Disclosure Choice and Cost of Capital: Evidence from Underpricing in Initial Public Offerings

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Abstract
Underpricing in IPOs is a significant cost of raising capital that theories purport arises from adverse selection at the IPO date. Disclosure is a tool firms can use to ameliorate adverse selection. We show that greater disclosure frequency in the pre-IPO period is associated with lower underpricing. The negative relation is significant only for informative disclosures, not for disclosures such as public relations announcements. The negative relation is significant after controlling for factors that affect ex ante uncertainty about the offering and for alternative mechanisms that firms can use to signal firm quality. The results are opposite for internet firms. They demonstrate a significant positive association between disclosure frequency and underpricing, consistent with claims that internet firms use underpricing to generate attention. Disclosure frequency also is associated with greater market liquidity subsequent to the IPO as measured by more traditional proxies: bid-ask spread and market depth.