The Over/Underpricing of Initial Public Offerings

Douglas A Hensler

Review of Quantitative Finance and Accounting, 1996, vol. 6, issue 3, 233-43

Abstract: This article shows that lawsuit avoidance motivation can lead entrepreneurs to overprice, as well as underprice, initial public offerings of equity. The article simplifies the lawsuit avoidance argument by addressing the entrepreneur's acceptable probability of lawsuit predicated on the loss of reputation capital, in lieu of the explicit offering revenue/litigation cost trade-off previously treated in the literature. The model yields offering price regimes which include rational cases of overpricing and correct pricing, as well as underpricing, and comparative statics results for the relationship of the optimal offering price with project size, project risk, investors' litigiousness, and the entrepreneur's acceptable probability of lawsuit. The article argues that existing empirical evidence previously used to refute the lawsuit avoidance hypothesis in the context of the model. Copyright 1996 by Kluwer Academic Publishers

Date: 1996
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