Bigger Pie, Bigger Slice : Liquidity Value and IPO Underpricing

Initial public offerings (IPOs) transform private firms into publicly traded ones, thereby radically improving liquidity of their shares. Better liquidity increases firm value, which we call “liquidity value”. Since investor participation is essential for a successful IPO, we hypothesize that issuers share the liquidity value with IPO investors, resulting in a discounted offer price termed “underpricing” in the literature. Larger liquidity value would cause more underpricing, i.e., bigger pie, bigger slice. We find supporting evi- dence that underpricing is positively related to the expected post-IPO liquidity of the issuer, controlling for market conditions, firm and deal characteristics, and time-varying industry effects. We also explore two regulation changes as exogenous shocks to issuers’ liquidity before and after IPO, respectively. In a difference-in-differences setting, un- derpricing is found to be more pronounced with better expected post-IPO liquidity or lower pre-IPO liquidity