Study Finds Going Public On The OTC First Can Avoid Underpricing and Stock Volatility
A recent revised study published by the Journal of Financial Intermediation looks at the impact a “two-stage IPO” can have a newly public company’s price and stock volatility.
The two-stage IPO is where a firm first gets quoted on the over-the-counter (OTC) stock market, and then upgrades to a national exchange where it first issues public equity.
Firms completing a two-stage IPO usually don’t issue new stock when listing on the OTC and complete a formal IPO upon uplisting to a senior exchange.
According to the study, a two-stage IPO lowers underpricing by reducing informational asymmetry, which occurs in transactions where one party has more or better information than the other.
“Investors don’t know as much about the quality of the firm as do the managers,” said Rebel Cole, Ph.D., author of the study and the Kaye Family Endowed Professor in Finance at FAU. “If the managers can signal or convey that information to investors then they’ll be more comfortable, as will the underwriters, and will be willing to price in less of a discount when they go public.”
When firms go on the OTC market, Cole explained, they don’t conduct public equity offerings. But they are traded, and they typically file disclosures that are made public. The median time from the firms’ first disclosure on the OTC market to upgrading to a national exchange is about four years. A two-stage IPO is particularly appealing to firms that cannot afford the direct cost of an IPO early in their lifespan, Cole said.
“This allows firms to have their shares priced by the market, but more importantly it allows a stream of information to be disseminated by the firms prior to going the traditional IPO path and issuing equity on the NASDAQ or the New York Stock Exchange or American Stock Exchange,” Cole said. “Then, when they do, there’s less underpricing.”
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