Strategic IPO underpricing, information momentum, and lockup ...

explains why managers at firms that underprice more generate more research coverage, pushing
up the stock price and leading them to sell more shares at the expiration of the lockup.
Third, Chemmanur (1993) argues that owner-managers of high quality firms will
underprice the IPO in order to compensate investors for gathering information about the firm.
Low quality firms pool with the high quality firms, and then are more likely revealed as low
quality through the production of information. A high quality firm is more likely revealed as high
quality, allowing managers to sell shares in a secondary offering at closer to the firm’s true value.
A key empirical implication of Chemmanur’s (1993) model is that greater underpricing is
associated with lower gross proceeds from the IPO. In Table 3, the correlation between IPO
proceeds and underpricing is insignificant. By contrast, if information momentum is important,
then underpricing is associated with greater managerial shareholdings (or option holdings). Table
3 supports this intuition.
While there may be alternative explanations for some of our results, we are not aware of an
alternative that explains all four of our findings. We find that 1) greater managerial share and
option holdings lead to greater underpricing, 2) first-day underpricing creates information
momentum as proxied by greater research coverage by non-lead analysts, 3) greater research
coverage leads to positive stock returns to the lockup expiration, and 4) insiders sell more stock at
lockup expiration when research coverage is higher. Our evidence is consistent with managers
strategically underpricing their IPOs in order to maximize their personal wealth from selling
shares at the expiration of the lockup period.
31