Underpricing: Lessons from Bookbuilt Initial Public Offerings in Hong Kong

Abstract

This dissertation consists of two chapters, each representing an independent study on Initial Public Offers. The first study tests the implications of some of the leading IPO underpricing models, using over five years of bid and allocation data on a Hong Kong sample of bookbuilt offerings, subject to clawback restrictions. I find that these allocation restrictions significantly modify the nature of the bookbuilding mechanism, reducing the amount of information underwriters are able to extract from road show participants. However, far from inducing a complete breakdown of the IPO price discovery process, I find that clawbacks enhance it. My tests show that when institutional investors have alternative ways to convey valuable pricing information to underwriters, the information gains from those alternative channels can more than offset the loss of road show information. Moreover, this can be done at no incremental cost in terms of underpricing, since the institutional investors who chose the alternative channels of can settle for larger allocations of shares with the standard underpricing levels. The second study evaluates the implications of three of the extant IPO models relating underpricing and aftermarket liquidity. Using the aforementioned sample of bookbuilt Hong Kong IPOs, this study tests the predictions of the these three models by evaluating not only the direction and sign of the theorized relation between underpricing and aftermarket liquidity, but also the role played by the shareholder base and information environment factors suspected of shaping this relation. The public availability of bid and allocation data in the Hong Kong Stock Exchange has made it possible to conduct such an in-depth evaluation of these models, an undertaking not yet attempted by prior empirical research. Test results show little support for models that posit that aftermarket liquidity and liquidity risk are responsible for higher underpricing. In contrast, I find strong support for models that conceive observed underpricing as a significant driver of post-IPO liquidity.