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Venture capital investments by IPO underwriters: Certification or conflict of interest?
Xi LiSchool of Business
University of MiamiCoral Gables, FL 33146Phone: 305-284-6891
Fax: 305-284-4800x.li@miami.edu
Ronald W. MasulisOwen Graduate School of Management
Vanderbilt UniversityNashville, TN 37203Phone: 615-322-3687
Fax: 615-343-7177ronald.masulis@owen.vanderbilt.edu
Current Version: November 3, 2002
Venture capital investments by IPO underwriters: Certification or conflict of interest?
Abstract
We study the impact on IPO pricing when underwriters have venture capital investments in
issuers and evaluate whether these investments create a serious conflict of interest between
underwriters and IPO investors. Theoretically, prior underwriter investment has two effects.
First, it can improve underwriter access to IPO issuer information, thus enhancing the credibility
of its due diligence investigations, thereby raising investor demand and IPO offer prices. Second,
it decreases alignment of underwriter interests with IPO investors, which can decrease the
credibility of underwriter due diligence investigations. However, underwriters can increase their
credibility through several contracting mechanisms. They can voluntarily accept a lockup
clause, which requires them to be long term shareholders, thereby increasing their alignment
with outside investors. Alternatively, they can seek an independent outside opinion of the
appropriate IPO offer price. Empirically, it is not prior equity investments by any underwriter
that significantly reduces IPO underpricing, but rather an equity investment by a lead
underwriter. Controlling for endogeneity effects does not change the conclusions. We also
observe a stronger certification effect for IPOs with higher investor uncertainty about issue
valuation. However, the issuer benefit from reduced underpricing is partially offset by larger
underwriter fees. In sum, we find support for a dominant certification benefit from underwriter
venture investments in IPO issuers. The evidence also suggests that additional contracting
mechanisms employed by underwriters have substantially reduced the moral hazard problem
faced by IPO investors.
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1. Introduction
The costs and benefits of permitting commercial bank underwriting are at the heart of the
debate over banking system reform in many countries. In the United States, the 1999 Gramm-
Leach-Bliley Financial Modernization Act repealed the 1933 Glass-Steagall Act ending nearly a
70-year prohibition on securities underwriting by commercial banks. In the last decade,
commercial banks are again able to invest in equity securities, through the creation of venture
capital subsidies and holding company structures.1 Given these recent and contemplated
regulatory changes, there is heightened interest in potential conflicts of interest created by
universal banking. These policy issues continue to be debated in the U.S., while banking
regulation continue to limit direct equity investments by banks and to restrict underwriting
activity to separate subsidiaries. Our focus is on one major element of this debate, the effects of
permitting commercial banks as well as other investment banks to be prior investors in the
issuers of securities that they underwrite
Since banks can have both lending and investment banking relationships with an issuer,
several conflicts of interest can result. First, banks can acquire proprietary firm specific
information from their lending and venture capital relationships and thus, lower their information
costs relative to competing investment banks. Having prior investments in issuers can give
underwriters superior information, which sends credible signals to the capital market that these
issuers are likely to be financially healthy [Leland and Pyle (1977), Puri (1999)]. Second, having
pre-existing investments in issuers can create a moral hazard problem between underwriters and
outside investors. For example, Puri emphasizes that banks with outstanding loans to weak
issuers have incentives to underwrite these issuers’ securities, which they might otherwise
1 Prior to enactment of the Gramm-Leach-Bliley Act, the Federal Reserve had slowly permitted limited underwriting by commercial banks on a case by case basis.
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decline. Banks have such an incentive because it strengthens an issuer’s financial condition,
thereby decreasing likelihood banks will sustain losses from issuer defaults. Alternatively, if an
underwriter has a prior venture capital investment in an issuer, it can benefit from having the
issuer sell overvalued stock to the public.2
In this study, we focus on the IPO underwriting process and the impact of underwriter
venture capital investments in IPO issuers and how that affects the IPO pricing decision and
underwriter percentage spreads and relate this to the potential conflicts of interest between IPO
investors and underwriters. To preview our results, we find that underwriters with prior equity
investments tend to set higher offer prices than those with no prior equity investments.
Following the introduction, the study reviews the prior research and empirical evidence on IPO
underpricing and underwriting fees in section 2 and then discusses data sources and descriptive
statistics in section 3. Section 4 explores the impact on underpricing of prior venture capital
investments by underwriters. In section 5, we examine underwriter spreads and whether they are
systematically affected by prior venture investments. The conclusions of this study follow.
2. Related Literature
Existing evidence focuses on the conflicts of interest in bond underwriting when there is
a prior lending relationship. U.S. evidence indicates a certification role for underwriters with
prior issuer banking relationships. For example, Ang and Richardson (1994), Kroszner and Rajan
(1994), and Puri (1994) show that pre-Glass-Steagall the default rates of bank underwritten bond
issues are lower than those of non-bank investment houses. Gande, Puri, Saunders, and Walter
(1997) and Puri (1996) find that bank-underwritten bond issues fetch higher price (lower yields)
2 Since underwriters’ pre-IPO investment is subject to longer lock-up period than issuer management, this lock-up clause may reduce underwriters’ incentive to overprice a deal. See NASD Rule 2710 for detailed regulation on the lock-up period of underwriter pre-IPO ownership.
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in both the post- and pre-Glass-Steagall period. This is consistent with bank underwriters
attracting or selecting higher quality issuers.
Evidence from other countries provides mixed evidence on whether bank underwriters,
who can also be issuer investors, have greater conflicts of interest than other underwriters.
Hamao and Hoshi (1998) find that Japanese bond issues brought to market by commercial banks
have lower offer prices (higher yields) than other issues in the post-1994 era, suggesting greater
market skepticism about issue quality. Ber, Yishay, and Yosha (2001) show that Israeli IPOs
underwritten by banks with prior lending relationships are significantly overpriced and exhibit
significantly lower after-market performance, which they interpret as evidence of a conflict of
interest between bank underwriters and IPO investors, which goes unrecognized by investors at
the time.
Several studies have examined the impact of prior equity ownership on the equity
underwriting process by studying venture capital (VC) backed IPOs where underwriters and VC
investors are affiliated. Hamao, Parker, and Ritter (2000) show that Japanese IPO firms backed
by the lead underwriters’ VC subsidiaries have similar long-run performance but higher IPO
underpricing compared to other VC-backed IPOs. Klein and Zoeller (2001) find similar results
for lead underwriter investments in German IPO issuers. Both interpret their finding as evidence
supporting the conflicts of interest between underwriters and IPO investors, who may discount
these IPO prices for perceived moral hazard risk. Ljungqvist and Wilhelm (2003) examine the
effects of prior venture capital and investment bank equity holdings of issuers on underpricing of
U.S. IPOs and find that both indicator variables are associated with less underpricing. However,
interacting the investment banking indicator with the underwriting indicator to generate an
underwriter equity holding indicator yields an insignificant parameter estimate. This suggests
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that the positive an negative effects of a venture capital investment by the underwriter are largely
offsetting with respect to the IPO pricing decision.
Our paper is the most closely related to that of Gompers and Lerner (1999). They find
that U.S. IPOs have significantly positive five-year excess returns only when all underwriters are
also venture investors in the issuer. Gompers and Lerner report that prior underwriter ownership
has no effect on the issuer’s bankruptcy and liquidation probability over the subsequent five
years. They also find no significant relationship between IPO underpricing and underwriter
ownership, although they argue that the sign of the coefficient estimates suggest a conflicts of
interest effect because underwriter ownership generally increases underpricing, though
insignificantly.
