Institutional investors are better informed and will subscribe to underpriced
fixed-price offerings, if permitted. Under the presence of winner’s curse in Taiwan
IPO markets, the participation of institutional investors will definitely reduce the
benefit of uninformed investors leading to more underpricing being required to attract
the uninformed investors. If the institutional investors were permitted to subscribe
to fixed-priced offerings, how much additional underpricing would be needed to cover
the winner’s curse?
We predict institutional investors’ subscription for our fixed-priced IPO sample
as if they were permitted to subscribe. Table 6 points out that without institutional
subscription, the over-subscription rate is 42.36 on average (over-subscription rate is
defined as number of shares subscribed divided by the number of shares offered).
Since the over-subscription rate is pretty high, it is unsurprising that it is difficult to be
allocated an IPO share. If institutional investors were permitted to subscribe
fixed-priced IPOs, the over-subscription rate would increase by 1.60 on average with
institutional subscription predicted via equation (5), leading to the over-subscription
rate being raised to 43.96 on average. With the increase in the over-subscription rate,
the probability of receiving an IPO allocation decreases from 32.61% to 27.38% on
average. As we have mentioned, even though IPOs are underpriced, the uninformed
investors earn no abnormal return on IPOs without institutional subscription.
However, if institutional investors are informed and were permitted to subscribe, the
uninformed investors would suffer losses of –1.95% (with t-value = –3.31, which is
significant at 1% level).
Table 6 shows that if institutional investors are permitted to subscribe, the
uninformed investors will suffer losses of –1.95% on IPO subscription. Obviously,
in this case the uninformed investors will escape from the IPO market unless issuers
underprice their IPOs further. Table 7 demonstrates how much additional
underpricing would be required to induce uninformed investors to join the IPO market
when institutional investors were permitted to subscribe to fixed-priced IPOs. In
Table 7, we add 1% to 11% additional underpricing to the existing underpricing and
measure the returns of uninformed investors to see whether the uninformed investors
would still suffer losses when the institutional investors were allowed to subscribe to
fixed-priced IPOs in Taiwan.
From Table 7, we can see that if institutional investors were permitted to
subscribe to fixed-priced offerings, even though the IPOs are underpriced by 4% more,
the uninformed investors would still suffer a significant loss of –0.93%, implying that
uninformed investors would not join the market even with 4% more underpricing. If
the IPOs were underpriced by 11% more, the uninformed investors will receive a
significant positive return of 0.76%, implying that the IPOs are underpriced by too
much. Therefore, we conclude that if institutional investors were permitted to
subscribe to fixed-priced IPOs, IPOs must be further underpriced by about 4% more
to attract the uninformed investors to join the IPO markets due to the presence of an
even more severe winner’s curse.
Without the institutional investors in the fixed-priced IPO markets, we show that
uninformed investors earn no abnormal returns on IPOs (see Table 3, ALLOCMAR
= –0.69%, with t-value = –0.64). Therefore, we confirm the presence of winner’s
curse in Taiwan even without the existence of institutional investors. Table 5 further
confirms that institutional investors can be regarded as informed investors. With the
existence of more informed investors, winner’s curse would be more severe and IPOs
would need to be even further underpriced. Under winner’s curse, Rock (1986)
argues that the uninformed investors should earn no abnormal returns given the
probability of winning an IPO allocation. That is, ALLOCMAR equals zero in
expectation. With more informed investors, the probability of being allocated an IPO share is even lower (ALLOCip= ALLOCi +a +ea,i,a ≤0, , where
is the predicted probability of receiving an IPO allocation with
institutional subscription;
a is the average decrease of the probability of winning an
allocation when institutional investors subscribed; is the error term.). IPOs
should be even more underpriced ( =
i
ea,
p
MARi MARi+b +eb,i,b ≥0, where is the predicted underpricing with institutional subscription;
)
average increase of underpricing if institutional investors subscribed; is the error
term.). Winner’s curse implies that × =0 in expectation.
