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5. Evidence on Theories Where there are Future Benefits to Underpricing

In contrast, the evidence is consistent with symmetric information models when there is a future

benefit to underpricing. We discuss three such models here. In these models, both the issuers and the

investors know the degree of underpricing in advance, which is consistent with our evidence. For each

model, there is one additional piece of corroborating evidence. First, in Booth and Chua’s (1996) model,

issuers deliberately underprice to achieve ownership dispersion. This creates more market liquidity and

future benefits from the resulting lower required return of investors. Consistent with this model, Google’s

prospectus states that, counter to its primary goal of price stability, it may have chosen to underprice its

shares deliberately to “achieve a broader distribution of our Class A common stock” (final prospectus, p.

38). Second, Tinic (1988) and Hughes and Thakor (1992) model underpricing to avoid potential future

lawsuits that may result if prices fall dramatically after the IPO. Consistent with this model, Google’s

prospectus goes on to state that it may have chosen to underprice its shares deliberately to “potentially

reduce the downward price volatility in the trading price of our shares in the period shortly following our

offering relative to what would be experienced if the initial public offering price were set at the auction

clearing price” (final prospectus, pp 38-39). Finally, Welch (1989) argues that high quality firms will

underprice IPO’s deliberately to signal firm quality and drive bad firms from the market in a fully

revealing separating equilibrium. They will recoup their losses in subsequent secondary offerings. The

evidence that both Google (from the estimated demand curve) and outsiders (from the prediction markets)

knew that Google would be underpriced is consistent with the fully revealing equilibrium. Also

consistent with this model, Google made a secondary offering on September 14, 2005 at a price of $295

per share, raising more than $4.18 billion. Thus, the overall evidence is consistent with Google

deliberately underpricing by an amount known to both investors and the issuer in exchange for future

benefits. Overall, the evidence is consistent with Ritter and Welch’s (2002) sentiment that underpricing is

not caused by asymmetric information between the issuer and investors.


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