RELATIONSHIP BETWEEN CEO S IPO SALES, POST-IPO OWNERSHIP STAKE AND IPO UNDERPRICING

RELATIONSHIP BETWEEN CEO S IPO SALES, POST-IPO OWNERSHIP STAKE AND IPO UNDERPRICING Abdullah Al Mahmud International Business School Brandeis University Waltham MA 02453, USA Contact: (781) 363-6356 mahmud@brandeis.edu Elif Sisli Ciamarra Assistant Professor International Business School Brandeis University Waltham MA 02453, USA Contact: (781) 736-8544 esisli@brandeis.edu Very Preliminary Draft Updated: February 16, 2015 ABSTRACT In this paper, we link IPO underpricing to chief executive officers (CEO) exposure to underpricing. We document that for the average CEO, a hypothetical one percent underpricing is associated with $241 thousand increase in the value of her post-ipo stockholdings. We then present evidence for a positive and significant relationship between underpricing and the sensitivity of a CEO s stock ownership to underpricing. We infer from this finding that if a CEO retains significant ownership subsequent to the IPO, she would be less concerned about the underpricing, as the increase in the prices after the IPO would translate into wealth gains. JEL Classification: G10; G14; G24; G32; Keywords: Initial Public Offering (IPO), Underpricing, CEO, Venture Capital, Investment Bank, Ownership stake

RELATIONSHIP BETWEEN CEO S IPO SALES, POST-IPO OWNERSHIP STAKE AND IPO UNDERPRICING If underwriters aimed to price each IPO exactly at fair-market value, there would be no incentive for institutions to take the risk of buying the stock before the shares started trading. Instead, they d just wait to see where the stock traded and then make their buying decision then. - Henry Blodget, Co-founder, CEO and Editor-In Chief, Business Insider (May 23, 2011) 1. Introduction It is well-documented that on average stock prices increase on the first trading day following the initial public offerings (IPOs). This increase in stock prices following an IPO, also known as IPO Underpricing, represents significant losses for the IPO firms. For example, the closing price of an IPO stock was recorded to be 29 percent higher than the offer price on the first day of trading in 2013. This underpricing translated in a loss of $70.18 million in gross proceeds for the IPO firms in our sample. The literature on IPO underpricing centers around the incentives of IPO underwriters to keep the offer prices low *. For example it has been contended that investment bankers who underwrite IPOs set offer prices low to avoid the risks and costs associated with an unsuccessful issue (Tinic, 1988). It has also been argued that underpricing may decrease the likelihood of legal action being taken against the investment banker for promoting issues that perform below expectations (Ritter, 1988). In addition, underpricing might contribute to positive reputational effects which can enable the investment banker to sell subsequent new issues at higher prices * Another strand of literature argues underpricing also results from the asymmetry of information that often exists, for example, between more vs. less informed investors or between the investment banker and the issuer (Tinic, 1988). 2

than otherwise possible (Ritter, 1988). While underpricing seems to benefit the underwriters, it imposes significant financial losses for the issuers. In this paper, we analyze the incentives of IPO firms CEOs to negotiate higher prices with the underwriters. We argue that if a CEO s post-ipo stockholding is large, he/she would not be incentivized properly to negotiate with underwriters to overcome any the possibility of underpricing. To our knowledge, ours is the first study that relates post-ipo stockholding of insiders to underpricing. Ljungqvist and Wilhelm (2003) study the relationship between initial return and pre-ipo insider s ownership stakes as well as the insider s sale at the time of offering. They show that initial returns are much larger when insiders have smaller pre-ipo ownership stake and sell fewer shares at the offering. Habib and Ljungqvist (2001) documented that the pre-ipo owners of the issuing firm care more about underpricing when they sell a larger amount of shares at the IPO. Our contribution to this literature is to analyze the post-ipo stockholdings of the CEOs. We also documented the net effect between CEOs IPO sale and Post IPO ownership stake not only participation ratio. To study the relationship between CEO post-ipo stockholdings and IPO underpricing, we handcollect data on CEO stock ownership and the CEO stock sales from the IPO prospectuses of 613 firms that were listed in the U.S. stock market between 2006 and 2013. We argue that the CEOs who sell more shares at the time of an IPO has greater incentives to negotiate with the underwriters, and at the same time would be willing to spend more to promote the issue. In line with this argument, we show that CEO stock sales are associated with higher underpricing. We also hypothesize that if a CEO retains significant ownership subsequent to the IPO, she would be less concerned about the underpricing, as the increase in the prices after the IPO would translate into wealth gains. In line with this prediction, we show that CEO stock holdings 3

