Are low-demand IPOs underpriced? Evidence from biotech IPOs
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We address the unresolved issue of how negative demand information affects the pricing of initial public offerings (IPOs). Using a sample of 557 biotech IPOs over the 1990-2004 period, we show that low-demand IPOs tend to be underpriced and the extent of this underpricing is significant. The post-IPO performance of low-demand IPOs supports the claim that low-demand IPOs are mildly underpriced in the long run and suggests potential negative overreaction in the market for IPOs with low demand. We use a new partial adjustment model to show that the traditional model generally fails to demonstrate little relation between initial return and price revision for low-demand IPOs. Our findings are robust to controlling for the measure-specific and industry-specific factors. In logistic regressions, we find evidence consistent with the view that underwriters may have difficulty in marketing a larger IPO where investor interest is low and thus are more likely to underprice. The underpricing likelihood is negatively related to pre-IPO market returns, which is consistent with the 'a bird in the hand' hypothesis. We also present evidence consistent with the hostile takeover avoidance hypothesis and with the prospect theory, respectively. We take the demand-dependent approach to explanation for underpricing and our approach has certain advantages. This study complements the information solicitation and price adjustment model in the literature.