Investment Banker Prestige and the Underpricing of Initial Public Offerings

James M. Johnson · Robert E. Miller

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Abstract

M During the past fifteen years, a number of studies have examined the differential performance of initial public offerings underwritten by prestigious and nonprestigious investment bankers. In each instance, the hypothesis that prestigious bankers underprice less often than non-prestigious bankers is supported. While a variety of explanations have been advanced to explain this phenomena, the finding of differential underpricing is unsettling, since it implies an inherently unstable situation. If issuers can leave less money on the table by employing the services of a prestigious underwriter, then we should observe issuers gravitating from nonprestigious to prestigious underwriters. This would be predicted by Beatty and Ritter's [1] Proposition II. Further, if investors can realize a higher return by investing in non-prestigious banker offerings, they would shift toward issues marketed by non-prestigious investment bankers. These two adjustments would persist until indifference by issuers and investors is achieved. However, these equilibrium adjustments are not significantly observed in the marketplace. Consistently, studies find that prestigious investment bankers underprice significantly less than non-prestigious underwriters (using data from 1965-1969, Logue [10] and Neuberger and Hammond [13]; 1969, McDonald and Fisher [11]; 1974-1978, Block and Stanley [3]; and 1975--1980, Neuberger and LaChapelle [14]). Both sides of the IPO market-the investor and the issuing firm-are mean-variance efficient. The investor hypothesis set forth here argues that the degree of IPO underpricing is positively related to the degree of uncertainty regarding a security's value, and is unrelated to underwriter prestige. If issues offered by prestigious bankers are underpriced less, it is because there

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References

1986Why new issues are underpriced 1986Investment banking, reputation, and the underpricing of initial public offerings 1984The "Hot Issue" Market of 1980 1975Price performance of common stock new issues 1986Information quality and the valuation of new issues 1987The costs of going public 1975"Hot Issue" Markets 1973On the Pricing of Unseasoned Equity Issues: 1965-1969

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