subsequent to IPO are associated with higher underpricing and less promotional expenditures. The economic impact of CEO incentives on IPO underpricing is significant. An increase in CEOs post-ipo holdings from its 25th percentile to its 75th percentile is associated with a 4 percentage points higher first day return. The rest of this paper is organized as follows. Section 2 summarizes the IPO process. In section 3, the detail summary and descriptive statistics along with the key variable formation is provided. Section 4 explains the empirical methods and provides the analysis of the results. Section 5 provides the conclusion followed by references in section 6 and appendix in section 7. The tables and figures are provided at the end of the paper. 2. IPO Process A company planning to conduct an IPO typically starts the process with the filing of a Registration Statement (S-1) with the Securities and Exchange Commission (SEC). In the registration statement, the company discloses the key business information to the potential investors, including a description of its business, risk factors, financial statements, planned use of the IPO proceeds and the underwriting structure. The registration statement also contains significant information about the ownership structure and the management of the IPO firm. In most cases, the registration statement does not contain any information with regards to the pricing and the number of shares that will be offered. There will be several revisions to be made by the issuing firm after the first version of preliminary prospectus is filled with the SEC. On average, the offer price range, and numbers of stocks offered by the firm are available after 4.5 months, in a subsequent preliminary prospectus. In this updated prospectus, there will also be information about the sale of primary stock by the insiders, including executives and directors, venture capitalists, investment bankers, and other blockholders exceeding the five percent pre- 4

IPO ownership. This version of the preliminary prospectus is also known as red herring as there is a red warning mentioned in the first page of the prospectus that it is not yet effective. [Insert Figure 1 about Here] [Insert Figure 2 about Here] The issuing company then hands out the preliminary prospectus about the IPO to the potential investors to seek interest in the IPO. This is also termed as pre-marketing campaign by the issuing company. The last preliminary prospectus is usually submitted 7 days before the submission of final prospectus. The issuing company and underwriters then conduct a marketing campaign, which includes Road Shows in the major cities during this one week period. This road show includes presentations to the potential buyers and the one-on-one discussion with the institutional investors (Ritter, 1988). After the road show, the final IPO offer price is set and the selling shareholders also finalize the number of the primary shares they want to sell at the IPO. 3. Data and Descriptive Statistics 3.1. Sample Construction The sample consists of firms completing an initial public offering (IPO) between January 1 st, 2006 and December 31 st, 2013. We collect the list of the IPO firms from the Thomson Financial s SDC database. Consistent with the earlier literature, we exclude best efforts, unit offers, close-end funds (including REITS), financial institutions (SIC codes 6000), utility companies (SIC codes 4000), ADRs, and limited partnerships (Ritter and Welch, 2002; Loughran and Ritter, 2004; Ljungqvist and Wilhelm, 2003; and Ritter, 2011). We also excluded the IPOs with offer price below five dollars and with proceeds below $25 million. For large offerings (classified as offers greater than $25 million), companies required to submit 5

registration Form S-1 with SEC which contains necessary financial statements about the company (Ritter, 1998). But for smaller offering, companies can submit registrations form SB-2 with SEC which contains only necessary description about the company s business or for offering less than $5 million, companies can register under Regulation A which has the stringent disclosure requirement (Ritter, 1988). We also require that the firms are included in the Center for Research in Security Prices (CRSP) database, where we get the stock price data. With these filters, there are 613 US IPO firms in our sample. 3.2. Ownership Structure The SEC regulation requires the issuing firm to disclose the beneficial ownership of common stock by directors, executives and any shareholders who have stake more than 5 percent of the outstanding stock into the prospectus. We classified stakes held by CEOs, venture capitalists (VCs), and investment banker. ThomsonOne does not contain information on primary stock sales and post-ipo holdings of the individual parties. Therefore, we hand collect the pre and post-ipo ownership and primary stock sales from the preliminary prospectuses that are accessible at the SEC s Electronic Data Gathering and Retrieval (EDGAR) system. We collect information regarding 1 st preliminary prospectus date, the date of preliminary prospectus (identified on EDGAR as S-1/A) at which the offer price range and number shares to be offered at the IPO, and the last preliminary prospectus (identified on EDGAR as S-1/A) date close to IPO date. Specifically, at each point of information disclosure, we record the offer price range, total number of shares to be offered at the IPO, the amount of shares that the pre-ipo shareholders are This work is still in progress. The sample size in this draft is 313 IPO firms, because we are still hand-collecting the data for the rest of the firms. 6

selling at the IPO, last preliminary prospectus and final prospectus (identified on EDGAR as 424B). The final offer price and underwriting fee are collected from the final prospectus, and cross-checked with the ThomsonOne data for accuracy. [Insert Table 1 about Here] 3.2.1. Pre-IPO Stockholdings by the insiders As mentioned before the issuing firm has some common share outstanding before the IPO which is usually owned by the founders, executives and directors, corporation, venture capitalist, and investment banker. The CEO on average has 0.044 fraction of pre-ipo outstanding common stock with a median of 0.034 fraction of pre-ipo outstanding common stock across the sample period. The Venture capital has on average has 0.53 fraction of pre-ipo outstanding common stock with a median of 0.53 fraction of pre-ipo outstanding common stock across the sample period. 3.2.2. Primary Stock Sales by the Insiders At the IPO, founders on average sold 4.1 percent of the pre-ipo outstanding common stock, CEOs on average sold one percent of the pre-ipo outstanding common stock, and VCs on average sold 2.6 percent of the pre-ipo outstanding common stock. 3.2.3. Post-IPO Stockholdings by the insiders After the IPO, CEOs on average retained 3.6 percent of the pre-ipo outstanding common stock, and VCs on average retained 45 percent of the post-ipo outstanding common stock. Across the entire sample, about 56 percent issuing firms are backed venture capital or private equity funds. During the period of 2008 and 2009 when the US economy was in financial crisis this backing was relatively low. Following Loughran and Ritter (2001) updated version of the Carter and 7

