How discounts impact IPOs valuation performance and underpricing? A confrontation between warranted and unwarranted discounts

https://doi.org/10.35912/ijfam.v3i1.510
Published: Jun 3, 2021

Abstract:

Purpose: We investigated the different impacts warranted and unwarranted discounts have on IPOs valuation performance and underpricing.

Research methodology: We used multivariate ordinary least squares regression analysis to examine discounts’ determinants, and their impacts on valuation errors and underpricing. We also used bias and accuracy errors to examine valuation performance.

Results: We find both final offer price accuracy errors and underpricing negatively related to warranted discounts and positively related to unwarranted discounts. Additionally, warranted discounts are positively related to fair value estimate bias errors, contrarily to unwarranted discounts.

Limitations: The relatively small sample size represents our study’s main limitation.

Contribution: Unwarranted discounts allow assessing by issuers' underpricing level and underwriters’ sub-optimal efforts and investors' positive returns. Whereas warranted discounts allow issuers to avoid overpricing IPOs and communicate their intrinsic value, investors assess their negative returns, and underwriters reveal their superior qualitative valuation. Regulators can increase after-market efficiency and protect investors by implementing unwarranted discounts’ constraints and warranted discounts’ thresholds.

Keywords:
1. IPO
2. Underwriters
3. Equity valuation
4. Optimism
5. Discount
6. Underpricing
Authors:
1 . Douaa Tizniti
Faculty of Juridical, Economic and Social Sciences – Souissi, Mohammed V University of Rabat, Rabat, Morocco
2 . Mohammed Rachid Aasri
Faculty of Juridical, Economic and Social Sciences – Souissi, Mohammed V University of Rabat, Rabat, Morocco
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How to Cite
Tizniti, D., & Aasri, M. R. (2021). How discounts impact IPOs valuation performance and underpricing? A confrontation between warranted and unwarranted discounts. International Journal of Financial, Accounting, and Management, 3(1), 1–14. https://doi.org/10.35912/ijfam.v3i1.510
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Issue & Section
Vol. 3 No. 1 (2021): June
Articles
References

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    Albada, A., Yong, O., & Low, S.-W. (2019b). Relationship between prestige signals and over-subscription ratio: Evidence from Malaysian initial public offerings. International Journal of Managerial Finance, 15, 564–579. https://doi.org/10.1108/IJMF-02-2018-0067

    Badru, B.O., Ahmad-Zaluki, N.A., & Wan-Hussin, W.N. (2019) Signalling IPO quality through female directors. International Journal of Managerial Finance, 15, 719–743. https://doi.org/10.1108/IJMF-01-2018-0025

    Baron, D.P. (1982). A Model of the demand for investment banking advising and distribution services for new issues. Journal Finance 37, 955–976. https://doi.org/10.2307/2327760

    Benveniste, L.M., Spindt, P.A. (1989). How investment bankers determine the offer price and allocation of new issues. Journal of Financial Economics, 24, 343–361. https://doi.org/10.1016/0304-405X(89)90051-2

    Berkman, H., Bradbury, M.E., Ferguson, J. (2000). The accuracy of price-earnings and discounted cash flow methods of IPO equity valuation. Journal of International Financial Management & Accounting, 11, 71–83. https://doi.org/10.1111/1467-646X.00056

    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, 391–413. https://doi.org/10.1016/S0304-405X(97)00022-6

    Cassia, L., Paleari, S., Vismara, S. (2004). The valuation of firms listed on the nuovo mercato: the peer comparables approach. https://doi.org/10.1016/S1569-3732(04)10005-4

    Chhabra, S., Kiran, R., Sah, A.N. (2017). Information asymmetry leads to underpricing: validation through SEM for Indian IPOs. Program, 51, 116–131. https://doi.org/10.1108/PROG-01-2016-0009

    D. Sundarasen, S.D. (2019). Institutional characteristics, signaling variables and IPO initial returns: A study on OECD countries. PSU Research Review, 3, 29–49. https://doi.org/10.1108/PRR-10-2016-0003

    Darmadi, S., Gunawan, R. (2013). Underpricing, board structure, and ownership: An empirical examination of Indonesian IPO firms. Managerial Finance, 39, 181–200. https://doi.org/10.1108/03074351311294016

    Deloof, M., Maeseneire, W.D., Inghelbrecht, K. (2009). How do investment banks value initial public offerings (IPOs)? Journal of Business Finance & Accounting, 36, 130–160. https://doi.org/10.1111/j.1468-5957.2008.02117.x

