Executive Stock Options and IPO Underpricing

In about one-third of US IPOs between 1996 and 2000, executives received stock options with an exercise price set equal to the IPO offer price (rather than a price determined by the market). Among firms with such “IPO options”, 58 percent of top executives receive a net gain from underpricing, meaning the gain from IPO options exceeds the loss from the dilution of their pre-IPO shareholdings. If executives can influence the IPO offer price, we expect a positive relation between these IPO options and underpricing. Alternatively, executives may be able to influence the timing and terms of their stock options, and this would similarly predict a positive relation between IPO options and underpricing. However, we fail to find any evidence of such a relation. Our results run counter to the emerging literature claiming that managers blatantly take self-serving actions to improve their personal welfare at shareholder expense.

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