Our study differs from the previous literature with respect to the hypotheses we test. First,
the previous literature compares mean IPO underpricing based on whether underwriters have
prior equity ownership or not. We extend this analysis by examining the relation between the
size of underwriter ownership and IPO underpricing. Puri (1999) predicts that underwriter
ownership of issuer debt or equity strengthens the certification effect. However, a larger
shareholding in an issuer exacerbates the conflict of interest with outside investors, thereby
undermining an underwriter’s credibility in the capital market. Thus, issues underwritten under
such circumstances could fetch lower, rather than higher prices. We can directly test this
hypothesis, given our detailed underwriter shareholding information,. We also control for
selection bias in our sensitivity tests. Finally, our study benefits from access to more recent IPO
data. Consistent with Puri’s certification prediction, we find underwriter ownership significantly
reduces IPO underpricing. We also find the explanatory power of our model substantially
exceeds that reported in most of the earlier literature, which may reflect our larger sample.
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Second, the previous literature does not examine the effects of regulations which are
created to mitigate the conflicts of interest between IPO investors and underwriters. In 1971
NASD issued Rule 2720 which specifically regulates the pricing of IPOs when a lead
underwriter has significant debt or equity ownership in an issuer. Changes in this rule could
significantly reduce the conflicts of interest with IPO investors and NASD has substantially
revised the rule in the intervening period.3 Fortunately, over our sample period this rule has
essentially unchanged.
Thirdly, our study focuses on stock prices immediately following IPOs. We develop a
new approach to differentiating the moral hazard and certification hypotheses which does not
require data on long-run abnormal stock price performance. This is advantageous since
measures of long run abnormal performance are very sensitive to the benchmarks used. Fourth,
we focus on a hot IPO period, when underwriters can face stronger conflicts of interest with both
issuers and IPO investors. As a result, our evidence should be more informative on the
importance of moral hazard effects in the underwriting relationship.
Fifth, we also investigate the relation between underwriting fees and their ability to
certify the quality of their offerings. Puri (1999) predicts that more credible underwriters can
charge higher underwriting fees due to their superior certification ability. Gande et. al. (1999)
examines the difference in underwriting fees between Section 20 bank subsidiaries and
investment houses, but do not find any significant difference. Instead of inferring the existence of
3 NASD initially required two qualified independent underwriters (QIU) who each own less than 10% of either of the issuer’s debt or equity to set the maximum IPO prices, whenever the lead underwriter has a position of more than 10% ownership in the firm that it underwrites. NASD reduced the number of QIUs from 2 to 1 in 1983. In 1988, NASD changed the ownership requirement for a QIU so that they can own no more than 5% of the debt or equity of an IPO firm. Currently, Rule 2720 presumes conflicts of interest if the lead underwriters own more than 10% or more of the outstanding voting securities, common equity, subordinated debt, or preferred equity of a company. The rule requires the opinion about offering price from a qualified independent underwriter (QIU). The offering price should not exceed the price recommended by the QIU. QIU should meet several requirements and own less than 5% of the outstanding voting securities, common equity, subordinated debt, or preferred equity of a company. We find that in all cases during our sample, the QIU actually introduced does not have any ownership in the IPO firms.
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underwriter ownership positions in issuers’ debt from the fact that commercial banks are active
debt investors, we analyze the relationship between underwriting fees and underwriters’ actual
equity ownership positions. Our study is also related to research examining the reputation effects
of underwriters and VCs on issue underpricing and long-run performance.
3. Data Sources and Descriptive Statistics
We focus on the 1996-2000 period because there are a large number of investment banks
with venture capital investments in this period and NASD rules regarding conflicts of interest in
securities underwriting remain relatively stable over the period. Prospectuses are taken from
online databases such as Lexis-Nexis and Edgar Online. To obtain our sample, we first identify
976 venture-backed IPOs from Securities Data Corporation’s (SDC) Corporate New Issue
Database, after excluding unit offers, closed-end funds (including REITs), ADRs, limited
partnership, and foreign issues. We then search for prospectuses on Lexis-Nexis, and if
unavailable, go to Edgar Online. We verify that the IPOs in our sample are venture capital
backed by reading the “Principal Shareholder” section of each prospectus.
Of the 976 offerings, 772 have prospectuses available and are backed by venture capital
funds. Requiring issuers to have at least 125 stock returns during the post-IPO period, defined as
event days +6 to +255 relative to the IPO event day 0, yields a final sample of 674 IPOs. We
have four issues with offer prices lower than $5. Since the offer prices are all at least $4, we
decided to include them in our sample, though our results are invariant to excluding them.
Detailed underwriter ownership information is obtained from the prospectuses. Usually
underwriters disclose their pre-IPO equity ownership in the “Underwriting” section of the
prospectus, though we also searched in the “Principal Shareholder” section. Underwriter
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ownership includes both direct ownership by all underwriters in the syndicate and indirect
ownership by employees or their subsidiaries such as a captive venture capital funds. The vast
majority of these underwriter share investment positions involve venture capital.
Detailed underwriter ownership information is hand collected from IPO prospectuses.
Underwriter pre-IPO equity ownership is typically disclosed in the “Underwriting” section of
prospectuses and less frequently in the “Principal Shareholder” section. Table 2 presents
descriptive information for the final sample. The sample has the fewest observation in 1998 and
the most in 1999. The annual percentage of venture-backed IPOs ranges from 25 to 38%, with a
clear upward trend. The lead underwriters tend to make roughly half those investments.
However, all underwriters’ prior shareholding percentage of issuers’ outstanding shares falls
from 14% to 4% over the five year sample period. Among venture-backed IPOs, we find lead
underwriter involvement in 128 issues and lead or non-lead underwriter involvement in 232
issues. In issues that involve pricing by QIUs, lead underwriters are prior shareholders in 18
cases, while non-lead underwriters are shareholders in 28 cases. Only three IPOs required a QIU
because underwriters owned more than 10% of the debt of the IPO firms.
We obtain information on underwriters’ warrant ownership from IPO prospectuses.
Because there are very few non-lead underwriters who own warrants in IPO firms, we focus on
the 14 IPO firms where lead underwriters own warrants. The information source for issuer size,
stock closing prices, bid, and ask on event days 1, 5, and 10, stock returns and trading volume
over event days +6 through +250, and market returns over event days –255 through -6 and +6
through +255 is the University of Chicago’s Center for Research in Securities Prices (CRSP).
IPO issuer industry classification codes are also taken from CRSP. Information on IPO filing
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price range, lock-up clauses and simultaneous global offering designations is taken from
Thomson Financial’s SDC New Issues database.
Turning to Panel B of Table 2, we can compare the mean level of underpricing, measured
by the first two-day return for IPOs with and without prior underwriter venture investments. The
table examines IPO statistics classified by share ownership of all underwriters, lead underwriters
and non-lead underwriters. For all underwriters, we find little evidence that underpricing is
significantly different across IPOs with and without underwriter venture investments. However,
when we isolate lead underwriter venture investment, IPO underpricing appears to be reduced
when they have prior shareholdings. At the same time, just the reverse pattern is observed for
non-lead underwriters. This indicates that we need to distinguish between these two groups of
underwriters when studying the impacts of shareholdings on the IPO process. However, we
should use caution in drawing conclusions about underpricing, since we do not control for
various issuer differences across the two samples.