    Dhamija, S., Arora, R.K. (2017). Impact of quality certification on IPO underpricing: Evidence from India. Global Business Review, 18, 428–444. https://doi.org/10.1177/0972150916668611

    Dittmann, I., Maug, E.G. (2008). Biases and error measures: how to compare valuation methods. https://doi.org/10.2139/ssrn.947436

    Dumrongwong, K. (2020). Do institutional investors stabilize stock returns? Evidence from emerging IPO markets. Pacific Accounting Review, 32, 585–600. https://doi.org/10.1108/PAR-11-2019-0145

    Handa, R., Singh, B. (2015). Women directors and IPO underpricing: evidence from Indian markets. Gender in Management International Journal, 30, 186–205. https://doi.org/10.1108/GM-02-2014-0011

    Hearn, B. (2014). The impact of institutions, ownership structure, business angels, venture capital and lead managers on IPO firm underpricing across North Africa. Journal of Multinational Financial Management, 24, 19–42. https://doi.org/10.1016/j.mulfin.2013.12.002

    Ibbotson, R.G. (1975). Price performance of common stock new issues. Journal of Financial Economics, 2, 235–272. https://doi.org/10.1016/0304-405X(75)90015-X

    Javid, A.Y., Malik, H. (2016). Performance and capital structure of IPOs in Pakistan from 2000 to 2015. Financial Innovation, 2, 14. https://doi.org/10.1186/s40854-016-0032-y

    Jeribi, A., Jarboui, A. (2014). Explaining deliberate IPO price discount evidence from the Tunisian stock market. International Journal of Business and Emerging Markets, 6, 121. https://doi.org/10.1504/IJBEM.2014.060510

    Jeribi, A., Jarboui, A. (2015). The role of the ex ante uncertainty in the pre-listing IPO process: evidence from the Tunisian stock market. Internatioal Journal of Economy Business Research, 10, 46. https://doi.org/10.1504/IJEBR.2015.070275

    Kaur, A., Singh, B. (2019). Edifying role of corporate reputation in new issue market: Indian evidence. Asia-Pac. Journal of Business Administration, 11, 159–170. https://doi.org/10.1108/APJBA-06-2018-0098

    Kenourgios, D.F., Papathanasiou, S., Rafail Melas, E. (2007). Initial performance of Greek IPOs, underwriter’s reputation and oversubscription. Managerial Finance, 33, 332–343. https://doi.org/10.1108/03074350710739614

    Kim, M., Ritter, J. (1999). Valuing IPOs. Journal of Financial Economics, 53, 409–437. https://doi.org/10.1016/S0304-405X(99)00027-6

    Ljungqvist, A. (2007). IPO Underpricing: A Survey. https://papers.ssrn.com/abstract=609422

    Ljungqvist, A., Nanda, V., Singh, R. (2004). Hot markets, investor sentiment, and IPO pricing. Journal of Business, 79, 1667–1702.

    Logue, D.E. (1973). On the pricing of unseasoned equity issues: 1965–1969. Journal of Finance, 8, 91–103. https://doi.org/10.2307/2329751

    Loughran, T., Ritter, J.R. (2002). Why don’t issuers get upset about leaving money on the table in IPOs?. Review Finance Study, 15, 413–443.

    Mehmood, W., Mohd-Rashid, R., Che-Yahya, N., Ong, C.Z. (2020). Determinants of heterogeneity in investors’ opinions on IPO valuation: evidence from the Pakistan stock market. Review of Behavioral Finance ahead-of-print. https://doi.org/10.1108/RBF-04-2020-0078

    Omran, M. (2005). Underpricing and long-run performance of share issue privatizations in the egyptian stock market. Journal of Financial Research, 28, 215–234. https://doi.org/10.1111/j.1475-6803.2005.00122.x

    Ong, C.Z., Mohd-Rashid, R., Taufil-Mohd, K.N. (2020). Underwriter reputation and IPO valuation in an emerging market: evidence from Malaysia. Managerial Finance, 46, 1283–1304. https://doi.org/10.1108/MF-11-2019-0579

    Paleari, S., Signori, A., Vismara, S. (2014). How do underwriters select peers when valuing IPOs?. Financial Management, 43, 731–755. https://doi.org/10.1111/fima.12060

    Pratoomsuwan, T. (2012 ). The effect of an audit firm’s brand on security pricing. International Journal of Emerging Markets, 7, 430–442. https://doi.org/10.1108/17468801211264333

    Rasheed, A., Sohail, M.K., Din, S.-U., Ijaz, M. (2018). How do investment banks price initial public offerings? an empirical analysis of emerging market. International Journal of Financial Study, 6, 1–19. https://doi.org/10.3390/ijfs6030077

