Electronic copy available at: http://ssrn.

com/abstract=890859








Heterogeneous Beliefs, Short Sale Constraints, and the
Economic Role of the Underwriter in IPOs

Thomas J. Chemmanur

and
Karthik Krishnan

Current version: November 2009

Professor of Finance, Carroll School of Management, Boston College, 440 Fulton Hall, Chestnut Hill,
MA 02467. E-mail: chemmanu@bc.edu. Phone: (617) 552-3980. Fax: (617) 552-0431.

Assistant Professor of Finance, College of Business, Northeastern University, 414C Hayden Hall, 360
Huntington Ave., Boston, MA 02115. E-mail: k.krishnan@neu.edu. Phone: (617) 373-4707, Fax (617) 373-
8798

For helpful comments and discussions, we thank Douglas Cook, Iraj Fooladi, Elena Loutskina, Gang Hu,
and seminar participants at Boston College, Babson College, Dalhousie University, the 2008 FIRS
conference, the 2008 European Finance Association annual meetings, the 2007 Financial Management
Association annual meetings, and the 2007 Eastern Finance Association annual meetings. We would like to
thank Jay Ritter for providing data on founding dates of IPO firms on his web-page.
Electronic copy available at: http://ssrn.com/abstract=890859







Heterogeneous Beliefs, Short Sale Constraints, and the
Economic Role of the Underwriter in IPOs






Abstract

Several theoretical papers have argued that the valuation of equity will reflect the beliefs of the most
optimistic investors and be at a premium over intrinsic value when rational investors subject to short sale
constraints have heterogeneous priors. We test the above theories by analyzing the effect of IPO underwriter
reputation on the heterogeneity in investor beliefs and the tightness of short sale constraints and consequently
on equity valuation in IPOs. We propose a market power hypothesis, postulating that higher reputation
underwriters are able to attract a greater number of higher quality market participants (such as institutional
investors, analysts, and co-managing underwriters) to the IPOs backed by them, thereby yielding higher IPO
valuations by increasing the heterogeneity in investor beliefs and the tightness of short sale constraints. We
empirically distinguish between the above hypothesis and the certification hypothesis, which implies that
higher reputation underwriters are associated with IPOs priced closer to intrinsic value. We find that equity
in higher reputation underwriter backed IPOs are priced higher and further away from intrinsic value
compared to lower reputation underwriter backed IPOs; this result is robust to controlling for endogenous
matching between higher reputation underwriters and higher quality issuers. We show that the above
relationship between underwriter reputation and IPO valuation is driven by the greater heterogeneity in
investor beliefs, tighter short sale constraints, and greater participation by institutional investors, analysts,
and higher reputation co-managing underwriters that characterize higher reputation underwriter backed IPOs.
Overall, our results support the market power hypothesis and reject the certification hypothesis.





JEL classification: G24
Keywords: Investment banks, Underwriter reputation, IPOs



Electronic copy available at: http://ssrn.com/abstract=890859

1

1. Introduction
Starting with Miller (1977), the effect of heterogeneity in investor beliefs on the valuation of equity has
been the subject of considerable debate among financial economists. In particular, formalizing Millers (1977)
intuition, Harrison and Kreps (1978) and Morris (1996) have shown that the equity of firms will reflect the
valuation of the most optimistic investors (and will sell at a premium over their fundamental value) when
rational investors subject to short sale constraints have heterogeneous prior beliefs (see also Duffie, Garleanu,
and Pederson (2002) and Chen, Hong, and Stein (2002)). Given that firms going public have a very sparse track
record publicly available to investors, the equity of IPO firms are likely to be characterized by a higher degree of
heterogeneity in investor beliefs and therefore provide a particularly appropriate context to test the implications
of heterogeneous beliefs theories of equity valuation. Existing empirical analyses of such theories have been
primarily in non-IPO settings (see, e.g., Chen, Hong, and Stein (2002), Geczy, Musto, and Reed (2002), Diether,
Malloy, and Scherbina (2002), and Nagel (2005)). The objective of this paper is to extend this literature to the
IPO setting by analyzing the role of heterogeneity in investor beliefs under short sale constraints on the
valuations of the equity of firms going public. In particular, we empirically analyze the implications of an
extended version of the Miller (1977) theory which explicitly incorporates the role of the underwriter in the
valuation of the equity of firms going public, both in the IPO and in the immediate secondary market.
Underwriters have a particularly important role to play in IPO valuation.
1
This is because, first, they set
the IPO offer price after ascertaining the views of investors on their valuation of the IPO through the book
building process. Second, participation by a highly reputable underwriting syndicate may affect the beliefs of at
least some investors about the future prospects of the IPO firm. We therefore focus on the economic role of the
underwriter in affecting the heterogeneity in investor beliefs and the extent of short sale constraints faced by
IPO firms, which in turn, will affect the valuation of equity in the IPOs that they underwrite. The economic role
of the underwriter in IPOs has become a particularly relevant topic of study in light of the recent empirical
evidence that the relationship between underwriter reputation and IPO underpricing has reversed. While earlier

1
While we focus on the role of underwriters in IPO valuation in the current paper, investment banks may also play an
important role in the valuation of firms in acquisitions, and therefore in a firms choice between IPOs and acquisitions.
Some of the arguments we make in this paper regarding the role of underwriters in IPOs may have implications for the
above choice as well. See, e.g., Poulsen and Stegemoller (2008) for an analysis of a firms choice between IPOs and
acquisitions.

2

evidence documented that IPOs underwritten by higher reputation investment banks were characterized by a
smaller extent of underpricing, more recent evidence indicates that IPOs underwritten by higher reputation
underwriters are characterized by greater underpricing: see, e.g., Beatty and Welch (1996), Loughran and Ritter
(2004), and Cooney, Carter, Dark, and Singh (2001) who find that the average underpricing has gone from being
smaller for higher reputation underwriters in the 1980s to being larger for higher reputation underwriters in the
1990s.
In explicitly incorporating the role of the underwriter in the Miller (1977) setting, we conjecture that
underwriters are motivated to obtain the highest possible valuations for the equity of firms they take public by
making use of their long-term relationships with various participants in the IPO market (institutional investors,
analysts, and co-managing underwriters). These relationships enable them to attract greater participation by
these market players in the IPOs of firms backed by them, leading to higher valuations for the equity of these
firms (both in the IPO and in the secondary market).
2,3
Participation by a larger number of higher quality market
participants (i.e. higher reputation co-managers and a larger number of institutional investors and analysts) may
make retail investors more optimistic about the IPO firms prospects, thereby increasing the heterogeneity in
investor beliefs about the firm. For example, Welch (1992) shows that later investors in a firms IPO will
optimally ignore their private information and buy shares in the IPO offer after becoming more optimistic about
the IPO firms prospects if they observe strong demand from earlier investors for these shares.
4
In our context,
greater participation by institutional investors in a firms IPO and more favorable coverage by analysts (some of
whom may be affiliated with the lead underwriters or the co-managers of the IPO) may make retail investors
more optimistic about the IPO firm. This increases the heterogeneity in investor beliefs which in turn may lead
to higher valuations, both in the IPO and in the immediate aftermarket, based on arguments made by Miller
(1977) and others discussed earlier. Further, since higher reputation underwriters can be more effective at

2
Underwriters may be motivated to obtain the highest possible share price for the IPO firm for two reasons. First, their
gross spread revenue per share is proportional to the IPO offer price. Second, successfully obtaining higher IPO proceeds
will increase the underwriters reputation with subsequent issuers leading to higher future revenues.
3
In addition to the other mechanisms along the lines discussed here in the context of IPO valuations in the immediate
aftermarket, higher reputation underwriters can also provide better aftermarket price support for the IPOs they underwrite:
see, e.g., Boehmer and Fishe (2004), who document the important role of the lead underwriter in providing price support to
the equity of IPO firms in the aftermarket.
4
Consistent with this, in their survey of the diffusion of interest among institutional and retail investors, Shiller and Pound
(1989) found that 44% of investors who bought shares in a firms IPO did so because someone they knew of bought stock
in the company.

3

limiting the extent of short selling in the equity of the IPO firm by investors, we expect short sale constraints to
be tighter (more binding) for IPOs backed by higher reputation underwriters.
5
In summary, the greater
heterogeneity in investor beliefs and tighter short sale constraints associated with higher reputation underwriters
will lead to a higher valuation of the firm in the IPO as well as in the immediate secondary market.
6
We will
refer to the above hypothesis as the market power hypothesis.
7

The above hypothesis contrasts with the prevailing view that the underwriter acts as a certifying
intermediary who produces information about the intrinsic value of the firm in an IPO market characterized by
asymmetric information between firm insiders and outsiders. Since information production is costly (and
therefore characterized by moral hazard), underwriters have a short-term incentive to sell the equity of firms
they take public at a price higher than their intrinsic value. However, underwriters have reputation at stake with
investors, mitigating this moral hazard problem in information production, thereby inducing them to price equity
in IPOs consistent with intrinsic value (see, e.g., Chemmanur and Fulghieri (1994)). This means that the
certification hypothesis has implications dramatically different than the market power hypothesis for the pricing
of IPOs: while the certification hypothesis implies that higher reputation underwriters price equity in IPOs
backed by them closer to intrinsic value due to their concern for preserving reputation in the IPO market, the
market power hypothesis implies that higher reputation underwriters would price this equity higher and further
away from intrinsic value.
We choose to study IPO valuation ratios (i.e., the ratio of primary and secondary market IPO stock
valuations relative to their intrinsic value) rather than IPO underpricing in our empirical analysis. This is
because underpricing simply reflects the price rise of a firms equity from the IPO offer price to the first day
closing price in the secondary market, so that it is affected not only by the price of the equity in the IPO, but also

5
Underwriters can limit short sales by restricting short sales by institutional investors to whom they allocate shares in the
IPOs underwritten by them. They can also restrict the lending of shares by brokerages or institutional investors for the
purpose of short selling, making use of various punitive mechanisms in the event of short selling (for example, restricting
allocations in future IPOs).
6
We are assuming here that the increase in the heterogeneity in investor beliefs is symmetric about the mean level of
investor beliefs about the firm. In such a setting, it can be shown using a formal theoretical model that the beliefs of the
marginal investor about the firm going public and therefore the valuation of the firms equity in the IPO and in the
immediate secondary market will be increasing in the heterogeneity in investor beliefs. While, due to space limitations, we
will not present a formal theoretical analysis here, the above results will follow from a model along the lines of Bayar,
Chemmanur, and Liu (2009).
7


This paper primarily focuses on the role of the lead underwriter in IPOs. Through the rest of the paper, we refer to lead
underwriters in an IPO as underwriters and explicitly refer to co-managing underwriters (co-managers) wherever necessary.

4

by the first day closing price of the equity in the secondary market. This implies that, for underpricing to be a
meaningful measure in any study of the economic role of underwriters in IPOs, one has to make the crucial (and
rather strong) assumption that the closing price of a firms stock on the first day of secondary market trading is
not affected by underwriter reputation and always equals the intrinsic value of that stock. Clearly, it is difficult
to assume that, in a setting with heterogeneous beliefs and short sale constraints, the price of an IPO firms
equity at the close of the first day secondary market trading will equal its intrinsic value (little information
regarding the future performance of the IPO firm is released between the time the IPO offer price is set and the
close of trading on the first day).
8

We use four sets of measures in our empirical analysis. The first measure we study is the ratio of the
valuation placed on the firm in the IPO (valuation at the offer price (OP)) to its intrinsic value (IV). The market
power hypothesis, which implies that the role of the underwriter is to obtain a higher valuation for firms in IPOs
(through increasing the degree of heterogeneity in investor beliefs about the IPO firm and by making short-sale
constraints more binding), suggests that the ratio of the IPO firm value to intrinsic value will be larger for
higher reputation underwriter backed IPOs than for lower reputation underwriter backed IPOs (H1A). On the
other hand, if the role of the underwriter in IPOs is that of certification, one would expect higher reputation
underwriter backed IPOs to be priced closer to intrinsic value than lower reputation underwriter backed IPOs, so
that this ratio will be closer to one for higher reputation underwriter backed IPOs (H1B).
The second measure we study is the ratio of the valuation placed on a firm at the close of the first
trading day in the secondary market (SMP) to its intrinsic value (IV). The market power hypothesis predicts that
this ratio will be higher for the IPOs of higher reputation underwriter backed firms than for the IPOs of lower
reputation underwriter backed firms (H2). This is because the valuation impact of backing by higher reputation
underwriters (through increasing the degree of heterogeneity in investor beliefs about the IPO firm and by

8
The empirical literature on the long run underperformance of IPOs (see, e.g., Ritter (1991)) also indicates that the closing
price of an IPO firms equity is not equal to its intrinsic value. This literature suggests that, if investors buy IPO shares at
the first trading day closing price and hold them for one to three years, they are likely to earn inferior returns compared to
similar investments in the equity of firms which have been public for some time. Apart from the above evidence provided
by academic studies, it is easy to see from casual observation that the opening day secondary market price of IPO shares is
significantly different from intrinsic value during some periods. One example is the internet bubble period of 1999-2000,
where a number of IPOs were priced far above their intrinsic value, only to climb much higher on the first day of trading in
the secondary market. It seems obvious (at least in hindsight) that while these IPOs were highly underpriced (in the sense
that their initial returns were very large), they were also significantly overvalued (relative to intrinsic value).

5

making short sale constraints more binding) can be expected to persist for some time after the IPO. Of course,
one would expect this valuation difference between higher reputation underwriter backed and lower reputation
underwriter backed IPOs to go down over time as hard information about the operating performance of the IPO
firm becomes available to investors. We therefore study the ratio of secondary market valuation to intrinsic
value at the end of one year, two years, and three years after the IPO. The market power hypothesis predicts that
price to intrinsic value ratio of IPOs backed by higher reputation underwriters and lower reputation underwriters
should converge to each other, and towards unity in the years after the IPO (H3A). On the other hand, given that
firm value is now determined by the equity market (once the firms shares start trading in the secondary market),
the certification hypothesis predicts that the secondary market price to intrinsic value ratio will not change over
time subsequent to the IPO (H3B).
The next two sets of measures we analyze are meant to study the channels through which, under the
market power hypothesis, higher reputation underwriters are able to obtain higher valuations for the firms
backed by them. The third set of measures compare the extent of participation by three important groups of
agents in IPOs backed by higher reputation underwriters versus those backed by lower reputation underwriters:
institutional investors, analysts, and co-managing underwriters. Under the market power hypothesis, we expect
the number (H4) and reputation (H5) of co-managing underwriters, institutional investor participation (H6), and
post-IPO analyst coverage (H7) to be greater for the IPOs of higher reputation underwriter backed firms relative
to those of lower reputation underwriter backed firms. More importantly, we expect that the greater the
participation of these market players in the IPO, the higher the valuation placed on the firms equity both in the
IPO and in the secondary market (H8).
The fourth set of measures relate to the relationship between underwriter reputation and the
heterogeneity in investor beliefs about the IPO firm as well as the relationship between underwriter reputation
and the tightness of the short sale constraints faced by investors when trading in the IPO firms equity. Under
the market power hypothesis, we expect the heterogeneity in investor beliefs to be greater for IPOs backed by
higher reputation underwriters (H9). Further, under the assumption that higher reputation underwriters are more
effective at limiting the extent of short selling in the equity of the IPO firm by investors, we expect short sale
constraints to be tighter (more binding) for IPOs backed by higher reputation underwriters (H10). Clearly,

6

greater the heterogeneity in investor beliefs and tighter the short sale constraints facing investors in the IPO
firm, higher the valuation of the firms equity, both in the IPO and in the secondary market (H11). Our empirical
predictions are summarized in Appendix 1.
We find that equity in higher reputation underwriter backed IPOs are priced higher and further away
from intrinsic value compared to lower reputation underwriter backed IPOs. One potential explanation for our
results is that they reflect endogenous matching between higher reputation underwriters and higher quality
issuing firms, based on unobservable value-relevant firm characteristics not captured by our valuation
methodology. To correct for this potential endogeneity, we use two endogeneity correction models; namely a
two stage least squares model and a treatment effects model. In the above analysis we instrument for underwriter
reputation using the average per-capita newspaper circulation in the states of firms that have previously used the
underwriter for their IPO over a five year period prior to the sample IPO date. We find that, even after
controlling for any such endogeneity, higher reputation underwriter backed firms are associated with higher IPO
and secondary market valuations. Thus, our result is robust to correction for endogenous selection between
higher reputation underwriters and firms based on unobservable firm and underwriter characteristics. We then
show that the above relationship between underwriter reputation and IPO valuation is driven by the greater
heterogeneity in investor beliefs, tighter short sale constraints, and greater participation by institutional
investors, analysts, and higher reputation co-managing underwriters that characterize higher reputation
underwriter backed IPOs. Overall, our results (discussed in detail in the next section) support the market power
hypothesis and reject the certification hypothesis.
In addition to the theoretical and empirical literature (discussed earlier) on the effect of heterogeneous
beliefs among investors on equity valuation, this paper is also related to the broader literature on the role of
financial intermediaries in IPOs: See, e.g., Chemmanur and Loutskina (2005) who study the role of venture
backing in IPOs, and conclude that venture capitalists perform a marketing rather than a certifying role. They,
however, do not study the role of underwriter reputation in IPOs. Our paper is also related to Cook, Kieschnick,
and Van Ness (2006), who argue that investment bankers try to promote IPOs to induce sentiment investors to
buy the stock. While they show that pre-offer publicity is related to investment bank compensation and IPO

7

underpricing, they do not study the role of underwriter reputation in IPOs or its impact on the heterogeneity in
investor beliefs about the firms prospects and the short sales constraints on the firms equity.
9

The rest of the paper is organized as follows. Section 2 summarizes our results and our interpretation of
them. Section 3 describes the data and the sample selection methodology. Section 4 outlines the empirical
methodology used in the paper. Section 5 describes the empirical results on IPO underpricing and valuation.
Section 6 describes the empirical results on market player participation in IPOs. Section 7 describes our results
on heterogeneity in investor beliefs and short sale constraints in IPOs. Section 8 describes our multivariate
analysis of the IPO offer price and first day closing secondary market valuation ratios. Section 9 discusses some
potential limitations of our analysis and certain additional robustness tests and section 10 concludes.