4. Empirical Results on Underpricing
We begin our analysis by examining whether there is evidence that underwriters with
venture investments have superior information about IPO issuers. We approach this question by
first examining revisions (measured in absolute values) of IPO offer prices from their indicative
price range midpoints, as reported in their registration statements. The left panel of Table 3
presents evidence on the effect of prior venture investment by lead and non-lead underwriters on
IPO percentage price revisions between registration and offering dates, measured by the
difference between offer price and pricing range midpoint divided by pricing range midpoint.
Because other differences across IPOs could affect the degree of price revision, we also control
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for a variety of issuer characteristics in our OLS regressions. The basic result is that there is a
significant reduction in price revision size when the lead underwriter has a prior venture
investment in the IPO issuer. This evidence is consistent with underwriters having lower IPO
pricing uncertainty when they have prior equity investments in issuers.
One measure of underwriter IPO pricing uncertainty is the filing range of high and low
indicative prices taken from the IPO issuer’s registration statement. An underwriter with
superior access to the issuer’s financial condition would be expected to set a lower indicative
range, everything else the same. So if underwriters with prior shareholdings in the firm have
superior information access, then we would expect them to have greater confidence in pricing the
IPO, which they could signal with a lower filing price range. The right hand panel of Table 3
presents estimates for regressions similar to the left hand panel, except that the dependent
variable is the IPO filing price range. Similar to the evidence on the left panel of Table 3, we
again find lead underwriter venture capital investments are associated with lower filing ranges.
We also find that this is primarily related to lead underwriter with large equity investments
requiring the use of a QIU. This may reflect the impact of having a QIU involved in the pricing
IPO decision, or it may proxy for lead underwriters owning issuer equity exceeding 10% of
outstanding shares. One explanation for this reduced price uncertainty is that lead underwriters
with venture investments have greater access to issuer specific information. As a major equity
investor in a privately held firm, an underwriter can have possible board membership or board
observation rights as well as frequent access to senior management.
Turning to our primary concern, we examine whether conflicts of interests with IPO
investors become worse when underwriters have prior issuer shareholdings. Table 4 reports
estimates from regressions of IPO two-day initial returns on underwriter share ownership
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measures such as prior percentage and dollar shareholdings and indicators of lead and non-lead
underwriter share holdings. The key result is that only prior percentage shareholdings of
underwriters significantly reduce underpricing. The sum of the percentage equity stakes held by
lead and non-lead underwriters exhibits a significant impact on underpricing. However, when
lead and non-lead ownership are separated, only lead underwriter ownership matters. The
adjusted R-squares indicate that these ownership measures by themselves have modest
explanatory power.
Puri (1999) predicts that the underwriter certification effect is reduced with larger
underwriter stock ownership. She argues that underwriters will have greater incentives to
underwrite bad firms when they have larger financial investments in these issuers. The
reasoning is that underwriters incur smaller losses when their prior percentage ownership in bad
firms is reduced by the success of these IPOs. However, our results do not support this
prediction. Parameter estimates on the venture capital indicator show no significant impact of
prior underwriter equity investment on underpricing, which is similar to the conclusions of
Gompers and Lerner (1999). Analyzing underwriter percentage shareholdings suggests a
positive certification effect, which dominates any moral hazard concerns.
Puri (1999) observes that the length of the holding period in an issuer’s stock is crucial to
a credible underwriter certification effect. Her prediction of a negative relationship between the
underwriter certification effect and prior stockholdings assumes that an underwriter cannot be
contractually bound to retain issuer stock for an extended period of time, as required by a lock-
up clause, and is apt to sell quickly following the IPO. The fact that our evidence does not
support this prediction suggests that a lock-up clause can be an effective mechanism for
protecting outside shareholders from an underwriter moral hazard problem. In addition,
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subsequent sales by underwriters can be severely limited by SEC disclosure regulations and
NASD rule 2710, which tightly restricts subsequent sales of stock by underwriters and venture
capital investors.
Given the significance of underwriter venture investment for IPO underpricing, we next
examine how underwriter shareholdings affect initial post-IPO two day stock returns. Table 5
reports the marginal effects of underwriter venture investment on these initial returns, after
inclusion of a wide set of control variables which primarily capture issuer characteristics.4
Almost all the regression estimates on the control variables are significant. The adjusted R2 levels
indicate that 45% of the cross sectional variability in IPO returns is explained. In the first model,
we examine the impact of the prior equity ownership stakes of all underwriters (lead and non-
lead) together. We find that the sign of the parameter estimate on percentage ownership is
negative as expected, though insignificant. When we distinguish between lead and non-lead
underwriter ownership in the second regression, we find that only lead underwriter ownership
significantly reduces underpricing. This suggests that the previous finding of an insignificant
effect from the sum of underwriter ownership stakes is mainly due to non-lead underwriter
shareholdings having little impact on IPO initial returns.
In the third regression, we further segment our underwriters into cases that do and do not
use a qualified independent underwriter (QIU) to set the offer prices. As explained earlier, the
1971 rule requires a QIU when the lead underwriter has a relatively large equity investment in an
issuer, which is typically the result of venture capital activity. We find that lead underwriter
ownership significantly reduces underpricing when a QIU is not involved. When a lead
underwriter is a shareholder and a QIU is involved there appears to be a marginally significant
reduction in underpricing, but it is only a quarter of the size observed when a QIU is not
4 Previous studies have found issuer characteristics useful in predicting stock issue flotation costs.
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involved. Since a QIU is usually employed when underwriter share ownership exceeds 10%, it
appears that lead underwriter shareholdings reduce underpricing more as the size of these
investments rises. Separating non-lead underwriter ownership into cases with and without a QIU,
indicates that non-lead underwriter ownership is not important in either case and has negligible
impact on the strength of the lead underwriter ownership - IPO underpricing relationship.
An interesting result that we uncover is that although lead underwriter share ownership
has a negative effect on underpricing, the effect is much smaller when a QIU is involved. Since
the purpose of a QIU is to prevent overpricing, the smaller underpricing effect associated with
using a QIU suggests that this mechanism is effective in reducing the perceived underwriter
conflict of interest with IPO investors, which on average enables a higher offer price to be set on
average. An alternative interpretation is that the QIU reduces the information asymmetry
between the issuer and IPO investors, which enables a higher offer price to be set. We will
further investigate this issue latter in this study.
In examining the results for the control variables, we see that underwriting spread, offer
size, IPO share volume and the prior market return over event days -5 to -1 all have positive
effects on underpricing. This evidence indicates that underpricing rises with offer size which is
consistent with there being a larger adverse selection effect as offer size rises. Underpricing also
rises with the initial share trading level, which may also be a proxy for adverse selection since
sophisticated institutional investors with IPO allocations are more likely to sell their shares
quickly if they view them as overvalued. The evidence also indicates that underpricing and
underwriter spread are positively related, presumably because they are both related to certain
issuer qualities such as the prior sales and earnings history. Finally, a rise in the market return
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over the week prior to the IPO appears to result in a smaller adjustment in the IPO offer price,
which is consistent with prior IPO studies.
We explore the robustness of our initial findings in several ways. We first examine
whether the results in Table 5 on underpricing are insensitive to replacing two-day IPO returns
with five-day returns as the dependent variable. We also examine initial ten and twenty day IPO
returns, but do not present these results since they are qualitatively similar to the two day returns.
We also re-estimate the earlier regressions when two-day IPO returns are based on the midpoints
of closing bid and ask quotes, instead of closing prices. This procedure extracts any bid-ask
bounce effect from initial IPO returns, an effect which Lease-Masulis-Page (1991) find has a
significant impact on public offering date returns of seasoned equity offers. We find the earlier
results are insensitive to this stock return adjustment. Moreover, we find that the bid-ask bounce
effect has little effect on initial IPO returns.
