Underpricing or Overvaluation? Theoretical Review of Initial Public Offering Phenomenon
Main Article Content
Abstract
The abnormal initial return of Initial Public Offerings (IPOs) has become an interesting financial phenomenon that attracts many researchers’ interest. This phenomenon has become more attractive because IPOs have increased during the pandemic since 2021. This study investigates whether the positive initial performance of IPO stock led to underpricing or overvaluation in a broader context in the form of literature reviews. After elaborating and analyzing several related studies, theories and empirical research in the literature, this research finds that the aftermarket has a lower performance than the initial one. It shows that abnormal initial returns tend to be caused by investors’ overvaluation and overreaction instead of underpricing.
Keywords:
Abnormal return, initial return, IPO, underpricing, overvaluation.
References
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Agarwal, S., Liu, C., & Rhee, S. G. (2008). Investor demand for IPOs and aftermarket performance: Evidence from the Hong Kong stock market. Journal of International Financial Markets, Institutions and Money, 18(2), 176-190. https://doi.org/10.1016/j.intfin.2006.09.001
Albada, A., Yong, O., Ezani, M., & Mat Hassan, M. (2019). Information Asymmetry and Signalling in Emerging IPO Markets: The Case of Malaysia. Asian Journal of Business and Accounting, 12, 1-28. doi:10.22452/ajba.vol12no2.1
Allen, F., & Faulhaber, G. R. (1989). Signalling by underpricing in the IPO market. Journal of Financial Economics, 23(2), 303-323. doi: https://doi.org/10.1016/0304-405X(89)90060-3
Baig, A. S., & Chen, M. (2022). Did the COVID-19 pandemic (really) positively impact the IPO Market? An Analysis of information uncertainty. Finance Research Letters, 46, 102372. https://doi.org/10.1016/j.frl.2021.102372
Balvers, R., Affleck-Graves, J., Miller, R., & Scanlon, K. (1993). The underpricing of initial public offerings: A theoretical and empirical reconsideration of the adverse selection hypothesis. Review of Quantitative Finance and Accounting, 3, 221-239. doi:10.1007/BF02407007
Baron, D. P. J. J. o. F. (1982). A Model of the Demand for Investment Banking Advising and Distribution Services for New Issues. 37, 955-976.
Benveniste, L. M., & Spindt, P. A. (1989). How investment bankers determine the offer price and allocation of new issues. Journal of Financial Economics, 24(2), 343-361. https://doi.org/10.1016/0304-405X(89)90051-2
Bondt, W., F. M. De, & Thaler, R. (1985). Does the Stock Market Overreact? The Journal of Finance, 40(3), 793-805. doi:10.2307/2327804
Booth, J. R., & Smith, R. (1986). Capital raising, underwriting and the certification hypothesis. Journal of Financial Economics, 15(1-2), 261-281.
