IPO underpricing has been looked at in almost every way. And yet there always seems to be another angle. In this paper Fang and Che look at IPOs in Hong Kong where, unlike in the US, IPOs are paid for in advance.
"The Hong Kong IPO market was ranked second in the world surpassing New York and behind only London... new equity capital raised in 2006 (Hong Kong Securities and Futures Commission, 2007). In sharp contrast to the US and European markets, Hong Kong adopts a non-discretionary allocation process and subscribers are required to pay in advance for the shares they apply for. Australia, China, Korea, and the UK also use an advance payment process."
In other words, whoever wants to buy shares for an IPO pay up front. Then all the demand is tallied up, and the shares are distributed. In the event that the investor does not get his/her full order, the money is returned but with no interest. Not surprisingly the authors find that the higher the demand, the greater the returns when the IPO eventually does go public. They also find that the interest rates matter to both investors (interest paid reduces returns) and to firms.
"Data from a sample of 386 IPOs listed between 2000 and 2007 reveals that interest cost can reduce the return to public subscribers by 44%; while the HIBOR-based interest earnings to issuers are estimated at 0.59% of funds raised, and at 6.27% of forecast earnings. "Not surprisingly they also find that subscription rates help predict returns but that subscriptions reduce as interest rates (i.e. opportunity costs) increase.
Cite: Fung, Joseph K. W. and Che, Sanry Y.S., Initial Day Return and Underpricing Cost in Advance Payment Initial Public Offerings (December 31, 2009). HKIMR Working Paper No. 35/2009. Available at SSRN: http://ssrn.com/abstract=1628012