French IPO returns and subsequent security offerings:Signaling hypothesis versus market feedback hypothesis

In this article, we look at two competing hypotheses to explain IPO underpricing in France when a seasoned offering follows the IPO. The first hypothesis assumes that the initial underpricing is a signal from a high quality firm in the anticipation of a subsequent equity issue at a higher price. The second competing hypothesis assumes that the market transmits to managers their valuation of the company. Our database examines two types of subsequent risky issuances: on the one hand, stocks and on the other hand, hybrid issuances (such as convertible bonds, bonds with attached warrants, and stocks with attached warrants). Further, in the French market, firms may be introduced through different mechanisms, which are not equally compatible with both hypotheses. We show that the initial underpricing is greater if a stock issuance rather than other security offerings of a convertible nature subsequently follow the IPO. We find evidence in favor of the signaling hypothesis in the case of fixed price IPOs. For the auction-like procedures, we show that the initial investors' demand, rather than post-IPO performance, determines the type of security that is issued, but has no effect on the financing decision itself. The market feedback hypothesis is therefore only weakly supported: a poor market message does not keep managers from expanding, but rather encourages them to use stage financing rather than straight equity.