The above evidence indicates the positive certification effect of underwriter stock
ownership dominates the agency cost effect arising from the conflict of interest between
underwriter and IPO investors. To pursue this question further, we take the following approach.
Since IPOs are regarded as overpriced if their initial returns are zero or negative, we study the
relationship between underwriter share ownership and whether an IPO is overpriced. So in the
current approach we ignore size of the underpricing, focusing instead on whether the IPO is
overpricing or not. Using a probit model, it is possible to find a significant negative impact of
underwriter venture investments, even though a few IPOs with prior venture investment by
underwriters are seriously overpriced. This approach is also quite similar to the approach taken
by several prior researchers.
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Explaining a pattern of overpriced IPOs requires something more than an enhanced
certification effect due to under writer venture investment, but must also appeal to an underwriter
moral hazard problem. Thus, a simple negative relationship between underpricing and prior
underwriter ownership implies that initial IPO returns could become negative (overpriced) as
prior underwriter ownership increases substantially. Once the offer price reaches the stock’s true
value, represented by the initial after market closing price, an underwriter is exploiting its
certification reputation to reap financial benefits at the expense of IPO investors. If investors
reduce their assessment of underwriter credibility as its venture capital investment rises, then the
functional relation of underwriter venture investment and underpricing should attenuate as the
size of the venture investment gets large. A probit model has several attractive properties. It
allows us to focus on only certain qualitative aspects of the dependent variable (e.g. its sign) and
its estimates are not strongly influenced by a few outliers.
We define the dependent variable in our probit model to equal one if an IPO has a non-
positive initial two-day return and is zero otherwise. Looking at the probit estimates on Table 6,
we find that none of the prior underwriter ownership measures has a significant impact on the
probability of an IPO being overpriced, which suggests the conflict of interest arising from prior
underwriter share ownership is not a serious factor in IPO pricing for this sample period. We also
estimate the probit model with IPO initial returns defined over the first 5, 10, and 20 trading days
and come to similar conclusions.
If underwriter ownership serves as a certification device in IPOs, then the certification
benefit should be stronger for IPO issuers with greater investor uncertainty. We use aftermarket
stock return variance measured over trading days +6 to +255 as a proxy for investor uncertainty
about IPO valuation. Investors in IPOs with high stock return variance are likely to face more
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information asymmetry and thus the certification effect of underwriter ownership should be more
pronounced in these cases. We test this prediction by including as added regressors two indicator
variables for high and low stock return variance IPO issuers, measured over trading days +6 to
+255, where we divide the sample at the median return variance. We create interactive variables
by multiplying these variance indicators by indicators of syndicate status (lead or non-lead) and
QIU presence.
In Table 7, we replicate some earlier results after effectively splitting the IPO sample by
stock return variance, which we use as proxy for information asymmetry. In the first regression,
we find no difference between issuers with high and low return variance when underwriter
venture capital investment is measured as the sum of lead and non-lead underwriter equity
stakes. In the second regression, we decompose underwriter investment into leads and non-leads
and find that only lead underwriter venture investment reduces underpricing. Moreover, the
economic significance of the parameter estimate for high return variance issuers is more than
four times larger than that for low variance issuers. In the third regression, we further separate
lead and non-lead underwriter ownership by QIU status. The underwriter certification effect of
lead underwriter ownership is economically and statistically more significant for high return
variance issuers when there is no QIU. This is consistent with the QIU reducing the information
asymmetry borne by IPO investors. For IPOs employing a QIU, the certification effect of the
lead underwriters of high variance issuers is more than twice as large as the low return variance
issuers, though surprisingly, it is only statistically significant for low variance issuers. The
adjusted R-squares show that the regressions explain about 58% of the underpricing. Non-lead
underwriter ownership does not matter in any of these cases, which is similar to the findings in
Table 5.
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Up to this point, the analysis treats underwriter shareholdings in an issuer as an
exogenous variable. However, it could be endogenously determined, causing selection bias in the
prior model estimates. The key economic issue is whether the factors that cause a banker to
underwrite a particular IPO also caused the banker to make a prior venture investment in the
issuer. That is to say, the various issuer characteristics that influenced underwriter decisions to
make venture capital investments could also be relevant in determining underwriter positions on
IPO pricing. Looking back at Panel B of Table 2, there seem to be a number of notable
differences in issuer characteristics across the two samples. Specifically, issuers with prior
underwriter venture investments are larger in equity capitalization, increase outstanding shares
by a larger percentage, are more apt to be internet stocks, are less frequently global offers, are
marginally smaller offers and subsequently tend to trade less frequently.
Selection bias creates inconsistent parameter estimates in regressions. As noted above,
selection bias may adversely affect our prior estimates if underpricing is strongly influenced by
some of the same characteristics that attract underwriters to make prior venture investments. This
would result in the venture investment variable capturing some of effects of these underlying
issuer characteristics on the IPO pricing decision. To address this concern, we use a variation on
the Heckman (1979) correction to control for self-selection bias induced by the prior venture
investment decision [Greene (1997)]. It is easy to see that the prior underwriter equity
investment (UPCT) is a Tobit variable:
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Where UPCT* is the latent variable, observed only when underwriters make a minimum size
venture investment. Of course, the model also yields information on what attracts underwriters to
make venture investments in these privately held firms.
Specifically, we estimate the prior equation as a tobit regression and then in the second-
step linear regression replace underwriter venture investment with the residual from the first step
tobit model:
First Step:
Second Step:
In Table 8, we report IPO underpricing results based on initial two-day stock returns,
after controlling for a selection bias or endogeneity problem in the underwriter shareholdings
variable. We find that lead underwriter venture investment is significantly affected by several
explanatory variables used to explain IPO underpricing. Specifically, the initial two-day market
return and its prior five day return, post issue return squared and an utility industry indicator are
all significant. It should not be surprising that the results in the second-step OLS regression are
qualitatively similar to those in Table 5, given the limited explanatory power of the first stage
regressions. Specifically, it is only the lead underwriter shareholdings that reduce IPO
underpricing.
5. Evidence on Underwriter Spreads
The remainder of the paper examines another major component of IPO flotation costs,
gross underwriting spread and the impact of prior underwriter ownership on it. Puri (1999)
predicts that issuers benefiting from higher offer prices will find this partially offset by
underwriter rent seeking in the form of higher underwriting fees. However, Gande et al. (1999)
18
find that debt offering underwriting fees charged by Section 20 bank subsidiaries are lower than
those charged by other investment houses, though not significantly so. Thus, even though
Section 20 bank underwriters have more credibility in certifying debt offerings due to their
superior monitoring ability as lenders, they don’t appear to charge higher fees.
Before examining the effect of prior venture investment on underwriting fees, we need to
first be better acquainted with the basic properties of underwriter percentage gross spreads in our
IPO sample. Figure 1 shows that there could be some economies of scale in the issuance
process since percentage gross spreads are much lower when issue size is larger. Figure 2
suggests that the predominant percentage spread charged by underwriters in our IPO sample is
7% and that it exhibits little cross-sectional variation, which is consistent with the previous
literature.
Table 9 investigates the impact of underwriter share ownership on gross spreads in a
multivariate framework. The left panel is based on OLS estimation. We find that gross spread
exhibits scale economies, indicated by a negative coefficient on gross proceeds, which
diminishes with offer size, as indicated by a significantly positive coefficient on gross proceeds
squared. Simultaneous global offerings are found to entail significantly lower underwriter fees.
