Two-Stage IPOs May Reduce Underpricing and Market Volatility

Owners of privately-held companies may want to think twice about how to go public, according to research by Ioannis V. Floros, Assistant Professor of Finance at the Lubar School of Business.

A new study, published by the Journal of Financial Intermediation, examines the effects of a two-stage IPO (initial public offering) in reducing underpricing and volatility of the stock. Floros and colleagues at Florida Atlantic University and the U.S. Securities and Exchange Commission found that a two-stage IPO – based on the results of studying more than 400 U.S. firms that used a first stage such as OTC (over-the-counter quotation) – experiences lower underpricing and market volatility than does the traditional IPO process.

“The reason for this lower underpricing may be that the company is more transparent when releasing information to over-the-counter investors,” said Floros. “By the time it gets to the IPO stage, investors are far more comfortable with the company, reducing the need to underprice the stock.”

The study shows that a two-stage IPO lowers underpricing by reducing informational asymmetry, which occurs in transactions where insiders share more information about the forthcoming companies’ projects with outsiders.

“Companies’ reluctance to release too much information could be due to their fear of exposing proprietary information,” Floros said. “There also has been a tarnished reputation for quoting over-the-counter stocks in the past.”

Companies that cannot afford the direct costs of an IPO early in their lifespan may find the two-stage process particularly appealing. However, Floros explained, the two-stage IPO process delays a company from appearing on the NASDAQ, the New York Stock Exchange or, earlier, the American Stock Exchange. Typically, companies may do quotation on the OTC market for a few months (on average five years) before issuing equity on one of the major exchanges.

Floros noted that the phenomenon of two-stage IPOs has existed in the U.S. for about a decade. Previously, it was more traditional in the United Kingdom and in Taiwan as well. Although there hasn’t been a recent rush toward two-stage IPOS, it has picked up since the recovery from the last recession.

Floros said that this current research is a “natural progression” from his previous research, which involved small cap financing, PIPEs (private investments in public equity), reverse takeovers and security offerings.