Retail Investor Attention and IPO Valuation

Published date01 September 2017
AuthorShantaram P. Hegde,Amedeo De Cesari,Hugh M. J. Colaco
Date01 September 2017
Retail Investor Attention and IPO
Hugh M. J. Colaco
Aston Business School, Birmingham B4 7ET, UK
Amedeo De Cesari
Alliance Manchester Business School, Manchester M15 6PB, UK
Shantaram P. Hegde
University of Connecticut, Storrs, CT 06269, USA
Given restrictions placed on communication with prospective investors, retail
investor attention can help rms/underwriters with the task of initially valuing an
IPO. Using Google search volume to proxy for retail investor attention, we nd
that the presence of and an increase in retail attention following initial ling but
prior to initial pricing are positively related to initial valuations. Our results are
robust to alternative matching methods to identify our matched sample of non-IPO
rms and to including several controls for institutional demand. We conclude that
retail investor attention plays a critical role in the early stages of IPO valuation.
Keywords: initia l public offering, e quity valuation, r etail investor, in vestor
JEL classification: G30,G32
1. Introduction
IPO valuation is challenging because of limited rm history and lack of presence in the
capital markets. While the offer price has the advantage of reecting institutional
We thank three anonymous referees, John Doukas (the Editor), Tim Jenkinson, Robert
Kieschnick, Jay Ritter, and participants at the 2013 European Financial Management
Association meetings (University of Reading, UK), 2013 Financial Management
Association meetings (Chicago, USA), 2013 India Finance Conference (Indian Institute
of Management, Ahmedabad, India), and 2014 Behavioural Finance Working Group
Conference (Queen Mary University of London, UK) for useful comments.
European Financial Management, Vol. 23, No. 4, 2017, 691727
doi: 10.1111/eufm.12113
© 2017 John Wiley & Sons, Ltd.
demand for the IPO, the initial valuation is at a signicant disadvantage since the
roadshow typically occurs later.
Moreover, restrictions are placed on communication
between issuers/underwriters and prospective (mostly institutional) investors prior to
setting the initial price range. In this environment, rms and underwriters may be
dependent on other sources of information to initially value an IPO.
Retail investor
attention, a precursor of retail demand for shares, may be one such source. For example,
Demos and Dembosky (2012) report that unusually strong demand from retail investors
was one factor inuencing the upward valuation of Facebook, Inc.s IPO price in 2012.
The objective of this paper is to examine the inuence of retail investor attention on
initial IPO valuation.
The importance of initial valuation to rms and underwriters is highlighted in Hanley
and Hoberg (2010, p. 2,826), who argue that signicant resources are expended by a rm
and its underwriters and legal counsel to acquire information about the IPO, which
results in a more precise initial valuation relative to the nal valuation; as a result, the
rms dependence on bookbuilding is reduced. The implication in Hanley and Hoberg
(2010) is that institutional interest is not available before the ling of the initial price
range. Furthermore, Kim and Ritter (1999, p. 411) posit that accounting information and
comparable rm multiples alone are not sufcient to ensure accurate pricing when
determining the initial price range. Rather, the markets demand for the IPO helps to
improve pricing accuracy.
Prior to the passage of the Jumpstart Our Business Startups (JOBS) Act in 2012 in the
United States (US), Section 5 of the Securities Act of 1933 did not allow issuers and
underwriters to communicatewith investors before the ling of a preliminary registration
statement. Moreover, Rule 15c2-8 of the Securities Exchange Act of 1934 imposed
restrictions on issuers and underwriters that prevented them from soliciting offers and
indications of interestfrom investors before the ling of a prospectus containingan initial
price range(Practical Law, 2014). As a result, US rms and underwritershave been unable
to engage in oral and written communication to a signicant extent with prospective
investorsbefore the initial price range is led (Latham and Watkins,2014). Several studies
documentthat institutional investor demand is not ofciallyavailable when the initial price
range is set (Hanley,1993, pp. 231232; Ljungqvist and Wilhelm,2002, p. 178; Wang and
Yung, 2011, p. 302; Chuluun, 2015, footnote 7).
