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5 years ago

* I would like to thank Frank Dobbin, Christopher Marquis, Peter ...

* I would like to thank Frank Dobbin, Christopher Marquis, Peter ...

influencing their

influencing their perceptions of how objects in the environment will react. As Weber noted, calculative rationality is “determined by expectations as to the behavior of objects in the environment and of other human beings; these expectations are used as ‘conditions’ or ‘means’ for the attainment of the actor’s own rationally pursued and calculated ends” (Weber [1922] 1978:24). The ontological perception of what companies are and how they operate obviously impacts how rational actors generate investment gains. By informing actors how objects react to their strategic actions, logics become compatible with, rather than opposed to, calculative rationality. I propose that this aspect of institutional logics could undermine the price predictions of economic models. The next section outlines the main alternative explanations from neoclassical and behavioral theory before discussing the IPO process and how logics impact prices. Economic Alternatives: Rationality and Non-rationality 2 Neoclassical price theory formalizes calculative rationality among atomized actors: market participants with rational preferences and expectations process information to maximize utility against resource constraints (Manski 2000; Dybvig and Ross 2003). Rational preferences involve making “correct” normatively acceptable choices consistent with Savage’s subjective expected utility (SEU), and rational expectations entail observational learning based on “appropriately” updating beliefs with new information in accordance with Bayes’ theorem (Barberis and Thaler 2003). 3 Applied to stock prices, actors should perform mean-variance optimization: the mean excess return for each asset should be proportional to the marginal contribution of volatility in the actor’s optimal portfolio. The resulting asset-price model—Capital Asset Pricing Model (CAPM)— equates a stock’s excess return over the risk-free rate of return to its exposure to 6

elevant risks (Fama and French 1992). 4 Efficient Market Hypothesis (EMH) further asserts that a functioning market does not require all actors being rational. As long as irrational reactions are random and follow a normal distribution so that the net price impact cannot be exploited to make excess returns, then market prices remain the best indicator of intrinsic value. Hence, EMH predicts that stock prices equal intrinsic value, defined as the discounted present value (DPV) 5 of future dividends (Fama 1965, 1976, 1990). Equivalently, returns from purchasing stock at prevailing market prices should only reflect compensation for exposure to systematic risks, with no investor being able to earn excess returns in the long run. IPO pricing remains a significant area of study after decades of economic research due to its theoretical import as an ideal natural experiment testing EMH. As discussed more fully in the “Underwriting Returns” section, underwriters price IPOs in two stages. The second-stage price outcome (first-day close price) is usually higher than the first-stage price outcome (offer price to institutional investors). Since the second-stage outcome generally occurs only one day after the first-stage outcome, IPO first-day returns (second-stage returns, or increase in price between the two stages of pricing) are purged of the explanatory factors underlying CAPM and EMH. In other words, each company remains unchanged in its exposure to systematic risks to market returns, size, and value (CAPM), and no new information on future dividends could cause rational investors to update their estimates of intrinsic value (EMH). IPO first-day returns should thus equal zero, with the second-stage price equaling the first-stage price. Numerous studies over the past three decades have confirmed the persistence of positive first-day returns contradicting EMH (Ritter and Welch 2002). Economists have attempted to account for first-day returns by noting agency costs, substitution costs, information asymmetries, or employing behavioral theories. Agency theory, 7

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