Manaster (1990) underwriter reputation ranking from 0 to 9.1 scale, we found that the mean score of underwriter ranking varies between 7.3 to 8.8 during the period of 2006 to 2013. 3.3. Sensitivity of Insiders Wealth to IPO Underpricing We created two variables that quantify the insiders loss or gain due to underpricing based on their sale at the IPO and stake after the offering. The first one is sensitivity of IPO sale due to underpricing based on their sale of stock at the IPO. Another one is sensitivity of post-ipo proceeds by insiders due to underpricing based on their stake after the offering. Example of the Insider Incentives Case 1 Case 2 Case 3 True Value??? Offer Price $10 $10 $10 Insider Sale (# of Shares) 100 200 100 Insider post-ipo Ownership Stake (# of Shares) 100 100 200 Underpricing 1% 1% 1% Money lost for sale at the IPO $10 $20 $10 Money gained for after IPO ownership Stake $10 $10 $20 Net effect 0 -$10 $10 From an IPO price and a first trading day closing price we can estimate underpricing. However, we do not know anything about the true price of the newly issued IPO shares. For example, in case 1 the offer price is $10 and the insider sells 100 shares at the IPO and retains 100 shares after the offering. If there is 1% underpricing then the insider will lose $10 for selling shares at the IPO and will gain $10 for the ownership stake after the offering. Thus, the net effect is zero. Again, in case 2 if the offer price and the ownership stake after the offering remain same but the insider sale 200 share at the IPO, then he or she will lose $20 and gain the same amount as before. Thus, the net effect is negative $10. In case 3, the offer price and the amount the insider sells at the IPO are the same as they were in case 1. However, now the insider retains 200 shares after the IPO; the insider will lose $10 for selling at the IPO and will gain $20 for his or her 8

ownership stake after the offering. Thus, the net effect will be positive $10. From the above discussion, it is evident that the insider has some bargaining in case 2 as he or she is selling at the IPO. Otherwise there will be more underpricing. On the other hand, in case 3 the insider may want more underpricing as that will create a positive gain in wealth for them. To sum up the above motivation we have created the following two variables: Sensitivity of IPO Sale = log(1+0.01*ceo stock sale at the IPO*offer price) (1) Sensitivity of Post-IPO Proceeds = log(1+0.01*ceo stock holding after IPO*offer price) (2) [Insert Figure 3 about Here] If an insider s sells more at the offer price during the IPO he/she will lose as a result of underpricing. Because the higher the underpricing the higher the loss due to underpricing in our formula above we use 0.01 as a base but it is even worse in the empirical data. On the other hand, if an insider s retains ownership after the IPO, he/she will have more wealth due to underpricing in terms of market value of equity. [Insert Table 2 about Here] Table 2 summarizes the descriptive statistics of the Key Variables. We have found the insiders gains a lot when they retains share after the offering. 3.4. Control Variables We collected the first trading prices from Center for Research in Security Prices (CRSP). To measure underwriter quality, we use the SDC database for the information regarding lead underwriter and book-runner for each IPO. For underwriter prestige rankings, we followed the ranking provided by Loughran and Ritter (2004). In our empirical work, if we find more than one lead underwriter then we used the book-runner and the highest ranking joint book-runner. 9

Following Habib and Ljungqvist (2001) we estimated the promotional expense by adding auditing, legal, road show, exchange, printing, and miscellaneous expenses. We also hand collected the Pre-IPO sales revenue, net income, total assets, total debt and total stockholder s equity. 3.4.1. IPO Underpricing In Figure 3, we present the number of IPOs and the average first-day returns for these IPOs during our sample period (2006 to 2013). The first-day return is calculated as the percentage change from the IPO price to the first trading day closing price. First-day returns have been used extensively as a proxy for the extent of underpricing in the extant literature (e.g., Smith, 1977; Rock, 1986; Ritter, 1984; Beatty and Ritter, 1986; Ibbotson, Sindelar and Ritter, 1988; Loughran and Ritter, 2004). [Insert Figure 3 about Here] During our sample period, the average IPO underpricing is 18 percent, and ranges from 10 percent to 29 percent. 3.4.2. Firm Characteristics Table 3 (Panel A) provides a snapshot of the issuing firm characteristics between 2006 and 2013. The mean (median) market value of equity of the IPO firms in our sample is $1,280 million ($568 million). The mean (median) age of the IPO firms in our sample is 21 (11) years. By comparison, Habib and Ljungqvist (2001) and Ljungqvist and Wilhelm (2003) report average firm age for US IPOs of 13 years for the periods of 1991-1995 and 1996-2000, respectively. The average asset turnover is 0.91 with a median of 0.75 and a standard deviation of 0.78. The average pre-ipo return on assets (ROA) is -0.16 with a median of -0.01 and a standard deviation 10

