Founders, Private Equity Investors and Underpricing in Entrepreneurial Initial Public Offerings
One of the most important events in the life of an entrepreneurial firm is when it undergoes an Initial Public Offering (IPO). Underpricing of the stock at the IPO is the difference between the initial price at which a firm’s stock is offered and the closing price of the stock on the first day of trading. It is a major concern to the entrepreneur and firm since it represents value the market ultimately sees in the stock but which the firm/entrepreneur did not obtain when the stock was first offered for sale. This paper examines IPO underpricing in a sample of UK entrepreneurial IPOs where founders retain a significant ownership stake.
An Initial Public Offering (IPO) can provide an entrepreneurial firm with critical resources for its future expansion. It can also provide the entrepreneur with the first substantive access to cash from their investment of time and resources in the entrepreneurial effort. Underpricing of the stock at the IPO, the difference between the initial price at which a firm's stock is offered and the closing price of the stock on the first day of trading, is a major concern to the entrepreneurial firm and to the entrepreneur since it represents value the market ultimately sees in the stock but which the firm/entrepreneur did not obtain when the stock was first offered for sale.
This paper examines IPO underpricing in a sample of UK entrepreneurial IPOs where founders retain a significant ownership stake. The study combines both IPO signaling and agency perspectives. Signaling research suggests that underpricing can be reduced by idiosyncratic signals through which an IPO team conveys information about the firm's quality to outside parties. Agency-based studies argue that these signals may be associated with the firm's ownership structure and the governance roles of early stage investors.
For entrepreneurial firms the IPO represents a high degree of success to date and an indication that the firm will have greater resources to pursue its strategic goals in the future. For the entrepreneurs, who are often referred to as "paper millionaires" until the IPO stock market flotation, the IPO is the first opportunity to actually obtain cash from their entrepreneurial venture. The IPO is thus a highly significant event for the entrepreneurial firm, where underpricing can steal part of the benefit that the entrepreneurial firm and the entrepreneur may seek. This research extends our understanding of how underpricing can be limited in the IPO process. It sheds light on the role played by founder and private equity investor ownership and informs future research on this important event in the life of an entrepreneurial firm.
The research paper is available to read in full by clicking on the document link below.