2. Summary and Interpretation of Results
Our empirical results strongly support the market power hypothesis. First, we find that IPOs backed by
higher reputation underwriters have higher primary and secondary market valuations relative to their intrinsic
value compared to those backed by lower reputation underwriters. IPOs backed by higher reputation
underwriters have a median overvaluation of 55% relative to intrinsic value, while those backed by lower
reputation underwriters are overvalued by 21%. This difference is even higher in the secondary market where
higher reputation underwriter backed IPOs are 75% overvalued while lower reputation backed IPOs are 30%
overvalued at the median. As mentioned before, one potential explanation for our results is that they reflect
endogenous matching between higher reputation underwriters and higher quality issuing firms, based on
unobservable value-relevant firm characteristics not captured by our valuation methodology. To correct for this
potential endogeneity, we use two endogeneity correction models, namely, a two stage least squares model and a
treatment effects model. In the above analysis we instrument for underwriter reputation using the average per-
capita newspaper circulation in the states of firms that have previously used the underwriter for their IPO over a
five year period prior to the sample IPO date. We discuss the construction of the instrument and the

9
Houge, Loughran, Suchanek, and Yan (2001) study the relationship between the long term performance of IPOs and
investor uncertainty and the divergence of investor opinion about the firms IPO. In contrast, our focus here is on the effect
of heterogeneous beliefs and short sale constraints on IPO valuation, and the impact of the underwriter on the above
variables.

8

endogeneity correction methodology in more detail in section 4.3. The results of the endogeneity correction
analysis confirm our univariate results: higher reputation underwriters are able to obtain higher valuation for the
IPOs that they back relative to lower reputation underwriters, both in the IPO offer and in the immediate post-
IPO secondary market. This suggests that underwriters do not use their reputation to certify the IPO. Rather,
they try to obtain the highest possible valuations for the firms they take public. Further, unlike the IPO
underpricing results, which switch between the 1980s and the 1990s, our valuation results remain the same
across the 1980s and the 1990s.
We also find that, consistent with the predictions of the market power hypothesis, the difference in
valuations between higher and lower reputation underwriter backed IPOs disappears over time: while this
valuation difference at the IPO and at the close of first day of trading in the secondary market is very large, this
valuation difference becomes smaller over time and almost disappears three years after the IPO (the ratio of
price to intrinsic value converges toward unity at this time). We find that the valuation difference between
higher and lower reputation underwriter backed IPOs is around 23.2% (relative to intrinsic value) at the time of
the IPO. This value increases to 38% at the close of the first day of trading in the secondary market and then
gradually declines to a statistically insignificant value of 6% after three years. Moreover, these valuation ratios
themselves converge towards unity at that time.
10

Second, we find that higher reputation underwriters are able to generate greater institutional
participation, analyst coverage, and co-managing underwriter participation for the IPOs backed by them
compared to IPOs backed by lower reputation underwriters. This supports the notion that the mechanism
through which higher reputation underwriters are able to obtain higher market valuations for IPO firms is by
attracting participation by higher quality market players. The evidence indicates that institutional investors are
6.5% more likely to participate in IPOs backed by higher reputation underwriters as compared to those backed
by lower reputation underwriters. Further, the number of participating institutions increases by 36% and
institutional holdings increase by 10.1% of the shares outstanding for higher reputation underwriter backed IPOs
relative to lower reputation underwriter backed IPOs. Similarly, we find that post-IPO analyst coverage of an

10
This also helps to validate our measures of intrinsic value, since one would expect that valuations would converge to fair
values over time.

9

IPO stock is 11.3% higher for IPOs backed by higher reputation underwriters compared to those backed by
lower reputation underwriters. Further, we find that IPOs underwritten by higher reputation underwriters are
also associated with a higher extent of participation by more reputable co-managing underwriters compared to
IPOs backed by lower reputation underwriters.
Third, we find that higher reputation underwriters are associated with higher levels of heterogeneity in
investor beliefs (using trading volume and share turnover as proxies) and tighter short sale constraints. Adjusted
volume (i.e., volume adjusted for liquidity) for higher reputation underwriter backed IPOs is almost twice the
value for lower reputation underwriter backed IPOs. Also, post-IPO first quarter short interest (which is a proxy
for short sale constraints) is 56% higher for higher reputation underwriter backed IPOs compared to lower
reputation underwriter backed IPOs in the first quarter after the IPO month. This is consistent with the market
power hypothesis, which posits that higher reputation underwriters are able to get higher valuations by
increasing the heterogeneity in investor beliefs and making short sale constraints on the IPO stock more binding.
We also show that the effect of underwriter reputation on heterogeneity in investor beliefs disappears over time,
consistent with valuations converging to fundamental values.
Finally, we analyze how the extent of participation in the IPO by various market players, heterogeneity
in investor beliefs, and the tightness of short sale constraints affect IPO and secondary market valuations. We
regress the log of the valuation ratios (for the IPO and the first day closing secondary market price) on the
various proxies for market participation, heterogeneous beliefs, short sale constraints, and other controls. We
find that, as predicted by the market power hypothesis, IPO and secondary market valuations have a positive
relationship with these variables as well as to underwriter reputation. Further, as we add the above variables
related to the market power hypothesis incrementally to the valuation regression, the coefficient on the high
reputation variable diminishes significantly. This suggests that the above effects drive a significant portion of
the effect of underwriter reputation on IPO valuation ratios.
What do our empirical results imply about the effect of heterogeneous beliefs among investors (in the
presence of short sale constraints) on IPO valuation and the role of underwriters in IPOs? First, consistent with
the heterogeneous beliefs theory of Miller (1977) and Morris (1996), a greater extent of heterogeneity in
investor beliefs and tighter short sale constraints are associated with higher equity valuations, both in the IPO

10

and in the immediate secondary market. Second, rather than being concerned about preserving reputation with
IPO market investors by pricing equity in IPOs close to their intrinsic value, underwriters are concerned about
preserving reputation with issuers by obtaining the highest possible valuation for shares sold in the IPO and in
the immediate secondary market.
Third, the mechanism through which higher reputation underwriters are able to obtain higher IPO
valuations is by generating greater participation by higher quality market players such as higher reputation co-
managing underwriters and institutional investors, and by obtaining greater analyst coverage for IPOs backed by
them. This, in turn, induces retail investors in the IPO market to become more optimistic about the future
prospects of these firms, thus increasing the heterogeneity in investor beliefs and resulting in higher valuations
(as suggested by Miller (1977) and Morris (1996)). Higher reputation underwriters may also be able to induce
tighter short sale constraints in the shares of IPOs backed by them in the immediate secondary market, further
increasing share valuations.
11

Fourth, the above pricing behavior by higher reputation underwriters may not damage their reputation
with institutional investors, since the valuation of equity in firms backed by higher reputation underwriters
becomes even higher (and commands an even higher premium over shares in IPOs backed by lower reputation
underwriters) in the first few days of secondary market trading. Since there is considerable evidence indicating
that there is a significant amount of flipping of IPO shares by institutional investors to retail investors both in the
first few days of trading in the secondary market shares (Aggarwal (2003)) and in the subsequent months
(Chemmanur and Hu (2006)), institutional investors may in fact be able to make higher profits by buying shares
in IPOs backed by higher reputation underwriters (despite their high IPO valuations) by selling them at even
higher valuations to retail investors. Finally, the above indicates that the investors who are least well off from
participating in IPOs backed by higher reputation underwriters are retail investors, who, consistent with the well
documented long-term underperformance of IPOs (Ritter (1991)), may be purchasing heavily overvalued shares
of equity when they invest in IPOs in the secondary market. Further, such retail investors are worse off investing

11
Since no IPO shares are available for short selling till trading begins in the secondary market, the direct effect of tighter
short sales constraints will be on secondary market valuations. However, higher secondary market valuations for shares in
IPOs backed by higher reputation underwriters will induce higher IPO valuations for these shares as well.

11

in shares backed by higher reputation underwriters relative to investing in IPOs backed by lower reputation
underwriters, since the former are priced higher and further away from intrinsic value.

3. Data and Sample Selection
The initial sample is obtained from the SDC Platinum New Issues database and consists of 7780 IPOs
issued between 1980 and 2000. Out of this sample, only 5276 firms are present on the CRSP and Compustat
datasets. As is common in the IPO literature, we remove IPOs of ADRs, non-ordinary shares, REITs, closed end
fund shares or unit offerings.
12
We also remove firms with offer price of IPO less than $5, as well as firms with
missing data for assets which leaves us with 3737 IPOs in the sample period.
Panel A of Table 1 shows the descriptive statistics for our IPO sample. The IPOs in our sample have a
median asset size of $21.07 million, median EBITDA of $3.01 million, and median proceeds from IPO of about
$29 million. Venture capital firms back about 45% of the all the IPO firms in the sample. The mean
underpricing (21%) and the median underpricing (7%) for our sample are consistent with the numbers reported
in Loughran and Ritter (2004) (mean underpricing of 18.7% and median underpricing of 6.3%).
For further analysis, we need to impose additional filters depending on the intrinsic value calculation
methodology. This further decreases the size of the sample for which we can calculate intrinsic value ratios. The
next section describes these valuation methodologies in detail.

4. Methodology
4.1 Intrinsic Value Calculations
To calculate intrinsic value, we follow a methodology similar to the one in Chemmanur and Loutskina
(2005) and Purnanandam and Swaminathan (2004). We compute three measures of intrinsic value. The first
measure uses the market valuation of a comparable firm based on similar industry, size, and EBITDA/sales ratio
to that of the IPO firm. The second method uses the market value of a comparable firm based on a propensity

12
We do not rely only on SDC classification to identify ADRs, non-ordinary shares, REITs, and closed end funds. Instead,
we use share codes from CRSP to implement this filter.

12

score based matching approach. The final method is a discounted cash flow approach using Ohlsons (1990)
residual income valuation method. A detailed overview of the three methods follows.

4.1.1 The Basic Comparable Firm Approach
The first approach that we use to estimate the intrinsic value of IPO companies is a matching technique
based on finding an industry peer with comparable Sales and EBITDA profit margin (EBITDA/Sales). This
approach is similar to the one followed in Chemmanur and Loutskina (2005), Purnanandam and Swaminathan
(2004), and Bhojraj and Lee (2002). We first remove the IPO firms that have negative or missing sales and
EBITDA values in Compustat, which leaves us with 2724 firms. To obtain candidate firms to match, we use all
the Compustat firms that have been public for at least three years prior to the IPO date and exclude ADRs,
foreign company stocks, REITS, non-ordinary shares, closed end funds, and firms with stock price less than $5
at IPO date. The remaining Compustat firms are divided into 48 industry portfolios based on Fama and French
(1997) industry classifications. For each year, we divide each industry portfolio into three portfolios based on
sales and then separate each sales portfolio into three portfolios based on EBITDA profit margin
(EBITDA/Sales). This procedure gives us nine portfolios for each industry-year. If there are less than 3 firms in
any of the industry-year-sales-EBITDA margin portfolio, we then do a 2 by 2 sort on sales and EBITDA/sales.
If this sort is not sufficient, we then consider only one portfolio per industry-year. For each IPO firm, an
appropriate comparable firm is then chosen from the corresponding year-industry-Sales-EBITDA margin
portfolio having the closest sales value to the sales of the IPO firm. We then estimate the offer price to intrinsic
value and secondary market price to intrinsic value ratios of the IPO firms based on the price multiples of their
comparable firms as follows.
(1)
g Outstandin Shares x Price
Sales Fiscal Year Prior
Sales Fiscal Year Prior
g Outstandin Shares x Price Offer
Comparable Comparable
Comparable
IPO
IPO IPO
|
|
.
|

\
|
|
|
.
|

\
|
= |
.
|

\
|
x
IV
OP
Sales

(2)
g Outstandin Shares x Price
Sales Fiscal Year Prior
Sales Fiscal Year Prior
g Outstandin Shares x Price Closing Day First
Comparable Comparable
Comparable
IPO
IPO IPO
|
|
.
|

\
|
|
|
.
|

\
|
= |
.
|

\
|
x
IV
SMP
Sales


13

(3)
g Outstandin Shares x Price
EBITDA Fiscal Year Prior
EBITDA Fiscal Year Prior
g Outstandin Shares x Price Offer
Comparable Comparable
Comparable
IPO
IPO IPO
|
|
.
|

\
|
|
|
.
|

\
|
= |
.
|

\
|
x
IV
OP
EBITDA

(4)
g Outstandin Shares x Price
EBITDA Fiscal Year Prior
EBITDA Fiscal Year Prior
g Outstandin Shares x Price Closing Day First
Comparable Comparable
Comparable
IPO
IPO IPO
|
|
.
|

\
|
|
|
.
|

\
|
= |
.
|

\
|
x
IV
SMP
EBITDA

(5)
g Outstandin Shares x Price
Earnings Fiscal Year Prior
Earnings Fiscal Year Prior
g Outstandin Shares x Price Offer
Comparable Comparable
Comparable
IPO
IPO IPO
|
|
.
|

\
|
|
|
.
|

\
|
= |
.
|

\
|
x
IV
OP
Earnings

(6)
g Outstandin Shares x Price
Earnings Fiscal Year Prior
Earnings Fiscal Year Prior
g Outstandin Shares x Price Closing Day First
Comparable Comparable
Comparable
IPO
IPO IPO
|
|
.
|

\
|
|
|
.
|

\
|
= |
.
|

\
|
x
IV
SMP
Earnings


Here, OP/IV is the offer price to intrinsic value ratio and SMP/IV is the first day closing secondary
market price to intrinsic value ratio for the IPO stock. Offer price of the IPO stock is obtained from the SDC
Platinum database. Shares outstanding is the number of shares outstanding immediately after the IPO for IPO
stocks and the number of shares outstanding on the day closest to the IPO day for the comparable firm. The
shares outstanding data and the market prices are obtained from the CRSP daily files. Earnings, Sales, and
EBITDA data are obtained from the annual Compustat files. Based on this procedure, we are able to
successfully find matching firms for 2655 IPO firms.


4.1.2 Propensity Score Based Comparable Firm Approach
The propensity score based approach of obtaining comparable firms has significant advantages over the
basic comparable firm approach. First, the propensity score based approach allows us to match on a larger set of
parameters than the basic matching method. Second, it allows us to control for a possible endogeneity bias in
our intrinsic value calculations.
To expand a bit more on the endogeneity issue, it is possible that higher reputation underwriters have
information about the future performance of firms and therefore select firms that they expect to perform better in
the future. This could potentially bias our intrinsic value calculations. To correct for this, we include three year
ex-post average growth in sales, average growth in cost of goods sold, and average growth in selling and general

14

expenses in the propensity score model. These variables allow us to control for the underwriters private
information regarding improvements in future sales as well as cost efficiency of the firm.
13

Following Chemmanur and Loutskina (2005), we make use of the nearest-match version of the
propensity score based matching approach similar to Dehejia and Wahba (1999, 2002). We run the same filters
for the set of candidate and IPO firms as we did in the basic comparables approach. For each fiscal year, we then
run a probit model for the set of all IPO and non-IPO firms where the dependent variable takes on the value 1 if
the firm is an IPO firm and 0 if it is not. The independent variables in the regression are sales, EBITDA to sales
ratio, net income to sales ratio, the average three year ex-post growth in sales, the average three year ex-post
growth in cost of goods sold, and the average three year ex-post growth rate in selling and general expenses. We
then obtain the predicted value of the probabilities from the probit model and match the IPO firm with a non-
IPO firm having the closest predicted probability to that of the IPO firm, while keeping the restriction that the
comparable firm must be in the same industry as the IPO firm. Finally, offer price and secondary market price to
intrinsic value ratios are calculated as before using equations (1) through (6). Based on this procedure, we are
able to successfully find matching firms for 2277 IPO firms.

