I Part

When companies grow sufficiently large, they can raise funds by trading
their shares to public. As Zingales (1995) pointed, its much easier for
investors to spot a company when its public. Moreover, by selling its
shares to public, a company facilitates its acquisition at a higher value
(Brau, et al., 2003). However, as Ritter & Welch (2002) show in their
research, in the period 1990-2001, companies on their first day of trading
had on average an 18.8% increase in their stock price. In other words,
the difference between the closing price of IPO day and the offer price of
IPO which is called underpricing was 18.8% on average. This paper will
analyse what makes entrepreneurs to underprice their stocks IPO. As
well the analysis will check if the degree of underpricing is correlated
with the proximity of companies headquarters and NYSE or with the
R&D expenses of companies. For analysis are used 20 non-financial US
companies from the given set of data what had their IPO day in the
period between 2004-2014.
IPO Date Company Name SIC Distance Underpricing R&D
code from NY intensity
(km)
14/12/2006 Isilon Systems 3572 3869 77.69% 12.06%
14/03/2007 BigBand 7373 4129 30.77% 23.73%
Networks
21/04/2008 Intrepid Potash 1400 2621 57.50% 0.00%
29/06/2010 Tesla Motors 3711 4123 41.06% 24.09%
04/01/2011 GNC Holdings 5400 507 4.69% 0.02%
19/05/2011 LinkedIn 7370 4120 109.44% 15.13%
25/05/2011 Active Network 7372 2208 6.00% 11.14%
(The)
26/05/2011 Spirit Airlines 4512 1739 0.92% 0.00%
19/01/2012 Renewable 2990 1642 1.00% 0.00%
Energy Group
08/05/2012 Facebook 7370 4126 0.61% 9.26%
13/12/2012 SolarCity 3620 4134 47.38% 0.00%
16/04/2013 Fairway Group 5411 0 23.93% 0.00%
Holdings
10/10/2013 MacroGenics 2836 324 56.19% 37.03%
10/01/2014 GlycoMimetics 2836 324 12.63% 34.18%
28/02/2014 Varonis Systems 7372 0 100.00% 17.91%
13/03/2014 Castlight Health 7370 4133 148.75% 10.26%
26/06/2014 Imprivata 7372 950 8.33% 21.82%
05/11/2014 Xenon 2836 3898 16.67% 6.71%
Pharmaceuticals
12/11/2014 Axalta Coating 2851 129 6.41% 0.79%
Systems Ltd
12/12/2014 Hortonworks 7372 4111 64.88% 14.75%

As the table shows, the underpricing calculated with the formula 1 varies
from 0% to more than 100% for some companies therefore, the
underpricing is caused by a set of factors (Kennedy, et al., 2006). One of
the main theory why IPOs are underpriced is asymmetric information
between the issuer and investors. If the issuer knows more than
investors, the lemon problem might appear and only issuers of worse
than average quality stocks will want to sell them for average price. As a
result, high quality firms, to signal their quality to market, sell their shares
on IPO day for a lower price than they actually are. With time, these
companies will recover costs by seasoned issues and by increase in
shares price in response to good news like dividends announcements
(Ritter & Welch, 2002). However low quality companies will mislead
investors and will try to appear as well as high quality firms. Therefore,
investors are uncertain about how riskier IPOs are and how well they will
perform in the future. Beatty & Ritter (1986) demonstrated that The
greater is the ex-ante uncertainty about the value of an issue, the greater
is the expected underpricing. Hence, underpricing is considered a
coverage of the loss investors might have. To avoid the adverse
selection, informed investors research the true value of a company they
want to invest in but they incur some costs. Consequently, they require
Closing price of the1 st dayOffer price of the 1 st day
1 100 =IPO Underpricing
Offer price of the 1 st day
more money on the table to cover these costs. As a result, companies
underprice their shares on IPO day so investors will earn enough profit in
the future to recover the loss on research (Kennedy, et al., 2006). For
uninformed investors that dont acquire any information and buy a big
amount of overpriced stocks during IPOs, underpricing is acting as a
form of compensation for the adverse selection and avoids uniformed
investors from winners curse (Levis, 1990). In addition, Ritter & Welch
(2002) said that firms underprice their IPOs in order to make the
underwriters to put the maximum effort in selling shares. Moreover, the
monitoring of underwriters doesnt occur without costs so its normal for
issuers to permit underpricing. Theories of underpricing based on
asymmetric information suggest that the more asymmetric information
exists, the more underpriced IPOs are. However, recent researches in
underpricing explore the role of firms proximity compared to the stock
exchanges and investors location as well as the level of R&D expenses
of companies. For this analysis was used the website
http://www.distancefromto.net2 to calculate the distance between
selected companies headquarters and NYSE. For the R&D intensity
calculation was used the next formula:

ResearchDevelopment expenses
100 =RD Intensity
Total Assests

As the given set of data contained R&D expenses and Total Assets,
using Excel were found R&D intensity as well as correlation of
underpricing with this 2 factors: distance and R&D intensity. The graphs
and the table below show that both the distance and R&D have a
positive correlation with underpricing.

2 The website uses Vincentys (Appendix A) formula to calculate the distance between 2
points on the surface of a spheroid.
Correlation Distance R&D Intensity
Underprcing 0.341932619 0.186494121

Underpricing/Distance Correlation
4500
4000
3500 R = 0.12
3000
2500
Distance KM 2000
1500
1000
500
0
0.00% 50.00% 100.00% 150.00% 200.00%

UNDERPRICING%

Underpricing/R&D correlation
40.00%
35.00%
30.00%
25.00%

R&D % 20.00%
15.00% R = 0.03
10.00%
5.00%
0.00%
0.00% 50.00% 100.00% 150.00% 200.00%

UNDERPRICING %

Nielsson & Wjcik (2016) have shown that rural IPOs are less
underpriced because local investors tend to invest in these stocks a big
amount of their portfolio due to superior local information. Investors that
are further from companies headquarters know less about firms as their
access to information is limited and they require a bigger return in form
of underpricing.

Word count: 684

II Part

Bibliography
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Kennedy, D. B., Sivakumar, R. & Kenneth R. Vetzal, 2006. The implications of IPO
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Levis, M., 1990. "The Winner's Curse Problem, Interest Costs and the Underpricing
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Appendix A
Vincenty's formulae are two related iterative methods used in geodesy to calculate
the distance between two points on the surface of a spheroid, developed by
Thaddeus Vincenty (1975a) They are based on the assumption that the figure of the
Earth is an oblate spheroid, and hence are more accurate than methods that assume
a spherical Earth, such as great-circle distance.
The first (direct) method computes the location of a point that is a given distance and
azimuth (direction) from another point. The second (inverse) method computes the
geographical distance and azimuth between two given points. They have been
widely used in geodesy because they are accurate to within 0.5 mm (0.020) on the
Earth ellipsoid.