We exploit variation in the amount of proceeds raised that is unrelated to firm size and manager decisions using an instrumental variable approach. We find that marginal increases in IPO proceeds lead to large increases in liquidity, analyst coverage, and institutional ownership in the first two years a firm is public. Increases in IPO proceeds also lead to more frequent follow-on offerings and longer survival as a public firm.
A perplexing result in the initial public offering (IPO) literature is the large marginal cost associated with raising initial equity. Firms forego seven percent on every share sold in the form of a spread to underwriters and leave about twenty percent of proceeds on the table in the form of IPO underpricing.
We use 30-day post-IPO market returns as a shock to overallotment option exercise (OAE) (and in turn, the amount of IPO equity raised) that is unrelated to firm size or any decisions made during the IPO process. The overallotment (or greenshoe) option (OAO) is a standard feature in firm-commitment IPOs that allows underwriters to increase the amount of proceeds raised in an IPO by up to 15% by purchasing shares from the issuer at the offer price anytime within 30 days of the IPO issue date. In practice, underwriters typically oversell the issue by at least 15% in the pre-market, meaning that the overallotment option amounts to a decision of how to buy back the additional shares sold short. If the issuer’s newly issued shares trade above the IPO offer price, it is optimal for underwriters to fully exercise the overallotment option and cover the entire pre-IPO short position via direct purchase of shares from the firm, leading to an increase in the proceeds raised (see e.g., Chen and Ritter, 2000). If the firm’s shares trade at or below the offer price in the aftermarket, underwriters will likely not exercise the full (or any of the) option, leading to a lower amount of IPO proceeds raised.