Jurnal Good Corporate Governance

Acquisition Activity and IPO
Underpricing
Thomas J. Boulton, Scott B. Smart, and Chad J. Zutter∗
We propose an “M&A activity” hypothesis as a partial explanation for initial public offering (IPO)
underpricing. When going public during active corporate control markets, managers may take
actions to safeguard their control. In support of this conjecture, we find that pre-IPO M&A activity
directly explains IPO underpricing. We also find that underpricing and ownership dispersion are
positively correlated, as are ownership dispersion and the probability of remaining independent.
Considering the possibility that some managers take their firms public to be acquired, we find that
the positive link between M&A activity and underpricing is not robust for firms that are viewed
as likely targets.
For entrepreneurs, in addition to the often substantial underpricing cost of going public, a
potential downside to undertaking an initial public offering (IPO) is the possibility of losing
control and the associated private benefits.1 Pagano, Panetta, and Zingales (1998) find that IPO
firms are twice as likely to experience a turnover in control within three years of the IPO as are
comparable private firms.2 For managers who wish to maintain control of their firm after the
IPO, an active market for corporate control threatens their ability to do so. Recognizing such a
threat, managers may take steps to protect their discretion over the firm.
A desire to maintain control does not necessarily imply that managers will use their control to
pursue policies that are detrimental to atomistic shareholders. In fact, DeAngelo and Rice (1983)
suggest that anti-takeover defenses, which strengthen managerial control, can benefit shareholders
by facilitating higher takeover premiums. If, as Zingales (1995) and Mello and Parsons (1998)
suggest, the IPO is the first stage of an eventual sale of the firm, stronger post-IPO managerial
control may result in higher takeover premiums since eventual bidders will have to negotiate with
managers for control of the firm. Forcing bidders to negotiate with managers for control ensures
that the bidder pays for both the cash flow and control rights, thus likely requiring the bidder
The authors thank Bill Christie (editor) and the referee for helpful criticism, and Wendy Jennings for editorial assistance.
We also wish to thank Oya Altinkiliç, Robert Jennings, Kenneth Lehn, Gershon Mandelker, Shawn Thomas, Frederik
Schlingemann, and seminar participants at the Financial Management Association and Eastern Finance Association
meetings for many helpful comments.
∗
Thomas J. Boulton is an Assistant Professor of Finance in the Farmer School of Business at Miami University, Oxford,
OH 45056. Scott B. Smart is a Professor of Finance in the Kelly School of Business at Indiana University, Bloomington,
IN 47405. Chad J. Zutter is an Associate Professor of Finance in the Katz Graduate School of Business at the University
of Pittsburgh, Pittsburgh, PA 15260.
1
For evidence that managers enjoy private control benefits, see Barclay and Holderness (1989, 1991), Zingales (1994),
Franks and Mayer (2001), Nenova (2003), Doidge (2004), Dyck and Zingales (2004), and Atanasov (2005).
2
Holderness and Sheehan (1988) and Rydqvist and Högholm (1995) also offer evidence of control turnover following the
IPO.
Financial Management • Winter 2010 • pages 1521 - 1546
1522 Financial Management r Winter 2010
to pay a premium relative to the prevailing preacquisition price.3 Protecting managerial control
may also serve to mitigate underinvestment problems as managers will not fear losing their job
if a risky investment does not prove beneficial to shareholders. Regardless of the motivation for
wanting to maintain control of the firm, an active market for corporate control provides incentive
for managers taking their firm public to act strategically.
Existing research finds that the actions of IPO managers are consistent with a desire to maintain
control following the IPO. A few examples include Brennan and Franks (1997), who suggest that
insiders opportunistically underprice their IPO to discourage the formation of large, external
blockholdings; Field and Karpoff (2002), who report that entrepreneurs often adopt anti-takeover
measures prior to the IPO; and Smart and Zutter (2003), who find that a significant fraction of
IPO firms employ dual-class capital structures. Smart and Zutter (2003) also find that in the
absence of a dual-class structure, firms that underprice more are associated with greater outside
ownership dispersion and less takeover risk. Although managers may not be able to guarantee
their absolute control of the firm following the IPO, they can take actions that will make wresting
control away from them more costly and, thus, less likely.
Given that the existing literature finds a correlation between underpricing and post-IPO outside
ownership dispersion, and a relation between post-IPO ownership dispersion and the likelihood
of experiencing a turnover in control, we conjecture that the level of IPO underpricing is, in
part, a function of the level of corporate control activity leading up to the IPO date. In other
words, we contend that entrepreneurs can form an expectation regarding their ability to maintain
control of the firm following the IPO, in some measure, as a function of the level of mergers and
acquisitions (M&A) activity prior to the IPO. In response to a higher assessed threat, managers
can underprice more at the margin in an attempt to reduce the post-IPO concentration of outside
share ownership and the likelihood of an unwanted turnover in control. This argument gives rise
to our main hypothesis that predicts a positive association between IPO underpricing and the
level of pre-IPO M&A activity.
Utilizing over 6,000 new issues listed in the United States from 1980 to 2001, we confirm that
firms taken public during active corporate control markets are less likely to remain independent.
An entrepreneur would be correct to expect a shorter tenure at the helm if they take their firm
public in the midst of a flurry of M&A transactions. But does underpricing present a strategy that
enhances an entrepreneur’s position in such an environment?
In support of our main hypothesis, we identify a positive correlation between pre-IPO corporate
control activity and IPO first-day returns. This relation is robust to the standard control variables
employed in earlier underpricing studies, including event-specific characteristics and market
conditions such as “hot market” indicators. We find further support for our main hypothesis in
that we fail to find an association between M&A activity and underpricing for a subsample of
dual-class IPOs that protect managerial control through the dual-class voting structure.
3
Fair pricing provisions ensure that all shareholders receive the same price per share and, as such, allow atomistic
shareholders to benefit from the bidder negotiating with mangers for control rights. The empirical evidence is mixed
regarding the possibility of a link between managerial control and takeover premiums. Examining a sample of IPOs,
Smart and Zutter (2003) find that dual-class firms, which concentrate control in the hands of insiders, receive larger
takeover premiums than do single-class firms. Bauguess et al. (2009) find that target premiums are positively related
to the level of insider ownership and negatively related to the level of active-outside ownership. Alternatively, Field and
Karpoff (2002) fail to find an association between the takeover defenses of IPO firms and post-IPO takeover premiums;
although they do find that takeover defenses are negatively related with the likelihood of post-IPO acquisitions. Field
and Karpoff (2002) reject the notion that takeover defenses deployed at the IPO lead to higher takeover premiums. In
unreported tests, we fail to find significant correlations between either underpricing and takeover premiums or ownership
dispersion and takeover premiums.
Boulton, Smart, & Zutter r Acquisition Activity and IPO Underpricing 1523
We suggest that one channel through which underpricing may affect post-IPO control activity
is the concentration of the outside ownership structure. We find that initial returns and post-
IPO institutional ownership are negatively related. This is true whether we examine the largest
institutional block, the average holdings of an institutional investor, the aggregate institutional
ownership, or the number of institutional investors. The negative impact underpricing has on
these ownership measures supports the notion that underpricing can be used strategically to affect
the level of outside ownership dispersion.
Dispersed outside ownership does not in and of itself prevent a takeover, but it can make
a takeover more costly. Consistent with the theory that greater outside ownership dispersion is
associated with a higher cost of acquisition, we find that firms with less concentrated institutional
ownership are more likely to remain independent following the IPO. Given that our data indicate
that greater underpricing leads to more outside ownership dispersion and greater ownership
dispersion raises the likelihood that a firm remains independent, our results support the assertion
that a control motivation can explain the empirical correlation between pre-IPO M&A activity
and IPO underpricing.
Although our empirical results support our hypotheses, they could also be construed, at least
partially, as consistent with the view that some entrepreneurs underprice, not to avoid a subsequent
takeover but to capitalize on one. Zingales (1995) suggests that the IPO can be the first step of the
eventual sale of the firm. He argues that an entrepreneur can maximize the proceeds from the sale
of the firm by first selling to disperse shareholders at the IPO to maximize the value of the cash
flows and then subsequently negotiating in private for the controlling interest to maximize the
value of the control rights. In this framework, it is possible that some managers will underprice to
generate dispersion, not for the purpose of avoiding a transfer of control but rather to maximize
the proceeds from ultimately relinquishing control. Moreover, these managers may find a period
of high corporate control activity opportunistic.
To further explore this possibility, we examine the relation between M&A activity and under-
pricing within various subgroups that we believe differ in terms of the ex ante probability that
managers wish to remain independent. Our findings indicate that the positive association between
M&A activity and underpricing is not robust for groups of firms that have a subjectively higher
ex ante probability of selling to an acquirer.
Although we cannot rule out the possibility that an alternative theory could better explain the
relation between corporate control activity and IPO underpricing, our evidence supports the idea
that control incentives provide a reasonable explanation. The remainder of the paper proceeds as
