The Impact of Uncertainty in the Text of S-1 Forms on IPO Underpricing

This paper investigates the theory of information asymmetry in terms of the impact of uncertain, negative and weak-modal tone in the text of registration forms S-1 on the underpricing of initial public offerings of U.S. companies in the period from 2000 to 2020. We analyze the tone of both the full text of the prospectus and the texts of four separate chapters – “Prospectus Summary”, “Risk Factors”, “Use of Proceeds”, and “Management's Discussions and Analysis (MD&A)”. To account for fundamental differences between the two sectors of the economy, separate linear regression models are estimated for high-tech and non-tech firm samples. We find no support for the signaling theory of information asymmetry in terms of the effect of uncertainty in the text of prospectuses on IPO underpricing: we find a negative relationship between the share of uncertainty in the entire text of Forms S-1 and IPO underpricing and a positive relationship bet­ween underpricing of non-technology companies and the negative tone of the “Risk Factors” and “Use of Proceeds” chapters of Registration Forms S-1. No significant effect of low-modal tone on IPO underpricing was found. The results may suggest that uncertainty cautions market participants against investing in IPOs, while a negative tone may, on the contrary, attract investors if a low stock price is set to compensate for the risks. The study also uses machine learning models: random forest and boosting the results of which show an increase in the predictive power of the models when textual characteristics of S-1 forms are taken into account. When variables were ranked by their importance in the random forest model, the top ten most important variables included three textual variables of prospectus tone, which confirms the need to take into account the textual information contained in registration forms when analyzing underpricing. The results of the paper contribute to a better understanding of the factors of underpricing of public offerings, which can be useful for company managers in the preparation of IPO and its pre-documentation to reduce the probability of underpricing and attract the desired amount of capital, as well as for investors making decisions about investing in IPO shares.