The incremental value relevance of firm-specific risk measures in pricing junk IPOs

Purpose – The purpose of this paper is to describe a study which examined the effects of underwriter reputation market segments on the value relevance of firm specific risk measures in the pricing of initial public offerings (IPOs). Design/methodology/approach – The study abandons the notion of a homogenous market for IPOs and focuses instead on the differential demand for information across identifiable segments of the IPO market in the pre-market offering period leading to the first day trading closing prices. Ordinary least square (OLS) regressions were used to test the two hypotheses developed in the paper. Findings – It was found that firm-specific risk measures are associated with the initial trading day returns of IPOs managed by low reputation underwriters, but not those by high reputation underwriters. However, as expected, these risk measures are impounded in initial trading day returns only for a sub-sample of high-risk junk IPOs that were marked down in price by the underwriter prior to the offering in order to make them more attractive to investors. Research limitations – As with all empirical studies the tests are joint tests of the hypotheses stipulated and econometric assumptions underlying OLS. The findings of the study may not be generalized to an unrelated domain. Practical implications – The findings suggest that ex ante risk measures are useful in picking among junk IPOs those with the best chances of survival, and thus earning an initial trading return on those IPOs. Originality/value – This is the first study to look at junk IPOs in a systematic manner using a quasi-experimental design.