    Rathnayake, D.N., Louembé, P.A., Kassi, D.F., Sun, G., Ning, D. (2019). Are IPOs underpriced or overpriced? Evidence from an emerging market. Research of International Business Finance, 50, 171–190. https://doi.org/10.1016/j.ribaf.2019.04.013

    Ritter, J.R., Welch, I. (2002). A review of IPO activity, pricing, and allocations. Journal of Finance, 1795–1828. https://doi.org/10.3386/w8805

    Rock, K. (1986). Why new issues are underpriced. Journal of Financial and Economics, 15, 187–212. https://doi.org/10.1016/0304-405X(86)90054-1

    Roosenboom, P. (2012). Valuing and pricing IPOs. Journal of Banking and Finance, 36, 1653–1664. https://doi.org/10.1016/j.jbankfin.2012.01.009

    Ruud, J.S. (1993). Underwriter price support and the IPO underpricing puzzle. Journal of Financial Economics, 34, 135–151. https://doi.org/10.1016/0304-405X(93)90015-4

    Rydqvist, K. (1997). IPO underpricing as tax-efficient compensation. Journal of Banking and Finance, 21, 295–313. https://doi.org/10.1016/S0378-4266(96)00043-X

    Sahoo, S., Rajib, P. (2010). Post-issue promoter groups holding, signalling and IPO underprice: evidence from Indian IPOs. International Journal of Financial Services Management, 4, 95–113.

    Stoughton, N.M., Zechner, J. (1998). IPO-mechanisms, monitoring and ownership structure. Journal of Financial Economics, 33.

    Tian, L., Zhang, W. (2014). Extreme IPO underpricing: Can the market-oriented incremental reform work in China?. Nankai Business Review International, 5, 225–255. https://doi.org/10.1108/NBRI-02-2014-0012

    Tran, L., Le, D.C., Hoang, T.P.T. (2013). The underpricing and long-run underperformance of initial public offerings: evidence from vietnam (SSRN Scholarly Paper No. ID 2316577). Social Science Research Network, Rochester, NY. https://doi.org/10.2139/ssrn.2316577

    Tutuncu, L. (2020). Valuation and underpricing of Turkish IPOs. Journal of Business and Economics Management, 21, 157–179. https://doi.org/10.3846/jbem.2020.11927

    Vismara, S., Signori, A., Paleari, S. (2015). Changes in underwriters’ selection of comparable firms pre- and post-IPO: Same bank, same company, different peers. Journal of Corporate Finance, 34, 235–250. https://doi.org/10.1016/j.jcorpfin.2015.07.010

    Welch, I. (1992). Sequential sales, learning, and cascades. Journal of Finance, 47, 695–732. https://doi.org/10.2307/2329120

    Zhang, F., Zhou, X.-H., Su, J., Tsai, S.-B., Zhai, Y.-M. (2020). Governance role of media information’s uncertainty in IPO market-oriented pricing. Kybernetes, 49, 2849–2871. https://doi.org/10.1108/K-01-2019-0066

