IPO Underpricing and Insurance Against Legal Liability

Philip D. Drake and Michael R. Vetsuypens

Financial Management, 1993, vol. 22, issue 1

Abstract: Initial public offerings (IPOs) of equity are typically underpriced on the day of the offering. A frequently mentioned explanation for this puzzling phenomenon relies on issuers' desire to avoid legal liabilities under federal securities laws for misstatements in the offering prospectus or registration statement. According to this "lawsuit avoidance hypothesis," large positive returns from offer price to early after market trading reduce (i) the probability of a lawsuit, (ii) the conditional probability of an adverse judgment if a lawsuit is filed, and (iii) the amount of damages in the event of an adverse judgment.

Date: 1993
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