Anatomy of Initial Public Offerings of Common Stock

Initial public offerings of common stocks are typically underpriced . In this paper, the author develops and tests the hypothesis that underpricing serves as a form of insurance against legal liabili ty and the associated damages to the reputations of investment banker s. The empirical results, based on samples of initial public offering s of common stocks that were brought to the market before and after t he Securities Act of 1933, provide considerable support for the impli cit insurance hypothesis. Specifically, gross underpricing and market segmentation between prestigious and fringe investment bankers in or iginating unseasoned new issues appear to be peculiar to the post-193 3 era. Copyright 1988 by American Finance Association.

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