Assuming that ,
expectation can be reformulated as:
MARp ALLOCp
∑
MARip×ALLOCip =0 (6) underpriced by 4.65% to make uninformed investors earn no abnormal returns wheninstitutional investors were permitted to subscribe. In other words, issuers earn
4.65% when excluding institutional investors from subscribing to fixed-priced
offerings in Taiwan.
VI. Conclusion
IPOs are typically underpriced. Issuers will be better off with a reduction in
IPO underpricing. However, Rock (1986) argues that IPOs must be underpriced to
compensate the uninformed investors for the cost of adverse selection. Koh and
Walter (1989), Levis (1990), Keloherju (1993), and Amihud, Hauser, and Kirsh (2003)
confirm the presence of winner’s curse in IPOs. This paper investigates the benefit
of excluding institutional investors in fixed-priced offerings using the unique data
from Taiwan. Since institutional investors are typically better informed, we show
that excluding institutional investors can effectively alleviate winner’s curse in IPOs.
In Taiwan, institutional investors are not permitted to subscribe to fixed-priced
offerings. In this paper, we first show that without institutional subscription, the
market-adjusted initial return is negatively related to the probability of winning an
IPO allocation and is positively related to the number of orders accepted in IPOs and
that uninformed investors earn no abnormal returns even IPOs are underpriced on
average. Obviously, IPO subscribers in Taiwan do suffer adverse selection problems.
That is, we re-confirm the presence of winner’s curse in IPOs with Taiwan IPO data.
From the auctioned IPOs in Taiwan, we show that institutional investors are
really interested in the underpriced offerings. The higher the extent of IPO
underpricing is, the more the institutional subscription. Therefore, the auctioned IPO
sample implies that institutional investors would subscribe to fixed-priced IPOs if
permitted. IPO issuers are better off with less underpricing as institutional investors
are excluded from fixed-priced offerings.
With the estimation from auctioned IPOs, we find that institutional subscription
will raise the over-subscription rate by 1.60 leading to the uninformed investors’
suffering losses of –1.95% on average. As a result, uninformed investors will not
join the IPO market if not further compensated. Therefore, with institutional
subscription, fixed-priced IPOs in Taiwan should be further underpriced by at least
4% in order to attract uninformed investors. We conclude that excluding informed
investors is a simple way to mitigate winner’s curse and that issuers in Taiwan earn at
least 4% when institutional investors are not permitted to subscribe to fixed-priced
IPOs.
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Figure 1: The time line of fixed-priced offering process in Taiwan MAR
RMF-30 STD
RMFI
F-30 Filing date (F) Drawing date. Issuance I+20 I+25 I+54 P0 is set. Winners are
chosen.
date (I) Subscription
begins.
Table 1: Variable definition
Variable Definition Panel A: Fixed-priced IPO characteristics
LPROCEED logarithm of IPO proceeds.
STD standard deviation of daily returns over [I+25, I+54].
ALLOC probability of winning an allocation.
ALLOCT ALLOCT=log((ALLOC+0.5/N)/(1-ALLOC+0.5/N)), N: sample size.
LORDER logarithm of number of orders.
OVERSUB Over-subscription rate, OVERSUB= (Number of shares subscribed) / (number of shares offered).
Panel B: Market condition RMF-30 market return 30 days before filing date.
RMFI market return from filing date to issuance date.
Panel C: Underpricing
MAR market-adjusted initial return which is the proxy for IPO underpricing.
ALLOCMAR ALLOCMAR=MAR×ALLOC.
Panel D: Auctioned IPOs
INSTSUB INSTSUB=(institutional investors’ subscription) / (number of shares auctioned).
Panel E: Predicted variable as if institution investors subscribed.
INSTSUBp predicted INSTSUB.
OVERSUBp predicted OVERSUB, OVERSUBp=OVERSUB + INSTSUBp. ALLOCp predicted ALLOC.
ALLOCMARp predicted ALLOCMAR, ALLOCMARp=MAR×ALLOCp.
Table 2: Descriptive statistics of fixed-priced IPO characteristics
This table reports the mean and median of fixed-priced IPO characteristics including market-adjusted initial return, the probability of winning an allocation, proceeds, market return 30 days before filing, market return from filing to issuance, and IPO uncertainty. The entire sample is further split into subsamples based on the market-adjusted initial return and the probability of winning an allocation.
