The effect of underwriters' reputations on post-deregulation IPO pricing: Price discovery ability versus bargaining power

Abstract

This study empirically examines the role of underwriters' reputations on the IPO pricing process and its effect on subsequent initial returns. We analyzed 275 IPOs between July, 2002 and December, 2006. The reputation of each underwriters was analyzed based on the data reflecting their performances over the preceding three years. The analysis considered the following: number of offerings, the natural logarithm of average offering size, the relative offering size, the inverse of average underpricing ratio, and the ratio of refraining from undertaking a market stabilization activity or exercising a putback option. The logarithm of the underwriter's asset size and the composite index of the above six reputation variables are included in the variable we call "reputation." We find that underwriters with higher reputation exercise more bargaining power than either issuing firms or institutional investors in the offer price decision process. On the other hand, the underwriters' certification role is not sufficiently carried out to build a reputation on price discovery. We propose an incentive system that would encourage voluntary assessment of underwriters' competency, which can ultimately bolster their reputations in terms of their price discovery ability.