Underpricing, share retention, and the IPO aftermarket liquidity

Purpose – To test the effects of underpricing and share retention (i.e. the proportion of shares retained by the pre-initial-public-offering (IPO) owners) on IPO aftermarket liquidity. Design/methodology/approach – Uses both percentage spread and turnover ratio to measure liquidity. The percentage spread is the quoted bid-ask spread divided by the quoted midpoint and measures the trading cost relative to share price. Turnover ratio is the daily trading volume divided by the number of shares offered and measures the speed of transaction. Both non-parametric analyses and multiple regressions are conducted to investigate the effects of underpricing and share retention on liquidity. Findings – Results indicate that initial return is positively related to turnover ratio and negatively related to percentage spread. These relations are significant even after controlling for other factors. Also finds that the pre-IPO owners’ retention rate is positively related to turnover ratio and negatively related to percentage spread. High retention rates attract more trades, provide quality assurance, and improve IPO aftermarket liquidity. Originality/value – This paper investigates the theoretical links between underpricing and liquidity and provides direct evidence on Booth and Chua's liquidity theory. In addition, this is one of the first empirical studies to analyze the effect of share retention on aftermarket liquidity.