' influence on underpricing and is measured as the difference between the intrinsic value of an IPO share and its market price at listing.

Mispricing is modelled with issuer-related variables that have hypothesised associations with offer price. Results show a proxy for IPO market sentiment and the size of the IPO relative to industry median market capitalisation make significant contributions to the explanation of mispricing. Misvaluation is modelled with investor characteristics that have hypothesised associations with market price. A proxy for general market sentiment and the level of mispricing make significant contributions to the explanation of misvaluation. The third stage of the research integrates results from the disaggregation of underpricing with the baseline model.

Several conclusions can be drawn from the results. First, with respect to mispricing, issuers incorporate their knowledge of current IPO market conditions when establishing offer price, with more positive mispricing observed during hot IPO markets. Further, issuers taking relatively larger companies public tend to overprice their issues. This result persists even after controlling for potential scale effects. Second, with respect to misvaluation, overpriced issues (i.e. positive mispricing) are also overvalued by the market. This result provides an indication that price is not a suitable proxy for value. Third, prior Australian research [Cotter, Goyen & Hegarty (2005) and How, Lam & Yeo (2007)] reports a negative association for mispricing and underpricing. Consistent with US results (Zheng, 2007), no relationship is
observed for this sample. Overall, the results from this research indicate that investor-related factors are the primary drivers of underpricing.

This research makes eight major contributions to the body of knowledge. The first is the novel approach of disaggregating underpricing into mispricing and misvaluation components. Second, mispricing is modelled and it is demonstrated that previously hypothesised issuer-related factors do not explain mispricing. Third, misvaluation is modelled, providing some interesting insights into the role of market sentiment in the underpricing context. Fourth, the relationships of mispricing, misvaluation and underpricing are investigated. Fifth, the Australian institutional setting is compared to that of the US and implications for future research are identified. Sixth, the baseline model of underpricing consolidates variables developed from prior Australian literature, providing a yardstick for comparison in future underpricing research. Seventh, evidence shows issuers exploit high market sentiment with positive mispricing in the fixed-price setting. The final major contribution relates to the role of institutional investors in the fixed-price setting. Contributions to the IPO literature on ownership and control, signalling, asymmetric information theories of ex ante uncertainty and agency theory are also made with tests of key variables in the mispricing and misvaluation models. Finally, evidence on the role of institutional investors in the fixed-price setting and on the role of demand (informed and total) sheds light on the underpricing puzzle.