of 0.59. The average leverage ratio is 0.75 with a median of 0.69 and a standard deviation of 0.50. In the sample there are 18 firms that have no revenues. [Insert Table 3 about Here] 3.4.3. Transaction Characteristics Table 3 (Panel B) provides a snapshot of the IPO characteristics. The average IPO proceeds is $242 million with a median of $108 million and a standard deviation of $914 million. The average (median) first-day return of the IPO stocks in our sample is 18 (10) percent, with a standard deviation of 26 percent. Following Habib and Ljungqvist (2001) we estimated the promotional expense by adding auditing, legal, road show, exchange, printing, and miscellaneous expenses. The average Promotional expense as a percentage of IPO proceeds is 0.03 with a median of 0.02 and a standard deviation of 0.02. In our sample, on an average 13 percent of the IPO prices is equal to the midpoint of the filing range. About 48 percent of the firms in our sample priced above the midpoint of the filing range and about 39 percent of the firms in our sample priced below the midpoint of the filing range. The fraction of shares offered at the IPO is about 27 percent of the total shares outstanding after the offering. A large fraction (0.22) of that consists of the new shares sold by the firm, and a very smaller fraction of shares (0.05) sold by insiders. 4. Empirical Framework and Results 4.1. IPO Underpricing and Insiders Ownership Following Habib and Ljungqvist (2001), Ljungqvist and Wilhelm (2003), and Liu and Ritter (2011), we estimate the relationship between first-day return as the proxy for IPO underpricing and the Insiders sale of shares at the IPO as well as the Insiders stake after the offering. The main equation of interest takes the following form: 11

First Day Return i,t = α + β 1 Sensitivity of IPO Sale i,t + β 2 Sensitivity of Post IPO Proceeds i,t + γx i,t + δ Year + ε i,t (3) We measure first day return for firm i of the t time period using the IPO offer price relative to first trading day closing price of the issuing firm s stock. We also include year (δ Year ) fixed effects. We cluster the errors at the year level to account for the error dependencies at the year level. Our main variables of interest are the natural logarithm of the Sensitivity of IPO Sale by insiders and Sensitivity of Post-IPO Proceeds by insiders. The control variables (X) include pre-issue book value of the assets, venture capital dummy, top-tier underwriter dummy, price revision, leverage, return on assets, and age of the IPO firms. These are the standard control variables used in the Habib and Ljungqvist (2001), Ljungqvist and Wilhelm (2003), Loughran and Ritter (2004), and Liu and Ritter (2011). Similar to Baron (1982), Habib and Ljungqvist (2001), Biais et al. (2002) and Ljungqvist and Wilhelm (2003), we also assume that the agency problem between issuer and underwriter increases the underpricing. It is evident from the reasoning provided by Hoberg (2007), Liu and Ritter (2011), and Ritter (2011) that the underwriters excessively underprice the IPOs. In these circumstances we expect insiders will bargain more for increasing the issuing firm offer price if the insiders of the issuing firms sale shares at the IPO. But they will bargain less if they retain shares after the IPO rather than selling shares at the IPO. [Insert Table 4A about Here] In column 1 of Table 4A, we present the baseline OLS regression results. In columns 2, 3, 4 and 5, we include our two key variables of interest: Sensitivity of IPO Sale and Sensitivity of Post- 12

IPO Proceeds. We only found significance for money gained by CEOs due to underpricing based on the CEOs stake after the offering. The coefficient on log (money gained by CEOs) is 0.0103 which means 1 percent change in Sensitivity of Post-IPO Proceeds is associated with 0.0103 increases in underpricing. The more the stake the CEO has retained after the IPO the more underpricing he/she wish to have because it will increase the implicit value of the CEO s wealth. [Insert Table 4B about Here] We also estimate the net effect of the insider s sale at the offering and post-ipo stake. In Table 4B, we found significant net gain of post-ipo stake over the sale at the time of offering only in case of CEO. 4.2. IPO Underpricing and Promotional Cost Following Habib and Ljungqvist (2001), we estimate the relationship between Promotional cost as the proxy for IPO underpricing and the Insiders sale of shares at the IPO as well as the Insiders stake after the offering. The main equation of interest takes the following form: log(promotional cost) i,t = α + β 1 Sensitivity of IPO Sale i,t + β 2 Sensitivity of Post IPO Proceeds i,t + γx i,t + δ Year + ε i,t (4) We measure promotional cost of firm i at time t by adding auditing, legal, road show, exchange, printing, and miscellaneous expenses. We also include year (δ Year ) fixed effect. We cluster the error at the year level to account for the error dependencies at the year level. We also include the same standard control variables similar to equation 4. [Insert Table 5 about Here] 13