Bower, N. L. (1989). Firm Value and the Choice of Offering Method in Initial Public Offerings. The Journal of Finance, 44(3), 647-662. doi:10.2307/2328775
Brennan, M. J., & Franks, J. (1997). Underpricing, ownership and control in initial public offerings of equity securities in the UK. Journal of Financial Economics, 45(3), 391-413. https://doi.org/10.1016/S0304-405X(97)00022-6
Chang, H.-H., Chen, A., Kao, L., & Wu, C.-S. (2014). IPO price discovery efficiency under alternative regulatory constraints: Taiwan, Hong Kong and the U.S. International Review of Economics & Finance, 29, 83-96. doi:10.1016/j.iref.2013.05.00
Chen, C., & Mohan, N. (2002). Underwriter Spread, Underwriter Reputation, and IPO Underpricing: A Simultaneous Equation Analysis. Journal of Business Finance & Accounting, 29, 521-540. doi:10.1111/1468-5957.00441
Chen, Y., Wang, S. S., Tong, W. H. S., & Zhu, H. (2017). Economic freedom and IPO underpricing. Frontiers of Business Research in China, 11(1), 20. doi:10.1186/s11782-017-0019-1
Dell’Acqua, A., Etro, L. L., Tetia, E., & Murria, M. (2015). IPO underpricing and aftermarket performance in Italy. Journal of Economic & Financial Studies, 3(3), 1-14. http://dx.doi.org/10.18533/jefs.v3i03.160
Derrien, F. (2005). IPO Pricing in "Hot" Market Conditions: Who Leaves Money on the Table? Journal of Finance, 60, 487-521. doi:10.2139/ssrn.386420
Engelen, P.-J., & van Essen, M. (2010). Underpricing of IPOs: Firm-, issue- and country-specific characteristics. Journal of Banking & Finance, 34(8), 1958-1969. https://doi.org/10.1016/j.jbankfin.2010.01.002
Fama, E. (1970). Efficient Capital Markets: A Review of Theory and Empirical Work. The Journal of Finance, 25(2), 383-417. doi:10.2307/2325486
Fama, E. (1991). Efficient Capital Markets: II. The Journal of Finance, 46(5), 1575-1617. doi:10.2307/2328565
Friesen, G., & Swift, C. (2009). Overreaction in the Thrift IPO Aftermarket. Journal of Banking & Finance, 33, 1285-1298. doi:10.1016/j.jbankfin.2009.01.002
Füllbrunn, S., Neugebauer, T., & Nicklisch, A. (2020). Underpricing of initial public offerings in experimental asset markets. Experimental Economics, 23(4), 1002-1029. doi:10.1007/s10683-019-09638-7
Grinblatt, M., & Hwang, C. Y. (1989). Signalling and the Pricing of New Issues. The Journal of Finance, 44(2), 393-420. doi:10.2307/2328596
Han, L. Y., & Wu, Y. R. (2007). Enigma of Investor Sentiment and IPOs—Underpricing or Premium. Management World, 3, 51-61.
Ibbotson, R. G. (1975). Price performance of common stock new issues. Journal of Financial Economics, 2(3), 235-272. https://doi.org/10.1016/0304-405X(75)90015-X
Jaiyeoba, H. B., Abdullah, M. A., & Ibrahim, K. (2020). Institutional investors vs retail investors. International Journal of Bank Marketing, 38(3), 671-691. doi:10.1108/IJBM-07-2019-0242
Jamaani, F., & Alidarous, M. (2019). Review of Theoretical Explanations of IPO Underpricing. Journal of Accounting, Business and Finance Research, 6(1), 1-18. doi:10.20448/2002.61.1.18
Jenkinson, T., & Ljungqvist, A. (2001). Going Public: The Theory and Evidence on How Companies Raise Equity Finance.
Jensen, M. C. (1986). Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers. The American Economic Review, 76.
Kennedy, D. B., Sivakumar, R., & Vetzal, K. R. (2006). The implications of IPO underpricing for the firm and insiders: Tests of asymmetric information theories. Journal of Empirical Finance, 13(1), 49-78. https://doi.org/10.1016/j.jempfin.2004.10.003
Kok, S. C., & Munir, Q. (2015). Malaysian finance sector weak-form efficiency: Heterogeneity, structural breaks, and cross-sectional dependence. Journal of Economics, Finance and Administrative Science, 20(39), 105-117. doi:https://doi.org/10.1016/j.jefas.2015.10.002
Kuswanto, R. (2021). IPO Stock Performance amidst the COVID-19 Pandemic: Has It been Undervalued? Jurnal Dinamika Akuntansi dan Bisnis, 8(1), 105-116. doi:https://dx.doi.org/ 10.24815/JDAB.V8I1.19830
Ljungqvist, A. (2004). IPO Underpricing: A Survey.
Loughran, T., & Ritter, J. (1995). The New Issues Puzzle. Journal of Finance, 50, 23-51. doi:10.1111/j.1540-6261.1995.tb05166.x
Loughran, T., & Ritter, J. (2004). Why Has IPO Underpricing Changed over Time? Financial Management, 33(3), 5-37.
Mindosa, B., & Pasaribu, P. (2020). Initial Public Offering: New Evidence from Indonesia. Journal of Business and Entrepreneurship, 8(1), 1-17.
