Partial Adjustment to Public Information in the Pricing of IPOs

Abstract

Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a new explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)'s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This "incentive e ffect" receives strong empirical support in a sample of 6,300 IPOs in 1983-2012. The positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is most informative, e ffectively resolving the predictability puzzle.