follows. In Section I, we develop our hypotheses. Section II describes our sample selection and
descriptive statistics. In Section III, we present our empirical results, while in Section IV, we offer
our conclusions.
I. Hypotheses Development
Brennan and Franks (1997) and other papers suggest that entrepreneurs faced with a control
threat can underprice more at the margin in an attempt to reduce the post-IPO concentration of
share ownership and, as such, the likelihood of an unwanted turnover in control. The central idea
of this paper is to examine the relation between the level of M&A activity prior to the IPO (a proxy
for the control threat faced by managers of newly public firms) and underpricing. Accordingly,
our main hypothesis is:
H1: IPO underpricing is positively related to the level of pre-IPO M&A activity.
The argument that insiders strategically underprice as a function of M&A activity in order
to influence the firm’s post-IPO ownership structure may seem at odds with the conventional
wisdom concerning the interactions among issuers, underwriters, and investors. For example,
Loughran and Ritter (2002), Reuter (2006), and Nimalendran, Ritter, and Zhang (2007) present
evidence that underwriters use their discretion regarding offer prices and share allocations to
generate higher trading commissions after the IPO. Further, Lowry and Murphy’s (2007) inability
to find a correlation between stock option holdings and underpricing leads them to conclude that
underwriters, not issuers, control underpricing. In general, we have no quarrel with the notion that
the primary responsibility for pricing new issues rests with underwriters. The analysis presented
here requires only that entrepreneurs have some influence on underpricing. Indeed, several studies
report evidence that suggests issuers play a role in underpricing. For example, field evidence from
a survey of 336 chief financial officers (CFOs) who either took their firms public or attempted
to do so during 2000-2002 suggests that, in practice, companies use underpricing to influence
ownership structure. Brau and Fawcett (2006) presented CFOs with a list of factors that might
influence underpricing and asked them, “To what extent do you feel the following led to the level
of underpricing that you expected?” Approximately 41% of the CFOs responded that “to ensure a
wide ownership base” was an important or very important determinant of expected underpricing.
CFOs cited this motivation for underpricing as being more important than several alternatives
suggested in the theoretical literature such as compensating investors for revealing information
(Benveniste and Spindt, 1989), mitigating litigation risk (Tinic, 1988; Hughes and Thakor, 1992;
Zhu, 2009), starting an information cascade (Welch, 1992), and increasing publicity for the firm
(Demers and Lewellen, 2003).4
Given that the impact of underpricing on post-IPO ownership is an important link in our
primary hypothesis, we also test a second hypothesis focusing exclusively on the relation between
underpricing and ownership. That hypothesis is:
H2: Post-IPO ownership concentration is negatively correlated with IPO underpricing.
In addition to Brennan and Franks (1997), Grossman and Hart (1980) and Shleifer and Vishny
(1986) embrace the notion that dispersed outside ownership results in greater managerial au-
tonomy since, relative to large blockholders, it is not incentive compatible for atomistic outside
shareholders to monitor management. The view that block ownership presents a threat to in-
siders receives support from papers such as Shivdasani (1993) and Smart and Zutter (2003).
Shivdasani (1993) finds that ownership by unaffiliated blockholders is positively correlated with
hostile takeover attempts. Smart and Zutter (2003) determine that the probability of being ac-
quired within the first five years following the IPO is positively correlated with the fraction of
institutional ownership. Also, the literature cites a variety of mechanisms by which institutional
investors affect acquisitions. Jarrell and Poulsen (1987) and Brickley, Lease, and Smith (1988)
posit that institutional investors influence acquisition likelihood by impacting the use of anti-
takeover measures. For example, Brickley et al. (1988) find that institutional investors (and other
blockholders) are more likely to oppose anti-takeover amendments than are nonblockholders.
4
Additional evidence that issuers influence underpricing comes from Ljungqvist and Wilhelm (2003), who find that
underpricing is positively linked to the fraction of IPO shares that firms allocate to employees’ friends and family
members, while Habib and Ljungqvist (2001) offer both theoretical and empirical evidence indicating that entrepreneurs
minimize their wealth losses from going public by trading off the costs of promoting IPOs against underpricing. This
finding is independently confirmed by Kennedy, Sivakumar, and Vetzal (2006). Furthermore, issuers may influence
underpricing indirectly through their choices regarding other aspects of the IPO process. Leone, Rock, and Willenborg
(2007) identify substantial variation in the specificity of information regarding the subsequent use of IPO proceeds across
IPO firms. Firms that choose to reveal more information experience less underpricing.
Eakins (1993) observes that institutional investors rapidly sell shares during tender offers. Sim-
ilarly, Holmstrom and Kaplan (2001) believe that institutional investors support takeovers by
selling large blocks in the takeovers. International support for the role of institutional investors in
firm acquisition comes from Ferreira, Massa, and Matos (2010) who report that foreign institu-
tional investors facilitate cross-border takeovers by building bridges between firms. If corporate
control motivation helps to explain the existence of a relation between the level of pre-IPO M&A
activity and IPO underpricing, then the following hypothesis is warranted:
H3: The probability of takeover is positively correlated with post-IPO ownership concentration.
II. Sample Selection and Descriptive Statistics
Our sample of IPOs is extracted from Thomson Financial’s SDC New Issues database. We
extract from Securities Data Company (SDC) all firm commitment new issues for the period
January 1980-December 2001. We exclude offerings that are associated with limited partnerships,
closed-end funds, units, investment companies, real estate investment trusts, and dual-class capital
structures, all of which are typically excluded from underpricing studies. We also exclude IPOs
with an offer price less than $5. Finally, after excluding firms that do not have stock price data
available in the Center for Research in Security Prices (CRSP) database within 14 days of the
SDC issue date, our final sample includes 6,156 IPOs.
To track corporate control events, we use Thomson Financial’s SDC M&A database. We use
SDC M&A events to construct measures of industry-level M&A activity. Our corporate control
activity measures include deals involving both public and private targets worth at least $1 million.
Because we are trying to measure the overall pace of corporate control activity, we include both
completed and withdrawn transactions and transactions in which an acquirer buys, or attempts to
buy, any portion of another firm. From January 1979 to December 2001, there are 41,376 deals
that met the selection criteria. We use these deals to construct industry-level corporate control
activity measures based on the number of deals in a Fama and French (1997) industry over 3-,
6-, and 12-month horizons leading up to the IPO. We normalize these measures by dividing the
number of deals for a given horizon by the respective industry’s number of Compustat-listed
firms.5
We retrieve end-of-quarter institutional ownership data from Thomson Financial’s
CDA/Spectrum 13f Institutional Holdings database for up to five years following each IPO.
Consistent with Field and Lowry (2009), our earliest institutional ownership measure comes from
the institutional holdings reported between one and four months after the IPO and subsequent
ownership measures come from the quarterly reports thereafter. We code institutional ownership
as zero for any firm that has no institutional ownership reported in the Spectrum 13f database.
We follow Dor (2003) and Field and Lowry (2009) and exclude large blocks likely to have been
formed prior to the IPO.6 The primary institutional ownership measures utilized in this study
are the ownership of the single largest institutional holding and the aggregate ownership of all
institutional holdings, both measured as a percentage of the total shares outstanding.
5
We also gauge corporate control activity by measuring the aggregate deal value for an industry divided by the industry’s
aggregate asset value for the respective Compustat firms. The deal-based and asset-based proxies produce very similar
results.
6
We also check the robustness of our ownership results to include large blocks likely to have been formed prior to the
IPO. Our results are unaffected by including these blocks.
Table I presents descriptive statistics for our sample of IPOs, corporate control activity mea-
sures, and institutional ownership. We measure IPO underpricing, or the first-day return, as the
percentage difference between the IPO offer price and the closing price on the first day of trading.
The average IPO in our sample earns a first-day return of 18.5%. Fewer than 38% of our IPOs
receive backing from venture capitalists (VCs). Attributes of our sample compare favorably to
those reported for the 1980-2000 period in Appendix C of Loughran and Ritter (2004). In their
sample of 6,181 IPOs, they report average underpricing of 18.9%, with just over 39% of the firms
receiving venture backing.
Almost 80% of our IPOs list on NASDAQ. For the average firm, aggregate institutional
ownership is 10.3% immediately following the IPO, with the largest institutional holder owning
2.5% of the outstanding equity. For each IPO in our sample, we calculate the return on the CRSP
value-weighted index over the 22 trading days leading up to the IPO. On average, the 22-day
return is 1.5%, roughly equivalent to 18% per year. This finding is consistent with prior evidence
that firms go public when overall stock market conditions are favorable.
Our measures of corporate control activity indicate that, on average, the number of M&A
deals involving public and private targets in a particular industry over 3-, 6-, and 12-month
horizons equals 7%, 13.7%, and 26.2% of the number of Compustat-listed firms in that industry,
respectively. In other words, if a given industry has 1,000 public firms, then in the average three-
month window there will be about 70 deals involving either public or private targets announced
in that industry. As expected, there is considerable time series variation in these figures. For
example, the standard deviation of the three-month M&A activity is 5% as compared to the 7%
mean.
III. Empirical Results