Ritter, J. (2020). Initial Public Offerings: Underpricing In. Florida.
Rock, K. (1986). Why new issues are underpriced. Journal of Financial Economics, 15(1), 187-212. https://doi.org/10.1016/0304-405X(86)90054-1
Rydqvist, K. (1997). IPO underpricing as tax-efficient compensation. Journal of Banking & Finance, 21(3), 295-313.
Shayne, J. A., & Soderquist, L. D. (1995). Inefficiency in the Market for Initial Public Offerings. 48 Vanderbilt Law Review 964.
Singh, A. K., & Kumar, M. (2018). IPO’s Underpricing: Trends, Determinants and Role of Underwriters. Asia-Pacific Journal of Management Research and Innovation, 14(3-4), 81-93. doi:10.1177/2319510X18817450
Song, S., Tan, J., & Yi, Y. (2014). IPO initial returns in China: Underpricing or overvaluation? China Journal of Accounting Research, 7(1), 31-49. https://doi.org/10.1016/j.cjar.2013.12.001
Stoughton, N. M., & Zechner, J. (1998). IPO-mechanisms, monitoring and ownership structure. Journal of Financial Economics, 49(1), 45-77.
Vakrman, T., & Kristoufek, L. (2015). Underpricing, underperformance and overreaction in initial public offerings: Evidence from investor attention using online searches. SpringerPlus, 4, 84-84. doi:10.1186/s40064-015-0839-4
Vidal-Tomás, D., & Ibáñez, A. (2018). Semi-strong efficiency of Bitcoin. Finance Research Letters, 27. doi:10.1016/j.frl.2018.03.013
Welch, I. (1989). Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings. 44,
421-449.
Welch, I. (1992). Sequential Sales, Learning, and Cascades. The Journal of Finance, 47(2), 695-732.
Welch, I., & Ritter, J. (2002). A Review of IPO Activity, Pricing, and Allocations. The Journal of Finance, 57. doi:10.1111/1540-6261.00478
Yu, T., & Tse, Y. K. (2006). An empirical examination of IPO underpricing in the Chinese A-share market. China Economic Review, 17(4), 363-382. https://doi.org/10.1016/j.chieco.2005.07.001
Adjasi, C., Osei, K. A., & Fiawoyife, E. U. (2011). Explaining underpricing of IPOs in frontier markets: Evidence from the Nigeria Stock Exchange. Research in International Business and Finance, 25(3), 255-265.
Agarwal, S., Liu, C., & Rhee, S. G. (2008). Investor demand for IPOs and aftermarket performance: Evidence from the Hong Kong stock market. Journal of International Financial Markets, Institutions and Money, 18(2), 176-190. https://doi.org/10.1016/j.intfin.2006.09.001
Albada, A., Yong, O., Ezani, M., & Mat Hassan, M. (2019). Information Asymmetry and Signalling in Emerging IPO Markets: The Case of Malaysia. Asian Journal of Business and Accounting, 12, 1-28. doi:10.22452/ajba.vol12no2.1
Allen, F., & Faulhaber, G. R. (1989). Signalling by underpricing in the IPO market. Journal of Financial Economics, 23(2), 303-323. doi: https://doi.org/10.1016/0304-405X(89)90060-3
Baig, A. S., & Chen, M. (2022). Did the COVID-19 pandemic (really) positively impact the IPO Market? An Analysis of information uncertainty. Finance Research Letters, 46, 102372. https://doi.org/10.1016/j.frl.2021.102372
Balvers, R., Affleck-Graves, J., Miller, R., & Scanlon, K. (1993). The underpricing of initial public offerings: A theoretical and empirical reconsideration of the adverse selection hypothesis. Review of Quantitative Finance and Accounting, 3, 221-239. doi:10.1007/BF02407007
Baron, D. P. J. J. o. F. (1982). A Model of the Demand for Investment Banking Advising and Distribution Services for New Issues. 37, 955-976.