In this restricted information environment, retail investor attention may contain
valuable clues about latent investor demand for the IPO that could help rms and
The initial valuation typically occurs in the form of a price range. The midpoint of the initial
price range (i.e., average of high and low prices) is used as an unbiased estimator of nal
valuation (offer price) by many studies, including Hanley (1993), Loughran and Ritter
(2002), and Bradley and Jordan (2002). However, Lowry and Schwert (2004) nd that public
information is not fully incorporated into the initial price range although the economic
signicance is small. Many studies focus on valuation based on the offer price (e.g.,
Purnanandam and Swaminathan, 2004; Houston et al., 2006).
Given that valuing an IPO is an inherently complex activity that is more of an art than a
science, underwriters generally rely on a wide set of variables to assess market conditions and
investor demand for an issue (McCarthy, 1999). For instance, Internet IPOs are sometimes
valued using criteria such as web trafc, number of page views per user, and number of
engaged shoppers (Rueda, 2001).
© 2017 John Wiley & Sons, Ltd.
692 Hugh M. J. Colaco, Amedeo De Cesari and Shantaram P. Hegde
underwriters initiallyvalue an IPO. Retail investors areallocated a reasonably large block
of IPO shares.
Furthermore, Barber and Odean (2008) posit that retail attention is
importantbecause it may be a precursor of retail demand for shares inthe aftermarket. As a
result, incorporating retail attention could lead to more appropriate valuations for newly
public rms and reduce the need for underwriters to engage in costly price stabilisation
activities when tradingbegins (Chowdhry and Nanda, 1996). The attention paidby retail
investors to a going-public rm may reect the intrinsic quality of the rms IPO and
convey genuine information that the rm and its underwriters can use when setting the
rms IPO valuation. At the sametime, even if retail attention is inuenced by investors
behavioural biases, theresulting irrational retail investor demand couldstill be taken into
account by rational rms and underwriters in the IPO valuation process.
Based on a sample of 185 US IPOs from 2004 to 2007, Da et al. (2011) nd a
signicant upward trend in Googles search volume index (SVI) a proxy for retail
investor attention
beginning two to three weeks before the IPO week, followed by a
signicant jump in SVI during the IPO week, indicating an increase in retail attention
towards the stock.
The SVI, however, reverts to its pre-IPO level two to three weeks
after the IPO, an indication that retail attention is not permanent.
We examine the relationship between retail investor attention (proxied by SVI) and
initial IPO valuation as measured by Price-to-Sales,Price-to-Assets, and Price-to-
EBITDA. Each of the three valuation measures is captured for an IPO rm relative to that
of a matched rm. We are specically interested in examining how the presence of and
change in retail attention following the initial ling (S-1, or equivalent) are related to the
initial valuation, which is typically presented for the rst time in a later amended ling
(S-1/A, or equivalent) with the Securities and Exchange Commission (SEC).
The initial
Aggarwal et al. (2002) nd that institutional investors are allocated a median of around
three-quarters of the shares offered in an IPO, implying that retail investors get the remaining
one-quarter. More recently, Demos and Light (2013) state that typically less than a third of
IPO shares are set aside for retail investors.
Using retail order execution from SEC Rule 11Ac1-5 (Dash-5) reports, Da et al. (2011) nd
a strong link between changes in SVI and retail investor trading. Furthermore, this link is
stronger for market centres that attract less sophisticated individual investors. Other recent
papers that rely on this proxy for attention are Doukas et al. (2016), Dimpand Jank (2016),
Vozlyublennaia (2014), Bae and Wang (2012), and Drake et al. (2012).
We are not claiming that Googles SVI is the only proxy for retail attention or that this proxy
is used by issuers and underwriters and is available to them in a timely way to price an IPO.
Retail attention could be estimated in alternative ways, for instance, by using information on
informal inquiries from retail customers of the underwriter, on the customer base of the issuer
(e.g., number of customers, customer loyalty and satisfaction, wealth of the average
customer, and likelihood that the average customer trades stock), and on web trafc on the
issuers website. It is likely that Googles SVI is correlated with alternative measures of retail
attention that issuers and underwriters may use. If not, we would not be able to report
signicant ndings in our study.
To clarify terminology used henceforth, the date on which the initial ling is led with the
SEC is referred to as the ling date. Similarly, the date on which the initial valuation (or
initial pricing) is led with the SEC is referred to as the pricing date.Byequivalent,we
mean other ling types (e.g., SB-2 and SB-2/A) that satisfy our screening criteria.
© 2017 John Wiley & Sons, Ltd.
Retail Investor Attention and IPO Valuation 693

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