In this section, we present six pieces of evidence suggesting a link between corporate control
and underpricing. First, we present some simple descriptive statistics indicating that IPO firms
are more likely to be acquired if they go public during a period of high M&A activity. Second, we
demonstrate that firms underprice more if they go public when M&A activity is high. In addition,
we find that higher underpricing leads to more dispersed outside ownership, while we find that
both M&A activity at the time of a firm’s IPO and post-IPO ownership structure influence the
likelihood that the firm will become a takeover target. Moreover, we confirm that no positive
association exists between pre-IPO M&A activity and the level of underpricing for dual-class
firms whose managers need not fear the market for corporate control given their ownership of
superior voting shares. Furthermore, we fail to find a robust positive correlation between pre-IPO
corporate control activity and IPO underpricing for groups of firms that are subjectively viewed
as having a high ex ante probability of selling to an acquirer after the IPO. All of this evidence
is consistent with control motivation as the linkage between pre-IPO M&A activity and IPO
underpricing.
A. Correlation between Corporate Control Activity and Underpricing

We argue that managers underprice more when going public during periods of high corporate
control activity in order to create outside ownership dispersion and that they do so because they
want to maintain their discretion over their firm. Table II offers simple evidence that firms going
public during more active M&A periods are less likely to remain independent. In Table II, we
divide our IPO firms into two groups based on whether they went public during a month in which
Table I. Sample Descriptive Statistics
This table presents descriptive statistics for the entire sample of 6,156 IPOs. Initial return is the first-day
secondary market closing price divided by the final offer price minus one. Pre-IPO M&A activity measures
are calculated by dividing the total number of M&A transactions listed in SDC for a given Fama and French
(1997) industry for the 3, 6, and 12 months prior to the IPO month by the total number of Compustat-listed
firms for the industry. The largest institutional holding is the largest fraction of ownership held by a 13f
institution at the end of the quarter that occurs between one and four months after the IPO. The aggregate
institutional holding is the aggregate fraction of ownership held by all 13f institutions at the end of the
quarter that occurs between one and four months after the IPO. Offer size is the CPI-adjusted offer value
in millions of year 2001 dollars. Share overhang is the number of pre-IPO shares retained divided by the
shares issued in the offering. Offer price revision is the final offer price divided by the midpoint of the initial
offer price range minus one. Underwriter reputation is the updated Carter and Manaster (1990) ranking, as
provided by Jay Ritter. Dummy variables are equal to one for venture capital backed, equity carveout, reverse
LBO, and NASDAQ-listed deals and zero otherwise. Recent market return is a buy-and-hold return for the
22 trading days prior the IPO date. Investor sentiment is the Michigan Consumer Sentiment Index reading
from the month prior to the IPO issue date (divided by 100). Rate spread is the commercial and industrial
loans rate minus the fed funds rate. IPO volume is the ratio of IPOs issued in the calendar year to the number
of firms covered by the CRSP database at the end of the prior calendar year for a given industry. Market
capitalization is the CPI-adjusted market capitalization in millions of year 2001 dollars. Positive earnings
before interest and taxes (EBIT) is set to one for firms with EBIT greater than zero and zero otherwise.
Industry takeover is equal to one if an acquisition announcement occurred in the issuing firm’s four-digit
SIC code in the calendar year preceding the issue and zero otherwise. Return on assets is net income divided
by book assets minus the median Fama and French (1997) industry value (winsorized at the 2nd and 98th
percentiles). Debt-to-asset ratio is total long-term debt divided by total assets (winsorized at the 2nd and
98th percentiles). Net PPE to assets is net property, plant, and equipment divided by total assets (winsorized
at the 2nd and 98th percentiles).
Mean Median
Initial return 0.185 0.063
Pre-IPO M&A activity – Prior 3 months 0.070 0.059
Pre-IPO M&A activity – Prior 6 months 0.137 0.114
Pre-IPO largest institutional holding M&A activity – 0.262 0.218
Prior 12 months
Largest institutional holding 0.025 0.020
Aggregate institutional holding 0.103 0.075
Offer size in millions of dollars 59.933 29.631
Share overhang 2.820 2.327
Offer price revision 0.003 0.000
Underwriter reputation 6.930 8.000
Venture capital backed 0.379 0.000
Equity carveout 0.079 0.000
Reverse LBO 0.038 0.000
NASDAQ listed 0.792 1.000
Recent market return 0.015 0.016
Investor sentiment 0.933 0.929
Rate spread 0.014 0.014
IPO volume 0.106 0.086
Market capitalization 4.954 4.879
Positive EBIT 0.687 1.000
Industry takeover dummy 0.859 1.000
Return on assets −0.225 0.039
Debt-to-asset ratio 0.157 0.021
Net PPE to assets 0.245 0.171
Table II. Cumulative Percent of Post-IPO Acquisitions by Median Pre-IPO
M&A Activity
This table presents the cumulative percent of post-IPO acquisitions by median pre-IPO M&A activity for
the entire sample of 6,156 IPOs. Pre-IPO M&A activity is the total number of M&A transactions listed in
SDC for a given Fama and French (1997) industry for the three months prior to the IPO month divided
by the total number of Compustat-listed firms for the industry. The median M&A activity is calculated at
the industry level across the full sample period. Fisher exact chi-square statistics test for equal proportions
above and below the median pre-IPO M&A activity.
Cumulative Percent of IPOs 1 Year 2 Years 3 Years 4 Years 5 Years

Acquired Within
Above the median Pre-IPO M&A activity 1.6% 7.5% 15.6% 22.8% 30.2%
Below the median Pre-IPO M&A activity 0.6% 4.7% 10.1% 16.2% 21.3%
Chi-square statistic 11.351 18.197 33.889 35.266 49.596
the three-month pre-IPO M&A activity was above or below the median for the industry’s sample
IPOs. Next, we determine the percentage of each group of IPO firms that is acquired over one- to
five-year windows following the IPO. A chi-square test indicates that the proportion of acquired
firms is much higher for firms that conducted an IPO during an active corporate control market.
For instance, the percentage of IPO firms acquired in the first post-IPO year is 2.7 times higher for
firms that went public during an active control market versus those going public during a period
of below median M&A activity. Over time, the relative gap between the two groups narrows, as
might be expected. By the fifth anniversary of the IPO, the percentage of firms acquired is about
1.4 times higher for firms that went public during an active control market.
Our main hypothesis predicts that the level of underpricing will be positively correlated with the
amount of pre-IPO M&A activity in the issuing firm’s industry. If firms going public during active
M&A markets are more likely to become takeover targets, then managers who value independence
may opportunistically underprice as a means of maintaining control. Table III details the results
of three regressions designed to examine the relation between the prevailing corporate control
climate and the level of IPO underpricing. Table III regressions use a normalized deal-based
M&A activity measure, which is the number of control transactions in a Fama and French (1997)
industry for the 3, 6, or 12 months leading up to a particular IPO divided by the total number
of Compustat-listed firms in that industry. Each column in Table III corresponds to a different
horizon over which we measure pre-IPO M&A activity.
The IPO underpricing literature identifies a number of factors related to initial returns. A
standard control in IPO underpricing studies is the IPO offer size (Ritter, 1984). Offer size may
account for a number of factors including risk and information asymmetry, so we include the log
of the inflation-adjusted offer value as a control variable.
Habib and Ljungqvist (2001) suggest that underpricing will be greater if managers sell fewer
shares in the IPO. To control for this effect, we include a share overhang variable, which is the
number of pre-IPO shares retained divided by the shares issued in the offering. Bradley and
Jordan (2002) document a positive correlation between share overhang and underpricing.
Hanley (1993) documents a “partial adjustment” phenomenon in which greater underpricing
occurs when an IPO firm’s offer price is adjusted upward prior to the actual IPO date. Accordingly,
the regressions include a control for revisions to the offer price that equals the percentage change
from the midpoint of the initial offer price range to the final offer price. Table I reports that the
mean offer price revision in our sample equals 0.3%. Hanley (1993) documents a mean revision
Table III. OLS Regressions of IPO Underpricing on Pre-IPO M&A Activity
This table presents OLS regressions of IPO underpricing on pre-IPO M&A activity. The dependent variable
is the IPO initial return, which is the first-day secondary market closing price divided by the final offer price
minus one. Pre-IPO M&A activity measures are calculated by dividing the total number of M&A transactions
listed in SDC for a given Fama and French (1997) industry for the 3, 6, and 12 months prior to the IPO month
by the total number of Compustat-listed firms for the industry. Offer size is the CPI-adjusted offer value
offer price range minus one. Underwriter reputation is the updated Carter and Manaster (1990) ranking,
as provided by Jay Ritter. Dummy variables are equal to one for venture capital backed, equity carveout,
reverse LBO, and NASDAQ-listed deals and zero otherwise. Recent market return is a buy-and-hold return
for the 22 trading days prior the IPO date. Investor sentiment is the Michigan Consumer Sentiment Index
reading from the month prior to the IPO issue date (divided by 100). Rate spread is the commercial and
industrial loans rate minus the fed funds rate (multiplied by 100). IPO volume is the ratio of IPOs issued
in the calendar year to the number of firms covered by the CRSP database at the end of the prior calendar
year for a given industry. All regressions include unreported Fama and French (1997) industry dummies and
controls for issue year. The t-statistics are presented in parentheses.
Pre-IPO M&A Activity

