Do Underwriters Create Value In The Determination Of The IPO Final Offering Price?

Abstract

A company sets a price range in their “red herring” prospectus filed with the Securities and Exchange Commission when they issue shares for the first time.  The firm’s investment bankers then test the market to determine if the shares can be sold.  The final offer price will be above, within or below the initial price range in the “red herring.”  This paper studies the first day price change and relates it to the final offering price being set below, within or above the initial price range.  Based on six years (2002-2007) of market data, covering both bull and bear markets, it appears that investors might be able to realize higher percentage gains on the first day by investing in those stocks that are priced above the range indicated in the “red herring.” Furthermore, the exchange on which the IPOs are traded also plays a significant role in the first day price change. We find empirical support for the partial price adjustment hypothesis of IPO underpricing and this finding is robust with respect to market regiments.