Does Prospect Theory Explain IPO Market Behavior?

Alexander P. Ljungqvist · William J. Wilhelm

191 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Corporate Finance and Governance Decision-Making and Behavioral Economics

Abstract

ABSTRACT We derive a behavioral measure of the IPO decision‐maker's satisfaction with the underwriter's performance based on Loughran and Ritter (2002) and assess its ability to explain the decision‐maker's choice among underwriters in subsequent securities offerings. Controlling for other known factors, IPO firms are less likely to switch underwriters when our behavioral measure indicates they were satisfied with the IPO underwriter's performance. Underwriters also extract higher fees for subsequent transactions involving satisfied decision‐makers. Although our tests suggest that the behavioral model has explanatory power, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns.

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References

1979Prospect Theory: An Analysis of Decision under Risk 1988Prospect theory: An analysis of decision under risk 1972Conditional logit analysis of qualitative choice behavior 1980Toward a positive theory of consumer choice 1994The Benefits of Lending Relationships: Evidence from Small Business Data 1985Mental Accounting and Consumer Choice 2008Mental Accounting and Consumer Choice 1995The Effect of Credit Market Competition on Lending Relationships

Cited by

2007IPO Underpricing**Thanks for helpful comments go to Martijn Cremers, Espen Eckbo, Roger Edelen, David Goldreich, Tim Jenkinson, Ron Masulis, Jay Ritter, Ann Sherman, Seha Tinic, and William J. Wilhelm.2011Equilibrium in the Initial Public Offerings Market 2016Superstition and Financial Decision Making 2010Can Operating Leverage Be the Cause of the Value Premium?2015Managerial overconfidence and corporate risk management 2007Behavioral Corporate Finance**The authors are grateful to Heitor Almeida, Nick Barberis, Zahi Ben-David, Espen Eckbo, Xavier Gabaix, Dirk Hackbarth, Dirk Jenter, Augustin Landier, Alexander Ljungqvist, Ulrike Malmendier, Jay Ritter, David Robinson, Hersh Shefrin, Andrei Shleifer, Meir Statman, Theo Vermaelen, Ivo Welch, and Jeffrey Zweibel for helpful comments. Baker and Ruback gratefully acknowledge financial support from the Division of Research of the Harvard Business School.

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