Institutional Investor Presence, Underpricing and Flipping Activity - Empirical Findings from Western European Exchanges

Abstract

Purpose: This undergraduate thesis examines IPO pre-market demand as a predictor of total institutional investment (pre-IPO institutional owners maintaining their stake + institutional allocation). It also aims to investigate institutional owners’ effect on underpricing and overall flipping. Theoretical evidence: A number of studies have observed underwriters favouring institutional investors in initial share allocation of popular, ‘hot’ IPOs. This is especially controversial considering that pre-market demand is often followed by higher initial returns. A number of theories have sprung up, trying to explain what amount of favouring as well as underpricing that could be justified, and why. But because of restricted data access, empirical research in the field has been limited. Institutional investors are also expected to flip less as well as induce less flipping in retail investors, another assumption that could be highly misleading without proper empirical evidence. Furthermore, the literature on flipping suffers from similar data problems. Methodology: Institutional ownership as reported in the first public filing, less percentage change, is used as an approximation for initial interest, labelled institutional presence. The percentage is also used to examine the effect it has on underpricing. Finally, institutional presence and other variables are regressed against a common flipping proxy, as well two novel variations of it. We analyse a sample of 110 Western European IPOs as well as an interview with a Swedish investment banking analyst. Empirical findings: Pre-market demand significantly predicts underpricing (dependent on what variations of the variables that are observed) but not institutional presence (p=5.4%). Underpricing is not predicted by institutional presence nor does a larger model render significance in the relationship. Flipping activity is not predicted by institutional presence either, defying signalling theory and supply-&-demand theory. Conclusions: Institutional favouring in the share allocation of hot IPOs does not seem to translate into total institutional presence. The efficacy of proxies based on public information is discussed as well as current theories about institutional ownership, underwriters’ allocation decisions, and underpricing.