Anlin Chen and James F. Cotter
We show that private information as well as public information is
important in revising the terms of the offer during the pre-selling period
(or the waiting period) and that when the revealed private information is
positive, the underwriter compensates the investors for this information by
underpricing the issue more than when the information is negative. Even
though the cost of compensating positive information is quite high, the
issuer still benefits from the positive information in that the wealth
transferred to the investors is smaller under underwriter’s information
acquisition activities. Furthermore, IPO long-run performance is neg-
atively related to the positive information revealed during the waiting
period and the underwriter prestige. Finally, IPO firms without receiving
significant information during the waiting period survive longer after
Theoretical models by Benveniste and Spindt (1989) and Benveniste, Busaba
and Wilhelm (1996) examine the initial public offering (IPO) process when the
underwriter plays an active role in marketing the offer to investors and setting
Advances in Investment Analysis and Portfolio Management, Volume 9, pages 203–232.
Copyright © 2002 by Elsevier Science Ltd.
All rights of reproduction in any form reserved.
ISBN: 0-7623-0887-7
the parameters of the offering. A growing body of empirical literature analyzes
the observable activities of the underwriter and documents the factors that
affect the relationship between the issuer and investors in an IPO. This paper
examines the competing objectives of each party in the IPO process and
empirically documents the role the underwriter plays in balancing the differing
financial objectives of issuer, and investors. Specifically, we examine the costs
and benefits of the underwriter’s attempts to gather information to help issue a
successful offering. Further, we show how the financial incentives of each
participant are satisfied, either wholly or in part, given the other parties to the
transaction. Finally, we also show the effects of market fads on the adjustment
of pricing terms and on the short-run and long-run performance.
When a private firm is considering an equity offering, it must first interview
underwriting firms and select the appropriate investment bank to provide
advising and underwriting services. Once selected, the underwriter, in
conjunction with other advisers (accounting, legal, etc.), formulates a strategy
for the issuer to offer equity securities to the market. The first administrative
step in the process involves preparing and filing a registration statement. In
addition to detailed discussion of the issuer’s business operations and financial
condition, the underwriter and the issuer must agree on their first estimate of
the offering terms, including the offer price range and number of shares that the
issuer plans to offer. The period of time between filing of the registration
statement and the actual offering of securities is called “waiting period”.
During the waiting period, the underwriter assumes a special responsibility
to market the offer to the investment community and attempt to determine the
demand for the securities offered. Especially, for firm commitment offerings,
the underwriters bear the proceeds risk in case the issuance may fail.
Interestingly, the information the underwriter is seeking both from the market
and from the investors will lead to changes in the terms of the offer that
potentially may have an adverse affect on the investors’ financial situation. For
example, assume that the terms of the offer filed in the registration statement
are attractive to the investors considering the offer. If the investors
communicate their strong intent to purchase the offering, the underwriter then
knows that the terms of the offer can be adjusted to increase the price and/or
the number of shares offered.
In this paper, we examine the benefit of the issuer, and investors in an
attempt to document the role of information acquisition activities prior to
issuance and IPO long-run performance with respect to the information
received during the waiting period. We find that issuers benefit from the
underwriter’s activities because the benefits of higher proceeds when demand
is strong (positive information) are larger than when demand is weak (negative

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