One potential explanation for this finding is that global IPOs create greater underwriter
competition. This evidence complements a recent study by Chaplinsky and Ramchand (2000),
who report weak evidence that global offerings of seasoned common stock reduce underpricing,
but not underwriting fees. Underwriter reputation also significantly reduces spreads, which is
counterintuitive if one believes that higher quality underwriters charge higher fees. However,
since these underwriters can select from a large group of potential issuers, they are likely to be
underwriting the financially stronger issuers. They are also likely to capture a larger fraction of
19
rapidly growing firms likely to need more investment banking services and underwriters may be
willing to offer these issuers more attractive rates.
Focusing on prior underwriter shareholdings, we find the sum of lead and non-lead
underwriter stakes significantly reduces gross spread, in addition to our earlier finding that this
venture investment reduces underpricing. Separating underwriter ownership into lead and non-
lead holdings shows that only non-lead underwriter ownership affects underwriting fees. Further
analysis shows that this is primarily associated with prior venture investments by non-lead
underwriters in the presence of QIUs. One possible explanation for this result is that non-lead
underwriters may advise an issuer how to effectively negotiate for lower fees when they are an
issuer shareholder. Further, since the QIU has part of the pricing responsibility and receives a
separate fee for this work, the issuer has a strong argument in favor of lowering the underwriting
fee. The adjusted R-squares of these regression models averaged about 40%, indicating strong
explanatory power.
The sign of the underwriter ownership coefficient is consistent with Gande et al. (1999),
although they do not find the reduction in gross spread to be significant when Section 20 bank
subsidiaries underwrite debt offerings. Our evidence points to a more complex relationship with
underwriters than that predicted by Puri (1999) who argues that underwriters will charge higher
underwriting fees when they have better certification ability, without exploring the impact that
their position in the syndicate might have on this prediction.
It is interesting that only prior non-lead underwriter shareholdings matter in determining
the gross spread charged by an underwriting syndicate, while only lead-underwriter ownership
matters for IPO underpricing. One explanation is that lead underwriters and issuer management
usually negotiate the final IPO offer price, leaving a negligible role for non-lead underwriters in
20
IPO pricing decisions. In contrast, other syndicate members can play an important role in
determining underwriter gross spreads for several possible reasons. First, their participation may
be important to the success of the underwriting, especially in global offers. Second, they may
aid the issuer in negotiating a lower fee. Yet, this leaves unexplained why lead and non-lead
underwriters with similar venture investments in the issuer will have different incentives
regarding the setting of underwriter spreads. To see why these incentives could be different, we
have to take account that underwriters with prior venture investments have two different
incentives. As an issuer shareholder, they are better off if flotation costs are reduced, but as
underwriters, they are worse off. For the lead underwriter who captures a large portion of the
fee, it is almost surely the case that they are better off by setting a higher fee. For non-lead
underwriters with a venture investment, their shareholder incentive can dominate if their
percentage shareholding exceeds the portion of the underwriting fee they receive, which is quite
likely based on the Lee-Lochhead-Ritter-Zhao (1996) which finds that the non-lead underwriter
on average receives a small faction of the total underwriting fee due to its small issue allocation.
Since cross-sectional variation in gross spread is rather limited, we also use an ordered
probit model to examine the impact of prior venture investments by underwriters on gross
spread. We define the dependent variable as an indicator variable, GS, which is equal to zero if
the IPO’s percentage gross spread is less than 7%, one if the gross spread is equal to 7% and two
if gross spread exceeds 7%. The results are presented in the right panel of Table 9. Underwriter
ownership significantly reduces the probability that gross spread equals 7%. Most of the
reduction is due to venture investments by non-lead underwriter when a QIU is used to price the
IPO. This result is quite similar to that obtained when we use ordinary least squares regressions
with raw gross spread as the dependent variable.
21
One explanation for the more important role of non-lead underwriter ownership on gross
spread is related to how underwriter fees are allocated within the syndicate. If a top tier bank can
successfully demand to be lead underwriter, even though an underwriter-shareholder would
normally serve this role, then the incentives of this influential shareholder and the lead
underwriter are significantly changed. When a large shareholder serves as IPO lead underwriter,
it captures much of the underwriting fee, while its shareholdings are reduced in value only by its
share ownership percentage multiplied by the fee (assuming that issuer equity value is reduced
dollar for dollar with underwriting fee). In contrast, if the equity owner is a non-lead
underwriter, then a higher underwriter spread can mean a wealth transfer from itself to a
competing investment banker serving as the lead underwriter.
6. Conclusion
We study the impact of IPO underwriters having venture investments in these issuing
firms on IPO pricing and underwriting fees. Since banks are allowed to invest in IPOs through
venture capital subsidiaries, banks acting in the dual capacity of IPO underwriters and equity
investors provide a unique opportunity for evaluating the joint effects of share ownership and
underwriter due diligence. We provide some indirect evidence on IPO issuer’s costs and benefits
from allowing universal banks to underwrite equity offers, which is at the heart of the banking
reform debate in many countries. We find lead underwriters’ prior shareholdings significantly
reduce IPO underpricing. This result is primarily associated with venture investments by the lead
underwriters. However, this issuer pricing benefit is partly offset by larger gross spreads charged
by these underwriters. We also examine whether the differences in underpricing across these
underwriter groups is attributable to an underwriter conflict of interest or a certification effect.
22
We find that the probability of IPO aftermarket prices falling below their offer prices within a 20
trading days is unrelated to prior underwriter shareholdings, which does not support a serious
moral hazard problem between the underwriters and IPO investors. The certification effect is
also more pronounced for IPOs with higher information asymmetry as measured by aftermarket
stock return variances. This body of evidence is consistent with underwriter ownership in issuer
shares generally serving as a credible certification mechanism, rather than the source of a serious
moral hazard problem for IPO investors over our sample period.
23
Reference:
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Chaplinsky, Susan and L Ramchand, 2000, The Impact of Global Equity Offerings, Journal of Finance, December 2000, 2767-2789.
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Lease, Ronald, Ronald W. Masulis and John Page, 1991, An investigation of the earnings information content in issuer tender offers, Journal of Finance, 46.
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Lee, I., S. Lochhead, J. Ritter, and Q. Zhao, 1996, The Costs of Raising Capital, Journal of Financial Research 19 (3), 59-74
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Ljungqvist, A. and W. Wilhelm, 2003, IPO Pricing in the Dot-com Bubble, Journal of Finance forthcoming.
Michaely, Roni, and Kent L. Womack, 1999, Conflict of interest and the credibility of underwriter analyst recommendations, Review of Financial Studies 12, 653-686.
