Bigger pie, bigger slice: liquidity, value gain, and underpricing in IPOs

Since investor participation is essential for successful IPOs, we hypothesize that issuers share value gain from IPOs with IPO investors, resulting in IPO underpricing. We test the positive relation between value gain and underpricing from the liquidity angle, as improved liquidity via IPO increases firm value. We find supporting evidence that underpricing is positively related to the expected post-IPO liquidity of the issuer. Using two regulation changes as exogenous shocks to share liquidity before and after an IPO, we show that underpricing is more pronounced with better expected post-IPO liquidity or lower pre-IPO liquidity.