Prior 3 Months Prior 6 Months Prior 12 Months
∗ ∗
Intercept −0.330 −0.330 −0.331∗
(−1.82) (−1.82) (−1.82)
M&A activity 0.439∗∗∗ 0.230∗∗∗ 0.100∗∗
(3.46) (3.13) (2.42)
Log of offer size −0.028∗∗∗ −0.028∗∗∗ −0.028∗∗∗
(−4.66) (−4.63) (−4.61)
Share overhang 0.023∗∗∗ 0.023∗∗∗ 0.023∗∗∗
(12.11) (12.08) (12.08)
Offer price revision 0.799∗∗∗ 0.801∗∗∗ 0.801∗∗∗
(37.48) (37.57) (37.54)
Underwriter reputation 0.008∗∗∗ 0.008∗∗∗ 0.008∗∗∗
(2.95) (2.92) (2.93)
Venture capital backed 0.031∗∗∗ 0.031∗∗∗ 0.031∗∗∗
(3.05) (3.04) (3.05)
Equity carveout −0.039∗∗ −0.039∗∗ −0.039∗∗
(−2.47) (−2.46) (−2.47)
Reverse LBO −0.008 −0.006 −0.007
(−0.34) (−0.28) (−0.30)
NASDAQ listed 0.017 0.017 0.017
(1.47) (1.47) (1.47)
Recent market return 0.603∗∗∗ 0.605∗∗∗ 0.603∗∗∗
(5.05) (5.06) (5.05)
Investor sentiment 0.045 0.046 0.048
(0.41) (0.42) (0.43)
Rate spread 0.193∗∗∗ 0.189∗∗∗ 0.188∗∗∗
(2.65) (2.60) (2.58)
IPO volume 0.237∗∗∗ 0.237∗∗∗ 0.246∗∗∗
(2.89) (2.89) (3.00)
Adjusted R2 41.61% 41.59% 41.55%
Number of observations 6,037 6,037 6,037
∗∗∗
Significant at the 0.01 level.
∗∗
∗
of −4.3% for IPOs in 1983-1987, while that same figure is 3.1% for the Cliff and Denis (2004)
1993-2000 sample.
A number of studies examine the impact of investment bank reputation on underpricing.
Carter and Manaster (1990) and Megginson and Weiss (1991) find a negative relation between
underwriter reputation and IPO underpricing, but studies using IPOs from the 1990s find greater
underpricing for deals underwritten by more prestigious investment banks. To control for the
effects of an underwriter’s reputation on underpricing, we include the updated Carter and Manaster
(1990) rankings.7
The presence of VCs has also been shown to explain initial returns. Barry et al. (1990) identify a
negative correlation between venture capital backing and underpricing. More recently, Loughran
and Ritter (2004) find a positive association between the presence of venture capital backing and
first-day returns to new issues. A dummy variable denoting venture capital backing is included
in the underpricing regressions.
Numerous deal characteristics have been linked to underpricing. Dummies for equity carveouts
and reverse leveraged buyouts (LBOs), both of which are IPOs involving firms with a prior history
as publicly traded entities, are included as controls. We also include a dummy for firms listing
their shares on the NASDAQ.
One interpretation of the positive connection between M&A activity and underpricing is that
firms underprice more in an active M&A environment to generate more dispersed ownership.
Alternatively, there might be a common factor that drives both M&A activity and underpricing,
such as hot markets. Our regressions include several variables designed to control for this possi-
bility. For example, we include the return on the CRSP value-weighted index over the 22 trading
days leading up to a firm’s IPO to control for an environment of rising stock prices. Similarly,
we include the Michigan Consumer Sentiment Index (deflated by 100), which Qui and Welch
(2006) identify as a good proxy for investor sentiment. In a study of merger waves, Harford
(2005) concludes that economic, technological, or regulatory shocks, coupled with high market
liquidity, cause merger waves. Correlated industry shocks lead to merger waves only when capital
availability is sufficient to sustain the transactions needed to reallocate resources on a large scale.
Harford (2005) uses the rate spread between commercial and industrial loans and the federal funds
rate to measure capital availability. It is plausible that capital availability is also correlated with
IPO activity, which, in turn, is correlated with underpricing. As such, we include the rate spread
as a control in our regressions.8 Lowry (2003) provides motivation for our IPO volume measure,
which is the ratio of the number of IPOs in a calendar year to the number of CRSP-listed firms,
both measured at the Fama and French (1997) industry level. As a final control for possible hot
markets, the regressions include year dummies to capture the rising tide of underpricing through
the 1990s.9 Finally, we control for the industry of the issuing firm by including Fama and French
(1997) industry dummies in all regressions.
In all three Table III regressions, while holding constant other factors known to affect initial
returns, we find a positive and significant relation between pre-IPO M&A activity measures and
underpricing. The coefficient of 0.439 on the three-month M&A activity measure in Table III
7
The authors thank Jay Ritter for making the updated Carter and Manaster (1990) rankings available on his website.
Ritter’s rankings include those from Carter and Manaster (1990) and Carter, Dark, and Singh (1998). We obtain very
similar results if we use the Megginson and Weiss (1991) statistic, which is simply the market share of the underwriter
backing each IPO.
8
The authors thank Jarrad Harford for providing the rate-spread data.
9
We also experiment with a hot issue dummy calculated using the approach of Helwege and Liang (2004). The positive
correlation between underpricing and M&A activity is robust to the inclusion of this measure.
implies that an increase in M&A activity from the 25th percentile (a value of 0.036) to the 75th
percentile (a value of 0.096) is associated with an additional 2.6 percentage points of underpricing.
When we calculate the M&A proxy over horizons of 6 and 12 months leading up to the IPO,
increases in M&A activity continue to have an economically significant impact on underpricing.
It is interesting to note, however, that the effect of pre-IPO corporate control activity on IPO
underpricing diminishes as the duration over which pre-IPO M&A activity is measured increases.
This might suggest that managers assign a greater weight to the most recent M&A activity when
assessing the likelihood of losing control.
The variables that we include in the regressions to control for hot market effects are positively
related to underpricing. With the exception of investor sentiment, each is highly significant. The
regressions indicate that underpricing has a highly significant and positive association with both
recent market returns and IPO volume. Similarly, the coefficient on the rate-spread variable is
positive and highly significant, although this effect is much smaller if we exclude the Internet
bubble period of 1999-2000. The year dummy coefficients, which we do not report in the table,
generally increase through the 1990s, consistent with an upward drift in underpricing through
time. The positive link between M&A activity and underpricing is robust to the inclusion of these
hot market indicators and is consistent with the hypothesis that firms underprice more when the
corporate control market is more active.
The other variables in Table III are generally consistent with prior empirical literature. The
level of underpricing is inversely related to the size of the offering and directly related to share
overhang and the degree of offer price revision. Deals underwritten by more reputable banks are
underpriced more, as are venture-backed deals. Finally, equity carveouts are associated with less
underpricing.
B. Underpricing and Dispersed Ownership

