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Public Information, IPO Price Formation, and Long-run Returns: Japanese Evidence

Author

Listed:
  • Kenji Kutsuna

    (Graduate School of Business Administration, Kobe University)

  • Janet Kiholm Smith

    (Von Tobel Professor of Economics Claremont McKenna College)

  • Richard L. Smith

    (Peter F. Drucker amd Masatoshi Ito Graduate School of Management Claremont Graduate University)

Abstract

We use a sample of JASDAQ IPOs to study the effects of public information on offer price formation, initial returns, and long-run returns. Underwriters begin reporting anticipated offer prices of Japanese IPOs at an earlier point than in the US. The observable portion of the price formation process begins with an original price that is established before the roadshow, continues through establishment of the filing range, and concludes with the offer price. Neither price adjustment--from the original price to the midpoint of the range, or from the midpoint to the offer price--fully reflects public information from as long as four months before the IPO. As in the US, price adjustments are asymmetric. Prices adjust more fully in response to negative than to positive public information. It appears that adjustments are limited by an implicit agreement between the issuer and the underwriter that originates before marketing of the offer begins. The agreement reflects an expectation that the offer price will be based on the relative market values of public companies up to four months before the IPO. We find that one-year aftermarket returns are significantly lower when initial returns are high. Initial returns under-adjust relative to public information that is revealed before the IPO and the under-adjustment is substantially reversed in the aftermarket. The evidence connects the implicit contracting theory with the argument that offer prices are based partly on expected value at the time of early price discussions. As a result, it can explain episodes of substantial underpricing that are sustained over periods of several months. The paper also documents that over-allotment options affect price formation by enabling issuers to select significantly narrower filing ranges and to price more fully, so that initial returns are lower.

Suggested Citation

  • Kenji Kutsuna & Janet Kiholm Smith & Richard L. Smith, 2006. "Public Information, IPO Price Formation, and Long-run Returns: Japanese Evidence," Discussion Papers 2006-22, Kobe University, Graduate School of Business Administration.
  • Handle: RePEc:kbb:dpaper:2006-22
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    References listed on IDEAS

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    Cited by:

    1. Bao, Xiaolu & Johan, Sofia & Kutsuna, Kenji, 2016. "Do political connections matter in accessing capital markets? Evidence from China," Emerging Markets Review, Elsevier, vol. 29(C), pages 24-41.
    2. Hanley, Kathleen Weiss & Hoberg, Gerard, 2012. "Litigation risk, strategic disclosure and the underpricing of initial public offerings," Journal of Financial Economics, Elsevier, vol. 103(2), pages 235-254.
    3. Fabio Bertoni & Matteo Bonaventura & Giancarlo Giudici, 2013. "The allotment of IPO shares: placing strategies between retail versus institutional investors," Chapters,in: Handbook of Research on IPOs, chapter 10, pages 207-218 Edward Elgar Publishing.
    4. Chang, Hsiu-Hua & Chen, Anlin & Kao, Lanfeng & Wu, Chin-Shun, 2014. "IPO price discovery efficiency under alternative regulatory constraints: Taiwan, Hong Kong and the U.S," International Review of Economics & Finance, Elsevier, vol. 29(C), pages 83-96.
    5. Randall Morck & Bernard Yeung, 2017. "East Asian Financial and Economic Development," NBER Working Papers 23845, National Bureau of Economic Research, Inc.
    6. Jiang, Li & Li, Gao, 2013. "Investor sentiment and IPO pricing during pre-market and aftermarket periods: Evidence from Hong Kong," Pacific-Basin Finance Journal, Elsevier, vol. 23(C), pages 65-82.
    7. Feng, Xunan & Johansson, Anders C., 2016. "Judging a Book by Its Cover: Analysts and Attention-Driven Price Patterns in China’s IPO Market," Stockholm School of Economics Asia Working Paper Series 2016-39, Stockholm School of Economics, Stockholm China Economic Research Institute.
    8. Bakke, Einar & Leite, Tore E. & Thorburn, Karin S., 2010. "Public information and IPO underpricing," Discussion Papers 2010/6, Norwegian School of Economics, Department of Business and Management Science.
    9. Banerjee, Suman & Dai, Lili & Shrestha, Keshab, 2011. "Cross-country IPOs: What explains differences in underpricing?," Journal of Corporate Finance, Elsevier, vol. 17(5), pages 1289-1305.
    10. repec:eee:jfinin:v:32:y:2017:i:c:p:60-75 is not listed on IDEAS
    11. repec:eee:corfin:v:44:y:2017:i:c:p:34-47 is not listed on IDEAS
    12. Dorsman, André & Gounopoulos, Dimitrios, 2013. "European Sovereign Debt Crisis and the performance of Dutch IPOs," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 308-319.
    13. repec:eee:reveco:v:51:y:2017:i:c:p:295-313 is not listed on IDEAS
    14. Chang, Chih-Hsiang & Lin, Shih-Jia, 2015. "The effects of national culture and behavioral pitfalls on investors' decision-making: Herding behavior in international stock markets," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 380-392.

    More about this item

    Keywords

    IPO price formation; partial adjustment; underpricing; public information; long-run returns; over-allotment options;

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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