We examine IPO underpricing, valuation, and wealth allocation in relation to investor sentiment, information asymmetry, and underwriter reputation. We find that underpricing is significantly higher for overvalued IPOs than for undervalued IPOs, and is positively correlated to investor sentiment. Information asymmetry is also positively correlated to the magnitude of underpricing but only for undervalued IPOs. We find no evidence of systematic over or undervaluation of IPOs based on peer firm accounting ratios. Change in market sentiment and information asymmetry is positively correlated to overvalued IPOs but not for undervalued. Better underwriter reputation leads to higher IPO valuation for all IPOs. Further, roughly 70% of the wealth from overvaluing IPOs is retained by the issuers. For overvalued IPOs with positive first day returns, we find the proportion of total overvaluation that occurs in the after market trading, i.e., wealth allocated to IPO subscribers, is negatively correlated to underwriter reputation. We conclude underwriters selectively overvalue some IPOs after observing investor sentiment and take advantage of their information to maximize the benefit for issuers and indirectly themselves.
Campbell, Cynthia J.; Du, Yan; Rhee, S. Ghon; and Tang, Ning, "Market Sentiment, IPO Underpricing, and Valuation" (2008). Finance Publication. 2.