If the association between pre-IPO corporate control activity and IPO underpricing is motivated
by managers’ desire to maintain control of their firms, then we expect additional underpricing to
lead to an outcome that protects the position of managers. Brennan and Franks (1997) posit that
managers opportunistically underprice their IPO in an effort to disperse the post-IPO ownership
structure and decrease the likelihood of an unwanted turnover in control. In this section, we
consider whether higher underpricing leads to more dispersed outside ownership.
Higher underpricing facilitates outside ownership dispersion by increasing demand for a firm’s
offering. This is true whether issuers can selectively discriminate against large bidders in the share
allocation or shares are issued on a mandatory pro rata basis. Although we do not have access to
IPO share allocation data, we do have end-of-quarter institutional ownership data starting with the
quarter in which the IPO takes place. Undoubtedly, institutional ownership levels are not a perfect
proxy for outside ownership dispersion. However, Hanley and Wilhelm (1995) and Aggarwal,
Prabhala, and Puri (2002) report evidence that institutional investors receive the majority of
the shares available in the typical IPO. For example, Hanley and Wilhelm (1995) report that
institutions receive two shares for every one share allocated to retail investors. For these reasons,
we expect institutional ownership to be negatively correlated with outside ownership dispersion
for our IPO sample.
Although it is reasonable to assume that ownership dispersion is negatively correlated with the
level of institutional ownership, especially as it relates to the degree of atomistic shareholders,
there remain some perils associated with the interpretation of these measures as proxies regarding
the degree of ownership dispersion within the institutional holdings and, therefore, the overall level
of outside ownership dispersion. For example, an aggregate measure of institutional ownership
can be misleading since it is not apparent whether the aggregate is composed of many small
institutional ownership stakes or a few large stakes. Clearly, the former would be more consistent
with an overall high level of outside ownership dispersion than the latter. The measure of the
largest institutional ownership stake, unless it is 100%, can also be misleading as it does not
capture the number or size of remaining institutional investors. Given that we predict a positive
association between underpricing and ownership dispersion, we contend that the difficulties in
interpreting institutional ownership measures are somewhat mitigated by the belief that a decrease
of any of the institutional ownership measures is associated with an increase of the degree of
overall ownership dispersion.
Table IV examines the role of underpricing in explaining post-IPO institutional ownership in
order to determine if higher levels of underpricing are associated with more dispersed ownership
structures. We run regressions for two separate ownership measures: 1) the fraction of shares
owned by the single largest institutional investor and 2) the aggregate fraction of shares owned
by all institutional investors.
Table IV reports the results of ordinary least squares (OLS) regressions of post-IPO institutional
ownership on IPO underpricing and several control variables. To avoid the problems associated
with estimating an OLS regression on a dependent variable that ranges from zero to one, we
transform our ownership measures using the logistic transformation as follows:
ownership ÷ (1 − ownership), (1)
where ownership equals either the fraction owned by the single largest institutional investor or the
fraction of aggregate institutional holdings. We measure institutional holdings at three different
intervals following the IPO: 1) at the end of the quarter occurring between one and four months
after the IPO (first quarter), 2) at the end of the eighth full quarter following the IPO (two years),
and 3) at the end of the 20th full quarter following the IPO (five years).
Table IV presents strong evidence that higher IPO underpricing is related to lower institutional
holdings following the IPO. The coefficient on the initial return measure is negative and significant
at the 1% level for both the largest institutional investor and aggregate institutional holdings. The
effect of IPO underpricing on institutional ownership lasts for at least two full years after the
IPO, although, as expected, the effect is diminishing with time. Underpricing does not appear to
influence institutional ownership five years after the IPO.10 These findings are consistent with
the hypothesis that underpricing is a mechanism that can be used to increase outside ownership
dispersion subsequent to the IPO and they provide motivation for our primary result linking
pre-IPO M&A activity with the level of underpricing.
Our finding that post-IPO aggregate institutional ownership is negatively related to underpricing
is somewhat contrary to a finding by Aggarwal et al. (2002). For a sample of 174 IPOs conducted
from May 1997 to June 1998 by a group of 10 investment banks, Aggarwal et al. (2002) find a
positive association between underpricing and aggregate share allocation to institutional investors.
Ultimately, it is not possible to say what the positive link between underpricing and aggregate
share allocation to institutional investors means with respect to the rationing hypothesis since
we cannot know across how many individual institutional investors the shares are rationed. For
example, for firms in their sample, we do not know the number, minimum size, or maximum size
of the institutional investors that make up their aggregate allocation measures. Hence, we cannot
10
We obtain similar results if our ownership measure is the size of the average institutional investor’s holding or the
number of institutional investors in the firm. Also, if we include, rather than exclude, pre-IPO venture capitalists and
large blockholders, all results continue to hold though the economic significance diminishes slightly.
Table IV. OLS Regressions of Institutional Holdings on IPO Underpricing
This table presents OLS regressions of institutional holdings on IPO underpricing. The dependent variable
in the first three regressions is the log of the ratio of the largest institutional holding to one minus the
largest institutional holding. The dependent variable in the final three regressions is the log of the ratio of
the aggregate institutional holding to one minus the aggregate institutional holding. Institutional holdings
are measured at three different intervals following the IPO: 1) at the end of the first quarter that occurs
between one and four months after the IPO (first quarter), 2) at the end of the eighth full quarter following
the IPO (two years), and 3) at the end of the 20th full quarter following the IPO (five-year). We exclude
pre-IPO venture capitalists and large blockholders from both institutional holding measures following the
methodology of Dor (2003) and Field and Lowry (2009). Initial return is the first-day secondary market
closing price divided by the final offer price minus one. Positive price revision is a dummy variable set
to one for IPOs with a final offer price that exceeds the midpoint of the initial filing range and zero
otherwise. Underwriter reputation is the updated Carter and Manaster (1990) ranking as provided by Jay
Ritter. Dummy variables are equal to one for venture capital backed, equity carveout, and reverse LBO deals
and zero otherwise. Log of market capitalization is the natural log of the market value of common equity in
millions of US dollars. Positive EBIT is set to one for firms with EBIT greater than zero and zero otherwise.
All regressions include unreported Fama and French (1997) industry dummies and controls for issue year.
The t-statistics are presented in parentheses.
Post-IPO Largest Institutional Post-IPO Aggregate Institutional

Holding Holding
First 2 Years 5 Years First 2 Years 5 Years
Quarter Quarter
Intercept −7.988∗∗∗ −8.535∗∗∗ −6.602∗∗∗ −9.500∗∗∗ −11.273∗∗∗ −8.495∗∗∗
(−12.59) (−15.06) (−10.07) (−12.02) (−16.04) (−10.00)
Initial return −0.285∗∗∗ −0.223∗∗ 0.000 −0.382∗∗∗ −0.316∗∗ −0.050
(−2.90) (−2.03) (0.00) (−3.13) (−2.32) (−0.30)
Positive price 0.011 −0.102 −0.044 0.107 −0.096 −0.054
revision (0.13) (−1.15) (−0.42) (1.08) (−0.87) (−0.40)
Underwriter 0.324∗∗∗ 0.184∗∗∗ 0.142∗∗∗ 0.427∗∗∗ 0.217∗∗∗ 0.162∗∗∗
reputation (14.60) (8.28) (5.43) (15.45) (7.86) (4.77)
Venture capital 0.216∗∗∗ 0.274∗∗∗ 0.038 0.284∗∗∗ 0.480∗∗∗ 0.273∗
backed (2.63) (2.94) (0.34) (2.79) (4.14) (1.88)
Equity carveout 0.064 −0.034 −0.153 0.105 −0.018 −0.148
(0.50) (−0.23) (−0.86) (0.66) (−0.10) (−0.64)
Reverse LBO −0.028 −0.043 −0.151 0.000 −0.046 −0.182
(−0.16) (−0.21) (−0.60) (0.00) (−0.18) (−0.56)
Log of market −0.016 0.241∗∗∗ 0.175∗∗∗ 0.144∗∗∗ 0.564∗∗∗ 0.573∗∗∗
capitalization (−0.35) (8.02) (5.68) (2.61) (15.12) (14.35)
Positive EBIT 0.705∗∗∗ 0.620∗∗∗ 0.489∗∗∗ 0.941∗∗∗ 0.832∗∗∗ 0.772∗∗∗
(7.95) (6.07) (3.91) (8.52) (6.57) (4.76)
Adjusted R2 11.05% 9.17% 7.65% 15.20% 15.78% 17.38%
Number of 5,469 4,834 3,260 5,469 4,834 3,260
observations
∗∗∗
∗∗
∗
say whether, on average, their aggregate allocation measures represent a few large institutional
investors or many smaller institutional investors for a given firm. Clearly, the latter would be
consistent with our finding and would seem reasonable if one believes that increased underpricing
is equally likely to attract additional subscribers as it is to cause existing subscribers to increase
the number of shares they request. Alternatively, our finding that underpricing is inversely related
to post-IPO institutional ownership could stem from either a concentrated or dispersed aggregate
allocation to institutional investors if, as suggested by Aggarwal (2003), institutional subscribers
are more prone to flipping their share allocations the more underpriced the shares. Although the
positive link between underpricing and aggregate institutional share allocation remains possibly
inconsistent with a rationing hypothesis, the fact that IPO subscribers who flip their shares in
the secondary market typically sell to a broad base of retail investors nonetheless leads to less
post-IPO institutional ownership and more post-IPO ownership dispersion.
Like Field and Lowry (2009), we find that institutional investors prefer to invest in IPOs
underwritten by more reputable investment banks, backed by VCs, and with positive pre-IPO
earnings. Consistent with Gompers and Metrick (1998), the control variable measuring the
market value of common equity indicates that larger firms have larger institutional holdings. A
positive offer price revision, an equity carveout, or a reverse LBO have no affect on the level of
post-IPO institutional ownership.
C. Corporate Control Climate and Future Takeover Probability

