Retail Investor Attention And IPO Valuation
Aston Business School
Amedeo De Cesari
University of Manchester – Manchester Business School – Finance & Accounting Group
Shantaram P. Hegde
University of Connecticut
July 4, 2016
Given restrictions placed on communication with prospective investors, retail investor attention can help firms/underwriters with the difficult task of initially valuing an IPO. Using Google search volume to proxy for retail investor attention, we find that the presence of and an increase in retail attention following the initial filing but prior to initial pricing lead to higher initial valuations. Our results are robust to using basic/propensity score matching methods to identify our matched sample and to including several controls for institutional demand. We conclude that retail investor attention plays a crucial role in the early stages of IPO valuation.
Retail Investor Attention And IPO Valuation – Introduction
IPO valuation is challenging because of a firm’s limited history and lack of presence in the capital markets. While the offer price has the advantage of reflecting institutional demand for the IPO, the initial valuation is at a significant disadvantage since the roadshow typically occurs later.1 Moreover, restrictions are placed on communication between issuers/underwriters and prospective (mostly institutional) investors prior to the setting of the initial price range. In this environment, firms and underwriters may be dependent on other sources of information to initially value an IPO.2 Retail investor attention, a precursor of retail demand for shares, may be one such source. For example, Demos and Dembosky (2012) report that unusually strong demand from retail investors was one factor influencing the upward valuation of Facebook, Inc.’s IPO price in 2012. The objective of this paper is to examine the influence of retail investor attention on initial IPO valuation.
The importance of initial valuation to firms and underwriters is highlighted in Hanley and Hoberg (2010, p. 2826) who argue that significant resources are expended by a firm, and its underwriters and legal counsel to acquire information about the firm which results in more precise initial valuation relative to final valuation as a result of which the firm’s dependence on book-building is reduced. The implication in Hanley and Hoberg (2010) is that institutional interest is not available before the filing of the initial price range. Furthermore, Kim and Ritter (1999, p. 411) posit that accounting information and comparable firm multiples alone are not sufficient to ensure accurate pricing when determining the initial price range. Instead, the market’s demand for the IPO helps to improve pricing accuracy.
Prior to the passing of the Jumpstart Our Business Startups (JOBS) Act in 2012 in the United States (US), Section 5 of the Securities Act of 1933 did not allow issuers and underwriters to communicate with investors before the filing of a preliminary registration statement. Moreover, Rule 15c2-8 of the Securities Exchange Act of 1934 imposed restrictions on issuers and underwriters that prevented them from soliciting offers and indications of interest from investors before the filing of a prospectus containing an initial price range (Practical Law 2014). As a result, US firms and underwriters have been unable to engage in oral and written communication to a significant extent with prospective investors before the initial price range is filed (Latham & Watkins 2014) and several studies have documented the fact that institutional investor demand is not officially available when the initial price range is set (see Hanley (1993, pp. 231-32) on the Microsoft IPO, Ljungqvist and Wilhelm (2002, p. 178), Wang and Yung (2011, p. 302), and Chuluun (2015, footnote 7)).
In this restricted information environment, retail investor attention may contain valuable clues about the latent investor demand for the IPO which could help firms and underwriters to initially value an IPO. For one, retail investors get a reasonably large allocation of IPO shares.3 Furthermore, Barber and Odean (2008) posit that retail attention is important because it may be a precursor of retail demand for shares in the after-market. As a result, incorporating retail attention could lead to more appropriate valuations for newly public firms and reduce the need for underwriters to engage in costly price stabilization activities when trading begins (Chowdhry and Nanda 1996).
Based on a sample of 185 US IPOs from 2004 to 2007, Da et al. (2011) find a significant upward trend in Google’s search volume index (SVI) – a proxy for retail investor attention4 – beginning two-to-three weeks before the IPO week followed by a significant jump in SVI during the IPO week, indicating an increase in retail attention towards the stock.5 The SVI, however, reverts to its pre-IPO level two-to-three weeks after the IPO, an indication that retail attention is not permanent.
In this paper, we examine the impact of retail investor attention (proxied by SVI) on initial IPO valuation as measured by Price-to-Sales, Price-to-Assets, and Price-to-EBITDA. Each of the three valuation measures is captured for an IPO firm relative to that of a matched firm. We are specifically interested in examining the presence of and change in retail attention following the initial filing (S-1, or equivalent) on the initial valuation, which is typically presented for the first time in a later amended filing (S-1/A, or equivalent) with the Securities and Exchange Commission (SEC).6 The initial filing is typically the very first company document in the public domain and contains information on many aspects of the firm and the proposed offering including Use of Proceeds, Risk Factors, Management’s Discussion and Analysis (MD&A), and recent financial statements. Such comprehensive disclosure should increase attention to the firm prior to the initial valuation.
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