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Underpricing of Initial Public Offerings

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Underpricing of Initial Public Offerings Underpricing of Initial Public Offerings - Evidence from the Oslo Stock Exchange - Master thesis Cand. Merc. Applied Economics and Finance Copenhagen Business School 2016 Hand-in: August 2016 Supervisor: Christian Rix-Nielsen Number of pages (characters): 79 (202.845) Name of authors: Cathrine Fossum Berge and Ingvild Melby Hilton Holvik Abstract In this thesis we investigate the abnormal first-day return of 88 initial public offerings in Norway from 2005 to 2015. The majority of previous studies of IPO underpricing are directed towards larger stock markets, and only a limited number of research papers have examined the phenomenon in a smaller economy such as Norway. Thus, we attempt to explain the underpricing of Norwegian IPOs by using a selection of existing theories from the vast IPO literature. We find an average market-adjusted underpricing of 2.87 percent, which is slightly lower than the underpricing observed in previous studies in Norway. However, the low estimate is in line with the trend of decreasing initial returns, and the finding is statistically significant at the 1 percent level. After controlling for firm and issue specific characteristics, as well as year- and industry effects, we find evidence in support of Hanley's (1993) partial adjustment theory. That is, it appears that Norwegian underwriters do not fully adjust the offer price to reflect information obtained in the period prior to the IPO, which can explain parts of the abnormal first-day returns. Our results contribute to the IPO literature with two implications for potential investors. First, if the return of the Oslo Børs All-Share Index is increasing in the months prior to an IPO, the investors can expect to realize a higher initial return, on average. Second, if the share price is revised above the midpoint of the indicative file price range, the investors can assume that the IPO will be subject to higher underpricing. Contrarily, we find that the choice of pricing mechanism (book-building or fixed-price), and hiring a prestigious investment bank to underwrite the offering have no significant effect on the level of underpricing. Moreover, the volatility prior to an IPO is not related to the level of initial return, and going public in a "hot issue” market is not associated with more underpricing than going public in a "cold" or "neutral" period. Consequently, as the majority of our selected theories do not seem to be significant in explaining the underpricing of Norwegian IPOs, there is room for further research within this market. We want to thank our supervisor, Christian Rix-Nielsen, who has provided us with insightful guidance, inspiration, suggestions and constructive feedback throughout the process of writing this thesis. In addition, we would like to thank the team at the Oslo Stock Exchange for kindly providing us with the IPO sample and other relevant data that has been necessary in order to test the selected theories of underpricing. 1 Table of Contents 1. Introduction ................................................................................................................................................. 4 1.1. Background ........................................................................................................................................... 4 1.2. Problem statement ................................................................................................................................ 5 1.3. Delimitations ......................................................................................................................................... 5 1.4. Outline ................................................................................................................................................... 6 2. Theory ........................................................................................................................................................... 7 2.1. Initial public offering (IPO) ................................................................................................................. 7 2.1.1. The players ..................................................................................................................................... 7 2.1.2. The pricing mechanisms ............................................................................................................... 9 2.1.3. The IPO process ........................................................................................................................... 10 2.1.4. Why go public? ............................................................................................................................ 11 2.1.5. The Oslo Stock Exchange ............................................................................................................ 12 2.2. Previous evidence of underpricing .................................................................................................... 14 2.3. Underpricing of Norwegian IPOs ..................................................................................................... 15 2.4. Theories of underpricing.................................................................................................................... 16 2.4.1. Theories based on asymmetric information .............................................................................. 17 2.4.2. Risk compensation theory ........................................................................................................... 33 2.4.3. Institutional explanations ............................................................................................................ 36 2.4.4. Ownership and control ................................................................................................................ 38 2.4.5. Behavioral explanations ............................................................................................................. 39 3. Methodology and data ............................................................................................................................... 42 3.1. Structure of our analysis .................................................................................................................... 42 3.2. Hypotheses........................................................................................................................................... 42 3.3. Data selection ...................................................................................................................................... 46 3.4. Construction of variables ................................................................................................................... 48 3.4.1. Dependent variable ...................................................................................................................... 48 3.4.2. Explanatory variables ................................................................................................................. 49 4. Analysis and results ................................................................................................................................... 54 4.1. Descriptive statistics ........................................................................................................................... 54 4.2. Regression models and interpretation of results.............................................................................. 61 4.2.1. Regression variables .................................................................................................................... 62 4.2.2. Regression model and output ..................................................................................................... 62 4.2.3. Research variables ....................................................................................................................... 64 2 4.2.4. Research and control variables .................................................................................................. 65 4.2.5. Research, control and year- and industry dummies ................................................................. 66 4.3. Econometric issues .............................................................................................................................. 67 4.3.1. Functional form misspecification ............................................................................................... 67 4.3.2. Heteroscedasticity ........................................................................................................................ 67 4.3.3. Multicollinearity .......................................................................................................................... 68 4.3.4. Endogeneity .................................................................................................................................. 69 4.3.5. Unusual and influential observations......................................................................................... 70 4.3.6. Normality of residuals ................................................................................................................. 72 4.4. Interpreting results ............................................................................................................................. 72 5. Conclusion .................................................................................................................................................. 78 6. Bibliography ..............................................................................................................................................
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