The idea that institutional ownership influences corporate control is motivated by papers in-
cluding Shleifer and Vishny (1986), who suggest that the presence of a large outside blockholder
increases the probability of a takeover attempt, and Brickley et al. (1988), who find that in-
stitutional investors tend to vote against anti-takeover provisions proposed by management. In
the same vein, Chen, Harford, and Li (2007) report that concentrated holdings by independent,
long-term institutions are positively related to postmerger performance and to the withdrawal of
bad bids, while Hartzell and Starks (2003) find that increases in the ownership held by the largest
institutional investors lead to greater pay-for-performance sensitivity in executive compensation
contracts and lower executive compensation, on average. Further, Cornett, Marcus, and Tehra-
nian (2008) report a negative correlation between aggregate institutional ownership and earnings
management in a sample of S&P100 firms. They also find a (slight) positive association between
aggregate institutional ownership and firm performance. All of these findings point toward a
monitoring role played by institutional investors.
Table II demonstrates, in a univariate setting, that firms going public during active M&A
markets face longer odds of maintaining their independence. Table V revisits this issue in a
multivariate framework and controls for other factors that might affect a firm’s ability to remain
independent. In particular, Table V examines the role that ownership concentration plays in
determining the probability that a firm remains independent following the IPO. Table V presents
probit regressions with the dependent variable equal to one if the firm is acquired within the first
two years after the IPO (short term) or during the first five years following the IPO (long term). In
order to determine if firms with dispersed outside ownership survive longer, we rely on measures
of institutional ownership, either the largest institutional holding or the aggregate institutional
ownership at the end of the first full quarter following the IPO, to capture the degree of ownership
concentration. Given the evidence that either large institutional investors or institutional investors
as a group can influence manager related outcomes, we consider both ownership measures in our
regressions.
Table V. Probit Regressions of Takeover on Pre-IPO M&A Activity and
Institutional Holdings
This table presents probit regressions of post-IPO takeover on pre-IPO M&A activity and institutional
holdings. The dependent variable is equal to one for firms acquired within the takeover window and zero
otherwise. Takeover windows are either short term (within two years of the IPO date) or long term (within
five years of the IPO date). The largest institutional holding is the largest fraction of ownership held by a
13f institution at the end of the first quarter that occurs between one and four months after the IPO. The
aggregate institutional holding is the aggregate fraction of ownership held by all 13f institutions at the end
of the first quarter that occurs between one and four months after the IPO. Hot M&A market is equal to
one if the three-month pre-IPO M&A activity is above the median three-month pre-IPO M&A activity and
zero otherwise. Pre-IPO M&A activity is the total number of M&A transactions listed in SDC for a given
Fama and French (1997) industry for the three months prior to the IPO month divided by the total number
of Compustat-listed firms for the industry. Industry takeover is equal to one if an acquisition announcement
occurred in the issuing firm’s four-digit SIC code in the calendar year preceding the issue and zero otherwise.
Return on assets is net income divided by book assets minus the median Fama and French (1997) industry
value (winsorized at the 2nd and 98th percentiles). Debt to asset ratio is total long-term debt divided by total
assets (winsorized at the 2nd and 98th percentiles). Net PPE to assets is net property, plant, and equipment
divided by total assets (winsorized at the 2nd and 98th percentiles). Market capitalization is the natural log
of the market value of common equity in millions of US dollars. Share overhang is the number of pre-IPO
shares retained divided by the shares issued in the offering. Underwriter reputation is the updated Carter and
Manaster (1990) ranking, as provided by Jay Ritter. Dummy variables are equal to one for venture capital
backed, equity carveout, reverse LBO, and NASDAQ-listed deals and zero otherwise. All regressions include
unreported Fama and French (1997) industry dummies and dummies for the following offering subperiods
1980-1988, 1989-1998, and 1999-2000. Wald chi-square statistics are presented in parentheses.
Takeover Window
Short Term Long Term Short Term Long Term
∗∗∗ ∗∗∗ ∗∗∗
Intercept −2.559 −1.641 −2.583 −1.620∗∗∗
(35.17) (29.98) (35.29) (28.93)
Largest institutional holding 3.244∗∗∗ 4.520∗∗∗
(25.86) (35.75)
Aggregate institutional holding 1.680∗∗∗ 1.925∗∗∗
(45.65) (92.50)
Hot M&A market 0.180∗∗ 0.220∗∗∗ 0.189∗∗ 0.229∗∗∗
(5.13) (16.61) (5.55) (17.63)
Industry takeover dummy 0.008 −0.064 0.018 −0.056
(0.01) (0.77) (0.03) (0.57)
Return on assets −0.082 −0.060 −0.111∗ −0.088∗∗
(1.92) (1.88) (3.52) (4.09)
Debt to assets 0.063 0.109 0.049 0.089
(0.28) (1.47) (0.17) (0.98)
Net PPE to assets 0.182 −0.117 0.161 −0.143
(1.04) (0.78) (0.81) (1.13)
Log of market capitalization 0.048 0.081∗∗∗ 0.017 0.044
(1.16) (6.80) (0.15) (2.02)
Share overhang −0.023 −0.017 0.004 0.006
(1.66) (2.13) (0.06) (0.29)
Underwriter reputation 0.051∗∗ 0.037∗∗ 0.037∗ 0.025
(5.49) (5.69) (2.75) (2.54)
Venture capital backed 0.030 −0.018 0.022 −0.031
(0.18) (0.13) (0.09) (0.36)
(Continued)
Table V. Probit Regressions of Takeover on Pre-IPO M&A Activity and
Institutional Holdings (Continued)
Takeover Window
Short Term Long Term Short Term Long Term
Equity carveout 0.121 0.258∗∗∗ 0.109 0.251∗∗∗
(1.20) (10.65) (0.97) (9.92)
Reverse LBO 0.206 0.155 0.235 0.174
(1.98) (1.91) (2.58) (2.39)
NASDAQ listed 0.228∗∗ 0.361∗∗∗ 0.250∗∗∗ 0.378∗∗∗
(6.55) (33.66) (7.70) (36.28)
Correct predictions 72.00% 68.70% 73.00% 69.00%
Number of observations 4,646 4,068 4,646 4,068
Number of mergers 303 1,105 303 1,105
∗∗∗
∗∗
∗
In order to account for the level of pre-IPO M&A activity, we create a dummy variable that
is equal to one for firms with IPO dates during hot M&A markets and zero otherwise. A hot
M&A market is one where the three-month pre-IPO M&A activity is above the median M&A
activity, which is based on the normalized industry deal volume described in Section III. As an
additional measure of takeover activity, we follow Billett and Xue (2007) and include an industry
takeover dummy that is equal to one if an acquisition announcement occurred in the issuing firm’s
four-digit SIC code in the calendar year preceding the IPO and zero otherwise. We control for
firm performance with the return on assets (ROA) ratio defined as net income divided by book
assets, winsorized at the 2nd and 98th percentiles. We adjust this ratio for industry effects by
subtracting from each firm’s ROA the median Fama and French (1997) industry ROA. We also
include the ratio of debt to assets and net plant and equipment to assets (also winsorized at the
2nd and 98th percentiles). Other control variables include the log of market capitalization, share
overhang, a measure of underwriter reputation, and dummy variables for venture capital backed,
equity carveout, reverse LBO, and NASDAQ-listed deals. Finally, we control for industry effects
by including Fama and French (1997) industry dummies and time effects using dummies for
subperiods 1980-1988, 1989-1998, and 1999-2000.11
The regressions indicate that there is a highly significant and positive correlation between
institutional ownership and the likelihood that a firm is acquired. These results suggest that
greater outside ownership concentration, measured as institutional ownership at the end of the
first full quarter following the IPO, is associated with a greater likelihood of a turnover in control
for at least five years following the IPO. The results in Table V also highlight a strong relation
between the corporate control climate during the months preceding the IPO and the probability
that a firm is subsequently acquired. Firms are more likely to be acquired, both in the short and
long term, when the market for corporate control is more active leading up to the offering. The
industry takeover dummy motivated by Billett and Xue (2007) is not significant in any of the
regressions. This result suggests that our M&A activity measure does a better job of capturing the
effect of the prevailing corporate control climate on the probability of acquisition. The control
11
Excluding deals from the 1999 to 2000 bubble period does not remarkably affect our results.
variables in our regressions indicate that an IPO firm is more likely to be acquired if it is
underwritten by a top tier investment bank, if it is an equity carveout, or if it lists on NASDAQ.
Overall, Table V confirms that the corporate control climate at the time of the IPO and the
resulting ownership concentration following the IPO are positively associated with the firm’s
likelihood of subsequent takeover. If managers recognize these relations and desire to maintain
control of the firm, they will take actions designed to decrease the likelihood of being acquired or
to allow them to determine the conditions of a future takeover. These results, combined with the
finding in Table IV that higher underpricing leads to lower institutional ownership, are consistent
with the extant research cited earlier that offers evidence of a monitoring role played by institutions
and are supportive of the idea that a control motivation explains the empirical association between
pre-IPO M&A activity and IPO underpricing.
D. Correlation between Corporate Control Activity and Dual-Class Underpricing

