Litigation Risk and IPO Underpricing : Evidence from Federal Judge Ideology

Using federal judge ideology as an exogenous measure of firms’ ex ante litigation risk, we document that the initial public offerings (IPOs) of the firms headquartered in more liberal circuits are more underpriced. The effect is mitigated when plaintiffs’ pleading standards are more stringent and is amplified when the judges have more discretion in their decisions. The effect is also amplified among “deep pocket” firms, firms in litigious industries, and firms with greater agency problems, while is mitigated among firms hiring reputable intermediaries in the IPO process. Reinforcing the litigation risk narrative, the results of supplemental analysis suggest that IPO firms located in more liberal circuits engage in fewer earnings management activities in the year of listing. Collectively, our findings underscore the salience of litigation risk stemming from the issuing firms’ legal environment in driving IPO underpricing