In table 4, we present the OLS regression results for the Promotional cost and incentives of the insiders of the issuing firm including the control variables. We only found significance for money left by CEO due to underpricing based on their sale at the time of offering and money gained by CEOs due to underpricing based on the CEOs stake after the offering with the promotional cost. The significant positive coefficient of money left by CEOs indicates that there is more promotional expenditure if CEO sale more at the time of offering in an effort to reduce the underpricing. The significant negative coefficient of money gained by CEOs indicates that there is less promotional expenditure if CEO retained more after the offering. We don t find any such evidence for the other insiders. 5. CONCLUSION In this paper, we show that there is an incentive for CEO when there is a high underpricing and if the CEO has significant ownership stake after the offering. Because there is a significant wealth gain for the CEO following the IPO if there is a high underpricing. To our knowledge, this is the first study that looks into the two decisions (how much to sell during the IPO and how much to retain). We use two sensitivity variable two predict the CEOs incentive at the IPO and following the IPO. We use the hypothetical benchmark of one percent underpricing to find the on insiders sale at IPO and insiders post-ipo ownership stake. We only found significant impact in case of CEO. The IPO sale of primary shares is negatively associated with the underpricing as he or she is losing money due to underpricing. On the other hand, if the CEO has post IPO ownership stake then he will have a wealth gain from underpricing. However, CEO stock holdings subsequent to IPO are associated with more underpricing. Because If a CEO retains ownership after the IPO, he or she may negotiate less with the underwriters since her wealth will increase post-ipo. 14

Following Habib and Ljungqvist (2001), we also measure the impact of our key variables on promotional cost. However, we only found significant impact in case of CEO. If CEO sells more shares at the IPO, he or she will promote more to increase the demand for the IPO of issuing firm. On the other hand, if the CEO has significant ownership stake after the offer he or she will promote less for IPO. Note: To the extent of our study, we just look at the initial return and the insider s incentive. Thus, we have predicted an implicit wealth gain for the insiders following the IPO. However, it would be worthy to look at the long term return of the IPO and the insider s incentive. Because we know there is lock-up following the IPO, during which the insiders are not allowed to sell the shares of the issuing firm. We will update the study with the long term return soon. 15

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Appendix. Variable definitions and sources Variable Description Source A. Incentives of the Insiders Sensitivity of IPO Log(0.01*(Insiders stock sale at the IPO)*(offer Sale by Insiders price)) (CEO, Investment Bank, and Venture capital) Sensitivity of Post- IPO Proceeds by Insiders (CEO, Investment Bank, and Venture capital) Log(0.01*(Insiders stock holding after IPO)*(offer price)) SEC s Electronic Data Gathering and Retrieval (EDGAR) system SEC s Electronic Data Gathering and Retrieval (EDGAR) system B. Firm and IPO Characteristics Offer price The price at which issuer offer the IPO SEC s Electronic Data Gathering and Retrieval (EDGAR) system Closing Price First trading day closing price of the issuing firms CRSP First-Day Return Percentage change in offer price relative to the first EDGAR/CRSP trading day closing price. Promotional Cost Calculated by summing auditing, legal, road show, EDGAR exchange, printing, and miscellaneous expenses. Asset Pre-IPO assets of the Issuing firm EDGAR Age Offer year minus founding year of the issuing firm Jay Ritter Website Leverage ratio Ratio of long-term debt and debt in current liabilities EDGAR to pre-ipo book value of assets. Revenue Pre-IPO sales revenue EDGAR Return on assets Earnings after interest, taxes, depreciation and EDGAR (ROA) amortization (EBITDA) scaled by pre-ipo total assets Lead Underwriter Equal 1 (O otherwise) if the lead underwriter has rank Jay Ritter Website Dummy of 8 or more Price Revision Price revision is the revision from the midpoint of the EDGAR initial offer range to the final offer price Pre-IPO Equity Common stock outstanding before the offering Thomson Financial's New Issue Database with corrections Post-IPO Equity Common stock outstanding after the offering Thomson Financial's New Issue Database with corrections Market value of equity Estimated by multiplying the common equity outstanding after the offering with first trading day closing price EDGAR 18

Variable Description Source C. Ownership Structure Pre-IPO Pre-IPO ownership of common stock by insiders EDGAR Ownership Stake (CEO, Investment Bank and VC) Post-IPO Post-IPO ownership of common stock by insiders EDGAR Ownership Stake (CEO, Investment Bank and VC) Sale at IPO Stock sale by the insiders (CEO, Investment EDGAR Bank and VC) at the offering D. Different Dates IPO Date The date at which the issuing firm start trading Thomson Financial's New Issue Database with corrections 1st Preliminary The date at which the issuing firm registered the EDGAR/S-1 Prospectus Date offering at the SEC Offer Range Date The date at which the issuing firm disclose the offer EDGAR/S-1/A price range and the amount of the offering Last S-1 The date at which the issuing firm registered the final offering info. This is the last S-1 before the submission of final prospectus EDGAR/S-1/A Final Prospectus Date The date at which the issuing firm submit the final prospectus at the SEC EDGAR/424-b 19

Figure 1: Example of Red Herring 20

Figure 2: Timeline for IPO process IPO Process Submission of Registration of For S-1 Changes to the preliminary Prospectus and resubmission of S-1/A Pricing Range and Amount of shares to offered disclosed in S-1/A Changes in price range, shares offer amount by the insiders, Firms and resubmission of S-1/A Offer price set and Final Prospectus 424B 1st Trading Day Days -145... -21.. -7. 0 This S-1/A is also called Red Herring Pre-Marketing Period Road Show Trading Day No Pricing and shares offered disclosed Insiders also disclose how much share to sale at the IPO and retain after the offer Insiders shares sale at the IPO also changes with the changes in price range Figure 2: Timeline for IPO process 21