4.1.3 Discounted Cash Flow Valuation Method
We also use the discounted cash flow method to compute the intrinsic value of IPO firms. The most
significant benefit of the discounted cash flow method is that we do not have to restrict the sample of firms to
have positive earnings or net income. However, we do require that firms have earnings data for at least 2 years
after the IPO date. Intrinsic values computed using this method allows us to check the robustness of the results
from the comparables approach.
The specific model we follow to compute the intrinsic value of the firm is similar to Ohlson (1990). The
intrinsic value of the firm is computed as follows:



13
We explicitly control for endogeneous matching between underwriters and firms in section 5.4 using a two stage least
squares model and a treatment effects model.
(7)
) ( * ) 1 (
1
*
2
) * ( ) * (
) 1 (
*
1 2 0 1 0 1
|
|
.
|

\
|
+
+
+
+

+ =
g r r
B r EPS B r EPS
r
B r EPS
B IV
o

15

The last term is the discounted terminal value of the stock. B
i
is the book value of the issuer in year i
after the IPO, EPS
i
is the earnings per share in year i after IPO. EPS and book value data are obtained from
COMPUSTAT. We assume a constant required return of 13%. We do our calculations with two values of
terminal growth rates, g=0 and g=5% to check the robustness of our results. In doing intrinsic value calculations,
we set terminal value equal to 0 if it is negative under the assumption that managers are unlikely to continue
negative NPV projects to perpetuity. Finally, we only use firms that have positive intrinsic values for our
valuation ratio calculations. Based on this procedure, we are able to compute intrinsic value and valuation ratios
for 2112 firms using the 0% terminal growth rate and 2113 firms using the 5% terminal growth rate.
14,15,16

4.2 Underwriter Reputation Measurement
Our main test variable is underwriter reputation. We use two different market share based measures for
underwriter reputation. The first is the based on Megginson and Weiss (1991) and is calculated as the total
market share of the lead underwriter in the IPO market over the entire sample period. The second measure is
based on the market share of the lead underwriter over a rolling 12 month period prior to the IPO issue date
(e.g., Cooney, Carter, Dark, and Singh (2001)). The market share for a given time period is calculated as the
ratio of total proceeds issued by the underwriter in that period to the total size of the IPO market in that period.
If more than one underwriter acts as a lead underwriter for an issue, we split the proceeds from that offering
equally between each of the lead underwriters to calculate their individual market share. We then take the
average of the market shares of all the lead underwriters of the issue to calculate the lead underwriter syndicate
rank for that issue. We only report results using the Megginson and Weiss (1991) ranking measure in this paper

14
One firm that had a positive intrinsic value under a 5% growth rate assumption has a negative intrinsic value under a 0%
growth rate assumption.
15
There is a potential survivorship bias induced by this methodology since we are using actual future EPS of an IPO firm.
However, surviving firms are likely to have higher intrinsic values. Therefore, keeping the IPO valuation constant, a
survivorship bias should reduce the difference between offer price and the intrinsic value, thus biasing our results against
finding overvaluation of IPOs. Further and more importantly, while a survivorship bias can bias intrinsic value, it is
unlikely to bias the IPO and secondary market valuation of a firm for a given intrinsic value. That is, a survivorship bias
requires that underwriters value IPOs without any regard to intrinsic value, which is unlikely. Since our analysis focuses on
the valuation of a firm in the IPO and the immediate post-IPO aftermarket relative to intrinsic value, a survivorship issue is
less likely to affect our results. In addition, since we also conduct our analysis with the comparable firm methodology,
which is less likely to be affected by a survivorship bias, we believe that our results are not driven by such biases.
16
We also conduct our tests using an expanded specification :

) ( * ) 1 (
1
*
2
) * ( ) * (
) 1 (
*
) 1 (
*
2
2 3 1 2
2
1 2 0 1
|
|
.
|

\
|
+
+
+
+

+
+

+ =
g r r
B r EPS B r EPS
r
B r EPS
r
B r EPS
B IV
o

The results obtained with this measure of intrinsic value are qualitatively similar as the ones reported in the paper.


16

for brevity (MW ranking from here on). However, all our tests are conducted using both ranking methods and
the results are qualitatively similar when we use the 12 month rolling rankings.
We also measure the reputation of co-managing underwriters in IPOs in a similar manner. We calculate
the average market share of the co-managing underwriter group for each IPO as a measure of reputation. The
market share for each underwriter who acts as a co-managing underwriter is calculated as the total proceeds in
all IPOs for which the underwriter acts as a co-managing underwriter (IPO proceeds are split equally among all
co-managing underwriters if there is more than one) divided by total IPO proceeds within the sample period. As
with lead underwriters, we also calculate 12 month rolling rankings for co-managing underwriters and conduct
all tests using this ranking method.
We use both binary and continuous specifications of underwriter reputation for our tests. The binary
high reputation dummy takes the value 1 if the underwriter reputation is higher than the median of the sample
and 0 otherwise. We only report tests based on the binary version of underwriter reputation variable to ensure
continuity with the univariate comparisons. However, all our multivariate tests are replicated using the
continuous market share variables. The results obtained using the continuous variables are similar to the results
reported in this paper.

4.3 Endogenous Matching between Underwriter Reputation and Firms
An important empirical issue that we face is that firms and underwriters may endogenously select each
other based on unobservable characteristics related to the firm or to the underwriter. In particular, if there are
factors that affect the intrinsic value of issuers that are not captured in our valuation methodology, one may be
concerned that our results are driven by a matching between high reputation underwriters and truly higher
intrinsic value firms. To explicitly account for such endogeneity, we use a two stage least squares model (when
we use a continuous measure of underwriter reputation) or a treatment effects model (when we use a binary
measure of underwriter reputation). The analysis is done using the two-step estimators described below.
We are concerned with the effect of underwriter reputation on IPO valuation:
j j j j
z x y c o | + + = , (8)

17

Where, y
j
is the log of the ratio of IPO offer price (or the immediate secondary market price) to intrinsic value, x
j

is a set of exogenous control variables, and z
j
is either the continuous version of the underwriter reputation or a
dummy variable that is 1 if an IPO is backed by a high reputation underwriter and 0 otherwise. If z
j
is
continuous, then it is modeled as,
j j j
u w z + = . (9)
If z
j
is binary, the observed underwriter reputation is modeled as the outcome of z
*
j
, an unobserved latent
variable which is a function of exogenous covariates:
j j j
u w z + =
*
. (10)
Here, and u are assumed to be bivariate normal with mean 0 and a covariance matrix:
(

1
o
.
In equations (9) and (10), w
j,
includes instruments which we create on the basis of the following.
We expect that underwriter reputation is a function of an underwriters ability to value and sell their
clients securities to investors (an aspect that is fundamental to the endogeneity being discussed here since
higher quality firms would prefer such underwriters) as well as his visibility. Our identification strategy rests on
finding a variable that will be correlated with underwriters reputation but is not related to his ability to value or
sell his clients securities or attract business from a specific category of issuers (in other words, can act as a
random allocator of issuers to underwriters). To this end, we use the average per-capita newspaper circulation in
the states of firms that use the underwriter for their IPO over a five year period prior to the date of the sample
IPO. State level newspaper circulation data is hand-collected from the United States Statistical Abstracts. The
idea behind this variable is that state level per-capita newspaper consumption in the states of other firms using
the underwriter prior to the sample IPO can reasonably be considered to be exogenous to the underwriters
ability to value and sell IPOs or his ability to attract business from a specific category of issuers. However, the
underwriter can obtain more free advertising by working in states that have voracious newspaper readers.
17
This

17
The advent of the internet has had a significant impact on newspaper readership in recent years. However, newspapers
still remain an important source of news today. Further, the systematic decline in readership of paper versions of

18

free advertisement for the underwriter, in turn, may have a positive impact on their market share by bringing in
more new clients, inducing a correlation with underwriter reputation. We call this variable: client state
newspaper circulation.
18
In addition, to control for the possibility that any other state specific effect may be
contained in this variable, we control for the fixed effects of the state in which the sample IPO firms are located.
In unreported results, we repeat our empirical tests after adding another instrument, which is similar to
the above variable, except that we use the average per-capita newspaper circulation in the states of the firms that
use the underwriter for their debt issues over a five year period prior to the date of the sample IPO. The results
of these tests are very similar to those we report here.
Finally, even if there is any value-relevant variable affecting the intrinsic value of issuers that is not
captured in our valuation methodology, it has to manifest itself in the long-term post-IPO operating performance
of issuing firms. Therefore, to control for the effect of any such variables, we also present additional robustness
tests where we repeat the above empirical tests using the five year average post-IPO operating performance
(operating income to sales ratio) of issuers as a control variable.

4.4 Proxies for Heterogeneous Beliefs and Short Sales Constraints
4.4.1 Proxies for Heterogeneous Beliefs
We argue that higher reputation underwriters elicit more market participant interest and this in turn is
able to induce higher levels of heterogeneity in retail investor beliefs. This, in conjunction with short sale
constraints, is able to obtain higher valuations for IPOs. To examine the relationship between underwriter
reputation and heterogeneous beliefs, we identify proxies for heterogeneous beliefs. We motivate our proxy
using the model of Harris and Raviv (1993), who argue that when heterogeneous beliefs are higher in the
market, there is more trading between agents and this should be empirically measurable. A number of empirical
papers in the finance literature (see, e.g., Kandel and Pearson (1995)) as well as the accounting literature (see,

newspapers started much later in our sample period. Our controls for year effects should filter out any common decline in
newspaper readership over time.
18
We find that this instrument has a economically and statistically significant raw correlation with the underwriter
reputation measure (48% with the continuous underwriter reputation measure and 39% with the underwriter reputation
dummy).


19

e.g., Bamber (1987) and Bamber, Barron, and Stober (1997)) have used trading activity as a proxy for
heterogeneous beliefs among investors. The three market based proxies that we use are daily volume (defined as
the log of the price of the stock multiplied by the number of shares traded in that day), daily turnover (defined as
the ratio of the number of shares of the IPO stock traded in that day to the number of shares of that stock
outstanding on that day), and the number of trades in a given day. The first two proxies are also used in
Chemmanur and Loutskina (2005). We add the number of trades as it is also representative of the trading
activity for the stock. We obtain the weekly and monthly values of these variables by averaging the daily values
over time. To control for possible liquidity effects, we also use adjusted values of the statistics described above.
The adjusted values are calculated as the value of the variable minus the average monthly value of the same
variable after three years. The data for calculating the proxies of heterogeneous beliefs is obtained from the
CRSP database.

4.4.2 Proxies for Short Sale Constraints
The second leg of our hypothesis depends on the level of short sale constraints in the market, since
greater heterogeneity in investor beliefs leads to higher IPO valuations only in the presence of short sale
constraints. Figlewski (1981) was one of the first to develop a proxy for short sale constraints. He argued that
investors with mild negative information about a stock will sit on the sidelines when there are significant
constraints on short selling. On the other hand, investors with significant negative information will try to short
the stock even though the amount they short is less than they would without the constraints (due to reduced
profits). This means that the realized short interest would be positively correlated with the latent demand for
short selling in the stock. Since, for a given number of shares available for shorting, a large latent demand for
short selling a firms shares implies that the short sales constraints on its shares are even more binding, we can
use the short interest normalized by shares outstanding as a proxy for the tightness of short sale constraints.
Similar proxies have also been used in Figlewski and Webb (1993), Asquith and Meulbroek (1995), Woolridge
and Dickinson (1994), Dechow, Hutton, Meulbroek, and Sloan (2001), and Asquith, Pathak, and Ritter (2005).
We use the monthly short interest for the first, second, and third month after the IPO month divided by
the number of shares outstanding at the end of the month in CRSP to measure short sale constraints. The

20

monthly short interest data is hand-collected for all IPOs offered on or after 1990 that were available on the
Bloomberg Professional database. We use the months after the IPO month because in many cases when the IPO
is offered closer to the end of the month, the market participants have less time to short the stock. As a result,
Bloomberg has more missing data on short interest in the month of the IPO. We also take the average of the
short interest in the first three months after the IPO and use this first quarter figure as another proxy for short
sale constraints.

5. IPO Underpricing and Valuation
5.1 IPO Underpricing in the 1980s and 1990s
Table 1, Panel A reports the summary statistics of IPO firm characteristics and underpricing segmented
by underwriter reputation (using the MW ranking). On average, we find that IPOs underwritten by higher
reputation underwriters are larger, have larger issue proceeds, are more likely to be backed by venture
capitalists, and have higher underpricing. Panel B of Table 1 shows how underpricing and underpricing
differences between high and low reputation underwriters have evolved over time. In the table, the 80s period
includes IPOs from 1980 to 1989, the 90s period includes IPOs from 1990 to 1998 and the 90s including
bubble period includes IPOs issued between 1990 and 2000. The above results indicate that the underpricing
difference between higher and lower reputation underwriter backed IPOs has clearly flipped from the 80s to the
90s. The difference in underpricing between higher and lower reputation underwriter backed IPOs increases
from an average of -1.5% in the 80s to 7.6% in the 90s. The median underpricing difference increases from -
0.14% in the 80s to about 4.2% in the 90s. This effect is also documented in Loughran and Ritter (2004) who
find that the average underpricing has gone from being lower for higher reputation underwriter backed IPOs in
the 1980s to being higher for higher reputation underwriter backed IPOs in the 1990s.
19
The above trend
highlights our motivating question of the economic role of the underwriter in IPOs. One of the secondary
objectives of this paper is to test whether IPO valuation and the economic role of the underwriter in an IPO was

19
Carter, Dark, and Singh (1998) and Megginson and Weiss (1991) document a negative relationship between underwriter
reputation and IPO underpricing using data from 1980s.

21

fundamentally different in the 1980s and 1990s using alternative measures of the economic role of the
underwriter (such as IPO valuation relative to intrinsic value).

5.2 Univariate Results on Valuation
The univariate tests for primary and secondary market valuation ratios are reported in Tables 2, 3, and 4.
The tables list valuations over the same time periods as the underpricing trend reported in Table 1 for ease of
comparison. Table 2 reports the comparisons using the basic comparable firm approach. Based on the sales
multiple, high reputation underwriters obtain a median offer price of about 1.57 times the intrinsic value for the
stock of the IPO firm while low reputation underwriters get a statistically significantly lower offer price of about
1.52 times the intrinsic value in the 80s. The results are similar for first day closing secondary market prices
where high reputation underwriters obtain a median offer price that is 1.65 times the intrinsic market value while
low reputation underwriters obtain a median offer price that is 1.58 times the intrinsic value in the 80s. The
differences are even more stark for the 90s period: here the median offer price valuation ratio for IPOs backed
by high reputation underwriters is 0.36 higher than that for IPOs backed by low reputation underwriters. Further,
the median first day closing secondary market price valuation ratio for IPOs backed by high reputation
underwriters is 0.46 higher than the median valuation ratios for IPOs backed by low reputation underwriter in
the 1990s. These differences are highly statistically and economically significant. The results are also similar for
the 90s including the bubble period, where high reputation underwriter backed IPOs have higher median offer
price valuation ratios and first day closing secondary market price valuation ratios than low reputation
underwriter backed IPOs. The results obtained above hold when we use valuation ratios based on EBITDA and
earnings multiples.
20

Table 3 shows that the results are similar when we use the propensity score based comparable firm
approach. This method controls for the possibility that high reputation underwriters could potentially select

20
To test whether clustering around industry and year can affect the standard errors in our univariate analysis, we calculate
the Somers D clustered statistic and the 90% confidence intervals for the Hodges-Lehmann clustered median difference
test for all the univariate results presented here. Our results do not change qualitatively. Similarly, all subsequent
multivariate tests on valuations are conducted with and without clustering on industry as well as the year of issue. Our
results are robust to clustering the standard errors.


22

better firms and therefore bias the basic comparable method results. For the sales multiple based valuation, there
is a statistically significant difference of 0.28 between the median offer price valuation ratios of high and low
reputation underwriter backed IPOs and 0.32 between the median first day closing secondary market price ratios
of high and low reputation underwriter backed IPOs. The results based on valuation ratios using other multiples
are qualitatively similar although the statistical significance using the EBITDA multiple is weaker. Finally, we
use the discounted cash flow approach to value the IPO stocks in Table 4. The reported results are generally
consistent with the results above and corroborate our hypothesis that high reputation underwriters obtain higher
primary and secondary market valuations for their clients.
We show in subsequent sections that our valuation ratios are higher for higher reputation underwriters
in multivariate tests as well as in tests that control for endogenous matching between underwriters and firms.
Overall, our empirical results indicate that higher reputation underwriters are able to obtain higher valuations in
both the primary and the secondary markets for their clients, thus supporting our hypotheses (H1A) and (H2).
The results in this section are consistent with the idea that the underwriters primary goal is to get the highest
possible valuation for their clients and that higher reputation underwriters are better at obtaining these higher
valuations. Moreover, these valuation results are consistent across the 1980s and 1990s in the sense that high
reputation underwriters obtain higher valuations than low reputation underwriters in both these time periods. In
contrast, the underpricing results are not consistent in the 1980s and 1990s.

5.3 Multivariate Results on Endogenous Matching between Underwriter Reputation and Firms
The results of our OLS, two stage least squares, and treatment effects model estimations are reported in
Table 5. We report the results of the first and the second stage models separately as well. The standard errors in
the second stage are corrected for the estimation error from the first stage (Maddala (1983)). Our control
variables include the IPO firm size, whether the firm obtains venture capital or not, the fraction of firm sold in
the IPO, and year and industry effects. Panel A reports the results from the OLS and the two stage least squares
models. The OLS model confirms our univariate results that higher reputation underwriters are associated with
higher valuations, both in the IPO and the immediate post-IPO secondary market.

