IPO underpricing and international corporate governance

It is well established that a link exists between a country's legal system and the size, liquidity, and value of its capital markets. We study how differences in country-level governance affect the underpricing of initial public offerings (IPOs). Examining 4462 IPOs across 29 countries from 2000 to 2004, we find the surprising result that underpricing is higher in countries with corporate governance that strengthens the position of investors relative to insiders. We conjecture that when countries give outsiders more influence, IPO issuers underprice more to generate excess demand for the offer, which in turn leads to greater ownership dispersion and reduces outsiders’ incentives to monitor the behavior of corporate insiders. In other words, underpricing is a cost that insiders pay to maintain control in countries with legal systems designed to empower outsiders. Consistent with this control motivation for underpricing, we find that underpricing has a negative association with post-IPO outside blockholdings and a positive association with private control benefits. In addition, firms whose insiders are entrenched either by majority ownership or by dual-class structures do not underprice more in countries with better governance. In these firms the ownership structure protects managers from outside influence, eliminating the incentive to increase outside ownership dispersion through underpricing.