| Share overhang refers to shares retained (relative to total shares offered) by insiders of an issuing firm in an initial public offering (IPO). Previous studies find that share overhang is positively related to IPO underpricing and that both share overhang and underpricing have increased over time. As share overhang has increased, however, the relative accuracy of initial return as a measure of issuer opportunity cost has decreased, yet there appears to be no existing empirical literature that accounts for this change. Therefore, I derive and test a measure of the true opportunity cost of issuance ( OCI), as well as a measure of overhang that is denominated in dollars rather than shares, which I refer to as "economic overhang."; I find that OCI is much lower than the traditional initial return measure suggests, particularly in more recent periods when share overhang is higher. I also find that variables previously found to be related to underpricing are not as significantly related to OCI, and, in some cases, these variables have different relations to OCI than to underpricing, suggesting that previous studies may have come to incorrect conclusions as a result of the mismeasurement of true issue costs.; Previous studies also find that underpricing has increased over time, and much debate has surrounded potential explanations for this phenomenon. I add insight to this question by examining decomposed initial return, where initial return is equal to the product of OCI and economic overhang. Compared to underpricing, OCI has changed relatively little over the 1986 to 2000 time period, and I find that the small increase in OCI is generally consistent with a change in composition of issuing firms. Thus, based on the decomposition of initial return, the only remaining explanation for the large increase in underpricing is the increase in economic overhang, which I suggest may be consistent with a realignment of incentives and a change in the objective function of preexisting owners. |
