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The IPO filing volume is positively related to changes in market volatility, especially
when market returns are at normal levels. This is consistent with the view that filing
with the Security Exchange gives would-be issuers an option on market valuations.
Creating this option is attractive not only when market valuations rise but also when
volatility increases, and the effect of volatility is more pronounced when market
returns are neither high nor low. We therefore identify a distinct type of window of
opportunity for firms attempting to go public, characterized not particularly by
strong stock valuations but by increased volatility in valuations.
As such, the decision to attempt an IPO is a decision to create a call option on the
uncertain public price of the shares. The attractiveness of creating such an option at a
point in time depends on the issuers assessment at the time of potential public
1) how high relative to its private value (i.e., the moneyness) and
2) how variable.
These findings are robust to the proxy for market volatility, including whether implied
from option prices or based on historical returns, and to the definition of normal
market returns. The results also hold in the sub-samples before the tech boom of the
1990s and during the rise and fall of internet stocks, as well as in a sample period
that ends before the financial crisis of 2008.
At the time the firm considers going public, the firm does not know exactly how
investors are going to value its shares. The firm discovers the public price only after it
files with the Security exchange and engages an investment banker who solicits and
aggregates investor valuations. If the discovered public price exceeds the reservation
price, referred to henceforth as the private price, the firm completes its offering and
becomes public. If the public price falls short of the private price, the firm withdraws
its offering and stays private.
Algebraically, the outcome to a firm that files with the Security exchange and goes
through price discovery is
max(private price, public price),
private price + max(public price private price, 0)
Hence, a firm that files with the Security exchange to attempt a public offering
acquires a call option on the uncertain public price, with an exercise price equal to
the owners private value. Creating this option entails some costs, including filing,
accounting, auditing, and legal fees, and the indirect cost of management time. A
necessary condition for a firm to file with the Security exchange and attempt a public
offering is, therefore, that the value of the created option exceeds the total of these
costs, which for convenience we refer to as the filing cost:
Expected [max(public price private price, 0)] > filing cost
Without the need for further notation or mathematics, it can be stated that the higher
the value of this option (i.e., the LHS of the inequality), the more likely the firm will
attempt a public offering.
Our main sample includes the monthly series of IPO filing volume from January 1984
until September 2004 :
These results indicate that increases in market volatility are associated with higher IPO filing
volume when the current market return is medium or high. Yet it is plausible that irrespective of
the lag time, issuers would still adapt their decision to changing market conditions up until the
last minute .
A firm attempting to go public and filing with the Security Exchange creates an option on the
uncertain offer price. This option is exercised, and the firm goes public, if book building yields
an acceptable offer price. The value of this option increases with expected valuations
(moneyness) during strong stock markets, inducing many firms to attempt public offerings. This is
consistent with existing evidence on the timing of IPOs. But the option gains value also when
uncertainty surrounding market valuations increases, especially when the market is at normal
levels. This paper investigates whether the filing activity is indeed influenced as hypothesized
by changes in market valuation uncertainty.
Analyzing the IPO filing activity between 1984 and 2011, we find that an increase
in stock market volatility is associated with a statistically significant increase in
market-wide/ industry-level filing volume. This association is especially pronounced in
periods when market/industry stock returns are at normal levels, i.e. neither too high
nor too low