23

In the first stage of the two stage least squares model, we find that, consistent with our expectations,
client state newspaper circulation is positively related to underwriter reputation. The first stage F-statistic is
115.824 and highly statistically significant at the 1% level, suggesting that our instrument is valid (Staiger and
Stock (1997), Stock and Yogo (2005)). We find that, even after controlling for the endogenous selection of
reputable underwriters, higher reputation underwriters are associated with higher valuations, both in the IPO and
the immediate post-IPO secondary market. Controlling for endogeneity reduces our coefficient estimate on
underwriter reputation from the OLS model, but the association between underwriter reputation and valuation
remains statistically and economically significant. Economically, a one standard deviation increases in
underwriter reputation increases the offer price valuation ratio by 21.25%, while it increases the secondary
market price to valuation ratio by 24.53%. Panel B shows the results with the binary underwriter reputation
variable. We use a treatment effects framework to account for the binary form of underwriter reputation. Our
results remain similar to those from the two stage least squares model.
21

Panel C reports the results of the robustness tests including the post-IPO operating performance
(average five year post-IPO operating income to sales ratio) as an additional control variable.
22
The coefficient
estimate of the operating income to sales variable is statistically insignificant in our OLS regressions as well as
in the second stage of our endogeneity correction models. This indicates that our valuation methodology already
captures the effect of any value-relevant variables that may affect post-IPO operating performance. The fact that
the coefficient estimate on the post-IPO operating performance is significant in the first stage regressions of our
endogeneity correction models indicate that, as expected, higher reputation firms are indeed associated with
higher quality issuing firms. However, it is worth emphasizing that our results continue to hold even after
controlling for such effects.

21
In unreported tests, we repeat the above tests for the endogeneity correction models (two stage least squares and
the treatment effects model) while introducing a debt client state newspaper circulation instrument (average per-capita
newspaper circulation in states of firms that used the IPO underwriter for their debt issue over the last five years) and
controlling for whether the underwriting syndicate has debt underwriting ability (defined as whether at least one lead
underwriter having underwritten a debt issue over the last five years). The results of the analysis remain the same as before.
Further, debt client state newspaper circulation is also positively correlated with underwriter reputation, as expected.
Having multiple instruments allows us to conduct tests of overidentifying restrictions. This tests the joint null hypothesis
that the structural model is not misspecified and that our instruments are uncorrelated with the second stage variable. These
test results indicate that the null hypothesis is not rejected, thus providing additional assurance about the validity of our
instruments.
22
We use 3 year as well as 7 year average values of operating income to sales, and obtain similar results.

24


5.4 Dynamics of Valuation Ratios
We analyze how valuation ratios of IPO stocks evolve over time over a period of one, two, and three
years after the IPO date. To do this we calculate the intrinsic value of IPO stocks using the valuation
methodologies discussed above for one, two, and three years after the IPO and calculate the ratios in each of
these periods. For the comparable firms approaches (both the basic and propensity score based comparable firm
approaches), we find a new matched firm every year for one, two, and three years after the IPO date.
Table 6 reports the dynamics for the sales and earnings multiple based valuation ratios for both the basic
comparable firm and the propensity score based comparable firm approaches. The table lists the valuation ratios
at offer time, the first day closing, one, two, and three years after the IPO. The dynamics for the propensity score
based price ratios are graphed in figure 1. We find two interesting patterns of valuation ratios over time that
significantly support our hypotheses and our intrinsic valuation methodology. First, the median valuation ratios
decrease over time for both high and low reputation underwriter backed IPOs and move towards unity.
Consider, for example, the sales multiple based ratio dynamics for the propensity score based comparable firm
approach in Panel B. The ratio decreases from 1.823 at offer time to 1.295 at three years after the IPO date for
high reputation underwriter backed IPOs. For the low reputation underwriters backed IPOs, the ratio decreases
from 1.393 at the offer time to 1.088 at three years after the IPO date. We find similar declines in valuation
ratios for the earnings multiple based ratio. Further, the analysis obtains similar results even when we use the
basic comparable firm approach. Given that the effect of the underwriter diminishes over time and that our
valuation measures are not biased, this is the convergence pattern one would expect to see over time. This gives
credibility to our valuation methodology since one would expect that the effect of underwriters on valuations
fades over time and the valuations of IPOs converge towards their intrinsic values.
Another aspect of the valuation dynamics is that the difference in valuation ratios between high and low
reputation underwriter backed IPOs is decreasing over time after the IPO. For example, for the sales multiple
based ratio dynamics using the propensity score based approach, the difference in valuation between high and
low reputation underwriter backed IPOs starts from 0.43 at the IPO date, then increases to 0.663 at the closing of
the first trading day, and then decreases to 0.206 by the third year. For the earnings multiple based ratio

25

dynamics using the propensity score based approach, the pattern is similar: the valuation difference between
high and low reputation underwriter backed IPOs first increases from 0.232 at the IPO date to 0.382 at the
closing of the first trading day, and then decreases to a very small and statistically insignificant value of 0.061 at
the end of three years. This convergence in valuation further supports the idea that the effect of underwriter
reputation on valuation diminishes over time.
In summary, we document the dynamics of valuation ratios of IPO stocks over a time period of three
years after the IPO. We find that the valuation ratios of IPOs decrease over time towards 1. We also find that the
valuation ratios for high and low reputation underwriter backed IPOs converge towards each other indicating
that the effect of underwriter reputation diminishes over time. The above results provide evidence consistent
with our hypothesis (H3). The results obtained in this section also provide credibility to our valuation
methodology.

6. Effect of Underwriter Reputation on Participation by Various Market Players in IPOs
So far, we have been able to show that high reputation underwriters obtain higher valuations in the
primary and first day secondary markets for the IPOs backed by them than low reputation underwriters. Now we
ask how high reputation underwriters are able to obtain higher valuations for IPOs backed by them than low
reputation underwriters. We conjecture that higher reputation underwriters are able to increase the extent of
participation by high quality market players. The market participants that we analyze here are co-managing
underwriters, institutional investors, and equity analysts. This in turn may increase the heterogeneity in investor
beliefs about the firms future prospects and make short sale constraints more binding (this may occur both due
to the direct ability of higher reputation underwriters to discourage short-selling, and also indirectly through the
efforts of higher reputation co-managing underwriters being associated with the IPO). This increased
heterogeneity in investor beliefs and higher short-sale constraints will result in higher valuations for IPOs
backed by high reputation underwriters. In this section, we examine the relationship between underwriter
reputation and the extent and quality of participation by co-managing underwriters, institutional investors, and
equity analysts in IPOs.


26

6.1 Co-managing Underwriter Participation and Quality
Panel A of Table 7 reports univariate comparisons of the number of co-managing underwriters and their
market share segmented by lead underwriter reputation. We see that higher reputation underwriters are able to
obtain more co-managing underwriters and higher reputation co-managing underwriters to participate in the
IPOs underwritten by them than low reputation underwriters. At the median, high reputation underwriter backed
IPOs have one more co-managing underwriter than low reputation underwriter backed IPOs. This represents a
100% increase from the median co-manager participation for low reputation underwriter backed IPOs. Further,
the co-managing underwriter market share increases by 0.008 at the median (an increase of 200%) when the IPO
is underwritten by a high reputation underwriter rather than a low reputation underwriter.
Panel A of Table 8 reports multivariate tests for co-managing underwriter participation after controlling
for size, VC backing, year, and industry effects. The results obtained above are consistent with the univariate
results. High reputation underwriters are able to obtain about 0.30 more co-managing underwriters than low
reputation underwriters (as seen in the poisson regression specification (3)). This represents a 33% increase
relative to the median value for low reputation underwriters. Also, high reputation underwriters are able to
obtain higher quality co-managing underwriters than low reputation underwriters (as seen in the probit
specifications (4) to (6)). Thus, the results for co-managing underwriter participation are consistent with our
hypotheses (H4) and (H5).

6.2 Institutional Investor Participation
Table 7, Panel B reports univariate tests for our proxies of institutional investor participation. We use
data for institutional investor holdings from Thomson Financials 13f based institutional investor holdings
database that reports quarterly institutional holdings. We use three proxies for institutional investor
participation. The first is whether institutional investors participate in the IPO, which is defined as whether there
is an institution that has positive holdings in the IPO stock in the quarter of the IPO. The second proxy is the
number of institutional investors holding the IPO stock in the quarter of the IPO. The final proxy is the
institutional investor holdings of the IPO stock as a fraction of CRSP shares outstanding immediately after the
IPO.

27

The results are consistent with our conjectures. We find that the likelihood of institutional investor
participation is 11% higher for high reputation underwriter backed IPOs as compared to low reputation
underwriter backed IPOs. We also see that the number of institutions participating in the IPO increases from a
median of 11 for low reputation underwriter backed IPOs to 24 for high reputation underwriter backed IPOs.
This represents a statistically and economically significant increase of 118%. There is also an increase in the
median percentage institutional holdings in the IPO from 44% for low reputation underwriter backed IPOs to
about 73% for high reputation underwriter backed IPOs, which represents a statistically and economically
significant 62% increase. These numbers suggest that underwriter reputation has a strong and economically
meaningful impact on institutional investor participation.
We conduct multivariate tests to control for the presence of venture capital backing, co-managing
underwriter participation, size, and year and industry effects. Chemmanur and Loutskina (2005) document that
venture capital firms are able to bring in significantly higher participation by institutional investors. They also
document that larger firms are more likely to get institutional investor interest. Further, it is possible that
increased participation by higher reputation co-managing underwriters might induce more institutional investors
to participate in the IPO. Panel B of Table 8 presents the results of these regressions. We find that, even after
controlling for the above effects, there is a significant increase in the institutional investor participation for high
reputation underwriters. Regressions (1) to (4) are probit specifications with the dependent variable as the binary
institutional participation variable. Regressions (5) to (8) have the number of institutions as the dependent
variable and regressions (9) to (12) have percentage institutional holdings as the dependent variable. In all
specifications, we find that the high reputation dummy is highly significant. Based on marginal probabilities
from specification (4), the presence of a high reputation underwriter is associated with a 6.5% increase in the
probability of participation by institutional investors. Higher reputation underwriters are likely to induce around
4 more institutions to buy the IPO, based on specification (8). This implies that using a high reputation rather
than low reputation underwriter increases institutional investor participation by 36% (based on the median
institutional investor participation of 11 for IPOs backed by low reputation underwriters). We also infer from
specification (12) that institutional investors are likely to hold 10.1% more equity in the IPO firm for high
reputation underwriter backed IPOs as compared to low reputation underwriter backed IPOs. Given that the

28

median institutional holding for low reputation underwriter backed IPOs is about 45%, the coefficient from
specification (12) implies an economically significant increase in institutional holdings of about 23% with
underwriter reputation. Therefore, the results for institutional investor participation are consistent with our
hypothesis (H6).

6.3 Analyst Coverage After the IPO
We use two proxies for analyst coverage. The first is the number of unique analysts that provide
earnings estimates and the second is the number of unique analysts that provide buy/hold/sell stock
recommendations for the IPO stock in the IPO year. We obtain the analyst coverage data from the I/B/E/S
database.
Panel C of Table 7 reports the univariate comparisons of analyst coverage of high and low reputation
underwriter backed IPOs. The median increase in the number of analysts estimating earnings and issuing
recommendations is 1 if a high reputation underwriter rather than a low reputation underwriter is used. This
represents a 33% increase from the median of 3 analysts that low reputation underwriters are able to provide.
Therefore, underwriter reputation also significantly affects the level of analyst coverage obtained for the IPO
stock.
As in the case of participation by co-managing underwriters and institutional investors, there are other
known factors affecting analyst participation. Venture backing is one such effect documented by Chemmanur
and Loutskina (2005). Size is another variable that can affect analyst coverage. We also need to control for
institutional investor participation, co-managing underwriter participation, and co-managing underwriter quality
since we know that these variables will be correlated with lead underwriter reputation and can possibly affect
analyst interest in a stock. Panel C of Table 8 reports the results of the multivariate tests. We find that the
coefficient on the underwriter reputation dummy is positive and statistically significant. The lowest coefficient
on the high reputation dummy is 0.34 when the dependent variable is the number of analysts that provide
earnings estimate. This implies that the number of analysts providing earnings estimates increases by 11.3% if a
high reputation underwriter rather than a low reputation underwriter manages the IPO. Similarly, the lowest
coefficient on the high reputation dummy is 0.40 when the dependent variable is the number of analysts that

29

provide buy/hold/sell stock recommendations. The latter result translates to a 13.3% increase in the number of
analysts providing buy/hold/sell stock recommendations if a high reputation underwriter rather than a low
reputation underwriter manages the IPO. Therefore, consistent with hypothesis (H7), we find that the increase in
analyst participation obtained by high reputation underwriters is both statistically and economically significant.
To conclude this section, we find that the presence of a high reputation underwriter is able to increase
participation by various market players in IPOs, and this increase is significant in both the economic and the
statistical sense. The results in this section are thus consistent with hypotheses (H4), (H5), (H6), and (H7).

7. Heterogeneous Beliefs and Short Sale Constraints
7.1 Heterogeneous Beliefs
Now we test whether higher reputation underwriters are able to generate higher levels of heterogeneity
in investor beliefs about the IPO firms future prospects. This, in conjunction with short sale constraints, is
hypothesized to obtain higher prices for the IPO firms equity in the primary and the immediate post-IPO
secondary markets.
Panel A of Table 9 reports the univariate comparisons of our heterogeneous beliefs proxies for IPOs
backed by low and high reputation underwriters. For the first day, median volume increases from 7.88 to 42.77
with underwriter reputation, which corresponds to an increase in the dollar volume of about $35 million. This
result is statistically significant at the 1% level. The first day turnover increases from 13.74% for low reputation
underwriter backed IPOs to about 20.76% for high reputation underwriter backed IPOs. This corresponds to a
51.8% increase in the turnover of the IPO firms stock if the firm were to use a high reputation underwriter
instead of a low reputation underwriter. A similar result is obtained in the difference in number of trades
between low and high reputation underwriter backed IPOs. There is a median increase of 640 trades if a high
reputation underwriter rather than a low reputation underwriter manages the IPO, and this increase is highly
statistically significant. Thus, there is a significant difference in trading activity between low and high reputation
underwriter backed IPO stocks. This is consistent with our argument that high reputation underwriters are able
to induce more heterogeneity in beliefs among investors than low reputation underwriters.

30

To control for possible liquidity effects, we conduct our analysis using volume, turnover, and number of
trades variables adjusted for liquidity effects (as described in section 4.3.1) in Panel B of Table 9. We find that
the results obtained with the adjusted volume, turnover, and number of trades measures are consistent with the
unadjusted measures and still highly statistically significant.
We also conduct multivariate tests with our heterogeneous beliefs proxies as independent variables.
Panels A, B, and C of Table 10 report regressions with dependent variables as log of adjusted first day volume,
log of adjusted first day turnover, and log of adjusted first day number of trades, respectively.
23
The multivariate
results are consistent with our univariate results even after controlling for size, venture capital backing, number
of analysts estimating earnings, number of institutions, percentage institutional holdings, number of co-
managing underwriters, co-managing underwriter reputation, and year and industry dummies. Interestingly, the
coefficient on the high reputation dummy decreases as we add more market participant variables. The
coefficients on number of analysts, number of institutions, percentage institutional holdings, number of co-
managers, and co-managing underwriter reputation variables are generally statistically significant and positive.
In Panel A, the coefficient on the underwriter reputation dummy when we do not control for participation by
various market players is 0.754, which corresponds to a 2.12 times increase in the volume from using a high
reputation underwriter as compared to using a low reputation underwriter. After controlling for market
participants in the regression this coefficient falls to 0.254 and this corresponds to a 29% increase in the adjusted
volume. Therefore, we find that controlling for market participants diminishes the effect of the underwriter
reputation on the heterogeneous beliefs proxies. This indicates that underwriters are able to obtain higher
dispersion in investors beliefs, and they do this in significant part by involving more market participants in the
IPO.
We see similar results in the adjusted first day turnover regressions in Panel B of Table 10. Here, we get
a coefficient of 0.327 on the underwriter reputation dummy without controlling for institutional investor,
analyst, and co-managing underwriter participation in the IPO. When we add variables corresponding to the
presence of various market participants in the regression equations, we get a lower coefficient of 0.14 on the
underwriter reputation dummy. Therefore, there is a significant effect of underwriter reputation on dispersion in

23
We also conduct the same tests with unadjusted values and the results are qualitatively similar.

31

beliefs and a big part of this effect is explained by the presence of market participants. The results for adjusted
number of trades are similar to the results described above and are reported in Panel C of Table 10. The
coefficient of the high underwriter reputation dummy is statistically significant at 0.561 without market
participant variables and drops to 0.162 when we do use market participant variables.
In summary, we find evidence consistent with the following. First, high reputation underwriters are able
to induce significantly higher dispersion of beliefs among investors than low reputation underwriters. Second,
they do so in large part by involving more and higher quality market participants who in turn increase the
dispersion in beliefs among investors. The evidence therefore supports hypothesis (H8).

