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E-MailThe following post comes to us from Thomas Boulton of the Finance Department at Miami University, Scott Smart of the Finance Department at Indiana University, and Chad Zutter of the Finance Department at the University of Pittsburgh.
In the paper, Earnings Quality and International IPO Underpricing, forthcoming in The Accounting Review, we examine the impact of country-level earnings quality on IPO underpricing. When firms convert from private to public ownership through an initial public offering (IPO), they typically sell shares at a price that is below the market price that prevails once secondary market trading begins. This “underpricing” cost, which is prevalent in virtually every stock market around the world, is one of the largest costs that firms must bear when going public. Underpricing also varies widely between countries.
In our work, we trace international differences in underpricing to disclosure practices in different markets. Theory predicts that underpricing will be higher when information disparities between investors are greater. When accounting conventions in a particular market are transparent and informative, information disparities should be reduced, which in turn ought to reduce the underpricing cost of going public.
We measure the quality of earnings disclosures by public firms in 37 countries, and then we examine the correlation between country-level earnings quality measures and firm-level underpricing in a sample of 10,783 IPOs. A one standard deviation improvement in earnings quality reduces underpricing by 7.8 percentage points, which represents a significant decrease in the cost of going public. Our study contributes to a growing literature highlighting the importance of accounting disclosures to the development and functioning of capital markets around the world.
The full paper is available for download here.