Benveniste, L. M., & Spindt, P. A. (1989). How investment bankers determine the offer price and allocation of new issues. Journal of Financial Economics, 24(2), 343-361. https://doi.org/10.1016/0304-405X(89)90051-2
Bondt, W., F. M. De, & Thaler, R. (1985). Does the Stock Market Overreact? The Journal of Finance, 40(3), 793-805. doi:10.2307/2327804
Booth, J. R., & Smith, R. (1986). Capital raising, underwriting and the certification hypothesis. Journal of Financial Economics, 15(1-2), 261-281.
Bower, N. L. (1989). Firm Value and the Choice of Offering Method in Initial Public Offerings. The Journal of Finance, 44(3), 647-662. doi:10.2307/2328775
Brennan, M. J., & Franks, J. (1997). Underpricing, ownership and control in initial public offerings of equity securities in the UK. Journal of Financial Economics, 45(3), 391-413. https://doi.org/10.1016/S0304-405X(97)00022-6
Chang, H.-H., Chen, A., Kao, L., & Wu, C.-S. (2014). IPO price discovery efficiency under alternative regulatory constraints: Taiwan, Hong Kong and the U.S. International Review of Economics & Finance, 29, 83-96. doi:10.1016/j.iref.2013.05.00
Chen, C., & Mohan, N. (2002). Underwriter Spread, Underwriter Reputation, and IPO Underpricing: A Simultaneous Equation Analysis. Journal of Business Finance & Accounting, 29, 521-540. doi:10.1111/1468-5957.00441
Chen, Y., Wang, S. S., Tong, W. H. S., & Zhu, H. (2017). Economic freedom and IPO underpricing. Frontiers of Business Research in China, 11(1), 20. doi:10.1186/s11782-017-0019-1
Dell’Acqua, A., Etro, L. L., Tetia, E., & Murria, M. (2015). IPO underpricing and aftermarket performance in Italy. Journal of Economic & Financial Studies, 3(3), 1-14. http://dx.doi.org/10.18533/jefs.v3i03.160
Derrien, F. (2005). IPO Pricing in "Hot" Market Conditions: Who Leaves Money on the Table? Journal of Finance, 60, 487-521. doi:10.2139/ssrn.386420
Engelen, P.-J., & van Essen, M. (2010). Underpricing of IPOs: Firm-, issue- and country-specific characteristics. Journal of Banking & Finance, 34(8), 1958-1969. https://doi.org/10.1016/j.jbankfin.2010.01.002
Fama, E. (1970). Efficient Capital Markets: A Review of Theory and Empirical Work. The Journal of Finance, 25(2), 383-417. doi:10.2307/2325486
Fama, E. (1991). Efficient Capital Markets: II. The Journal of Finance, 46(5), 1575-1617. doi:10.2307/2328565
Friesen, G., & Swift, C. (2009). Overreaction in the Thrift IPO Aftermarket. Journal of Banking & Finance, 33, 1285-1298. doi:10.1016/j.jbankfin.2009.01.002
Füllbrunn, S., Neugebauer, T., & Nicklisch, A. (2020). Underpricing of initial public offerings in experimental asset markets. Experimental Economics, 23(4), 1002-1029. doi:10.1007/s10683-019-09638-7
Grinblatt, M., & Hwang, C. Y. (1989). Signalling and the Pricing of New Issues. The Journal of Finance, 44(2), 393-420. doi:10.2307/2328596
Han, L. Y., & Wu, Y. R. (2007). Enigma of Investor Sentiment and IPOs—Underpricing or Premium. Management World, 3, 51-61.
Ibbotson, R. G. (1975). Price performance of common stock new issues. Journal of Financial Economics, 2(3), 235-272. https://doi.org/10.1016/0304-405X(75)90015-X
Jaiyeoba, H. B., Abdullah, M. A., & Ibrahim, K. (2020). Institutional investors vs retail investors. International Journal of Bank Marketing, 38(3), 671-691. doi:10.1108/IJBM-07-2019-0242
Jamaani, F., & Alidarous, M. (2019). Review of Theoretical Explanations of IPO Underpricing. Journal of Accounting, Business and Finance Research, 6(1), 1-18. doi:10.20448/2002.61.1.18
Jenkinson, T., & Ljungqvist, A. (2001). Going Public: The Theory and Evidence on How Companies Raise Equity Finance.