7.2 The Dynamic Pattern in Heterogeneous Beliefs
We argue that higher reputation underwriters are able to induce significantly higher dispersion in the
beliefs of investors. We also conjecture that the effect of underwriter reputation may disappear over time. To
test this hypothesis, we study the dynamic pattern in our heterogeneous beliefs proxies over time. We obtain the
heterogeneous beliefs variables for one, two, and three years after the IPO date. The methodology used for
calculating the variables is the same as the one used for the IPO period.
Table 11 reports the dynamic pattern for our proxies of heterogeneous beliefs. We find that adjusted
volume, adjusted turnover, and the adjusted number of trades all decrease for both high and low reputation
underwriter backed IPO stocks for the three years after the issue date.
24
This is consistent with the idea that the
heterogeneity in investor beliefs about the IPO stock decreases over time. The above results are also consistent
with the results on the dynamics of IPO valuations over time reported in section 5.3, i.e., valuation premiums for
IPO stocks decline over time. For instance, the median adjusted volume comes down from 39.31 at the IPO date
to a statistically insignificant value of -0.001 at the end of three years for high reputation underwriter backed
IPO stocks. A similar pattern is observed for median adjusted volume of low reputation underwriter backed
IPOs.
We also find that the difference in heterogeneous beliefs between high and low reputation underwriter
backed IPO stocks diminishes over time. The difference in adjusted volume between high and low reputation

24
The results for the unadjusted values of our heterogeneous beliefs proxies are qualitatively similar.

32

underwriter backed IPOs decreases from 31.85 in year 0 to a statistically insignificant and economically small
value of -0.002 in year 3. Similarly, the difference in median turnover between high and low reputation
underwriter backed IPOs is the highest at time 0 at about 6.5% and comes down to an economically small value
of -0.01 % by the end of year 3. We find similar patterns for median adjusted number of trades.
In summary, we find evidence indicating that the heterogeneity in investor beliefs decreases over time
and that the difference in the heterogeneity in investor beliefs between high and low reputation underwriter
backed IPO stocks (which is high at the time of the IPO) also decreases over time. This is consistent with the
idea that the effect of underwriter reputation fades over time. This is also consistent with the dynamic pattern in
IPO valuation ratios in section 5.3.

7.3 Short Sale Constraints
The theories of by Miller (1977), Morris (1996), and Duffie, Garleanu, and Pederson (2002) imply that
heterogeneous beliefs combined with short sales constraints will lead to overvaluations in the IPO. Pessimistic
investors, on the other hand, have to satisfy themselves to shorting as much as the market constraints allow; such
shorting by pessimistic investors will move valuations downward. This implies that if underwriters can make
short sale constraints more binding, they will be able to obtain still higher valuations for the equity of the IPO
firms backed by them, potentially by reducing the extent of short selling through implicit or explicit penalties on
clients who short sell the IPO firms equity or by restricting lending by these clients to other short sellers.
Table 12 reports univariate comparisons for short interest between high and low reputation underwriter
backed IPOs. Recall that we use the monthly short interest for the first, second, and third month after the IPO
month divided by the number of shares outstanding at the end of the month in CRSP to measure short sale
constraints. We also take the average of the short interest in the first three months after the IPO and use this first
quarter figure as a proxy for short sale constraints. For the first month, short interest increases from 0.0018 to
0.0022 with underwriter reputation. This corresponds to a statistically and economically significant 22%
increase in the short selling activity from low to high reputation underwriter backed IPOs in the first month after
the IPO. The second month increase of short interest from low to high reputation underwriter backed IPOs is
significantly higher than that observed for the first month. The short interest in the second month is 64.3%

33

higher for high reputation underwriter backed IPOs than that for low reputation underwriter backed IPOs. In the
third month, the short interest for high reputation underwriter backed IPOs is 44% higher than low reputation
underwriter backed IPOs. On averaging the first three months, we see that the short interest in the first quarter
after the IPO increases by about 28.5% (from 0.0021 to 0.0027) from low to high reputation underwriter backed
IPOs. These increases are statistically significant at the 1% level. Therefore, the univariate comparisons are
consistent with our prediction that high reputation underwriters are able to constrain short sales in the IPO stock
more than low reputation underwriters.
Table 13 reports the results of multivariate regressions using the log of short interest in the first quarter
as the dependent variable.
25
The results are similar to the results from our univariate comparisons. The
coefficient on the high reputation dummy is 0.446 in specification (1) and is statistically significant at the 1%
level. This corresponds to an increase of 56% in the level of short interest from low to high reputation
underwriter backed IPOs. Further, the coefficient on the high reputation dummy falls when we control for
market participant measures. The coefficient on the high reputation dummy falls from 0.446 (a 56% increase) to
0.186 (a 20% increase) in specification (6). Therefore, a significant portion of the short interest effect of
underwriters is explained by the involvement of market participants. The coefficients on the market participant
variables are statistically significant and positive. This is consistent with our conjecture that high reputation
underwriters are able to constrain short sales more effectively through their extensive ties with various market
participants.
To summarize, we find that high reputation underwriters are associated with significantly higher short
sale constraints. This effect is highly statistically and economically significant and consistent with hypothesis
(H9). We also find that the effect of underwriter reputation on short constraints is driven in large part by their
ability to bring in market participants like higher reputation co-managing underwriters, institutional investors,
and analysts.

8. Multivariate Analysis of the Effect of Underwriter Reputation on IPO and Secondary Market
Valuations


25
Our results do not change qualitatively if we use short interest in quarters 1,2, and 3 individually as dependent variables.

34

We now conduct multivariate analysis of the effect of underwriter reputation on IPO and secondary
market valuations. In this section, we directly link the increase in the extent of participation by various market
players in the IPO, heterogeneity in investor beliefs about the IPO stock, and tightness of short sale constraints
on the IPO stock induced by underwriter reputation to the IPO valuation. We expect to see a positive coefficient
on the high underwriter reputation dummy after controlling for size, venture backing, fraction of the firm sold in
the IPO, and year and industry effects. We also expect to see that as we add co-managing underwriter,
institutional investor, and analyst participation variables, the coefficient on the high underwriter reputation
dummy should diminish, since we expect that underwriter reputation should affect IPO and secondary market
valuations through these channels. The coefficient on the high underwriter reputation dummy should decrease
further as we add proxies for heterogeneous beliefs of investors and short sales constraint, consistent with our
conjecture that high reputation underwriters obtain higher IPO and secondary market valuations by affecting
these two features of the market.
Panel A of Table 14 reports the results of our multivariate regressions with the log of IPO offer price to
intrinsic value ratio as the dependent variable. As expected, the coefficient on the high reputation dummy in
regression specification (1) in panel A is statistically significant and positive. The coefficient on high reputation
dummy for offer price ratio in specification (1) is 0.32 which corresponds to about a 38% increase in the IPO
offer valuation ratios for high reputation underwriter backed IPOs as compared to low reputation underwriter
backed IPOs. Further, the coefficient on the high reputation dummy decreases as we add the market participant,
heterogeneous beliefs, and short sale constraints proxies.
The coefficient on analyst participation in specification (7) is positive (0.045) and highly statistically
significant. This coefficient indicates that a unit increase in the number of analysts increases the IPO valuation
ratio by about 4.6%. This increase is highly statistically significant. Further, the coefficients on the number of
institutional investors participating in the IPO and the percentage institutional holdings are also positive and
significant. The coefficient on institutional investor holdings in specification (4) is 0.152 and statistically
significant at the 1% level. From this coefficient, we infer that a 1% increase in institutional investor holdings
increases the IPO valuation ratio by 16.4%. Further, co-managing underwriter reputation also has an
economically meaningful impact on IPO valuation ratios. The positive and statistically significant coefficient of

35

0.213 on co-manager reputation in specification (7) corresponds to an increase in the IPO valuation ratio of 24%
when the co-managing underwriter reputation increases by 1%. Thus, we find that participation by various
market players has an economically meaningful impact on IPO offer valuations. Further, as we add more market
participant variables to the regression equations, the statistical and economic significance of the coefficient on
the underwriter reputation dummy decreases. This indicates that underwriters may influence IPO valuations by
increasing the participation of more and higher quality market participants.
The analysis also indicates that the effect of the heterogeneous beliefs proxies on the IPO offer
valuations is statistically significant and positive. The coefficient on adjusted first day volume in specification
(12) is 0.195 and statistically significant at the 1% level. This coefficient corresponds to a 21.5% increase in the
IPO valuation ratio for a 1% increase in the log of adjusted first day turnover. Further, the coefficient on the
short interest proxy is positive and significant in these regressions. The coefficient on short interest in
specification (12) is 0.041, which is statistically significant at the 10% level. This coefficient value indicates that
a 1% increase in log of short interest increases the IPO valuation ratio by about 4.2%. Thus, the effect of
heterogeneous beliefs of investors and short sale constraints on IPO offer valuations is economically significant.
Moreover, adding the proxies for heterogeneous beliefs and short sale constraints in the regression equations
leads to a further reduction in the statistical and economic significance of the coefficient on the underwriter
reputation dummy. This suggests that higher reputation underwriters are able to obtain higher IPO time
valuations by increasing the heterogeneity in investor beliefs and inducing tighter short sale constraints.
Panel B of Table 14 reports the results for the multivariate analysis with the log of first day closing
secondary market price to intrinsic value as the dependent variable. The results for secondary market valuations
are similar to the results for IPO offer valuations as discussed above. For the secondary market valuation
regression (13) in panel B, the coefficient on underwriter reputation is 0.369 which corresponds to about a
44.6% increase in the secondary market valuation ratio for high reputation underwriter backed IPOs relative to
low reputation underwriter backed IPOs. This effect is highly statistically significant at the 1% level. As in the
offer price regressions, coefficients on the variables for participation by various market players, heterogeneous
beliefs of investors, and short sale constraints in the secondary market valuation regressions are economically
and statistically significant. Further, similar to the IPO offer valuation results, adding variables for participation

36

by various market players, heterogeneous beliefs of investors, and short sale constraints reduces the economic
and statistical significance of the coefficient on the underwriter reputation dummy in the secondary market
valuation regressions.
Overall, our multivariate analysis of IPO and secondary market valuation is consistent with the
hypothesis that higher reputation underwriters obtain higher valuations by involving more market participants,
inducing higher levels heterogeneity in investor beliefs, and exacerbating short sale constraints in the market for
the IPO stock. These results provide additional supporting evidence for hypotheses (H1A), (H2), and (H4)
through (H9).

9. Potential Limitations and Additional Robustness Tests
One possible alternative explanation is that our results are partially generated by higher quality firms
selecting higher quality underwriters: i.e., we have not been able to fully correct for the endogeneity problem in
our analysis. However, given that we have adopted several different approaches to solve any potential
endogeneity problem, such as propensity score matching on various dimensions including future operating
performance, using instrumental variable regressions, and directly controlling for future operating performance
in our valuation regressions; it is unlikely that our results are completely generated by such endogeneity issues.
In addition to the instruments that we have used in our endogeneity correction models discussed above,
namely, client state newspaper circulation (based on the underwriters prior IPO and debt underwriting
businesses), we have repeated our instrumental variables tests in unreported analysis using various other
instruments such as the number of businesses the underwriter works in (equity underwriting, debt underwriting,
and M&A advisory), log of one plus the IPO firms age, and firm age divided by assets (e.g., Loughran and
Ritter (2004)). Our results continue to hold even in the above analyses. In an alternative approach to address the
above endogeneity problem, we make use of a regression discontinuity analysis. This approach makes use of a
discontinuity in the treatment variable (in our case, underwriter reputation) to correct for endogeneity: see, e.g.,
Van Der Klaauw (2002), Angrist and Lavy (1999). The discontinuity we exploit in this analysis arises from the
fact that firms selling a majority controlling stake in their IPO will find it particularly hard to sell their stock in
the IPO market, and may therefore need to make use of high reputation underwriters to sell stock in their IPO to

37

counteract any negative signal sent by the disinvestment of a controlling stake by existing shareholders and
managers. Our results on the effect of underwriter reputation on IPO valuation continue to hold even after
controlling for any endogenous matching between firms and underwriters using the above approach.
Another approach to correct for any endogenous matching between firms and underwriters based on
value-relevant variables not reflected in our valuation methodology is to control directly for the effect of these
variables. One such variable may be real options available to the firm at the time of the IPO, as argued by
Carlson, Fisher, and Giammarino (2006), who hypothesize that firms issuing equity have a significant fraction
of their value in the form of real options, which they exercise subsequent to the equity offering by investing the
amount raised in the offering. We control for the effect of such variables by including the long-horizon (three,
five, and seven year averages) post-IPO operating performance of firms in our OLS as well as instrumental
variable regressions. Clearly, any variable that affects the IPO firms intrinsic value (including real options at
the time of the IPO) has to manifest itself in long-horizon operating performance. Our results continue to hold
even after controlling for post-IPO operating performance.
Finally, our market power hypothesis is consistent with our results showing that various proxies for
participation by higher quality market players, heterogeneous beliefs, and short sales constraints affect valuation
positively, and that adding these variables in the valuation regressions takes away significance from the
underwriter reputation variable. In contrast, arguments based on endogenous matching between firms and
underwriters are not able to explain the above results. However, as is true for many phenomena in corporate
finance, one or more alternative explanations can coexist along with our market power hypothesis for the
relationship between underwriter reputation and IPO valuation. Nevertheless, given the robustness of our results
to the various methodologies mentioned above, we believe that an underwriter plays a marketing rather than a
certification role in IPOs.

10. Conclusion
Several theoretical papers have argued that the valuation of equity will reflect the beliefs of the most
optimistic investors and be at a premium over intrinsic value when rational investors subject to short sale
constraints have heterogeneous priors. We test the above theories by analyzing the effect of IPO underwriter

38

reputation on the heterogeneity in investor beliefs and the tightness of short sale constraints, and consequently
on equity valuation in IPOs. We propose a market power hypothesis, postulating that higher reputation
underwriters are able to attract a greater number of higher quality market participants (such as institutional
investors, analysts, and co-managers in the syndicate) to the IPOs backed by them, thereby yielding higher IPO
valuations (relative to intrinsic value) by increasing the heterogeneity in retail investor beliefs and the tightness
of short sale constraints. We empirically distinguish between the above hypothesis and the certification
hypothesis, which implies that higher reputation underwriters are associated with IPOs priced closer to intrinsic
value.
We find that equity in higher reputation underwriter backed IPOs are priced higher and further away
from intrinsic value compared to lower reputation underwriter backed IPOs. We show that the above
relationship between underwriter reputation and IPO valuation is driven by the greater heterogeneity in investor
beliefs, tighter short sale constraints, and greater participation by institutional investors, analysts, and higher
reputation co-managing underwriters which characterize higher reputation underwriter backed IPOs. Overall,
our results support the market power hypothesis and reject the certification hypothesis. Further, unlike results
based on IPO underpricing, the evidence based on our measures indicates that the economic role of the
underwriter remains the same across the 1980s and the 1990s.
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Appendix 1: Summary of Empirical Predictions




Variable(s) of Interest Empirical Predictions
Offer price to intrinsic value
ratio
H1A: Market power Hypothesis- Higher reputation underwriter backed IPOs will have
higher offer price to intrinsic value ratios than lower reputation underwriter backed IPOs.

H1B: Certification Hypothesis- Higher reputation underwriter backed IPOs will have
offer price to intrinsic value ratios closer to 1 than lower reputation underwriter backed
IPOs.

Secondary market price to
intrinsic value ratio
H2: Higher reputation underwriter backed IPOs will have higher first day closing
secondary market price to intrinsic value ratios than lower reputation underwriter backed
IPOs.

Market price to intrinsic
value ratios over time
H3A: Market power Hypothesis- Over the long run, the stock price to intrinsic value
ratios of higher and lower reputation underwriter backed IPOs should converge towards
each other and towards unity.

H3B: Certification Hypothesis- Over the long run, the stock price to intrinsic value ratios
should not change.

Participation by market
players in IPOs
H4: Higher reputation underwriter backed IPOs will have more co-managers compared to
lower reputation underwriter backed IPOs.

H5: Higher reputation underwriter backed IPOs will have more reputable co-managers
compared to lower reputation underwriter backed IPOs.

H6: Higher reputation underwriter backed IPOs will have more institutional investor
participation compared to lower reputation underwriter backed IPOs.

H7: Higher reputation underwriter backed IPOs will have more analyst participation
compared to lower reputation underwriter backed IPOs.

Market player participation
and IPO valuation
H8: Higher Participation by market players will be associated with higher IPO offer price
to intrinsic value ratios and higher first day closing secondary market price to intrinsic
value ratios for IPO stocks.

Heterogeneous beliefs and
short sale constraints for the
IPO firm stock
H9: Higher reputation underwriter backed IPO stocks will have more heterogeneity in
investor beliefs compared to lower reputation underwriter backed IPO stocks.

H10: Higher reputation underwriter backed IPO stocks will have more binding short sale
constraints compared to lower reputation underwriter backed IPO stocks.

Heterogeneous beliefs, short
sale constraints, and IPO
valuation
H11: Higher levels of heterogeneous beliefs and more short sale constraints will be
associated with higher IPO offer price to intrinsic value ratios and higher first day closing
secondary market price to intrinsic value ratios for IPO stocks.