Number off Offerings Average First-Day Returns Figure 3: Average First Day Return and Average First-Day Return on US IPOs, 2006-2013 70 Number of Offerings and Average First-Day Returns on US IPOs, 2006-2013 35% 60 30% 50 25% 40 20% 30 15% 20 10% 10 5% 0 2006 2007 2008 2009 2010 2011 2012 2013 0% 22

Figure 4: Pattern of Ownership by Insiders Insiders Ownership before IPO # of Stock including options that will expire in 60 days IPO Date Insiders may sell some of the stock he/she owns Insiders Ownership after IPO # of stock Insiders hold after the offering Main variables Money lost by Insiders = 0.01*(Insiders stock sale at the IPO*offer price) Money gained by Insiders =0.01*(Insiders stock holding after IPO*offer price) 23

Table 1: Ownership Structure of IPOs 2006 2007 2008 2009 2010 2011 2012 2013 Total Number of Sample Firms 43 62 10 22 40 35 43 58 313 Pre-IPO CEO Stakes N 43 62 10 22 40 35 43 58 313 Mean (% of pre-ipo shares outstanding) 0.053 0.039 0.028 0.033 0.035 0.087 0.045 0.032 0.044 Median 0.037 0.038 0.021 0.019 0.036 0.033 0.043 0.028 0.034 Pre-IPO VCs Stakes N 43 62 10 22 40 35 43 58 313 Mean (% of pre-ipo shares outstanding) 0.597 0.589 0.359 0.410 0.447 0.572 0.564 0.497 0.530 Median 0.490 0.614 0.324 0.418 0.496 0.555 0.646 0.520 0.526 Post-IPO CEO Stakes N 43 62 10 22 40 35 43 58 313 Mean (% of post-ipo shares outstanding) 0.0380 0.0318 0.0460 0.0272 0.0367 0.0597 0.0355 0.0264 0.0360 Median 0.0257 0.0270 0.0197 0.0140 0.0282 0.0278 0.0310 0.0239 0.0268 Post-IPO VC Stakes N 43 62 10 22 40 35 43 58 313 Mean (% of post-ipo shares outstanding) 0.459 0.447 0.234 0.335 0.448 0.533 0.493 0.449 0.450 Median 0.352 0.479 0.203 0.325 0.417 0.533 0.449 0.418 0.427 CEO stock sale at IPO Mean (% of pre IPO stock holding) 0.001 0.001 0.001 0.002 0.001 0.002 0.001 0.000 0.001 VCs stock sale at IPO Mean (% of pre IPO stock holding) 0.031 0.034 0.056 0.036 0.023 0.027 0.025 0.010 0.026 Underwriter Ranking Mean (0-9) 7.268 8.098 8.850 8.864 8.450 8.857 8.686 8.793 8.401 VC-backing Fraction VC-backed 0.419 0.661 0.400 0.318 0.525 0.486 0.651 0.690 0.562 Pre-IPO ownership stakes of the insider is expressed by using the pre-ipo stock holding by insider as a percentage of pre-ipo total outstanding common stock of the issuing firm. Insider's Stock sale at the IPO is also expressed as a percentage of pre-ipo outstanding common stock of the issuing firm. Post-IPO ownership stakes of the insider is expressed by using the post-ipo stock holding by insider as a percentage of post-ipo total outstanding common stock of the issuing firm. For underwriter ranking we followed Laughran and Ritter (2001) updated version of the Carter and Manaster (1990) underwriter reputation ranking at the 0 to 9.1 scale. 24

Table 2: Summary Statistics of the Key Variables Mean Median Std. Dev. Minimum Maximum Panel A: Sensitivity of IPO Sale by Insiders (thousands of US dollars) Chief Executive Officer (CEO) 6 0 18 0 198 Venture Capital (VC) 186 0 756 0 10000 Investment Banker 28 0 274 0 4320 Panel B: Sensitivity of Post-IPO Proceeds by Insiders (thousands of US dollars) Chief Executive Officer (CEO) 262 122 649 0 8738 Venture Capital (VC) 3613 1679 6605 0 48800 Investment Banker 440 0 2129 0 18900 The main variable of interest is the sensitivity of IPO sale by insiders (CEO, VC and Investment Bank), Sensitivity of Post-IPO Proceeds by Insiders (CEO, VC and Investment Bank) and these variables are calculated using equation 1 and 2 respectively. 25