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25
Table 1Definitions of variables used in the analysis
Underwriter Reputation Investment Bank Rankings from Ritter and Loughran (2002)First Two-Day Return (Closing Price) (Closing Price on Day +1 - Offer Price) / Offer Price (%)First Two-Day Return (Bid-Ask Midpoint) (Midpoint of Closing Bid and Ask on Day +1 - Offer Price) / Offer Price (%)Offer Price Revision Revision in Offer Price from the Midpoint of the Filing Range (%) Abs (Offer Price Revision) Absolute Value of Offer Price RevisionIPO Filing Range IPO High-Low Filing Price Range Divided by the Midpoint of the Filing Range (%)Global Offering Equals 1 if IPO Is a Simultaneous Global Offering, and Is 0 Otherwise Underwriter Spread Underwriter’s Percentage Gross Spread Dollar Amount Offered Log (Dollar Gross Proceeds) Square of Dollar Amount Offered Log (Dollar Gross Proceeds) SquaredPercentage of Shares Offered Number of Shares Offered in IPO / Post-IPO Shares Outstanding Dollar Share Volume (+6, +255) Average Daily Dollar Volume of IPO from Event Day +6 to +255Dollar Share Volume Square Square of Average Daily Dollar Volume from Event Day +6 to +255Stock Return Variance (+6, +255) Stock Daily Return Variance of IPO from Event Days +6 to +255Market Return (-5, -1) Average Daily Return on the Nasdaq or NYSE Index from Event Days -5 to -1Market Return on Day 0 Average Daily Return on the Nasdaq or NYSE Index on Event Day 0“Bubble” Period Equals 1 if IPOs are Issued in 1999 or 2000Internet IPO Issuers Are Internet Companies Based on Ritter’s ClassificationUtilities IPO Issuers Are Utilities Based on SIC CodeFinancials IPO Issuers Are Financials Based on SIC CodeAll Underwriter Shareholders Pre-IPO Stockholdings in Issuer of All UnderwritersLead Shareholders Pre-IPO Stockholdings in Issuer Prior Stockholdings in Issuer of Lead Underwriter (%)Non-Lead Shareholders Pre-IPO Stockholdings in Issuer of Non-lead Underwriters (%)Lead Shareholders with QIU Pre-IPO Stockholdings in Issuer of Lead Underwriter when a QIU (%) Is UsedLead Shareholders without QIU Pre-IPO Stockholdings in Issuer of Lead Underwriter when a QIU (%) Is Not UsedNon-Lead Shareholders with QIU Pre-IPO Stockholdings in Issuer of Non-lead Underwriter when a QIU (%) Is Used Non-Lead Shareholders without QIU Pre-IPO Stockholdings in Issuer of Non-lead Underwriter when a QIU (%) Is Not UsedUnderwriter Shareholders (High Variance Stk) Interactive Variables of Underwriter Stockholdings and a Dummy Variable Equaling 1 if IPO
Stock Return Variance from Event Days +6 to +255 Is above the Median across all IPOs and 0 otherwise
Underwriter Shareholders (Low Variance Stk) Interactive Variables of Underwriter Stockholdings and a Dummy Variable Equaling 1 if IPO Stock Return Variance from Event Days +6 to +255 Is below the Median across all IPOs and 0 otherwise
Warrant Ownership Warrant Ownership of Lead Underwriter (%)
26
Table 2Summary statistics on prior underwriter share ownership
Panel A. Pre-IPO Underwriter Ownership by Year Proportion of IPOs with Prior Underwriter Ownership (%)
Percentage Underwriter Ownership
Year 1996 1997 1998 1999 2000 1996 1997 1998 1999 2000
Number of IPOs 118 121 76 244 115
Stock Ownership of All Underwriters 28 25 32 32 38 14 8 6 3 4
Stock Ownership of Lead Underwriters 14 12 18 17 25 13 4 4 2 4
Stock Ownership of Non-lead Underwriters 16 15 18 20 23 13 10 5 3 3
Stock Ownership of Lead With QIU 6 1 4 1 4 27 6 11 6 10
Stock Ownership of Lead, Without QIU 8 12 14 16 21 2 4 2 1 2
Stock Ownership of Non-lead With QIU 6 4 7 2 5 26 29 9 11 6
Stock Ownership of Non-lead, Without QIU 10 11 12 18 17 5 3 3 3 2
Warrant Ownership of Lead Underwriters 2 5 5 1 0 16 30 10 10 0
Panel B. Mean Statistics of Key Variables by Pre-IPO Underwriter OwnershipAll
IPOs All Underwriters Lead UnderwritersNon-lead
UnderwritersNo Stock Stock No Stock Stock No Stock Stock
Initial Two-Day Return (Closing Price) 0.608 0.620 0.552 0.594 0.641 0.580 0.729Initial Two-Day Return (Bid-Ask Midpoint) 0.622 0.635 0.562 0.605 0.662 0.591 0.759Offer Price Revision 0.131 0.129 0.143 0.125 0.146 0.127 0.151Abs (IPO Price Revision) 0.263 0.264 0.258 0.261 0.268 0.260 0.274IPO Filing Range 0.166 0.166 0.165 0.166 0.165 0.166 0.166Log (Firm Size) 19.227 19.207 19.322 19.160 19.377 19.178 19.437Offer Price 13.885 13.685 14.849 13.497 14.755 13.773 14.370Underwriter Reputation 8.162 8.123 8.350 8.030 8.458 8.072 8.553Offer Price Revision from Midpoint of IPO Filing Range (%) 0.131 0.129 0.143 0.125 0.146 0.127 0.151Global Offering 0.634 0.642 0.595 0.661 0.572 0.656 0.535“Bubble” Period 0.533 0.518 0.603 0.511 0.582 0.517 0.598Underwriter Spread (%) 0.070 0.070 0.070 0.071 0.070 0.071 0.069Log (Gross Proceeds) ($) 17.844 17.816 17.978 17.784 17.979 17.806 18.007Percentage of Shares Offered 0.345 0.298 0.574 0.304 0.438 0.314 0.479Average Daily $ Share Volume (Event Days +6 to +255) 15.908 16.152 14.730 16.021 15.653 15.591 17.273Average Daily Return (Event Days +6 to +255) 0.035 0.047 -0.025 0.046 0.009 0.033 0.041Average Return on Nasdaq Index (Event Days -5 to -1) 0.153 0.151 0.163 0.152 0.155 0.153 0.154Average Return on Nasdaq Index (Event Day 0) 0.003 0.002 0.006 0.002 0.005 0.002 0.004Internet 0.377 0.373 0.397 0.345 0.447 0.346 0.512Utilities 0.095 0.090 0.121 0.097 0.091 0.101 0.071Financials 0.015 0.018 0.000 0.013 0.019 0.011 0.031QIU Use in IPO Pricing 0.099 0.061 0.284 0.021 0.274 0.064 0.252NYSE Listed IPOs 0.030 0.029 0.034 0.026 0.038 0.026 0.047
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Table 3Effect of underwriter prior share ownership on IPO price revision and filing price range
Table 3 presents regression estimates of the following model:
The dependent variable Price Revision is the unsigned difference between IPO offer price and midpoint of the filing range divided by the same filing range midpoint. Filing Price Range is the high filing price minus low filing price divided by the midpoint of the range. UPCT represents alternative measures of percentage underwriter ownership. Control Variable definitions are given on Table 1. Coefficients are estimated using ordinary least squares and the t-statistics are based on White’s (1980) heteroscedasticity-consistent standard errors. The data are drawn from daily trading days in the January 1996 through December 2000 period.