Table 1
Summary Statistics and Underpricing Trend in the 1980s and the 1990s
This table reports the descriptive statistics for a sample of IPOs. IPOs with an offer price below $5.00 per share, unit offers, REITs,
closed-end funds, banks and S&Ls, and ADRs are excluded. Total Proceeds (in $ millions) and venture backed dummy are as reported
in SDC. Assets (in $ millions) and EBITDA (in $ millions) are as reported in Compustat for the fiscal year prior to the IPO date.
Underpricing is the percentage change in stock price from the offer price to the closing value at the end of the first trading day. Offer
price data is from SDC while first day closing prices are obtained from CRSP. Panel A reports descriptive statistics for the full IPO
sample; Panel B reports the time trend of underpricing for the sample. 80s time period corresponds to issues that are placed between
1980 and 1989, 90s time period corresponds to issues placed between 1990 and 1998, and 90s incl. bubble time period
corresponds to issues placed between 1990 and 2000. High reputation underwriter stands for IPOs whose lead underwriting
syndicate has reputation rank higher than the median for the sample. Low reputation underwriter stands for IPOs whose lead
underwriting syndicate has reputation rank lower than the median. The ranking is calculated as the average market share of the lead
underwriting syndicate over the sample period based on Megginson & Weiss (1991). Data are from SDC Platinum, CRSP, and
Compustat.

Panel A: Summary statistics
Assets EBITDA
Total
Proceeds
Venture
Backed
Underpricing

Mean 229.22 29.13 67.65 0.54 0.29
High Reputation
Underwriter
Median 30.99 4.31 42.00 0.11
Std. Dev. 1088.41 169.12 86.54 0.50 0.57
Count 1842 1842 1831 1842 1842

Mean 41.89 5.47 26.36 0.35 0.13
Low Reputation
Underwriter
Median 14.62 2.42 17.5 0.05
Std. Dev. 165.95 22.41 30.94 0.48 0.32
Count 1895 1895 1894 1895 1895

Total
Mean 134.23 17.13 46.66 0.45 0.21
Median 21.07 3.01 29.00 0.07
Std. Dev. 778.77 120.37 67.77 0.50 0.47
Count 3737 3737 3725 3737 3737
Panel B: Underpricing trend over time

Time
period

High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
80s Mean 0.071 0.086 -0.015
Median 0.023 0.025 -0.001
Count 304 682

90s Mean 0.182 0.106 0.076
Median 0.104 0.062 0.042
Count 1148 1027


90s incl.
bubble Mean 0.336 0.156 0.180
Median 0.137 0.070 0.067
Count 1538 1213











Table 2
The Valuation of IPOs Backed by High and Low Reputation Underwriters using the
Basic Comparable Firm Approach
This table reports the cross-sectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing
secondary market price to intrinsic value (SMP/IV) for IPOs. The intrinsic value is the fair value of the IPO firm computed based on
market price-to-sales, market price-to-EBITDA, or market price-to-earnings ratios of an industry peer. The industry peer is a
comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and has the closest sales and EBITDA
profit margin (EBITDA/ Sales) in the pre-IPO fiscal year. High Reputation Underwriter stands for IPOs whose lead underwriting
syndicate has reputation rank higher than the median for the sample. Low Reputation Underwriter stands for IPOs whose lead
underwriting syndicate has reputation rank lower than the median. The rankings are calculated as the average market share of the lead
underwriting syndicate over the sample period based on Megginson & Weiss (1991). 80s time period corresponds to issues that are
placed between 1980 and 1989, 90s time period corresponds to issues placed between 1990 and 1998, and 90s incl. bubble time
period corresponds to issues placed between 1990 and 2000. For median ratios, p-value corresponds to the sign test for median OP/ IV
(or SMP/IV) equal to 1. For differences, the p-values are for Wilcoxon-Mann-Whitney rank sum test for the equality of medians of
two sub-samples. ***, **, and * indicate significance at the 1, 5, and 10 percent levels, respectively. The IPOs are from SDC
Platinum and all other data are from CRSP and Compustat.

Sales multiple

OP/IV SMP/IV

High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s median 1.565 1.519 0.046 1.650 1.577 0.073
p-value (0.000)*** (0.000)*** (0.039)** (0.000)*** (0.000)*** (0.037)**
count 244 611 244 611
90s median 1.588 1.224 0.364 1.772 1.313 0.459
p-value (0.000)*** (0.002)*** (0.000)*** (0.0001)*** (0.0001)*** (0.000)***
count 904 716 904 716
90s incl. bubble median 1.670 1.264 0.406 1.923 1.349 0.574
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 1037 763 1037 763
EBITDA multiple



OP/IV SMP/IV

High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s median 1.503 1.215 0.289 1.608 1.341 0.267
p-value (0.000)*** (0.000)*** (0.003)*** (0.000)*** (0.000)*** (0.003)***
count 233 588 233 588
90s median 1.549 1.211 0.338 1.749 1.297 0.452
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 854 657 854 657
90s incl. bubble median 1.632 1.247 0.385 1.84 1.345 0.495
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 975 699 975 699
Earnings multiple

OP/IV SMP/IV

High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s median 1.518 1.315 0.203 1.664 1.347 0.316
p-value (0.000)*** (0.000)*** (0.009)*** (0.000)*** (0.000)*** (0.008)***
count 209 541 209 541 0
90s median 1.634 1.178 0.455 1.876 1.269 0.607
p-value (0.000)*** (0.008)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 621 522 0 621 522 0
90s incl. bubble median 1.7 1.237 0.463 1.94 1.305 0.635
p-value (0.000)*** (0.001)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 685 555 685 555







Table 3
The Valuation of IPOs Backed by High and Low Reputation Underwriters using the
Propensity Score Based Comparable Firm Approach
This table reports the cross- sectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing
secondary market price to intrinsic value (SMP/IV) for IPOs. The intrinsic value is the fair value of the IPO firm computed based on
market price-to-sales, market price-to-EBITDA, or market price-to-earnings ratio of an industry peer. The industry peer is a
comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and which has the closest propensity
score value based on sales, operating margin (EBITDA/ Sales), profit margin (Net Income/ Sales), sales growth, cost of goods sold
growth, and selling and general expenses growth. High Reputation Underwriter stands for IPOs whose lead underwriting syndicate
has reputation rank higher than the median for the sample. Low Reputation Underwriter stands for IPOs whose lead underwriting
syndicate has reputation rank lower than the median. The rankings are calculated as the average market share of the lead underwriting
syndicate over the sample period based on Megginson & Weiss (1991). 80s time period corresponds to issues that are placed
between 1980 and 1989, 90s time period corresponds to issues placed between 1990 and 1998, and 90s incl. bubble time period
corresponds to issues placed between 1990 and 2000. For median ratios, p-values correspond to the sign test for median OP/ IV (or
SMP/IV) equal to 1. For differences, the p-values are for Wilcoxon-Mann-Whitney rank sum test for the equality of medians of two
sub-samples. ***, **, and * indicate significance at the 1, 5, and 10 percent levels, respectively. The IPO data is from SDC Platinum
and all other data are from CRSP and Compustat.

Sales multiple
OP/IV SMP/IV

High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s median 1.839 1.556 0.283 2.000 1.676 0.324
p-value (0.000)*** (0.000)*** (0.018)** (0.000)*** (0.000)*** (0.025)**
count 200 440 200 440
90s median 1.728 1.21 0.518 2.073 1.358 0.716
p-value (0.000)*** (0.008)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 703 636 703 636
90s incl. Bubble median 1.9 1.312 0.588 2.322 1.43 0.891
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 917 720 917 720
EBITDA multiple


OP/IV SMP/IV


High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s median 1.449 1.289 0.159 1.487 1.319 0.168
p-value (0.003)*** (0.004)*** (0.061)* (0.002)*** (0.001)*** (0.071)*
count 161 360 161 360
90s median 1.287 1.171 0.115 1.464 1.241 0.223
p-value (0.000)*** (0.011)** (0.312) (0.000)*** (0.000)*** (0.135)
count 505 434 505 434
90s incl. Bubble median 1.288 1.178 0.11 1.5 1.252 0.248
p-value (0.000)*** (0.003)*** (0.263) (0.000)*** (0.000)*** (0.065)*
count 582 458 582 458
Earnings multiple

OP/IV SMP/IV

High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s median 1.37 1.266 0.104 1.535 1.378 0.157
p-value (0.001)*** (0.002)*** (0.293) (0.000)*** (0.000)*** (0.383)
count 143 326 143 326
90s median 1.451 1.127 0.323 1.73 1.236 0.494
p-value (0.000)*** (0.0702)* (0.0136)** (0.000)*** (0.011)** (0.003)***
count 360 353 360 353
90s incl. Bubble median 1.488 1.136 0.352 1.822 1.282 0.54
p-value (0.000)*** (0.029)** (0.004)*** (0.000)*** (0.003)*** (0.001)***
count 407 371 407 371




Table 4
The Valuation of IPOs Backed by High and Low Reputation Underwriters using the
Discounted Cash Flow Approach
This table reports the cross- sectional distribution of the ratio of offer price to intrinsic value (OP/ IV) and the first trading day closing
secondary market price to intrinsic value (SMP/IV) for IPOs. The intrinsic value is the fair value of the IPO firm estimated using the
residual income model of Ohlson (1990) with a constant discount rate of 13%. 5% growth represents the aggregate sample of IPOs
across years where IVs are calculated under the assumption of 5% indefinite earnings growth after year 3, 0% growth represents the
aggregate sample of IPOs across years where IVs are calculated under the assumption of no earnings growth after year 3. High
Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation rank higher than the median for the
sample. Low Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median.
The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on
Megginson & Weiss (1991). 80s time period corresponds to issues that are placed between 1980 and 1989, 90s time period
corresponds to issues placed between 1990 and 1998, and 90s incl. bubble time period corresponds to issues placed between 1990
and 2000. For median ratios, p-values correspond to the sign test for median OP/ IV (or SMP/IV) equal to 1. For differences, the p-
values are for Wilcoxon-Mann-Whitney rank sum test for the equality of medians of two sub-samples. ***, **, and * indicate
significance at the 1, 5, and 10 percent levels, respectively. The IPOs are from SDC Platinum and all other data are from CRSP and
Compustat.

Growth = 0
OP/IV SMP/IV

High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s median 2.190 1.898 0.292 2.438 2.031 0.406
p-value (0.000)*** (0.000)*** (0.040)** (0.000)*** (0.000)*** (0.027)**
count 151 381 151 381
90s median 2.575 2.236 0.338 2.949 2.432 0.517
p-value (0.000)*** (0.000)*** (0.017)** (0.000)*** (0.000)*** (0.001)***
Count 705 634 705 634
90s incl. Bubble
Median 2.825 2.377 0.449 3.220 2.614 0.607
p-value (0.000)*** (0.000)*** (0.005)*** (0.000)*** (0.000)*** (0.000)***
Count 863 717 863 717
Growth = 5%
OP/IV SMP/IV

High Reputation
Underwriter
Low Reputation
Underwriter
Difference
High Reputation
Underwriter
Low Reputation
Underwriter
Difference
80s Median 1.986 1.756 0.231 2.145 1.902 0.242
p-value (0.000)*** (0.000)*** (0.080)* (0.000)*** (0.000)*** (0.055)*
Count 151 381 151 381
90s Median 2.426 2.149 0.277 2.727 2.349 0.378
p-value (0.000)*** (0.000)*** (0.117) (0.000)*** (0.000)*** (0.014)**
Count 705 634 705 634
90s incl. Bubble
Median 2.607 2.323 0.283 3.071 2.565 0.507
p-value (0.000)*** (0.000)*** (0.036)** (0.000)*** (0.000)*** (0.001)***
Count 863 718 863 718





Table 5
Endogenous Matching between Underwriter Reputation and Firm Quality
This table reports the results of OLS, treatment effects, and two stage least squares model estimations. The dependent variable in the OLS and the second stage of the treatment effects and two stage least
squares models are the log of the ratio of offer price to intrinsic value and the log of the ratio of the secondary market price to intrinsic value. The intrinsic value is the fair value of the IPO firm
computed based on market price-to-sales ratio of an industry peer. The industry peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and has the
closest sales and EBITDA profit margin (EBITDA/ Sales) in the pre-IPO fiscal year. The treatment effects and the 2SLS models estimate two stages. The first stage (selection stage) dependent variables
are the underwriter reputation dummy (in the treatment effects model) and the log of the underwriter IPO market share (in the two stage least squares model). The independent variables are: Client state
newspaper circulation, which is average state level per-capita newspaper circulation in the states in which the underwriter has done IPO underwriting business over the five years prior to the sample
IPO; average post-IPO operating income to sales, which is the average 5 year post-IPO operating income to sales ratio; Size, which is the log of assets of the IPO firm; VC backing dummy; the fraction
of firm sold, calculated as the number of shares sold in IPO as fraction of number of shares outstanding; industry fixed effects; and year fixed effects. Firm state effects are included in the 2SLS and the
treatment effects models. Panel C reports the three models controlling for the average three year post-IPO operating income to sales ratio. ***, **, and * indicate significance at the 1, 5, and 10 percent
levels, respectively. The IPOs are from SDC Platinum and all other data are from CRSP and Compustat.

Panel A: OLS and Two Stage Least Squares models with continuous version of underwriter reputation
OLS Regression
Two stage least squares
First stage Second stage

Offer price
to intrinsic
value ratio

Secondary
market price
to intrinsic
value ratio

Underwriter
reputation
Offer price
to intrinsic
value ratios

Secondary
market price
to intrinsic
value ratio
Underwriter reputation
0.129 0.127
Underwriter reputation
0.094 0.107
[0.000]*** [0.000]*** [0.001]*** [0.000]***
Client state newspaper
circulation
10.481
[0.000]***
Size

-0.238

-0.229

Size
0.624

-0.205

-0.235

[0.000]***

[0.000]***

[0.000]***

[0.000]***

[0.000]***
VC Backing

0.171

0.157

VC Backing
0.519

0.182

0.196

[0.000]***

[0.000]***

[0.000]***

[0.000]***

[0.000]***
Fraction of firm sold

-1.555

-1.504

Fraction of firm sold
-0.497

-1.52

-1.668

[0.000]***

[0.000]***

[0.000]***

[0.000]***

[0.000]***
Constant

2.819

-0.009

Constant
-7.992

-0.228

1.151

[0.000]***

[0.978]

[0.000]***

[0.535]

[0.002]***

Adj. R-Square

0.207

0.21

Adj. R-Square

0.498

0.207

0.237
Observations

2655

2655

Observations

2655

2655

2655

Weak Instrument Test:
(First Stage F statistic)
115.824***

























Panel B: OLS and Treatment effects models with dummy version of underwriter reputation
OLS Regression

Treatment Effects Model
First stage Second stage

Offer price
to intrinsic
value ratio

Secondary
market price
to intrinsic
value ratio

Underwriter
reputation
Offer price to
intrinsic
value ratios

Secondary
market price
to intrinsic
value ratio
Underwriter reputation
dummy
0.319 0.369 Underwriter reputation
dummy
0.361 0.434
[0.000]*** [0.000]*** [0.002]** [0.000]***
Client state newspaper
circulation
6.633
[0.000]***
Size

-0.184

-0.211

Size
0.397

-0.181

-0.211

[0.000]***

[0.000]***

[0.000]***

[0.000]***

[0.000]***
VC Backing

0.216

0.232

VC Backing
0.413

0.192

0.204

[0.000]***

[0.000]***

[0.000]***

[0.000]***

[0.000]***
Fraction of firm sold

-1.575

-1.722

Fraction of firm sold

-0.48

-1.515

-1.66

[0.000]***

[0.000]***

[0.002]**

[0.000]***

[0.000]***
Constant

0.523

0.752

Constant
-1.621
-0.412

-0.023

[0.027]*

[0.002]**

[0.297]

[0.774]

[0.988]

Adj. R-Square

0.187

0.214

Wald Chi Sq.