Table 3: Descriptive Statistics for a sample of 313 IPOs, 2006-2013 Mean Median Std. Dev. Minimum Maximum Panel A: Firm Characteristics Market Value of Equity (millions of US dollars) $1,280 $568 $3,390 $95 $51,300 Age 21 11 28 1 159 Pre-IPO Sales Revenue/ Total Assets 0.91 0.75 0.78 0.00 4.42 Pre-IPO Net Income/ Total Assets -0.16-0.01 0.59-3.61 5.74 Pre-IPO Debt/ Total Assets 0.75 0.69 0.50 0.02 3.92 Panel B: Description of the IPO Sample IPO Proceeds ( Millions of US Dollar) $242 $108 $914 $50 $15,800 Offer price $15 $14 $6 $5 $65 First-Day Closing Price $18 $16 $9 $5 $94 First-Day Return 18% 10% 26% -30% 123% Promotional Expense/ IPO Proceeds 0.03 0.02 0.02 0.00 0.16 Price Revision 0.03 0.00 0.24-0.50 1.00 Fractions of Shares Offered 0.27 0.25 0.16 0.01 1.00 Fractions of Shares Offered by Firm 0.22 0.20 0.15 0.00 1.00 Fractions of Shares Offered by Insiders 0.05 0.00 0.09 0.00 0.84 Market Value of equity is estimated by multiplying the common equity outstanding after the offering with first trading day closing price; IPO proceeds is estimated by multiplying number of shares offered at the IPO with the offer price; Fractions of shares offered is estimated by using the number of shares offered at the IPO over the common equity outstanding after the offering; Fractions of shares offered by firm is estimated by using the number of shares sold by the firm at the IPO over the common equity outstanding after the offering; Fractions of shares offered by insiders is estimated by using the number of shares sold by the insiders at the IPO over the common equity outstanding after the offering; Initial return is estimated from the offer price relative to the first trading day closing price. 26

Table 4A. Insiders Incentive and IPO Underpricing Dependent Variable Incentives Sensitivity of IPO Sale (CEO) 0.00521 (0.201) Sensitivity of Post-IPO Proceeds (CEO) 0.0103** (0.026) Underpricing (First day return) (1) (2) (3) (4) (5) Sensitivity of IPO Sale (Investment Bank) -0.000908 (0.863) Sensitivity of Post-IPO Proceeds (Investment Bank) 0.00292 (0.456) Sensitivity of IPO Sale (VC) -0.000439 (0.735) Sensitivity of Post-IPO Proceeds (VC) 0.00127 (0.732) Controls Log(Assets) -0.00511-0.00514-0.00552-0.00504-0.00488 (0.176) (0.189) (0.181) (0.190) (0.202) Venture Backed Dummy 0.0505 0.0475 0.0492 0.0476 0.0490 (0.235) (0.262) (0.244) (0.321) (0.245) Lead Underwriter Dummy -0.0145-0.0134-0.0171-0.0155-0.0106 (0.721) (0.733) (0.677) (0.685) (0.792) Price Revision 0.258** 0.268** 0.261** 0.256** 0.261** (0.037) (0.037) (0.036) (0.034) (0.039) Log(promotional cost) 0.0368 0.0373 0.0373 0.0377 0.0430 (0.412) (0.402) (0.418) (0.399) (0.359) Leverage Ratio -0.0386-0.0456* -0.0379-0.0389-0.0412 (0.150) (0.071) (0.163) (0.160) (0.124) Return on Assets 0.0781** 0.0707** 0.0792** 0.0783** 0.0769** (0.026) (0.032) (0.027) (0.027) (0.029) Log(1+age) -0.00864 0.00308-0.0104-0.00771-0.00253 (0.667) (0.866) (0.584) (0.702) (0.895) Constant -0.386-0.539-0.392-0.413-0.489 (0.575) (0.446) (0.580) (0.541) (0.497) Year Fixed Effects Yes Yes Yes Yes Yes N 309 309 309 309 309 R-sq 0.171 0.193 0.174 0.172 0.175 adj. R-sq 0.129 0.146 0.125 0.124 0.130 This table presents the results for the estimation of Equation 3 in the text. The dependent variable is first-day return, calculated as the offer price relative to first-trading day closing price of the issuing firm. The main variable of interest is the logarithm of money left by insiders (CEO, Investment bank and VC), logarithm of money gained by insiders (CEO, Investment bank and VC) and these variables are calculated using equation 1 and 2 respectively. These represents the insider s incentives form the sale of stock at IPO and post-ipo ownership stake. The definitions of the rest of the variables are provided in the Appendix. All regressions control for year fixed effects. Robust standard errors are clustered at year level in regressions that control for year fixed effects. P-values are provided in brackets. *, **, *** mark the 10%, 5% and 1% statistical significance for the estimated coefficients. 27