Abs (IPO Price Revision) IPO Filing Price Range1 2 3 4 5 6
Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-statIntercept 0.094 1.91 0.092 1.86 0.094 1.91 0.171 8.59 0.171 8.57 0.169 8.51All Underwriter Shareholders -0.043 -0.41 -0.021 -0.82Lead Shareholders -0.241 -2.34 -0.071 -1.75Non-Lead Shareholders 0.057 0.45 0.004 0.17Lead Shareholders with QIU -0.183 -1.65 -0.095 -2.08Lead Shareholders without QIU -0.634 -1.57 0.085 0.99Non-Lead Shareholders with QIU 0.109 0.74 0.005 0.20Non-Lead Shareholders without QIU -0.123 -0.67 0.008 0.11Warrant Ownership -0.002 -0.02 0.009 0.10 0.004 0.04 0.024 0.44 0.027 0.49 0.029 0.54Underwriter Reputation 0.008 1.32 0.008 1.37 0.008 1.35 -0.001 -0.46 -0.001 -0.43 -0.001 -0.40“Bubble” Period 0.057 2.74 0.056 2.72 0.057 2.77 -0.007 -1.21 -0.007 -1.23 -0.007 -1.28Dollar Share Volume (+6, +255) 0.004 4.63 0.004 4.62 0.004 4.62 0.000 1.33 0.000 1.30 0.000 1.27Dollar Volume Square -0.067 -4.10 -0.067 -4.09 -0.068 -4.09 -0.004 -2.34 -0.004 -2.31 -0.004 -2.29Stock Return Variance (+6, +255) 0.041 1.18 0.042 1.21 0.041 1.18 0.009 0.80 0.009 0.83 0.009 0.85Internet 0.048 1.68 0.047 1.65 0.048 1.65 0.008 1.79 0.007 1.73 0.007 1.74Utilities -0.026 -0.88 -0.025 -0.84 -0.026 -0.88 -0.004 -0.57 -0.004 -0.52 -0.003 -0.45Financials -0.021 -0.21 -0.023 -0.24 -0.026 -0.27 -0.004 -0.37 -0.005 -0.43 -0.004 -0.39
Adjusted R2 0.16 0.16 0.16 0.01 0.01 0.01
28
Table 4 Effects of prior underwriter share ownership on IPO underpricing
Table 4 presents estimates of the following model:
The dependent variable Underpricing is the IPO initial two-day return based on the closing price at the end of day +1. Underwriter Ownership represents alternative measures of underwriter share ownership: underwriter percentage shareholdings, a dummy variable representing underwriter shareholdings, and dollar amounts of underwriter shareholdings where underwriters are distinguished by syndicate status. Control Variable definitions are given on Table 1. Coefficients are estimated using ordinary least squares and the t-statistics are based on White’s (1980) heteroscedasticity-consistent standard errors. The data are drawn from daily trading days in the January 1996 through December 2000 period.
1 2 3 4 5 6Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat
Intercept 0.625 16.83 0.627 16.82 0.594 14.23 0.594 14.53 0.592 14.18 0.591 14.47All Underwriter % Shareholdings -0.889 -2.84Lead % Shareholdings -1.741 -4.25Non-Lead % Shareholdings -0.501 -1.13Underwriter Shareholding Dummy 0.047 0.57Lead Shareholding Dummy -0.089 -1.02Non-Lead Shareholding Dummy 0.160 1.47Log (Underwriter $ Ownership) 0.004 0.64Log (Lead $ Ownership) -0.006 -0.95Log (Non-Lead $ Ownership) 0.011 1.50
Adjusted R2 0.003 0.003 0.004 -0.001 0.002 0.001Number of Observations 674 674 674 674 674 674
29
Table 5Effect of underwriter shareholdings in an issuer on IPO underpricing based on initial two-day returns
Table 5 presents regression estimates of the following model:
The dependent variable Underpricing is the IPO initial two-day return based on the closing prices at the end of day +1. UPCT represents alternative measures of percentage underwriter ownership. Control Variable definitions are given on Table 1. The coefficients are estimated using ordinary least squares. Heteroscedasticity-consistent t-statistics [White (1980)] are used to measure significance of the coefficient estimates. The data are daily from January 1996 through December 2000.
1 2 3Coeff. t-stat Coeff. t-stat Coeff. t-stat
Intercept -3.707 -3.31 -3.799 -3.38 -3.711 -3.31All Underwriter Shareholders -0.218 -0.83Lead Shareholders -0.981 -2.13Non-Lead Shareholders 0.170 0.58Lead Shareholders with QIU -0.702 -1.63Lead Shareholders without QIU -2.818 -2.23Non-Lead Shareholders with QIU 0.121 0.37Non-Lead Shareholders without QIU 0.270 0.37Warrant Ownership 0.195 1.27 0.239 1.53 0.205 1.29Underwriter Reputation 0.031 1.56 0.033 1.63 0.032 1.57Global Offering -0.101 -1.37 -0.099 -1.35 -0.099 -1.35Underwriter Spread 18.420 3.32 18.786 3.40 18.378 3.31Dollar Amount Offered 0.115 2.15 0.118 2.20 0.115 2.16Dollar Share Volume (+6, +255) 0.021 7.89 0.021 7.89 0.021 7.87Dollar Share Volume Square -0.374 -6.09 -0.373 -6.09 -0.374 -6.07Stock Return Variance (+6, +255) -0.099 -1.07 -0.096 -1.04 -0.099 -1.07Market Return (-5, -1) 3.978 5.73 3.994 5.75 4.001 5.76“Bubble” Period -0.057 -0.68 -0.061 -0.73 -0.058 -0.69Internet 0.100 1.16 0.096 1.12 0.095 1.10Utilities -0.062 -0.66 -0.057 -0.62 -0.061 -0.66Financials -0.369 -1.61 -0.380 -1.67 -0.382 -1.67
Adjusted R2 0.45 0.45 0.45
30
Table 6The impact of underwriter shareholdings on
the probability of IPO overpricing
Table 6 reports probit estimates of the relationship between underwriter percentage shareholdings and the probability that IPO’s closing price on event day two is below its offer price. The following model is estimated:
The dependent variable is 1 if the first two-day returns of IPOs based on the closing prices at the end of day +1.is non-positive and is 0 otherwise. UPCT represents alternative measures of prior underwriter shareholdings. P-values for the coefficient estimates are reported in the adjacent columns. The data are daily from January 1996 through December 2000.
1 2 3 4 5 6Coeff. p-val Coeff. p-val Coeff. p-val Coeff. p-val Coeff. p-val Coeff. p-val
Intercept -0.847 0.00 -0.848 0.00 -0.828 0.00 -0.824 0.00 -0.821 0.00 -0.818 0.00All Underwriter Shareholders 0.616 0.40Lead Shareholders 0.907 0.49Non-Lead Shareholders 0.482 0.59All Shareholders Dummy -0.024 0.84Lead Shareholder Dummy -0.008 0.96Non-Lead Shareholder Dummy -0.056 0.70Log (Syndicate $ Ownership) -0.003 0.70Log (Lead $ Ownership) -0.001 0.89Log (Non-Lead $ Ownership) -0.005 0.60
Log Likelihood -338.59 -338.55 -338.91 -338.85 -338.85 -338.77Number of Observations 674 674 674 674 674 674
31
Table 7Effect of underwriter venture investment on IPO underpricing
with varying levels of issuer information asymmetry
Table 7 shows estimates of the following model:
The dependent variable Underpricing is the first two-day returns of IPOs based on the closing prices at the end of day +1. UPCT represents various measures of percentage underwriter ownership. Information asymmetry is measured as stock return variance over the period from event day +6 through +255. Control Variable definitions are given on Table 1. The coefficients are estimated using ordinary least squares. Heteroscedasticity-consistent t-statistics [White (1980)] are used to measure significance of the coefficient estimates. The data are daily from January 1996 through February 2000.
