The joint decision to signal through IPO underpricing and lockup

Abstract

Before Initial Public Offerings (IPOs), the decisions on the offering price and lockup are made simultaneously. This study examines the endogenous relation between underpricing and lockup duration. We adopt the three-stage least square method to estimate a set of the simultaneous equations model, including the inverse Mill's ratio to correct the self-selective bias into the use of lockup. The results indicate a negative association between underpricing and the length of lockup, supporting our signalling hypothesis that IPO firms and underwriters employ underpricing and lockup duration in a substituted way to signal the firm quality. The bivariate analysis provides further support for this view. Our findings offer new insights into how pre-IPO shareholders and underwriters might combine both the underpricing and lockup strategies to signal.

Notes

¹ See, for example, Benveniste and Spindt (1989), Koh and Walter (1989), Ritter and Welch (2002) and Shiwakoti et al. (2005).

² The underwriter with rank 8 (on a 0–9 scale) is considered as the one with prestigious reputation.

³The definition of auditor reputation ranking is based on the statistical ranking of SDC Database.

⁴AMEX and NYSE are the listed markets; NASDAQ is the OTC market.