Thus far, we have demonstrated an empirical link between pre-IPO M&A activity and IPO
underpricing. We have also provided several pieces of corroborating evidence in support of the
idea that this link reflects managers’ desire to maintain control. Still, we cannot completely rule
out the possibility that an omitted variable, such as one that controls for hot markets, drives
both high M&A activity and underpricing. To strengthen the case for a control motivation for
the correlation between corporate control activity and underpricing, we propose an interesting
out-of-sample test using firms that went public with multiple share classes (i.e., dual-class IPOs).
The typical dual-class IPO has two classes of common stock outstanding at the IPO: Class A
shares, which generally have one vote per share and are issued to the public, and Class B shares,
which generally have 10 votes per share and are held by insiders. With respect to cash flow rights,
Class A and B shares are typically identical. Alternatively, the firms in our main sample have
only one class of common stock with the standard one-share one-vote structure.
Since dual-class firms concentrate voting power in the hands of insiders, they offer managers
a high degree of protection from the corporate control market. Smart and Zutter (2003) present
evidence that the extreme form of entrenchment provided by dual-class voting structures both
reduces firm value and increases the likelihood that dual-class firms will remain independent in
the years following the IPO. Smart, Thirumalai, and Zutter (2008) find that the lower valuations
attached to dual-class firms persist for at least five years beyond the IPO. Yeh, Shu, and Guo (2008)
obtain similar results for firms controlled by large shareholders through pyramidal structures. Li,
Ortiz-Molina, and Zhao (2009) find that institutions make fewer investments in dual-class firms.
To the extent that managers of dual-class class firms are protected from the corporate control
market, regardless of whether their firms go public during hot or cold M&A markets, we do not
expect to see a positive association between M&A activity and underpricing for these companies.
Alternatively, if an omitted variable in our prior analysis has led us astray in interpreting the link
between M&A activity and IPO underpricing, then we expect to observe the same patterns among
dual-class firms that we document for the IPOs in our main sample.
In Table VI, we expand our base sample to include dual-class IPOs in order to re-examine the
association between corporate control activity and underpricing for firms whose managers are
effectively entrenched.12 Similar to Table III, Table VI provides results for three separate regres-
sions intended to examine the relation between pre-IPO M&A activity and IPO underpricing.
Table VI regressions use the normalized deal-based M&A activity measures and the standard
control variables. To capture the differential effects for dual-class firms, we interact a dual-class
12
The authors thank Jay Ritter for providing the dual-class IPO sample on his website.
Table VI. OLS Regressions of Dual-Class IPO Underpricing on Pre-IPO
M&A Activity
This table presents OLS regressions of dual-class IPO underpricing on pre-IPO M&A activity. The dependent
variable is the IPO initial return, which is the first-day secondary market closing price divided by the final
offer price minus one. Pre-IPO M&A activity measures are calculated by dividing the total number of M&A
transactions listed in SDC for a given Fama and French (1997) industry for the 3, 6, and 12 months prior to
the IPO month by the total number of Compustat-listed firms for the industry. Dual indicator is a dummy
variable set equal to one for dual-class firms and zero otherwise. Offer size is the CPI-adjusted offer value
offer price range minus one. Underwriter reputation is the updated Carter and Manaster (1990) ranking
as provided by Jay Ritter. Dummy variables are equal to one for venture capital backed, equity carveout,
reverse LBO, and NASDAQ-listed deals and zero otherwise. Recent market return is a buy-and-hold return
for the 22 trading days prior the IPO date. Investor sentiment is the Michigan Consumer Sentiment Index
reading from the month prior to the IPO issue date (divided by 100). Rate spread is the commercial and
industrial loans rate minus the fed funds rate (multiplied by 100). IPO volume is the ratio of IPOs issued
year for a given industry. All regressions include unreported Fama and French (1997) industry dummies
and controls for issue year. We report the p-value from an F-test that the sum of the coefficients on M&A
activity and the M&A interaction term is equal to zero. The t-statistics are presented in parentheses.

Intercept −0.287 −0.287 −0.287
(−1.63) (−1.63) (−1.63)
M&A activity 0.439∗∗∗ 0.230∗∗∗ 0.101∗∗
(3.49) (3.15) (2.45)
M&A activity × Dual indicator −0.127 −0.078 0.035
(−0.18) (−0.19) (0.14)
Log of offer size −0.028∗∗∗ −0.028∗∗∗ −0.028∗∗∗
(−4.74) (−4.70) (−4.68)
Share overhang 0.023∗∗∗ 0.023∗∗∗ 0.023∗∗∗
(12.21) (12.19) (12.19)
Offer price revision 0.799∗∗∗ 0.801∗∗∗ 0.801∗∗∗
(37.82) (37.91) (37.88)
Underwriter reputation 0.008∗∗∗ 0.008∗∗∗ 0.008∗∗∗
(2.98) (2.95) (2.96)
Venture capital backed 0.031∗∗∗ 0.031∗∗∗ 0.031∗∗∗
(3.09) (3.09) (3.09)
Equity carveout −0.039∗∗ −0.039∗∗ −0.039∗∗
(−2.48) (−2.48) (−2.48)
Reverse LBO −0.008 −0.006 −0.007
(−0.35) (−0.29) (−0.31)
NASDAQ listed 0.017 0.017 0.017
(1.45) (1.46) (1.46)
Recent market return 0.604∗∗∗ 0.606∗∗∗ 0.605∗∗∗
(5.10) (5.12) (5.11)
Investor sentiment 0.028 0.030 0.031
(0.26) (0.27) (0.28)
Rate spread 0.180∗∗ 0.176∗∗ 0.175∗∗
(2.52) (2.47) (2.45)
(Continued)
Table VI. OLS Regressions of Dual-Class IPO Underpricing on Pre-IPO M&A
Activity (Continued)

IPO volume 0.248∗∗∗ 0.248∗∗∗ 0.258∗∗∗
(3.11) (3.11) (3.24)
Pr > F 0.6436 0.7074 0.5813
Adjusted R2 41.21% 41.19% 41.15%
Number of observations 6,416 6,416 6,416
∗∗∗
∗∗
indicator with the M&A activity measure and each of the control variables. For readability, we
suppress the coefficients on all of the interactions with the exception of the coefficient from the
interaction of the dual-class indicator with the M&A activity measure. If control considerations
explain the connection between pre-IPO M&A activity and IPO underpricing, then we expect the
sum of the coefficients on the M&A activity measure and the interaction of the M&A activity
measure and the dual-class indicator to be indistinguishable from zero. Otherwise, if the sum of
the coefficients is significantly different from zero, then a motivation other than control is neces-
sary to explain our empirical finding. The p-value from an F-test that the sum of the coefficients
is equal to zero is reported at the bottom of Table VI.
Table VI offers no evidence that dual-class IPO underpricing depends on the corporate control
climate prior to the offering. The p-value from the F-test indicates that the sum of the coefficients
on our M&A proxies are insignificant in all three models. This result does not appear to be an
artifact of differences in the time series distribution of dual-class IPOs and those in our main
sample. For instance, the mean levels of pre-IPO M&A activity for the dual-class sample are
virtually identical to those for our main sample. The average 3-, 6-, and 12-month pre-IPO M&A
activity measures for the dual-class sample are 7.5%, 14.5%, and 27.8%, respectively. The average
dual-class IPO takes place during a time when corporate control activity (and IPO activity) is, on
average, the same as it is for the typical IPO in our main sample.
Overall, the insights derived from the dual-class sample suggest that the empirical association
between corporate control activity and IPO underpricing observed for the average (i.e., single-
class) firm is indeed consistent with managers’ desire to maintain control of their firm subsequent
to the IPO. Given the extreme level of control afforded dual-class managers by their share structure,
they need not underprice at the margin to create a dispersed outside ownership structure to
discourage control challenges. Therefore, among duals, we do not observe the positive correlation
between the corporate control climate and underpricing that is evident for single-class firms.
E. What About Firms That Might Prefer to Sell to an Acquirer?

Although our results thus far are consistent with the idea that managers value control and under-
price more as a function of pre-IPO corporate control activity in order to protect the independence
of their enterprises, in this section, we consider the possibility that some entrepreneurs see the
IPO as a means of being acquired or the first step in the ultimate sale of the firm as Zingales
(1995), Mello and Parsons (1998), and Stoughton and Zechner (1998) suggest. Of course, it is
difficult to know ex ante which entrepreneurs desire to run their firms independently for a long
time and which ones hope to sell out. In an attempt to distinguish between these two types of
entrepreneurs, we sort firms into groups based on subjective, ex ante assessments of the likelihood
that IPO insiders intend to maintain control over their firms. The groups we consider are IPOs
backed by VCs compared to those that are not, firms in high-tech industries compared to all other
industries, young firms compared to old firms, and equity carveouts compared to all other IPOs.
The venture capital literature finds that when insiders receive venture backing, they immediately
give up some measure of control. VCs typically receive board seats, for example, and executive
turnover is higher in venture-backed firms (Gorman and Sahlman, 1989; Hellmann and Puri,
2002). For these reasons, we do not expect to find a positive relation between M&A activity and
underpricing among venture-backed firms.
It is common in high-tech industries, such as computer hardware and pharmaceuticals, for
startup firms to sell their technologies to established high-tech firms. Kohers and Kohers (2000)
find that premiums paid to high-tech targets exceed those paid to other firms and, in the first
half of 1999, acquisitions of firms in the communications and information technology industry
accounted for $1 out of every $3 spent by acquirers worldwide. They also report that acquirers
of high-tech targets experience positive abnormal merger announcement returns regardless of
the method of payment used in the acquisition. Here again, we do not expect to find a positive
correlation between M&A activity and underpricing for high-tech firms run by entrepreneurs
who are less inclined to protect their control through underpricing as compared to insiders from
other industries.
We rely on a revealed preference argument to justify our decision to group firms according
to age. If a firm has a long operating history as a private company prior to their IPO, then it is
more likely that insiders in that firm place a higher value on control when compared to insiders
of younger firms. Consistent with this conjecture, Smart and Zutter (2003) find that firm age is
positively associated with the choice to go public as a dual-class firm. Consequently, we expect
a positive relation between M&A activity and underpricing for old companies but not for young
companies.
Finally, Pagano et al. (1998) find that equity carveouts are driven by windows of opportunity
that allow pre-IPO shareholders to maximize the proceeds from selling their shares. If proceeds
maximization is of primary importance for equity carveouts, then it is less likely that insiders in
such firms place a high value on control as compared to nonequity carveouts. Thus, we do not
expect to find a positive correlation between M&A activity and underpricing for equity carveouts.
Table VII presents the results from regressions constructed to consider each of these sample
splits. In Model 1, we examine the impact of venture capital backing by interacting the venture-
backed indicator with the M&A activity measure and each of the control variables. In Model 2,
we consider the impact of operating in a high-tech industry. To capture the differential effects for
high-tech firms, we interact an indicator variable set to one for firms that operate in a high-tech
industry, as defined by Ljungqvist and Wilhelm (2003), with the M&A activity measure and each
of the control variables. In Model 3, we explore the role of firm age by interacting an indicator
variable set to one for young firms (less than 10 years old at the IPO) with the M&A activity
measure and each of the control variables. Lastly, in Model 4, we consider the impact of equity
carveouts by interacting the equity carveout indicator with the M&A activity measure and each of
the control variables. For readability, we suppress the coefficients on all of the interactions with
the exception of the coefficient from the interaction of the sample split indicator (i.e., venture
capital backed, high-tech, young, and equity carveout) with the M&A activity measure. The p-
value from an F-test that the sum of the M&A activity and M&A activity interaction coefficients
is equal to zero is reported at the bottom of Table VII.
Table VII. OLS Regressions of IPO Underpricing on Pre-IPO M&A Activity
for Subsamples
This table presents OLS regressions of IPO underpricing on pre-IPO M&A activity for subsamples. Sub-
samples include venture- and non-venture-backed firms, high-tech and non-high-tech firms, young and old
firms, and equity carveouts and nonequity carveouts. Dummy variables are set equal to one for VC-backed,
high-tech, young firms, and equity carveouts, and zero otherwise. High tech firms are classified according
to Ljungqvist and Wilhelm (2003). Young firms are less than 10 years old at the time of the IPO and old firms
are 10 years old or older at the IPO. The dependent variable is the IPO initial return, which is the first-day
secondary market closing price divided by the final offer price minus one. Pre-IPO M&A activity measures
are calculated by dividing the total number of M&A transactions listed in SDC for a given Fama and French
(1997) industry for the three months prior to the IPO month by the total number of Compustat-listed firms
for the industry. Offer size is the CPI-adjusted offer value in millions of year 2001 dollars. Share overhang is
the number of pre-IPO shares retained divided by the shares issued in the offering. Offer price revision is the
final offer price divided by the midpoint of the initial offer price range minus one. Underwriter reputation
is the updated Carter and Manaster (1990) ranking as provided by Jay Ritter. Dummy variables are equal to
one for reverse LBO and NASDAQ-listed deals and zero otherwise. Recent market return is a buy-and-hold
return for the 22-trading days prior the IPO date. Investor sentiment is the Michigan Consumer Sentiment
Index reading from the month prior to the IPO issue date (divided by 100). Rate spread is the commercial
and industrial loans rate minus the fed funds rate (multiplied by 100). IPO volume is the ratio of IPOs issued
year for a given industry. All regressions include unreported Fama and French (1997) industry dummies
and controls for issue year. We report the p-value from an F-test that the sum of the coefficients on M&A
activity and the M&A interaction term is equal to zero. The t-statistics are presented in parentheses.

