When Beyond Meat went IPO, its shares nearly tripled in its first day of trading. While investors might be starving for plant-based burgers, others may wonder why did the company choose to leave so much money on the table instead of rising the price of its IPO?
In a new research paper1, Dr. Zhenbin Liu of the Department of Accountancy and Law and researchers explore why IPOs featuring a Directed Share Program (DSP, aka “friends and family program”) are significantly underpriced and why issuers are not upset despite selling shares at such a bargain price.
IPOs underpricing has long been blamed on underwriting banks. Given the power to allocate shares, underwriters underprice IPOS to allow their preferred clients to buy at a low price in exchange for soft dollars commissions and future investment banking mandates. Meanwhile, issuers basking in the new wealth generated by the IPO, pay little attention to how much richer they could have been if the IPO had been priced higher.
In this study, the authors focus on how DSPs entice issuers to underprice their IPOs. By letting issuers allocate shares to clients, suppliers and advisors, DSPs empower issuers to reward key stakeholders such as clients, suppliers and consultants for their contribution to the firm while also giving them a stake in the future of the company. Since DSPs are used to cement relationships but are sold at the same price as IPO shares, issuers work hard to ensure these key stakeholders don’t lose money, especially since these shareholders are often precluded to sell their shares for a certain period of time.
The study demonstrates that, between 1997-2013, IPOs featuring a DSP gained 38.4% on the first day of trading compared with a 14.8% jump for IPOs without a DSP. IPOs with a DSP thus left an average of $47.5 million on the table, compared with $21.6 million for those without. Being “friends and family” is worth it!
But what can investors who are not “friends and family” do? For once, it seems that what we know is just as good as who we know. Simply invest in IPOs with a DSP for a quick return. Making money like an insider has never been easier!
1 Chong, B., & Liu, Z. (2020). Issuer IPO Underpricing and Directed Share Program (DSP). Journal of Empirical Finance, 56, 105-125.