IPO Underpricing, Insider Selling and Subsequent Equity Offerings: Is Underpricing a Signal of Quality?

Abstract

Recent papers posit that a firm may deliberately underprice its IPO in order to inform the market that the firm is of high quality. These papers argue that underpricing is a vehicle whereby firms can signal their favorable private information and thereby increase the price received in subsequent securities offerings. Similarly, insiders may also recoup the costs of underpricing through subsequent open market sales of their shares at a more favorable price. I test the implications of these models and find evidence generally inconsistent with their predictions. Specifically, I examine the relationship between IPO underpricing and the likelihood of returning to the market with a seasoned equity offer or an open market insider sale. Overall, I find no significant relation between IPO underpricing and the probability of reissue, after controlling for factors that may affect both underpricing and the probability of reissue. In addition, I find no relationship between underpricing and the probability of an open market insider sale. Thus, it appears that firms are not underpricing in a deliberate effort to inform the market of their quality.