  1. Albada, A., Low, S.-W., & Yong, O. (2019a). Prestige signals and heterogeneity of opinion regarding IPO values: Malaysian evidence. International Journal of Emerging Markets, 15, 302–319. https://doi.org/10.1108/IJOEM-04-2018-0170
  2. Albada, A., Yong, O., & Low, S.-W. (2019b). Relationship between prestige signals and over-subscription ratio: Evidence from Malaysian initial public offerings. International Journal of Managerial Finance, 15, 564–579. https://doi.org/10.1108/IJMF-02-2018-0067
  3. Badru, B.O., Ahmad-Zaluki, N.A., & Wan-Hussin, W.N. (2019) Signalling IPO quality through female directors. International Journal of Managerial Finance, 15, 719–743. https://doi.org/10.1108/IJMF-01-2018-0025
  4. Baron, D.P. (1982). A Model of the demand for investment banking advising and distribution services for new issues. Journal Finance 37, 955–976. https://doi.org/10.2307/2327760
  5. Benveniste, L.M., Spindt, P.A. (1989). How investment bankers determine the offer price and allocation of new issues. Journal of Financial Economics, 24, 343–361. https://doi.org/10.1016/0304-405X(89)90051-2
  6. Berkman, H., Bradbury, M.E., Ferguson, J. (2000). The accuracy of price-earnings and discounted cash flow methods of IPO equity valuation. Journal of International Financial Management & Accounting, 11, 71–83. https://doi.org/10.1111/1467-646X.00056
  7. 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, 391–413. https://doi.org/10.1016/S0304-405X(97)00022-6
  8. Cassia, L., Paleari, S., Vismara, S. (2004). The valuation of firms listed on the nuovo mercato: the peer comparables approach. https://doi.org/10.1016/S1569-3732(04)10005-4
  9. Chhabra, S., Kiran, R., Sah, A.N. (2017). Information asymmetry leads to underpricing: validation through SEM for Indian IPOs. Program, 51, 116–131. https://doi.org/10.1108/PROG-01-2016-0009
  10. D. Sundarasen, S.D. (2019). Institutional characteristics, signaling variables and IPO initial returns: A study on OECD countries. PSU Research Review, 3, 29–49. https://doi.org/10.1108/PRR-10-2016-0003
  11. Darmadi, S., Gunawan, R. (2013). Underpricing, board structure, and ownership: An empirical examination of Indonesian IPO firms. Managerial Finance, 39, 181–200. https://doi.org/10.1108/03074351311294016
  12. Deloof, M., Maeseneire, W.D., Inghelbrecht, K. (2009). How do investment banks value initial public offerings (IPOs)? Journal of Business Finance & Accounting, 36, 130–160. https://doi.org/10.1111/j.1468-5957.2008.02117.x
  13. Dhamija, S., Arora, R.K. (2017). Impact of quality certification on IPO underpricing: Evidence from India. Global Business Review, 18, 428–444. https://doi.org/10.1177/0972150916668611
  14. Dittmann, I., Maug, E.G. (2008). Biases and error measures: how to compare valuation methods. https://doi.org/10.2139/ssrn.947436
  15. Dumrongwong, K. (2020). Do institutional investors stabilize stock returns? Evidence from emerging IPO markets. Pacific Accounting Review, 32, 585–600. https://doi.org/10.1108/PAR-11-2019-0145
  16. Handa, R., Singh, B. (2015). Women directors and IPO underpricing: evidence from Indian markets. Gender in Management International Journal, 30, 186–205. https://doi.org/10.1108/GM-02-2014-0011
  17. Hearn, B. (2014). The impact of institutions, ownership structure, business angels, venture capital and lead managers on IPO firm underpricing across North Africa. Journal of Multinational Financial Management, 24, 19–42. https://doi.org/10.1016/j.mulfin.2013.12.002
  18. Ibbotson, R.G. (1975). Price performance of common stock new issues. Journal of Financial Economics, 2, 235–272. https://doi.org/10.1016/0304-405X(75)90015-X
  19. Javid, A.Y., Malik, H. (2016). Performance and capital structure of IPOs in Pakistan from 2000 to 2015. Financial Innovation, 2, 14. https://doi.org/10.1186/s40854-016-0032-y
  20. Jeribi, A., Jarboui, A. (2014). Explaining deliberate IPO price discount evidence from the Tunisian stock market. International Journal of Business and Emerging Markets, 6, 121. https://doi.org/10.1504/IJBEM.2014.060510
  21. Jeribi, A., Jarboui, A. (2015). The role of the ex ante uncertainty in the pre-listing IPO process: evidence from the Tunisian stock market. Internatioal Journal of Economy Business Research, 10, 46. https://doi.org/10.1504/IJEBR.2015.070275
  22. Kaur, A., Singh, B. (2019). Edifying role of corporate reputation in new issue market: Indian evidence. Asia-Pac. Journal of Business Administration, 11, 159–170. https://doi.org/10.1108/APJBA-06-2018-0098
  23. Kenourgios, D.F., Papathanasiou, S., Rafail Melas, E. (2007). Initial performance of Greek IPOs, underwriter’s reputation and oversubscription. Managerial Finance, 33, 332–343. https://doi.org/10.1108/03074350710739614
