Abstract:
This paper investigates two explanations for underpricing of initial public offering (IPO), which are related to information asymmetries in different stages of the IPO. The first part of this paper argues that the marketing and signaling effects generated by IPO underpricing can facilitate post-IPO divestiture. The sharp rise of stock price on offer day attracts the market's attention and signals the quality of the firm, which alleviates potential acquirers' search costs and information asymmetries in subsequent divestiture. Empirical results show that IPO underpricing has a short-term effect on the probability of being acquired after going public. During the Internet bubble period, IPO underpricing did not have an effect on post-IPO divestiture, but during 2001-2007, IPO underpricing had a dominant effect on the probability of being acquired. The second part of this study provides empirical evidence to support the information acquisition model where firms may strategically underprice themselves to reward sophisticated investors for providing accurate valuation information to reduce information asymmetries before setting the offer price.
