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Litigation risk, strategic disclosure and the underpricing of initial public offerings

  • Kathleen Weiss Hanley
  • Gerard Hoberg

Using word content analysis on the time-series of IPO prospectuses, we find evidence that issuers trade off underpricing and strategic disclosure as potential hedges against litigation risk. This tradeoff explains a significant fraction of the variation in prospectus revision patterns, IPO underpricing, the partial adjustment phenomenon, and litigation outcomes. We find that strong disclosure is an effective hedge against all lawsuits. Underpricing, however, is an effective hedge only against the incidence of Section 11 lawsuits, those lawsuits which are most damaging to the underwriter. Underwriters who fail to adequately hedge litigation risk experience economically large penalties including loss of market share.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2011-12.

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Date of creation: 2011
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Handle: RePEc:fip:fedgfe:2011-12
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