Underwriter Reputation and IPO Pricing and Performance: New Zealand Evidence, 1990–2009

This paper examines the initial and aftermarket performance of new issues of common equity in New Zealand offered to the public between 1990 and 2009. In addition, the paper tests whether there is a systematic relationship between underwriter reputation, underpricing and subsequent long-term performance in the New Zealand initial public offering (IPO) industry. The results confirm the empirical regularity that the average initial return on IPOs is positive (10.80%). The aftermarket excess returns, measured by comparing the returns on new issues and returns on a benchmark made up of matched companies over periods of one and three years were found to be negative in several years. On average, the new issues significantly underperform the market from one to three years, resulting in substantial losses to investors. This supports a recently advanced theory which posits that IPO underpricing is a consequence of investor overreaction in early aftermarket trading. In addition, I demonstrate that there is a monotonic relationship between the underpricing of an initial public offering and the uncertainty of investors regarding its value. The underwriting investment bank faces the risk of not filling an issue. The underwriter may seek to limit exposure by deliberately pricing issues below the expected value. Deliberate underpricing is shown to vary systematically with the level of investor uncertainty regarding issue value. I do not find any empirical support for the widespread notion that IPOs underwritten by more-prestigious investment banks experience significantly less underpricing. I find weak support for the idea that non-prestigious investment banks underwrite IPOs that perform worse in the long run, since IPOs underwritten by non-prestigious investment banks experience significantly larger negative excess returns one month after listing. This paper also investigates the effect of underpricing on the market share of investment banks that act as lead managers in IPOs. I support Beatty and Ritter’s (1986) argument that investment bankers who have reputational capital at stake enforce underpricing equilibrium. Most active underwriters in New Zealand maintain the apparent underpricing equilibrium over the sample period. An investment banker who violates underpricing equilibrium by underpricing “too little” loses potential investors and thus forfeits the value of its reputation capital. Consequently, the investment banks identified which violate equilibrium and engage in opportunistic underpricing behaviour are relatively inactive in the IPO market