690.323***

1396.675***

1510.352***
Observations

2655

2655

Observations

2655

2655

2655





Panel C: OLS, two stage least squares, and treatment effects models with additional control for post-IPO operating performance
OLS model Two stage least squares model Treatment Effects Model
First stage Second stage First stage Second stage

Offer
price to
intrinsic
value
ratio
Offer
price to
intrinsic
value
ratio
Secondary
market
price to
intrinsic
value ratio
Secondary
market
price to
intrinsic
value ratio
Underwriter
reputation
(continuous)
Offer
price to
intrinsic
value
ratio
Secondary
market
price to
intrinsic
value ratio
Underwriter
reputation
(dummy)
Offer price
to intrinsic
value ratio
Secondary
market
price to
intrinsic
value ratio
Underwriter reputation
(continuous)
0.128 0.145
0.093 0.108
[0.000]*** [0.000]***
[0.001]*** [0.000]***
Underwriter reputation
(dummy)
0.32 0.37
0.363 0.436
[0.000]*** [0.000]***
[0.002]** [0.000]***
Client state newspaper
circulation
10.761 6.966
[0.000]*** [0.000]***
Average post-IPO
operating income to sales
-0.001 0.054 0.033 0.095
0.547 0.028 0.059 0.382 0.056 0.089
[0.993] [0.736] [0.847] [0.584]
[0.006]** [0.856] [0.721] [0.089]* [0.672] [0.513]
Size
-0.233 -0.181 -0.266 -0.208
0.609 -0.2 -0.231 0.388 -0.178 -0.208
[0.000]*** [0.000]*** [0.000]*** [0.000]***
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
VC Backing
0.176 0.22 0.186 0.234
0.51 0.187 0.199 0.414 0.195 0.206
[0.000]*** [0.000]*** [0.000]*** [0.000]***
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Fraction of firm sold
-1.572 -1.593 -1.725 -1.748
-0.513 -1.536 -1.689 -0.484 -1.532 -1.682
[0.000]*** [0.000]*** [0.000]*** [0.000]***
[0.000]*** [0.000]*** [0.000]*** [0.002]** [0.000]*** [0.000]***
Constant
2.407 0.044 2.859 0.287
-7.872 -0.103 1.241 -3.162 -0.849 -0.563
[0.000]*** [0.854] [0.000]*** [0.239]
[0.000)*** [0.791] [0.001]*** [0.008]*** [0.554] [0.705]

Adj. R-Square/Chi-Sq
0.205 0.185 0.235 0.214

0.504 0.207 0.237
665.91***
1375.96*** 1490.80***
Observations
2602 2602 2602 2602

2602 2602 2602 2602 2602 2602
Weak Instrument Test:
(First Stage F statistic)
118.94***





Table 6
Dynamics of Market Valuation for IPOs Backed by
High and Low Reputation Underwriters
This table presents the ratio of offer price (OP/IV) and secondary market price to intrinsic value (SMP/ IV) for IPOs over time. The
dataset contains IPOs. The intrinsic value is the fair value of the IPO firm computed based on market price-to-sales , market price-to-
EBITDA ratio, or market price-to-earnings ratio of an industry peer. For the basic matching approach, the industry peer is a
comparable publicly traded firm generated by the basic comparable firm approach. For the propensity score approach, the industry
peer is a comparable publicly traded firm in the same Fama and French (1997) industry as the IPO firm and which has the closest
propensity score value based on sales, operating margin (EBITDA/ Sales), profit margin (Net Income/ Sales), sales growth, cost of
goods sold growth, and selling and general expenses growth. OP/IV is the ratio of offer price to estimated intrinsic value of the IPO
stock. SMP/IV t is the ratio of the closing price on the secondary market in year t after IPO to the estimated intrinsic value of the
IPO stock at year t. High Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation rank higher than
the median for the sample. Low Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation rank
lower than the median. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample
period based on Megginson & Weiss (1991). For median ratios, p-values corresponds to the sign test for median OP/ IV (or SMP/IV)
equal to 1. For differences, the p-values are for Wilcoxon-Mann-Whitney rank sum test for the equality of medians of two sub-
samples. ***, **, and * indicate significance at the 1, 5, and 10 percent levels, respectively. The IPOs are from SDC Platinum and all
other data are from CRSP and Compustat.

Basic Comparable Firm Valuation Dynamics
Sales Multiple Earnings Multiple

High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
OP/IV 1.616 1.303 0.313 1.632 1.274 0.358
(0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
SMP/IV 0 1.87 1.368 0.502 1.873 1.325 0.549
(0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
SMP/IV 1 1.442 1.206 0.236 1.387 1.072 0.315
(0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.092)* (0.000)***
SMP/IV 2 1.186 1.009 0.177 1.203 1.047 0.156
(0.000)*** (0.751) (0.000)*** (0.000)*** (0.127) (0.000)***
SMP/IV 3 1.118 0.904 0.214 1.195 1.086 0.109
(0.009)*** (0.005)*** (0.000)*** (0.000)*** (0.122) (0.083)*
Propensity Score Based Comparable Firm Valuation Dynamics
Sales Multiple Earnings Multiple

High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
OP/IV 1.823 1.393 0.43 1.455 1.223 0.232
(0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.002)***
SMP/IV 0 2.183 1.521 0.663 1.715 1.333 0.382
(0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
SMP/IV 1 1.523 1.188 0.335 1.197 1.157 0.041
(0.000)*** (0.000)*** (0.000)*** (0.001)*** (0.002)*** (0.349)
SMP/IV 2 1.495 1.212 0.284 1.277 1.15 0.126
(0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.022)** (0.119)
SMP/IV 3 1.295 1.088 0.206 1.142 1.081 0.061
(0.000)*** (0.505) (0.002)*** (0.176) (0.279) (0.479)




Table 7
Market Participants in IPOs Backed by High and Low Reputation Underwriters:
Univariate Tests
This table reports the cross-sectional distribution of underwriter reputation, institutional investor participation, analyst coverage, and
co-managing underwriter participation for IPOs. Panel A reports the number of co-managing underwriters participating in the IPO and
the MW reputation of the co-managing underwriter based on average market share of the investment bank as a co-managing
underwriter for all IPOs through the entire sample period. Panel B presents institutional investor participation statistics. It reports the
percentage of IPOs with the institutional investors holdings, number of the institutional investors with IPO allocations, and the
institutional investor holdings in IPO as a percentage of shares outstanding immediately after the IPO. Panel C reports the number of
unique analysts that provide earnings estimate and the number of unique analysts that provide buy/hold/sell recommendations in the
IPO year. High Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation rank higher than the
median for the sample. Low Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation rank lower
than the median. The rankings are calculated as average market share of the underwriting syndicate over the sample period based on
Megginson & Weiss (1991). The p-values for means and medians are reported in parentheses below the variable. The p-values for
individual means and medians test difference from 0 and the p-values for the differences test the difference between two subsamples.
***, **,and * indicate significance at the 1, 5, and 10 percent levels respectively. The IPO and underwriter data are from SDC. The
institutional investor holdings data are from Spectrum Institutional (13f) Holdings Database of Thomson Financial. The analyst data
are obtained from the I/B/E/S database.

Panel A: Co-managing Underwriter Participation


High Reputation
Underwriter
Low Reputation
Underwriter Difference
Number of co-managing
underwriters
Mean 1.654 0.812 0.842
p-value (0.000)*** (0.000)*** (0.000)***
Median 2 1 1
p-value (0.000)*** (0.000)*** (0.000)***
Count 1842 1895
MW co-managing
underwriter market share
Mean 0.015 0.008 0.007
p-value (0.000)*** (0.000)*** (0.000)***
Median 0.012 0.004 0.008
p-value (0.000)*** (0.000)*** (0.000)***
Count 1672 1135
Panel B: Institutional investor Participation

High Reputation
Underwriter
Low Reputation
Underwriter Difference
Number of institutions
Mean 27.718 13.723 13.995
p-value (0.000)*** (0.000)*** (0.000)***
Median 24 11 13
p-value (0.000)*** (0.000)*** (0.000)***
Count 1749 1589
Percentage institutional
holding
Mean 0.829 0.510 0.319
p-value (0.000)*** (0.000)*** (0.000)***
Median 0.728 0.442 0.286
p-value (0.000)*** (0.000)*** (0.000)***
Count 1749 1589
Institutional participation
(0/1)
Mean 0.955 0.843 0.112
p-value (0.000)*** (0.000)*** (0.000)***
Count 1832 1885
Panel C: Analyst Participation

High Reputation
Underwriter
Low Reputation
Underwriter Difference
Number of analysts
estimating earnings
Mean 5.433 3.472 1.961
p-value (0.000)*** (0.000)*** (0.000)***
Median 4 3 1
p-value (0.000)*** (0.000)*** (0.000)***
Count 1542 1548
Number of analysts issuing
recommendations
Mean 5.163 3.275 1.888
p-value (0.000)*** (0.000)*** (0.000)***
Median 4 3 1
p-value (0.000)*** (0.000)*** (0.000)***
Count 1135 976




Table 8
Market Participants in IPOs Backed by High and Low Reputation Underwriters:
Multivariate Tests
This table reports the results of our regression analysis of market participants in IPOs. Panel A presents the regression results with co-
managing underwriter participation proxies as the dependent variables. The dependent variables in these regressions are number of co-
managing underwriters participating in the IPO (poisson regression) and a high reputation dummy for the co-managing underwriter
syndicate calculated in a similar manner as that for the lead underwriter syndicate. The independent variables are the underwriter
reputation dummy, the VC backing dummy, size (log of total assets), and year and industry fixed effects. Panel B presents the results
of regressions with institutional investor participation proxies as the dependent variable. The dependent variables in these regressions
are institutional participation (0/1, probit regression), number of the institutional investors with IPO allocations, and the institutional
investor holdings in IPO as a percentage of shares outstanding immediately after IPO. The independent variables are the lead
underwriter reputation dummy, the VC backing dummy, size (log of total assets), the number of co-managing underwriters in the IPO,
co-managing underwriter reputation dummy, and year and industry fixed effects. Panel C presents the results of regressions with
analyst participation proxies as the dependent variable. The dependent variables in these regressions are the number of unique analysts
providing earnings estimates and the number of unique analysts issuing buy/hold/sell recommendations for the IPO firm. The
independent variables are the underwriter reputation dummy, the VC backing dummy, size (log of total assets), number of institutional
investors with IPO allocations, institutional investor holdings in the IPO as a percentage of shares outstanding immediately after the
IPO, the number of co-managing underwriters in the IPO, co-managing underwriter reputation dummy, and year and industry fixed
effects. The underwriter reputation dummy takes the value 1 if the lead underwriting syndicate has a ranking value greater than the
median for the sample and 0 otherwise. The rankings are calculated as the average market share of the lead underwriting syndicate
over the sample period based on Megginson & Weiss (1991). Robust p-values are reported in parentheses. ***, **, and * indicate
significance at the 1, 5, and 10 percent levels, respectively.

Panel A: Co-managing Underwriter Participation
(1) (2) (3) (4) (5) (6)

Number of Co-managing Underwriters
(Poisson)
High Reputation Co-managing Underwriter
(0/1)
(Probit)
Underwriter reputation dummy 0.470 0.311 0.298 0.659 0.626 0.596
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Size 0.172 0.156 0.163 0.232 0.248 0.295
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
VC backing 0.312 0.215 0.184 0.432 0.408 0.346
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Constant -0.81 -1.538 -1.236 -1.375 0.32 -0.596
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.557] [0.431]
Year dummies N Y Y N Y Y
Industry dummies N N Y N N Y
Observations 3737 3737 3737 2807 2807 2786
Pseudo R-sq. 0.085 0.158 0.164 0.124 0.147 0.176






























Panel B: Institutional Investor Participation
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

Institutional Participation (0/1)
(Probit)
Number of Institutions Percentage Institutional Holdings
Underwriter reputation
dummy
0.314 0.268 0.201 0.192 6.285 5.065 5.108 4.362 0.135 0.123 0.106 0.101
[0.000]*** [0.000]*** [0.019]** [0.028]** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Size
0.251 0.241 0.208 0.203 4.687 3.8 4.638 3.977 0.082 0.073 0.074 0.069
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
VC backing
0.268 0.245 0.261 0.259 0.532 0.057 -0.08 -0.114 0.191 0.185 0.202 0.201
[0.000]*** [0.001]*** [0.005]*** [0.005]*** [0.283] [0.912] [0.894] [0.849] [0.000]*** [0.000]*** [0.000]*** [0.000]***
Num. of co-managing
underwriters
0.115 0.062 3.634 3.414 0.037 0.024
[0.032]** [0.425] [0.000]*** [0.000]*** [0.007]*** [0.149]
Co-managing
underwriter reputation
0.168 0.162 3.144 2.891 0.057 0.055
[0.060]* [0.069]* [0.000]*** [0.000]*** [0.009]*** [0.011]**
Constant
-0.845 -0.827 -1.052 -1.099 -0.669 -0.372 0.078 -24.369 0.477 0.335 0.421 -0.451
[0.187] [0.191] [0.191] [0.167] [0.782] [0.851] [0.982] [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Year dummies Y Y Y Y Y Y Y Y Y Y Y Y
Ind. dummies Y Y Y Y Y Y Y Y Y Y Y Y
Observations 3619 3601 2597 2597 3338 3322 2612 2612 3338 3322 2612 2612
Pseudo R-sq. 0.179 0.182 0.184 0.185
Adj. R-sq. 0.422 0.446 0.361 0.381 0.225 0.226 0.164 0.164





Panel C: Analyst Participation Multivariate
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
Number of Analysts Estimating Earnings Number of Analysts Issuing Recommendations
Underwriter reputation
dummy
1.122 0.59 1.126 0.431 0.449 0.336 1.12 0.65 1.138 0.466 0.537 0.4
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.005]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Size
0.591 0.175 0.572 0.076 0.099 0.011 0.428 0.108 0.403 -0.006 0.07 -0.046
[0.000]*** [0.000]*** [0.000]*** [0.103] [0.055]* [0.822] [0.000]*** [0.023]** [0.000]*** [0.901] [0.171] [0.349]
VC backing
0.688 0.648 0.701 0.545 0.479 0.447 0.511 0.541 0.565 0.452 0.522 0.478
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Number of institutions
0.09 0.083 0.086 0.08 0.068 0.06 0.065 0.057
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Percentage institutional
holdings
0.28 0.085
[0.525] [0.842]
Num. of co-managing
underwriters
0.605 0.594 0.637 0.691
[0.000]*** [0.000]*** [0.000]*** [0.000]***
Co-managing
underwriter reputation
0.575 0.521 0.358 0.291
[0.000]*** [0.000]*** [0.003]*** [0.014]**
Constant
16.583 3.253 -0.007 -2.217 6.082 5.297 10.71 3.02 12.624 1.734 1.655 -0.362
[0.000]*** [0.000]*** [0.995] [0.001]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.107] [0.733]
Year dummies Y Y Y Y Y Y Y Y Y Y Y Y
Industry dummies Y Y Y Y Y Y Y Y Y Y Y Y
Observations 3090 2835 2768 2835 2431 2431 2111 1987 1936 1987 1842 1842
Adjusted R-sq. 0.259 0.403 0.244 0.421 0.386 0.4 0.301 0.422 0.289 0.451 0.399 0.429








Table 9
Heterogenous Beliefs About IPOs Backed by High and Low Reputation Underwriters : Univariate Tests
This table reports the distribution of average daily, weekly, and monthly volume, turnover, number of trades in Panel A and average daily, weekly, and monthly adj. volume, adj. turnover, and adj.
number of trades for IPOs in Panel B. The trading volume is calculated as the daily average of log (number of shares traded multiplied by price). The daily turnover calculated as the daily average of the
percentage of number of shares outstanding traded during the period. The number of trades is the daily average number of trades in that period. The adjusted values of the statistics are calculated by
subtracting from them the average monthly value of that statistic calculated 3 years after the IPO date. High Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation
rank higher than the median for the sample. Low Reputation Underwriter stands for IPOs whose lead underwriting syndicate has reputation rank lower than the median for the sample. The rankings
are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). The p-values for means and medians are reported in
parentheses below the variable. The p-values for individual means and medians test difference from 0 and the p-values for the differences test the difference between two subsamples. ***, **, and *
indicate significance at the 1, 5, and 10 percent levels, respectively. The trading volume, turnover, and number of trades data are from CRSP.

Panel A: Measures of heterogeneous beliefs, unadjusted
Volume Turnover Number of Trades
First
Day
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
Median 42.774 7.875 34.899 20.76 13.743 7.017 1005.5 366 639.5
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 1389 1342 1389 1343 1018 902
Volume Turnover Number of Trades
First
Week
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
Median 6.064 1.416 4.648 5.95 4.327 1.623 325.25 131.75 193.5
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 1392 1352 1392 1353 1021 911
Volume Turnover Number of Trades
First
Month
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
Median 1.807 0.445 1.362 2.148 1.686 0.462 121.815 56 65.815
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 1396 1371 1396 1371 1044 931













Panel A: Measures of heterogeneous beliefs, adjusted for liquidity effects
Volume Turnover Number of Trades
First
Day
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
Median 39.306 7.456 31.849 19.7557 13.2371 6.5186 840.758 322.55 518.208
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 1385 1340 1385 1341 966 859
Volume Turnover Number of Trades
First
Week
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
Median 3.639 1.078 2.561 5.152 3.805 1.347 193.609 92.318 101.291
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 1388 1350 1388 1351 969 868
Volume Turnover Number of Trades
First
Month
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter Difference
Median 0.613 0.208 0.405 1.412 1.19 0.222 38.455 23.654 14.8
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.005)***
count 1392 1368 1392 1368 989 886




Table 10
Heterogeneous Beliefs About IPOs Backed by
High and Low Reputation Underwriters: Multivariate Tests
This table reports the results of regression analysis of heterogeneous belief proxies. The dependent variables are: Adjusted daily
volume, log of adjusted daily turnover, and log of adjusted daily number of trades. Daily volume is calculated as log (number of
shares traded during the first trading day multiplied by price). Daily turnover calculated as the first day turnover. Daily number of
trades calculated as the first day number of trades. The adjusted values of the statistics are calculated by subtracting from them the
average monthly value of that statistic calculated 3 years after the IPO date. The independent variables are the underwriter reputation
dummy, size (log of total assets), the VC backing dummy, fraction of firm sold calculated as the number of shares sold in IPO as
fraction of number of shares outstanding, number of unique analysts that estimate earnings (Number of analysts), number of
institutional investors participating in the IPO, percentage share of IPO held by institutional investors, the number of co-managing
underwriters in the IPO, and the co-managing underwriter reputation dummy. Year and industry fixed effects are included in every
specification. The underwriter reputation dummy takes the value 1 if the lead underwriting syndicate has a ranking value greater than
the median for the sample and 0 otherwise. The rankings are calculated as the average market share of the lead underwriting syndicate
over the sample period based on Megginson & Weiss (1991). Robust p-values are reported in parentheses. ***, **, and * indicate
significance at the 1, 5, and 10 percent levels respectively.