Jensen, M. C. (1986). Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers. The American Economic Review, 76.
Kennedy, D. B., Sivakumar, R., & Vetzal, K. R. (2006). The implications of IPO underpricing for the firm and insiders: Tests of asymmetric information theories. Journal of Empirical Finance, 13(1), 49-78. https://doi.org/10.1016/j.jempfin.2004.10.003
Kok, S. C., & Munir, Q. (2015). Malaysian finance sector weak-form efficiency: Heterogeneity, structural breaks, and cross-sectional dependence. Journal of Economics, Finance and Administrative Science, 20(39), 105-117. doi:https://doi.org/10.1016/j.jefas.2015.10.002
Kuswanto, R. (2021). IPO Stock Performance amidst the COVID-19 Pandemic: Has It been Undervalued? Jurnal Dinamika Akuntansi dan Bisnis, 8(1), 105-116. doi:https://dx.doi.org/ 10.24815/JDAB.V8I1.19830
Ljungqvist, A. (2004). IPO Underpricing: A Survey.
Loughran, T., & Ritter, J. (1995). The New Issues Puzzle. Journal of Finance, 50, 23-51. doi:10.1111/j.1540-6261.1995.tb05166.x
Loughran, T., & Ritter, J. (2004). Why Has IPO Underpricing Changed over Time? Financial Management, 33(3), 5-37.
Mindosa, B., & Pasaribu, P. (2020). Initial Public Offering: New Evidence from Indonesia. Journal of Business and Entrepreneurship, 8(1), 1-17.
Ritter, J. (2020). Initial Public Offerings: Underpricing In. Florida.
Rock, K. (1986). Why new issues are underpriced. Journal of Financial Economics, 15(1), 187-212. https://doi.org/10.1016/0304-405X(86)90054-1
Rydqvist, K. (1997). IPO underpricing as tax-efficient compensation. Journal of Banking & Finance, 21(3), 295-313.
Shayne, J. A., & Soderquist, L. D. (1995). Inefficiency in the Market for Initial Public Offerings. 48 Vanderbilt Law Review 964.
Singh, A. K., & Kumar, M. (2018). IPO’s Underpricing: Trends, Determinants and Role of Underwriters. Asia-Pacific Journal of Management Research and Innovation, 14(3-4), 81-93. doi:10.1177/2319510X18817450
Song, S., Tan, J., & Yi, Y. (2014). IPO initial returns in China: Underpricing or overvaluation? China Journal of Accounting Research, 7(1), 31-49. https://doi.org/10.1016/j.cjar.2013.12.001
Stoughton, N. M., & Zechner, J. (1998). IPO-mechanisms, monitoring and ownership structure. Journal of Financial Economics, 49(1), 45-77.
Vakrman, T., & Kristoufek, L. (2015). Underpricing, underperformance and overreaction in initial public offerings: Evidence from investor attention using online searches. SpringerPlus, 4, 84-84. doi:10.1186/s40064-015-0839-4
Vidal-Tomás, D., & Ibáñez, A. (2018). Semi-strong efficiency of Bitcoin. Finance Research Letters, 27. doi:10.1016/j.frl.2018.03.013
Welch, I. (1989). Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings. 44,
421-449.
Welch, I. (1992). Sequential Sales, Learning, and Cascades. The Journal of Finance, 47(2), 695-732.
Welch, I., & Ritter, J. (2002). A Review of IPO Activity, Pricing, and Allocations. The Journal of Finance, 57. doi:10.1111/1540-6261.00478
Yu, T., & Tse, Y. K. (2006). An empirical examination of IPO underpricing in the Chinese A-share market. China Economic Review, 17(4), 363-382. https://doi.org/10.1016/j.chieco.2005.07.001