The information Content of IPO Prospectuses Authors: Kathleen Weiss Hanley, Gerard Hoberg Presenter: Lingyue Jiao Fresh business general template Applicable to enterprise introduction, summary report, sales marketing, chart data

Background Two methods to gather information during IPO: Gathering information from premarket due diligence. Gathering information produced by investors through Bookbuilding Bookbuilding Generating, capturing, and recording investor demand for shares during  IPO, or other securities during their issuance process, in order to support efficient price discovery. Background

Background Gathering information through Bookbuilding: Costly for issuers. Investors are compensated for providing an accurate assessment of value through higher initial return Traditional views of IPO pricing: Bookbuilding. Focus: A trade-off between pricing an issue using information gathered from premarket due diligence and information gathered from investors during bookbuilding. [Method: Using the information Content] Background

Content 01 02 03 04 05 06 The IPO Pricing Process Data and Methodology Standard Versus Informative Content 03 04 Underwriter Content 05 Topical and Tone Content 06 Conclusion

IPO Pricing Process

The IPO Pricing Process Three steps in IPO Pricing: Conduct due diligence, draft an initial prospectus and set the initial offer price. (the midpoint of the initial offer price range : the initial offer) 2. Specify a final offer price using information gathered from investors during bookbuilding. 3. A market price is established once trading begins. And the initial return or underpricing is determined.

The IPO Pricing Process Information in the IPO prospectus: Standard components: The exposure to information in an IPO prospectus that is already contained in both recent and past industry IPOs. Informative components: The disclosure in the prospectus (residual) not explained by these two sources.

The IPO Pricing Process Predictions: Greater information production in the premarket due diligence: Greater informative content, more accurate initial offer prices Underpricing will also be lower. Fewer resources on premarket due diligence: Greater standard content, larger absolute price changes Higher initial returns (as compensation to investors for revealing information). [Assumption]

Data and Methodology

Data and Methodology DATA 1750 IPOs in total. All U.S. IPOs (January 1, 1996 and October 31, 2005) ——the Securities Data Company U.S. New Issues Database  Eliminate: American Depository Receipts, unit issues, REITs, closed-end funds, financial firms, and firms with offer prices less than $5. Not machine readable IPOs (Machine Readable IPOs include the Prospectus Summary, Risk Factors, Use of Proceeds, Management's Discussion and Analysis ) 3. IPOs issued before August 1, 1996 (As the reference group). 1750 IPOs in total.

Data and Methodology Methodology For each IPO i , store the text of the prospectus in a word vector . Use word roots: all use the same global word list of 5,803 word. Then they normalize the raw word vector by the total number of root words used in the document and define this as .

Example for the Methodology Data and Methodology Example for the Methodology 1: “They sell potatoes and they sell corn” 2: “They sold knives” Discarding articles, conjunctions, and pronouns (the, and, they), Have four word roots: (sell, potato, corn, knife) Normalization of the vectors (total number of root words is 4):

Standard VS Informative Content

Standard Versus Informative Content Methodology Define the average of the normalized vectors of recent IPOs as Define the average of the normalized vectors of past IPOs as First-stage regression without an intercept for each IPO:

Standard Versus Informative Content Methodology The relative loading of standard content, The proportion of the standard words in IPO i’s prospectus. The vector of the absolute value of the residuals: The content not explained by these two sources, The“Informative Content”.

Standard Versus Informative Content Methodology P(mid), P(ipo), and P(mkt) are the filing date midpoint, the IPO price, and the aftermarket trading price, respectively. ΔΡ is the offer price adjustment from the filing date to the IPO date, IR is the adjustment from P(ipo) to P(mkt).

Standard Versus Informative Content

Standard Versus Informative Content Results of relation 1. The greater the standard content of the prospectus, the greater is ΔΡ or absolute ΔΡ and subsequent underpricing. 2. The greater the informative content, the smaller is ΔΡ or absolute ΔΡ and initial return.

Standard Versus Informative Content

Standard Versus Informative Content Conclusion Greater informative content increases offer price accuracy and reduce underpricing. Management and content in the MD&A section play a potentially important role in the IPO pricing process.

Underwriter Content

Underwriter Content

Underwriter Content Relation: Higher unique UW content: Greater reductions in ΔΡ and subsequent underpricing. Reason: Greater UW content : 1. Reflect more involvement 2. Be seen as certification of the issue by UW

Underwriter Content Relation: High reputation UW: Lower change in offer price and initial return High pricing accuracy Reason: High-reputation UW have the necessary experience to assess the IPO High-reputation UW may be in a better position to credibly convey information Low-reputation UW bring few IPO to market, more difficult for them to provide a precise estimation of unique underwriter content.

Underwriter Content Results 1. Greater unique underwriter content is associated with greater pricing accuracy 2. High-reputation underwriters can influence the amount of underpricing through enhanced due diligence and disclosure

Topical and Tone Content

Topical and Tone Content Average Prospectus Higher exposure to: Accounting, Marketing, Corporate Governance.

Topical and Tone Content Results Prospectus Summary: High exposure to marketing and accounting. [Positive tone ] Risk Factors: High exposure to accounting, marketing, and valuation. [Positive & Negative tone] Uses of Proceeds: High exposure to accounting and strategy. MD&A: High exposure to accounting, valuation, and strategy. [Positive tone]

Conclusion

Conclusion Greater informative (standard) content decreases (increases) both the price change from the filing midpoint to the IPO price and underpricing. The management's role in premarket due diligence and information generation might be significant. Unique underwriter content also improves pricing accuracy. But this reduction is significant for only UW with reputation. Informative content directly related to inputs into valuation models which most likely used by practitioners seems to matter most in pricing.

Opinion Pros: Examine the target trade-off in both qualitative analysis and quantitative analysis. Use the word roots, instead of common words, in the methodology, which increases the analysis efficiency. Analyze the IPO process from different angles. Cons: Costs and benefits to collect information prior to filing are likely to vary across firms. The article does not cover that which firms would benefit most from greater information gathering in the premarket. Published in 2010. Premarket due diligence is now the main trend.

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