Panel A: Adjusted Daily Volume
(1) (2) (3) (4) (5) (6)
Underwriter reputation
Dummy
0.754 0.553 0.4 0.533 0.379 0.255
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Size
0.341 0.192 0.043 0.177 0.028 0.011
[0.000]*** [0.000]*** [0.011]** [0.000]*** [0.118] [0.549]
VC backing
0.216 0.03 0.064 0.005 0.053 0.006
[0.000]*** [0.537] [0.145] [0.929] [0.228] [0.890]
Fraction of firm sold
-0.084 0.003 -0.098 0.003 -0.1 -0.124
[0.110] [0.957] [0.038]** [0.953] [0.035]** [0.012]**
Number of analysts
estimating earnings
0.114 0.026 0.113 0.021 0.016
[0.000]*** [0.005]*** [0.000]*** [0.026]** [0.091]*
Number of institutions
0.039 0.038 0.037
[0.000]*** [0.000]*** [0.000]***
Percentage institutional
holding
0.127
[0.063]*
Num. of co-managing
underwriters
0.089
[0.002]***
Co-managing underwriter
reputation
0.253
[0.000]***
Constant

0.457 1.746 1.058 1.519 1.187 2.249
[0.460] [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Observations 2637 2287 2143 2143 2143 1828
Adjusted R-squared 0.587 0.578 0.678 0.574 0.68 0.671

























Panel B: Adjusted Daily Turnover
(1) (2) (3) (4) (5) (6)
Underwriter reputation
Dummy
0.327 0.25 0.205 0.237 0.198 0.133
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Size
-0.012 -0.082 -0.121 -0.088 -0.126 -0.132
[0.275] [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
VC backing
0.13 0.07 0.079 0.06 0.076 0.057
[0.000]*** [0.028]** [0.014]** [0.076]* [0.019]** [0.080]*
Fraction of firm sold 0.821 0.861 0.833 0.863 0.832 0.798
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Number of analysts
estimating earnings
0.027 0.003 0.026 0.002 -0.002
[0.000]*** [0.514] [0.000]*** [0.715] [0.682]
Number of institutions
0.01 0.01 0.009
[0.000]*** [0.000]*** [0.000]***
Percentage institutional
holding
0.057
[0.069]*
Num. of co-managing
underwriters
0.027
[0.183]
Co-managing underwriter
reputation
0.083
[0.008]***
Constant 4.939 5.736 6.048 6.156 6.087 6.45
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Observations 2637 2287 2143 2143 2143 1828
Adjusted R-squared 0.424 0.445 0.462 0.441 0.463 0.467


Panel C: Adjusted Daily Number of Trades
(1) (2) (3) (4) (5) (6)
Underwriter reputation
Dummy
0.561 0.402 0.255 0.407 0.236 0.16
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.009]***
Size
0.169 0.078 -0.006 0.078 -0.014 -0.019
[0.000]*** [0.002]*** [0.788] [0.003]*** [0.538] [0.437]
VC backing
0.092 -0.01 -0.021 -0.011 -0.033 -0.071
[0.121] [0.868] [0.713] [0.862] [0.548] [0.232]
Fraction of firm sold -0.237 -0.119 -0.112 -0.112 -0.112 -0.126
[0.000]*** [0.074]* [0.079]* [0.115] [0.077]* [0.067]*
Number of analysts
estimating earnings
0.101 0.04 0.099 0.035 0.03
[0.000]*** [0.000]*** [0.000]*** [0.002]*** [0.008]***
Number of institutions
0.034 0.033 0.032
[0.000]*** [0.000]*** [0.000]***
Percentage institutional holding
0.009
[0.844]
Num. of co-managing
underwriters
0.087
[0.030]**
Co-managing underwriter
reputation
0.217
[0.000]***
Constant 4.141 5.599 4.789 4.889 4.111 4.218
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Observations 1703 1591 1494 1494 1494 1316
Adjusted R-squared 0.63 0.657 0.717 0.659 0.718 0.714




Table 11
The Dynamics of Heterogeneous Beliefs About IPOs Backed
by High and Low Reputation Underwriters
This table presents the daily adjusted volume, adjusted turnover, and adjusted number of trades over time from the IPO date to three
years after the IPO. High Reputation Underwriter stands for IPOs whose underwriting syndicate has a reputation rank higher than
the median for the sample. Low Reputation Underwriter stands for IPOs whose underwriting syndicate has a reputation rank lower
than the median. The rankings are calculated as average market share of the lead underwriting syndicate over the sample period based
on Megginson & Weiss (1991). For median ratios, p-values correspond to the Wilcoxon signtest for median equal to 0. For
differences, the p-values are for Wilcoxon- Mann-Whitney rank sum test for the equality of medians of two sub- samples. ***, **,
and * indicate significance at the 1, 5, and 10 percent levels, respectively. The IPO data is from SDC Platinum and all other data are
from CRSP and I/B/E/S.






















Adj. Volume Adj.Turnover

Adj.Number of trades

Time
after
IPO

High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
0 Median 39.306 7.456 31.849 19.7557 13.2371 6.5186 840.758 322.55 518.208
p-value (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)*** (0.000)***
count 1385 1340 1385 1341 966 859
1 Median 0.021 0.003 0.018 -0.078 -0.0731 -0.0048 -12.545 -4.19 -8.355
p-value (0.021)** (0.099)* (0.09)* (0.000)*** (0.000)*** (0.390) (0.000)*** (0.000)*** (0.000)***
count 1395 1368 1401 1388 1061 1065
2 Median 0.002 0.004 -0.003 -0.0821 -0.0607 -0.0213 -9.509 -3.286 -6.223
p-value (0.670) (0.000)*** (0.166) (0.000)*** (0.000)*** (0.035)** (0.000)*** (0.000)*** (0.000)***
count 1413 1426 1416 1446 1080 1157
3 Median -0.001 0 -0.002 -0.0688 -0.0619 -0.0069 -5.093 -1.952 -3.141
p-value (0.559) (0.544) (0.199) (0.000)*** (0.000)*** (0.048)** (0.000)*** (0.000)*** (0.000)***
count 1421 1440 1424 1463 1098 1198




Table 12
Short interest in IPOs Backed by High and Low Reputation Underwriters:
Univariate Tests
This table reports the distribution of monthly short interest for the subsequent three months after the IPO month and the average of the
first three months (Quarter 1 after IPO) for IPOs. Short interest in a particular month is the calculated as the ratio of the outstanding
short interest in that month to the shares outstanding at the end of the month. High Reputation Underwriter stands for IPOs whose
lead underwriting syndicate has a reputation rank higher than the median for the sample. Low Reputation Underwriter stands for
IPOs whose lead underwriting syndicate has a reputation rank lower than the median. The rankings are calculated as the average
market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). The p-values for
ranksum tests for medians are reported in parentheses below the variable. The p-values for medians test difference from 0 and the p-
values for the differences test the difference between two sub-samples. ***, **, and * indicate significance at the 1, 5, and 10 percent
levels, respectively. The shares outstanding data are from CRSP. The short interest data is hand collected from Bloomberg and is
available for IPOs that are issued on or after 1990.

Short Interest


High
Reputation
Underwriter
Low
Reputation
Underwriter
Difference
Month 1 Median 0.0022 0.0018 0.0004
after IPO p-value (0.002)*** (0.002)*** (0.000)***
count 592 638
Month 2 Median 0.0023 0.0014 0.0009
after IPO p-value (0.000)*** (0.000)*** (0.000)***
count 576 634
Month 3 Median 0.0026 0.0018 0.0008
after IPO p-value (0.000)*** (0.000)*** (0.000)***
count 572 626
Quarter 1 Median 0.0027 0.0021 0.0006
after IPO p-value (0.000)*** (0.000)*** (0.000)***
count 646 712
















Table 13
Short interest in IPOs Backed by High and Low Reputation Underwriters:
Multivariate Tests
This table reports the results of regression analysis with the first quarter short interest as the dependent variable. The first quarter short interest is
calculated as the log of the average short interest for the first three months after the IPO month. The independent variables are the underwriter reputation
dummy, size (log of total assets), the VC backing dummy, fraction of firm sold calculated as the number of shares sold in IPO as fraction of number of
shares outstanding, number of unique analysts that estimate earnings (Number of analysts), number of institutional investors participating in the IPO,
percentage share of the IPO stock held by institutional investors, the number of co-managing underwriters in the IPO, and the co-managing underwriter
reputation dummy. Year and industry fixed effects are included in every specification. The underwriter reputation dummy takes the value 1 if the lead
underwriting syndicate has a ranking value greater than the median for the sample and 0 otherwise. The rankings are calculated as the average market
share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). Robust p-values are reported in parentheses. ***,
**, and * indicate significance at the 1, 5, and 10 percent levels, respectively. The shares outstanding data are from CRSP. The short interest data is hand
collected from Bloomberg.



(1) (2) (3) (4) (5) (6)
First Quarter Short Interest
Underwriter reputation dummy
0.446 0.286 0.236 0.273 0.273 0.186
[0.000]*** [0.006]*** [0.023]** [0.008]*** [0.009]*** [0.086]*
Size
-0.08 -0.148 -0.199 -0.16 -0.185 -0.216
[0.033]** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
VC backing
0.33 0.292 0.306 0.257 0.323 0.271
[0.001]*** [0.003]*** [0.002]*** [0.011]** [0.001]*** [0.007]***
Fraction of firm sold
1.287 1.282 1.2 0.822 1.226 0.983
[0.000]*** [0.000]*** [0.000]*** [0.031]** [0.000]*** [0.002]***
Number of analysts estimating
earnings
0.125 0.085 0.122 0.087 0.073
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Number of institutions
0.016 0.016 0.016
[0.000]*** [0.000]*** [0.000]***
Percentage institutional holding
0.001
[0.047]**
Num. of co-managing
underwriters
-0.092
[0.104]
Co-managing underwriter
reputation
0.068
[0.496]
Constant -3.401 -5 -4.779 -5.044 -4.169 -4.093
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Observations
Adjusted R-squared
1286 1245 1245 1245 1239 1131
0.122 0.166 0.182 0.168 0.182 0.19






Table 14
Valuation ratios in IPOs Backed by High and Low Reputation Underwriters: Multivariate Tests
This table reports the results of our regression analysis of overvaluation. The dependent variables are the log of the offer price to intrinsic value ratio (OP/ IV) in panel A and the log of first trading day closing
secondary market price to intrinsic values ratio (SMP/IV) in panel B. The valuations ratios are generated by the basic comparable firm approach using the sales price multiple. The independent variables are the
underwriter reputation dummy, the log of assets of the IPO firm, the VC backing dummy, fraction of firm sold calculated as the number of shares sold in IPO as fraction of number of shares outstanding, number
of unique analysts estimating EPS for the firm in the first year after the IPO, percentage share of IPO held by institutional investors, number of institutional investors participating in the IPO , adj. first day
volume, adj. first day turnover, adj. first day number of trades, log of the first quarter short interest, the number of co-managing underwriters in the IPO, and the co-managing underwriter reputation dummy.
Year and industry fixed effects are included in every specification. The underwriter reputation dummy takes the value 1 if the lead underwriting syndicate has a ranking value greater than the median for the
sample and 0 otherwise. The rankings are calculated as the average market share of the lead underwriting syndicate over the sample period based on Megginson & Weiss (1991). Robust p-values are reported in
parentheses. ***, **, and * indicate significance at the 1, 5, and 10 percent levels, respectively.

Panel A: Offer price to Intrinsic Value Ratios
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
Underwriter reputation dummy
0.319 0.229 0.18 0.204 0.171 0.108 0.109 0.132 0.061 0.027 0.078 0.055
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.001]*** [0.055]* [0.055]* [0.016]** [0.390] [0.626] [0.299] [0.481]
Size
-0.184 -0.266 -0.316 -0.29 -0.323 -0.335 -0.334 -0.288 -0.272 -0.327 -0.306 -0.304
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
VC backing
0.216 0.103 0.115 0.079 0.109 0.077 0.078 0.113 0.144 0.115 0.118 0.122
[0.000]*** [0.032]** [0.021]** [0.118] [0.030]** [0.159] [0.158] [0.045]** [0.034]** [0.038]** [0.104] [0.113]
Fraction of firm sold
-1.575 -1.551 -1.628 -1.559 -1.628 -1.623 -1.622 -2.238 -1.722 -1.91 -2.01 -2.025
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Number of analysts
0.071 0.048 0.072 0.047 0.045 0.045 0.048 0.027 0.041 0.046 0.046
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.054]* [0.000]*** [0.001]*** [0.002]***
Percentage institutional holding
0.152
[0.003]***
Number of institutions
0.01 0.01 0.009 0.009 0.008 0.009 0.001 0 0
[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.001]*** [0.007]*** [0.706] [0.996] [0.963]
Num. of co-managing underwriters
0.038 -0.006 0.017 0.144 0.001 -0.006 -0.008
[0.280] [0.889] [0.674] [0.006]*** [0.986] [0.898] [0.880]
Co-managing underwriter
reputation
0.213 0.213 0.084
[0.000]*** [0.000]*** [0.258]
Adj. first day turnover
0.134
[0.001]***
Adj. first day number of trades
0.157
[0.000]***
Adj. first day volume
0.245 0.198 0.195
[0.000]*** [0.000]*** [0.000]***
Short interest
0.044 0.041
[0.047]** [0.092]*
Constant
0.523 1.175 1.095 1.101 1.097 0.098 0.102 0.545 0.749 1.163 2.729 2.818
[0.027]** [0.000]*** [0.001]*** [0.001]*** [0.001]*** [0.882] [0.878] [0.070]* [0.014]** [0.000]*** [0.000]*** [0.000]***
Observations 2655 2152 1990 1990 1990 1644 1644 1591 1002 1564 1003 888
Adjusted R-squared 0.187 0.24 0.264 0.254 0.264 0.275 0.274 0.279 0.286 0.308 0.301 0.293








Panel B: Secondary Market Price to Intrinsic Value Ratios
(13) (14) (15) (16) (17) (18) (19) (20) (21) (22) (23) (24)
Underwriter reputation dummy
0.369 0.265 0.200 0.238 0.191 0.117 0.12 0.134 0.037 0.006 0.05 0.023
[0.000]*** [0.000]***[0.000]***[0.000]***[0.000]*** [0.041]** [0.039]** [0.017]** [0.601] [0.919] [0.508] [0.767]
Size
-0.211 -0.309 -0.376 -0.336 -0.383 -0.401 -0.399 -0.336 -0.326 -0.388 -0.372 -0.372
[0.000]*** [0.000]***[0.000]***[0.000]***[0.000]***[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
VC backing
0.232 0.107 0.126 0.08 0.12 0.088 0.089 0.118 0.148 0.123 0.114 0.118
[0.000]*** [0.032]** [0.013]** [0.126] [0.019]** [0.117] [0.115] [0.039]** [0.030]** [0.028]** [0.116] [0.126]
Fraction of firm sold
-1.722 -1.693 -1.799 -1.704 -1.799 -1.801 -1.8 -2.429 -1.745 -1.99 -2.245 -2.264
[0.000]*** [0.000]***[0.000]***[0.000]***[0.000]***[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.000]***
Number of analysts
0.085 0.052 0.087 0.051 0.049 0.05 0.053 0.03 0.043 0.046 0.046
[0.000]***[0.000]***[0.000]***[0.000]***[0.000]*** [0.000]*** [0.000]*** [0.031]** [0.000]*** [0.001]*** [0.003]***
Percentage institutional holding
0.18
[0.002]***
Number of institutions
0.015 0.015 0.014 0.014 0.012 0.014 0.003 0.002 0.002
[0.000]*** [0.000]***[0.000]*** [0.000]*** [0.000]*** [0.000]*** [0.211] [0.446] [0.546]
Num. of co-managing underwriters
0.036 -0.015 0.018 0.133 -0.003 -0.006 -0.003
[0.322] [0.723] [0.662] [0.009]*** [0.948] [0.898] [0.951]
Co-managing underwriter reputation
0.254 0.255 0.099
[0.000]*** [0.000]*** [0.182]
Adj. first day turnover
0.187
[0.000]***
Adj. first day number of trades
0.229
[0.000]***
Adj. first day volume
0.316 0.277 0.281
[0.000]*** [0.000]*** [0.000]***
Short interest
0.062 0.062
[0.005]*** [0.014]**
Constant
1.266 0.705 1.068 1.088 1.07 0.38 0.391 0.505 0.682 1.438 3.257 3.021
[0.000]*** [0.103] [0.003]***[0.003]***[0.003]*** [0.546] [0.536] [0.104] [0.030]** [0.000]*** [0.000]*** [0.000]***
Observations 2655 2152 1990 1990 1990 1644 1644 1591 1002 1564 1003 888
Adjusted R-squared 0.214 0.279 0.315 0.294 0.315 0.333 0.333 0.326 0.36 0.367 0.376 0.372









Figure 1: Dynamics of Sales and Earnings Based Valuation Ratios Using
Propensity Score Based Comparable Firm Approach