Table 4B. Insiders Incentive (Net) and IPO Underpricing Dependent Variable Underpricing (First day return) (1) (2) (3) (4) (5) Incentives log(net gain CEO) 0.0118** 0.0125** (0.010) (0.020) log(net gain Investment Bank) 0.00287 0.00217 (0.338) (0.556) log(net gain VC) 0.00132-0.000724 (0.694) (0.823) Controls Log(Assets) -0.00506-0.00543-0.00552-0.00511-0.00596 (0.182) (0.173) (0.180) (0.187) (0.168) Venture Backed Dummy 0.0492 0.0567 0.0489 0.0479 0.0500 (0.236) (0.183) (0.246) (0.306) (0.261) Lead Underwriter Dummy -0.0126-0.0145-0.0169-0.0150-0.0124 (0.755) (0.714) (0.680) (0.697) (0.752) Price Revision 0.259** 0.253** 0.261** 0.257** 0.259** (0.044) (0.036) (0.037) (0.034) (0.032) log (promotional cost) 0.0438 0.0294 0.0366 0.0357 0.0386 (0.330) (0.556) (0.428) (0.430) (0.439) Leverage Ratio -0.0423-0.0387-0.0382-0.0402-0.0410 (0.110) (0.138) (0.160) (0.149) (0.131) Return on Assets 0.0727** 0.0764** 0.0791** 0.0779** 0.0745** (0.030) (0.037) (0.027) (0.030) (0.041) Log(1+age) 0.00449-0.00637-0.0104-0.00714 0.00381 (0.808) (0.751) (0.577) (0.712) (0.814) Constant -0.652-0.373-0.383-0.386-0.603 (0.362) (0.595) (0.591) (0.571) (0.409) Year Fixed Effects Yes Yes Yes Yes Yes N 308 306 308 307 303 R-sq 0.191 0.175 0.173 0.173 0.194 adj. R-sq 0.146 0.129 0.128 0.127 0.140 This table presents the results for the estimation of Equation 3 in the text. The dependent variable is first-day return as the proxy for underpricing, calculated as the offer price relative to first-trading day closing price of the issuing firm. The main variable of interest is the logarithm of net gain by insiders (CEO, Investment bank and VC), and it is the difference of the money gained and money left by insiders. These represents the insider s net incentives of the post-ipo ownership stake over the stock sale at the offering. The definitions of the rest of the variables are provided in the Appendix. All regressions control for year fixed effects. Robust standard errors are clustered at year level in regressions that control for year fixed effects. P-values are provided in brackets. *, **, *** mark the 10%, 5% and 1% statistical significance for the estimated coefficients. 28

Table 5. Insiders Incentive and Promotional Cost Dependent Variable Incentives Sensitivity of IPO Sale (CEO) 0.0181*** (0.001) Sensitivity of Post-IPO Proceeds (CEO) -0.0183* (0.070) Net Effect (CEO) -0.0124 (0.125) Sensitivity of IPO Sale (Investment Bank) -0.00112 (0.924) Sensitivity of Post-IPO Proceeds (Investment Bank) -0.00142 (0.822) Log (promotional cost) (1) (2) (3) (4) (5) (6) Net Effect (Investment Bank) -0.00112 (0.880) Sensitivity of IPO Sale (VC) 0.00129 (0.777) Sensitivity of Post-IPO Proceeds (VC) -0.00671 (0.356) Net Effect (VC) -0.00575 (0.483) Controls Log(Assets) 0.0327*** 0.0332*** 0.0335*** 0.0333*** 0.0328** 0.0330*** (0.009) (0.008) (0.009) (0.008) (0.011) (0.009) Venture Backed Dummy -0.0000821-0.00205-0.00481-0.00635 0.00916 0.00279 (0.999) (0.981) (0.955) (0.941) (0.926) (0.978) Lead Underwriter Dummy 0.203 0.216 0.222 0.222 0.225 0.226 (0.140) (0.137) (0.131) (0.131) (0.120) (0.123) Price Revision 0.00833-0.00840-0.00501-0.000877 0.00602 0.00384 (0.938) (0.937) (0.964) (0.994) (0.958) (0.972) Leverage Ratio -0.0170-0.00732-0.0118-0.0128-0.00884-0.0103 (0.752) (0.902) (0.839) (0.824) (0.878) (0.858) Return on Assets 0.0112 0.0213 0.0160 0.0156 0.0168 0.0181 (0.878) (0.793) (0.838) (0.840) (0.823) (0.819) 29

Dependent Variable Log (promotional cost) (1) (2) (3) (4) (5) (6) Log(1+age) 0.0529 0.0619 0.0787 0.0793 0.0727 0.0754 (0.355) (0.298) (0.213) (0.192) (0.243) (0.225) Constant 14.66*** 14.58*** 14.40*** 14.40*** 14.47*** 14.46*** (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) Year Fixed Effects Yes Yes Yes Yes Yes Yes N 309 308 309 308 309 307 R-sq 0.267 0.249 0.244 0.246 0.248 0.247 adj. R-sq 0.227 0.210 0.203 0.208 0.206 0.208 This table presents the results for the estimation of Equation 4 in the text. The dependent variable is logarithm of the promotional cost, calculated by summing auditing, legal, road show, exchange, printing, and miscellaneous expenses. The main variable of interest is the logarithm of money left by insiders (CEO, Investment bank and VC), logarithm of money gained by insiders (CEO, Investment bank and VC) and these variables are calculated using equation 1 and 2 respectively. These represent the insider s incentives form the sale of stock at IPO and post-ipo ownership stake. The definitions of the rest of the variables are provided in the Appendix. All regressions control for year fixed effects. Robust standard errors are clustered at year level in regressions that control for year fixed effects. P-values are provided in brackets. *, **, *** mark the 10%, 5% and 1% statistical significance for the estimated coefficients. 30