Model 1 Model 2 Model 3 Model 4
∗ ∗
Intercept −0.302 −0.268 −0.348 −0.334∗
(−1.69) (−1.54) (−1.83)
M&A activity 0.273∗ 0.240∗∗ 0.445∗∗∗
(1.91) (2.31) (3.38)
M&A activity × VC backed 0.013 0.452∗∗
(0.05) (1.96)
M&A activity × High tech −1.254∗∗∗
(−4.11)
M&A activity × Young −0.134
(−0.48)
M&A activity × Equity carveout −0.364
(−0.60)
Log of offer size −0.010 −0.016∗∗ −0.006 −0.026∗∗∗
(−1.45) (−2.42) (−0.68) (−4.12)
Share overhang 0.012∗∗∗ 0.015∗∗∗ 0.018∗∗∗ 0.027∗∗∗
(5.31) (6.54) (4.62) (13.05)
Offer price revision 0.429∗∗∗ 0.555∗∗∗ 0.462∗∗∗ 0.819∗∗∗
(14.21) (20.71) (11.92) (37.25)
Underwriter reputation 0.003 0.003 0.001 0.006∗∗
(1.06) (0.95) (0.28) (2.39)
Venture capital backed 0.027∗∗ 0.041∗∗ 0.028∗∗∗
(2.49) (2.41) (2.67)
Equity carveout −0.032∗ −0.029∗ −0.026
(−1.89) (−1.73) (−1.11)
(Continued)
Table VII. OLS Regressions of IPO Underpricing on Pre-IPO M&A Activity
for Subsamples (Continued)

Model 1 Model 2 Model 3 Model 4
Reverse LBO −0.024 −0.013 −0.012 −0.011
(−0.92) (−0.58) (−0.43) (−0.45)
NASDAQ listed 0.035∗∗∗ 0.022∗ 0.025 0.014
(2.64) (1.84) (1.43) (1.09)
Recent market return 0.753∗∗∗ 0.498∗∗∗ 0.661∗∗∗ 0.617∗∗∗
(4.99) (3.56) (3.33) (4.97)
Investor sentiment −0.002 0.022 0.017 0.050
(−0.02) (0.19) (0.11) (0.44)
Rate spread 0.193∗∗ 0.192∗∗ 0.190∗∗ 0.206∗∗∗
(2.50) (2.56) (2.06) (2.76)
IPO volume 0.107 0.128∗ 0.191 0.225∗∗∗
(1.09) (1.72) (1.39) (2.62)
Pr > F 0.2372 0.0004 0.0422 0.8929
Adjusted R2 46.55% 44.61% 43.65% 41.68%
Number of observations 6,037 6,037 5,859 6,037
∗∗∗
∗∗
∗
While pre-IPO corporate control activity and underpricing are positively associated for non-
venture-backed firms, the F-test for Model 1 indicates that no significant relation exists between
M&A activity and underpricing for venture-backed IPOs. This is consistent with the view that
venture-backed firms may be more amicable to post-IPO acquisitions. Consistent with our typing
of high-tech firms as those more likely to seek an acquisition following the IPO, we fail to find
a positive link between M&A activity and underpricing for the subsample of high-tech firms. In
fact, the F-test indicates that there is a significant negative correlation between M&A activity and
underpricing for high-tech firms. Alternatively, for firms in non-high-tech industries, a strong
positive association exists for M&A activity and underpricing. Surprisingly, we find a positive
connection between corporate control transactions and underpricing for both young and old
firms. A positive connection for the subsample of young firms indicates that even firms less than
10 years old at the time of their IPO underprice more in response to greater corporate control
activity. In unreported tests, however, we find no evidence of a relation between M&A activity
and underpricing for firms that go public within five years of their founding date. The difference
in outcomes, depending on the cutoff used for classifying firms as young, is supportive of our
revealed preference argument that firm age at the time of the IPO is reflective of managers’ desire
to retain control. Lastly, consistent with Pagano et al. (1998) who suggest that equity carveouts
are driven by windows of opportunity, we fail to find a positive link between M&A activity and
underpricing for the subsample of equity carveouts. In summary, we view the results presented in
Table VII as supportive of the idea that certain types of firms might prefer to sell to an acquirer
following the IPO and, therefore, lack the motivation to underprice additionally in response to
pre-IPO M&A activity.
It is worth noting that Table VII provides some additional confidence that the association
between M&A activity and underpricing is not due to an omitted hot markets or IPO activity
variable. If such a problem existed, we would not expect the relation between pre-IPO M&A
activity and IPO underpricing to disappear for venture-backed firms, firms less than five years
old, and equity carveouts, or change signs for high-tech firms unless one is willing to argue that
the timing of these types of IPO firms systematically varies with the omitted variable.
IV. Conclusions
Firms taken public in active corporate control markets are much more likely to be acquired
in subsequent years. While controlling for factors identified in the literature as associated with
initial returns, we find that IPO underpricing is positively related to the level of activity in the
market for corporate control prior to the IPO. The results hold for various measures of corporate
control and are both economically and statistically significant. In addition to showing a relation
between corporate control activity and underpricing, we demonstrate that greater underpricing
is associated with smaller institutional blockholdings, confirming that underpricing is related to
the ownership structure of the firm in the years following the IPO. We also demonstrate that a
firm is less likely to be acquired in the years following the IPO when institutional holdings are
smaller. These results support our assertion that a control motivation can explain the empirical
correlation between pre-IPO M&A activity and IPO underpricing.
Finally, when managers reveal their strong preference for control by adopting a dual-class
structure, we see no sensitivity of underpricing to corporate control activity. Nor do we observe
a positive link between M&A activity and underpricing for firms that are subjectively viewed as
likely wanting to be acquired, such as venture-backed firms, high-tech firms, firms younger than
five years old, or equity carveouts.
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Acquisition Activity and IPO

II. Sample Selection and Descriptive Statistics

III. Empirical Results

A. Correlation between Corporate Control Activity and Underpricing

Cumulative Percent of IPOs 1 Year 2 Years 3 Years 4 Years 5 Years

Pre-IPO M&A Activity

B. Underpricing and Dispersed Ownership

ownership ÷ (1 − ownership), (1)

Post-IPO Largest Institutional Post-IPO Aggregate Institutional

C. Corporate Control Climate and Future Takeover Probability

D. Correlation between Corporate Control Activity and Dual-Class Underpricing

Pre-IPO M&A Activity

Pre-IPO M&A Activity

E. What About Firms That Might Prefer to Sell to an Acquirer?

Pre-IPO M&A Activity

Pre-IPO M&A Activity

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