IPO underpricing and flotation methods in Taiwan – a stochastic frontier approach

Abstract

Adopting stochastic frontier analysis, this article studies the pricing model and underpricing phenomenon of the initial public offerings (IPOs) in Taiwan and further elucidates the potential impact of offering mechanisms on underpricing. The sampling period is from 1996 to 2003, in which 647 IPOs are selected. Empirical results suggest that issuing firms with greater earning potentials, less risk or less asymmetric information have lower underpricing. Furthermore, the variables included to explain underpricing are mostly significant, especially the proxy variable for flotation method. Observed mean IPO underpricing is 20.59% in the sample period, compared to 17.12% for the subgroup using the auction method. This statistically significant difference implies that the introduction of the auction method can help reduce IPO underpricing.

Notes

¹ The SFB pricing formulas is as follows: P = EPS × (P/E) × (0.4) + Dividend × 0.2 + Net Worth × 0.2 + ED × 0.2, where P = the formula price; EPS = the average earning per share over the past 3 years; P/E = the average price-earning ratio of three comparable firms over the past 3 years; Dividend = the average dividend per share over the past 3 years divided by the average dividend yields of three comparable firms over the past 3 years; Net worth = the issuer's book equity value per share and ED = the issuer's 1-year forecasted dividend divided by one-year prime rate.

² The three different measures of earnings management are: (1) : the firm-level SD of operating earnings 3 years before an IPO divided by the firm-level SD of cash flow from operation 3 years before an IPO; (2) : the contemporaneous correlation between changes in accounting accruals three years before an IPO and changes in operating cash flow 3 years before an IPO and (3) : the absolute value of average firm's accruals 3 years before an IPO scaled by the absolute value of average firm's cash flow from operations 3 years before an IPO;

³ Ritter (1991) shows that the average age for IPOs in the US is 3 years.