Analysis of the IPO Valuation Premium Puzzle: the Factor of Information Asymmetry

Abstract

Based on existing empirical evidence and the theoretical model developed by Akerlof (1970), the paper offers an explanation of the IPO valuation premium puzzle. When choosing between an IPO and a sellout as possible options of going public, an increasing number of companies prefer the latter despite the fact that the IPO potentially offers higher valuation premiums. The conclusions derived by means of a critical review of the empirical literature suggests that this phenomenon is mainly shaped by the factor of information asymmetry, which prompts the analogy with the 'lemons' market. Akerlof's model helps clarify the IPO valuation premium puzzle, however, some important deviations from the predictions of the normative analysis are observed in practice, which, as demonstrated in the paper, can be explained by the influence of behavioural factors. We postulate that the validity of the theoretical models, which explain the valuation puzzles, hinges upon the assumptions regarding market efficiency and rationality of the market participants. We systematize those assumptions and make conclusions regarding their relevance in case of the phenomenon in question. The paper explains how the market mechanisms, for example, the dual-track IPOs, allow overcoming the problem of information asymmetry and, possibly, eliminating the valuation anomalies.