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Allocations, Adverse Selection and Cascades in IPOs



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Allocations Adverse Selection and Cascades in IPOs Evidence from Israel Yakov Amihud1 Shmuel Hauser2 and Amir Kirsh3 October 2001 Comments are welcome 1 Ira Leon Rennert Professor of Entrepreneurial Finance Stern School of Business New York University 2 Associate Professor School of Management Ben Gurion University 3 PhD Student Faculty of Management Tel Aviv University We thank Amir Barnea Eli Berkovitch Iftekar Hasan Alexander Ljungqvist and Oded Sarig for helpful comments and suggestions The research was partially financed by the Israeli Institute for Business Research Recanati Graduate School of Business Tel Aviv University We thank Dorit Korner for research assistance and the Library of the Tel Aviv Stock Exchange for providing data on IPOs 1 Abstract This paper examines three theories of IPO underpricing using data from Israel where the allocations to subscribers are equally prorated and publicly known Rock s 1986 theory of adverse selection is supported subscribers receive greater allocations in overpriced IPOs And while the average IPO excess return is 12 the simulated allocationweighted return to uninformed investors is slightly negative Welch s 1992 theory of information cascades is supported by the pattern of allocations demand is either extremely high or there is undersubscription with very few cases in between Finally the theory that underpricing is a means to increase ownership dispersion is tested using data on accepted subscriptions and obtains a strong support 2 1 Introduction Stocks issued in IPOs appear to be underpriced they earn an average positive return immediately following the IPO This phenomenon has been documented in many countries 1 This paper tests three theories of underpricing in IPOs by using data from the Tel Aviv Stock Exchange TASE which make these tests feasible In addition a number of other explanations of underpricing which are not feasible in Israel are excluded The high positive returns observed in IPOs cannot be earned in



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