  24. Kim, M., Ritter, J. (1999). Valuing IPOs. Journal of Financial Economics, 53, 409–437. https://doi.org/10.1016/S0304-405X(99)00027-6
  25. Ljungqvist, A. (2007). IPO Underpricing: A Survey. https://papers.ssrn.com/abstract=609422
  26. Ljungqvist, A., Nanda, V., Singh, R. (2004). Hot markets, investor sentiment, and IPO pricing. Journal of Business, 79, 1667–1702.
  27. Logue, D.E. (1973). On the pricing of unseasoned equity issues: 1965–1969. Journal of Finance, 8, 91–103. https://doi.org/10.2307/2329751
  28. Loughran, T., Ritter, J.R. (2002). Why don’t issuers get upset about leaving money on the table in IPOs?. Review Finance Study, 15, 413–443.
  29. Mehmood, W., Mohd-Rashid, R., Che-Yahya, N., Ong, C.Z. (2020). Determinants of heterogeneity in investors’ opinions on IPO valuation: evidence from the Pakistan stock market. Review of Behavioral Finance ahead-of-print. https://doi.org/10.1108/RBF-04-2020-0078
  30. Omran, M. (2005). Underpricing and long-run performance of share issue privatizations in the egyptian stock market. Journal of Financial Research, 28, 215–234. https://doi.org/10.1111/j.1475-6803.2005.00122.x
  31. Ong, C.Z., Mohd-Rashid, R., Taufil-Mohd, K.N. (2020). Underwriter reputation and IPO valuation in an emerging market: evidence from Malaysia. Managerial Finance, 46, 1283–1304. https://doi.org/10.1108/MF-11-2019-0579
  32. Paleari, S., Signori, A., Vismara, S. (2014). How do underwriters select peers when valuing IPOs?. Financial Management, 43, 731–755. https://doi.org/10.1111/fima.12060
  33. Pratoomsuwan, T. (2012 ). The effect of an audit firm’s brand on security pricing. International Journal of Emerging Markets, 7, 430–442. https://doi.org/10.1108/17468801211264333
  34. Rasheed, A., Sohail, M.K., Din, S.-U., Ijaz, M. (2018). How do investment banks price initial public offerings? an empirical analysis of emerging market. International Journal of Financial Study, 6, 1–19. https://doi.org/10.3390/ijfs6030077
  35. Rathnayake, D.N., Louembé, P.A., Kassi, D.F., Sun, G., Ning, D. (2019). Are IPOs underpriced or overpriced? Evidence from an emerging market. Research of International Business Finance, 50, 171–190. https://doi.org/10.1016/j.ribaf.2019.04.013
  36. Ritter, J.R., Welch, I. (2002). A review of IPO activity, pricing, and allocations. Journal of Finance, 1795–1828. https://doi.org/10.3386/w8805
  37. Rock, K. (1986). Why new issues are underpriced. Journal of Financial and Economics, 15, 187–212. https://doi.org/10.1016/0304-405X(86)90054-1
  38. Roosenboom, P. (2012). Valuing and pricing IPOs. Journal of Banking and Finance, 36, 1653–1664. https://doi.org/10.1016/j.jbankfin.2012.01.009
  39. Ruud, J.S. (1993). Underwriter price support and the IPO underpricing puzzle. Journal of Financial Economics, 34, 135–151. https://doi.org/10.1016/0304-405X(93)90015-4
  40. Rydqvist, K. (1997). IPO underpricing as tax-efficient compensation. Journal of Banking and Finance, 21, 295–313. https://doi.org/10.1016/S0378-4266(96)00043-X
  41. Sahoo, S., Rajib, P. (2010). Post-issue promoter groups holding, signalling and IPO underprice: evidence from Indian IPOs. International Journal of Financial Services Management, 4, 95–113.
  42. Stoughton, N.M., Zechner, J. (1998). IPO-mechanisms, monitoring and ownership structure. Journal of Financial Economics, 33.
  43. Tian, L., Zhang, W. (2014). Extreme IPO underpricing: Can the market-oriented incremental reform work in China?. Nankai Business Review International, 5, 225–255. https://doi.org/10.1108/NBRI-02-2014-0012
  44. Tran, L., Le, D.C., Hoang, T.P.T. (2013). The underpricing and long-run underperformance of initial public offerings: evidence from vietnam (SSRN Scholarly Paper No. ID 2316577). Social Science Research Network, Rochester, NY. https://doi.org/10.2139/ssrn.2316577
  45. Tutuncu, L. (2020). Valuation and underpricing of Turkish IPOs. Journal of Business and Economics Management, 21, 157–179. https://doi.org/10.3846/jbem.2020.11927
  46. Vismara, S., Signori, A., Paleari, S. (2015). Changes in underwriters’ selection of comparable firms pre- and post-IPO: Same bank, same company, different peers. Journal of Corporate Finance, 34, 235–250. https://doi.org/10.1016/j.jcorpfin.2015.07.010
  47. Welch, I. (1992). Sequential sales, learning, and cascades. Journal of Finance, 47, 695–732. https://doi.org/10.2307/2329120
  48. Zhang, F., Zhou, X.-H., Su, J., Tsai, S.-B., Zhai, Y.-M. (2020). Governance role of media information’s uncertainty in IPO market-oriented pricing. Kybernetes, 49, 2849–2871. https://doi.org/10.1108/K-01-2019-0066