Tuesday, October 30, 2007

IPO Underpricing, Earnings Quality, and more

Another FMA paper. This one looks at IPO underpricing and Earnings Quality and is by Thomas J. Boulton, Scott B. Smart, Chad J. Zutter.

The shortest version is that using international evidence the authors find underpricing is greater where earnings quality (transparency) and liquidity are lower.

The abstract says it best:
"Examining 7,306 IPOs from 34 countries, we find less underpricing in countries with higher earnings quality. This finding persists after controlling for other deal- and country-specific factors, and it is not driven by large, relatively transparent markets such as the U.S. and U.K. Firms in countries with lower earnings quality can reduce underpricing by choosing higher quality underwriters. We also observe lower underpricing in countries that allow banks to hold equity in nonfinancial firms and in countries with more liquid markets. Finally, we provide results that suggest investors assign lower valuations to IPOs in countries with lower earnings quality."
As the title suggests, the authors first look at earnings quality and sure enough find the greater the transparency, the lower the underpricing. In their words:
"...sample’s mean first-day return is 27.5 percent, and a one standard deviation improvement in earnings quality reduces underpricing by about 4 percentage points."

Next on the agenda is whether bank ownership may affect underpricing. How? Read on:
"Through their lending relationships with firms, commercial banks gain access to private information. When they choose to invest in the equity of IPO firms, banks send a valuable signal to other market participants and, thereby, reduce information asymmetries....In countries with fewer restrictions on bank equity holdings, we observe less underpricing."

WOW. Great stuff. A definite I^3!!!! (Interesting, Informative, and Important)

Cite: Earnings Quality and International IPO Underpricing Thomas J. Boulton, Scott B. Smart, Chad J. Zutter. Working Paper: presented at FMA conference Orlando Florida.

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