1 2 3Coeff. t-stat Coeff. t-stat Coeff. t-stat
Intercept -3.663 -3.298 -3.877 -3.490 -3.834 -3.408All Underwriter Shareholders (High Variance) 0.827 0.505All Underwriter Shareholders (Low Variance) -0.323 -1.310Lead Shareholders (High Variance) -3.523 -1.659Lead Shareholders (Low Variance) -0.739 -1.761Non-Lead Shareholders (High Variance) 2.589 1.201Non-Lead Shareholders (Low Variance) -0.113 -0.463Lead Shareholders with QIU (High Variance) -1.078 -0.568Lead Shareholders with QIU (Low Variance) -0.677 -1.536Lead Shareholders without QIU (High Variance) -11.115 -3.304Lead Shareholders without QIU (Low Variance) -1.288 -1.265Non-Lead Shareholders with QIU (High Variance) 1.745 0.671Non-Lead Shareholders with QIU (Low Variance) -0.050 -0.188Non-Lead Shareholders without QIU (High Variance) 4.473 1.217Non-Lead Shareholders without QIU (Low Variance) -0.358 -0.856Warrant Ownership 0.145 0.860 0.343 1.828 0.230 1.346Underwriter Reputation 0.030 1.469 0.028 1.381 0.029 1.415Global Offering -0.102 -1.378 -0.108 -1.454 -0.102 -1.375Underwriter Spread 18.333 3.295 18.364 3.402 18.222 3.308Dollar Amount Offered 0.113 2.131 0.126 2.357 0.124 2.305Dollar Share Volume (+6, +255) 0.021 7.912 0.021 7.901 0.021 7.877Dollar Share Volume Square -0.373 -6.100 -0.370 -6.100 -0.374 -6.067Stock Return Variance (+6, +255) -0.118 -1.184 -0.085 -0.832 -0.096 -0.931Market Return (-5, -1) 3.994 5.718 3.916 5.628 3.957 5.668“Bubble” Period -0.053 -0.632 -0.056 -0.668 -0.047 -0.566Internet Companies 0.101 1.168 0.085 0.975 0.088 1.007Utilities -0.062 -0.662 -0.044 -0.477 -0.051 -0.550Financials -0.361 -1.576 -0.378 -1.677 -0.390 -1.737
Adjusted R2 0.45 0.45 0.45
32
Table 8Effect of prior underwriter share ownership on IPO underpricing controlling for selection bias
Table 8 reports on the relationship between IPO underpricing and underwriter share ownership controlling for selection bias. It presents estimates of the following two-step estimation procedure:First Step:
Second Step: In the Tobit regression, the dependent variables, UPCT, represents alternative measures of prior underwriter share ownership. The definitions of the control variables are in Table 1. The second step estimation uses ordinary least squares (OLS), where the dependent variable, Underpricing, is the IPO’s initial two-day return based on the closing price at the end of day +1. The residuals from the Tobit regressions are used to replace the corresponding UPCT. Heteroscedasticity-consistent t-statistics [White (1980)] are used to measure significance of the coefficient estimates. Daily data are taken from the sample period January 1996 through December 2000.
First Step: Tobit Model Estimation Second Step: OLS EstimationAll IPOs Lead Non-Lead All Lead Non-Lead
Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-statIntercept -0.126 -10.12 -0.092 -6.83 -0.163 -8.99 -3.826 -3.43 -3.727 -3.34 -3.728 -3.33Lead Underwriter Shareholders -1.064 -2.17 -0.224 -0.83 0.012 0.04Warrant Ownership 0.236 1.53 0.195 1.27 0.191 1.24Underwriter Reputation 0.033 1.65 0.031 1.56 0.032 1.56Global Offering -0.100 -1.35 -0.101 -1.37 -0.101 -1.37Underwriter Spread 18.564 3.39 18.414 3.32 18.669 3.34Gross Proceeds 0.115 2.16 0.114 2.14 0.115 2.14Market Return (-5, -1) 3.998 5.77 3.978 5.73 3.975 5.71“Bubble” Period -0.062 -0.74 -0.057 -0.68 -0.054 -0.65Dollar Share Volume (+6, +255) 0.000 -0.07 0.000 0.70 0.001 1.69 0.021 7.90 0.021 7.88 0.021 7.88Dollar Share Volume Square -0.001 -0.10 -0.013 -1.05 -0.058 -1.56 -0.372 -6.07 -0.373 -6.06 -0.374 -6.06Stock Return Variance (+6, +255) 0.011 0.53 -0.017 -0.74 -0.043 -1.36 -0.103 -1.12 -0.097 -1.05 -0.098 -1.05Internet -0.013 -0.85 0.007 0.40 0.039 1.72 0.102 1.19 0.100 1.16 0.101 1.18Utilities 0.041 2.03 0.042 1.83 0.006 0.20 -0.074 -0.82 -0.066 -0.72 -0.068 -0.74Financials -0.729 0.00 0.037 0.68 0.093 1.49 -0.282 -1.22 -0.372 -1.62 -0.371 -1.62Percentage of Shares Offered 0.007 1.65 0.008 1.50 0.007 1.27Market Return on Offer Date 0.840 2.10 0.341 0.81 -0.039 -0.07
Log Likelihood / Adjusted R2 -84.549 -103.315 -125.359 0.45 0.45 0.45
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Table 9Effect of prior underwriter share ownership on IPO gross spreads
Table 9 presents regression estimates of ordinary least square models and ordered probit models. The dependent variable for columns (1) through (3) is the underwriter gross spread measured as a percentage of IPO issue size. The dependent variable for columns (4) through (6) is an indicator variable, GS, which is equal to zero if the IPO’s percentage gross spread is less than 7%, one if it is equal to 7% and two if it exceeds 7%. The independent variables include various measures of percentage underwriter share ownership distinguished by syndicate status and some control variables. The definitions of the control variables are in Table 1. Heteroscedasticity-consistent t-statistics [White (1980)] are used to measure significance of the coefficient estimates in columns (1) through (3). Daily data are taken from the sample period January 1996 through December 2000.
Ordinary Least Square Regression Ordered Probit Model
1 2 3 4 5 6
Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat
Intercept 0.504 4.01 0.504 4.02 0.502 4.01 -72.079 -2.80 -72.204 -2.81 -72.323 -2.81
All Underwriter Shareholders -0.004 -2.07 -2.210 -2.49
Lead Shareholders -0.003 -0.76 -1.228 -0.70
Non-Lead Shareholders -0.005 -2.22 -2.581 -2.51
Lead Shareholders with QIU -0.002 -0.52 -1.159 -0.63
Lead Shareholders without QIU -0.008 -1.77 -1.920 -0.33
Non-Lead Shareholders with QIU -0.005 -2.18 -2.660 -2.33
Non-Lead Shareholders without QIU -0.005 -0.86 -2.312 -1.08
Warrant Ownership -0.001 -0.11 -0.001 -0.12 -0.001 -0.13 0.565 0.42 0.497 0.37 0.485 0.36
Underwriter Reputation -0.001 -5.25 -0.001 -5.25 -0.001 -5.24 -0.294 -4.45 -0.295 -4.46 -0.296 -4.47
Global Offering -0.002 -6.07 -0.002 -6.08 -0.002 -6.07 -0.408 -2.13 -0.415 -2.16 -0.417 -2.17
Dollar Amount Offered -0.046 -3.26 -0.046 -3.26 -0.045 -3.25 9.527 3.27 9.550 3.28 9.565 3.28
Dollar Amount Offered Square 0.001 3.16 0.001 3.16 0.001 3.15 -0.292 -3.59 -0.293 -3.61 -0.293 -3.61
Log Likelihood / Adjusted R2 0.48 0.48 0.48 -167.55 -167.31 -167.29
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Figure 1. Scatter diagram relating actual proceeds and gross spread. The sample consists of 674 firm-commitment venture-backed IPOs from 1996 to 2000.
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Figure 2. Gross spread distribution for IPOs The sample consists of 674 firm-commitment venture-backed IPOs from 1996 to 2000. Category 1, 2, and 3 includes IPOs whose gross spread is less than, equal to, and higher than 7% of gross proceeds, respectively.
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