Panel A: Subsamples by market-adjusted initial return
Variable Entire sample MAR<0 MAR 0 ≥
Table 2 continued
Panel B: Subsamples by the probability of winning an allocation
Entire sample ALLOC<50% ALLOC≥ 50%
N 293 210 83
Table 3: Descriptive statistics on underpricing
The market-adjusted initial return is used to examine IPO underpricing and returns of uninformed investors. The t-values are for H0: Mean=0. Cross-sectional standard deviations are used in calculating t-values. ***, **, and * represent the significance levels of 1%, 5%, and 10%, respectively.
Mean t STD Min Med Max
MAR 24.23% 7.98*** 51.74% -49.92% 10.63% 243.37%
ALLOCMAR -0.69% -0.64 18.42% -49.92% 0.30% 212.63%
Table 4: Winner’s curse analysis on the relation between underpricing and allocation
i ALLOCT LPROCEED RM RM STD
MAR =α0 +α1 +α2 +α3 −30, +α4 , +α5 +ε
i MAR LPROCEED RM STD u
LORDER =β0 +β1 +β2 +β3 −30, +β4 +
This table examines the relationship among underpricing measured by market-adjusted initial return, allocation measured by the probability of winning an allocation and number of orders measured by the logarithm of number of orders.
The market return before issuance and the uncertainty of the offerings are used as control variables. In the parentheses are the t-values. ***, **, and * represent the significance levels of 1%, 5%, and 10%, respectively.
Dependent variable MAR LORDER
Intercept -0.168
Table 5: Institutional investors’ subscription for auctioned IPOs
This table discusses how much institutional investors subscribe for auctioned IPO shares with respect to the underpricing of the IPOs. Since institutional investors are not allowed to subscribe for fixed-priced offerings in Taiwan, we estimate institutional investors’ demand on IPO shares from auctioned offerings. The entire sample is further split into two subsamples, underpriced offerings and overpriced offerings, to examine the relationship between underpricing and institutional subscription through piecewise regression. In the parentheses are the t-values. ***, **, and * represent the significance levels of 1%, 5%, and 10%, respectively.
Dependent variable: INSTSUB
Intercept 0.956***
Table 6: Analyses on institutional investors’ subscription
Institutional investors’ subscription is estimated from the auctioned IPOs with respect to IPO underpricing. We analyze IPO subscription, probability of receiving IPO allocation, and return of uninformed investors under the assumption that institutional investors were allowed to subscribe for fixed-priced offerings. The t-values are for H0: Mean=0. Cross-sectional standard deviations are used in calculating t-values.
***, **, and * represent the significance levels of 1%, 5%, and 10%, respectively.
Mean t STD Min Med Max
MAR 24.23% 7.98*** 51.74% -49.92% 10.63% 243.37%
OVERSUB 42.36 12.32*** 58.88 0.002 17.63 421.11 INSTSUBp 1.60 20.02*** 1.36 0.67 0.98 7.91 OVERSUBp 43.96 12.64*** 59.50 0.70 19.56 428.22 ALLOC 32.61% 13.30*** 41.98% 0.23% 5.46% 100.00%
ALLOCp 27.38% 12.71 36.85% 0.23% 5.11% 100.00%
ALLOCMAR -0.69% -0.64 18.42% -49.92% 0.30% 212.63%
ALLOCMARp -1.95% -3.31*** 10.09% -49.92% 0.30% 30.06%
Table 7: Required underpricing to attract uninformed investors with institutional investors’ subscription
Institutional investors’ subscription is estimated from the auctioned IPOs with respect to IPO underpricing. We analyze the required underpricing of IPOs to attract the uninformed investors to join the IPO markets when institutional investors were allowed to subscribe IPO shares. Mean values of institutional subscription, over-subscription rate, the probability of winning an allocation, and uninformed investors’ expected returns are reported. In the parentheses are the t-values. ***,
**, and * represent the significance levels of 1%, 5%, and 10%, respectively.
INSTSUBp OVERSUBp ALLOCp ALLOCMARp
MAR+0% 1.60 43.96 27.38% -1.95%***