New article by Einar Bakke, Tore Leite and Karin Thorburn
The article "Partial Adjustment to Public Information in the Pricing of IPOs" by Einar Bakke, Tore Leite and Karin Thorburn is forthcoming in the Journal of Financial Intermediation.
Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a rational explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)'s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This "incentive effect"' receives strong empirical support in a sample of 6,300 IPOs in 1983-2012. Controlling for the incentive effect, the positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is held to be most informative, effectively resolving the predictability puzzle.