Going public across borders: A study of foreign IPO’s and the underpricing-liquidity link

Abstract

Initial public offering (IPO) underpricing is one of the ten major puzzles in financial research. Underpricing can be used to resolve information asymmetry between informed and uninformed investors. Even so, it is not completely understood why underpricing and uninformed participation would be of benefit to the IPO issuer. A positive association between underpricing and liquidity has been found. Two hypotheses attempt to explain this link. The ‘ownership dispersion hypothesis’ suggests that underpricing creates a broad ownership base aiding liquidity, while the ‘information production hypothesis’ suggests that underpricing generates analyst coverage, also benefitting liquidity. This research aimed to test the ‘ownership dispersion’ and ‘information production’ hypotheses, using a sample of foreign IPOs. The overarching hypothesis was that the underpricing of foreign IPOs leads to a higher level of post listing liquidity. The ownership dispersion theory then hypothesized that ownership dispersion increases with initial underpricing and ownership dispersion created by initial underpricing contributes to increased post listing liquidity. Finally the information production theory hypothesized that initial underpricing results in a higher level of information production about the firm following the IPO and that the information production generated by initial underpricing contributes to increased post listing liquidity Companies were identified that have used ‘depository receipts’ to perform a foreign IPO, from a combination of the depositary bank databases. Data from 183 of these companies were examined to test each research hypothesis using regression models and controlling for potential confounding variables. Robustness checks were also carried out to assess for potential misspecification bias, endogeneity bias and selection bias. The research found that underpricing did lead to significantly higher levels of post listing liquidity in the sample of foreign IPOs, supporting research hypothesis 1. Results also showed that greater underpricing of IPOs was associated with more disperse institutional ownership structure. Ownership dispersion forecast by initial underpricing was then found to have a positive association with post listing liquidity, which supports hypotheses 2a and 2b, as well as the ownership dispersion hypothesis. Although results also revealed a positive association between the level of information production and post-listing liquidity, which supports research hypothesis 3a, this relationship could not be explained by underpricing, contradicting hypothesis 3b. Therefore, the results did not support the information production hypothesis. These results were shown to be relatively robust to a selection of potential confounders, misspecification, some endogeneity issues and selection bias. Foreign IPOs often struggle with liquidity concerns. Although a body of research exists covering secondary international cross listings, there is little research examining international IPOs. To better address liquidity concerns and reduce the level of uncertainty for firms looking to list abroad, an opportunity arises to examine how IPO underpricing can be used by foreign firms to enhance post listing liquidity. This is the main contribution of this research.