‘Offering’ Up An Explanation: An Empirical and Theoretical Analysis of IPO Underpricing and its Determinants in the U.S. Stock Market

Abstract

The large, generally positive, fluctuations of a stock price during its first day in the public market (a phenomenon known as underpricing) occur worldwide, and there exists many theories as to the underlying causes. One theory - the signalling effect - suggests that new companies with limited share offerings see large first-day stock returns due to positive speculation. Another hypothesis is the principal-agent theory, which argues that financial negotiations between the issuing firm, investment bank, and investors influence the price of a stock to a great extent. The objective of this research is to determine the significance of different firm and market factors that potentially affect the level of underpricing of initial public offerings (IPOs). The sample for the study consists of 150 American companies that underwent IPOs between 1980-2020. We perform univariate and multivariate regressions for various factors against the level of underpricing. The study revealed that there is an inconclusive relationship between the number of shares and underpricing. A negative relationship between these two variables would be consistent with signalling theory, but a positive relationship would still align with principal-agent theory - whichever theory is more prevalent will have the more influential effect. The positive relationship between company age and underpricing is contradictory to our expectations based on the signalling effect. The positive coefficient for the number of reputable underwriters, as well as the negative coefficient for employees, both indicate the credence of principal-agent theory.