Voluntary Disclosure with Informed Trading in the IPO Market

• DOI: http://doi.org/10.1111/1475-679X.12133
• Date: 01 December 2016
• Published date: 01 December 2016

DOI: 10.1111/1475-679X.12133

Journal of Accounting Research

Vol. 54 No. 5 December 2016

Printed in U.S.A.

Voluntary Disclosure with Informed

Trading in the IPO Market

PRAVEEN KUMAR,

∗NISAN LANGBERG,

†

AND K. SIVARAMAKRISHNAN

‡

Received 30 July 2014; accepted 31 May 2016

ABSTRACT

We examine voluntary disclosure and capital investment by an informed

manager in an initial public offering (IPO) in the presence of informed

and uninformed investors. We find that in equilibrium, disclosure is more

forthcoming—and investment efficiency is lower—when a greater fraction of

the investment community is already informed. Moreover, managers disclose

more information when the likelihood of an information event is higher,

more equity is issued, or the cost of information acquisition is lower. Invest-

ment efficiency and the expected level of underpricing are non-monotonic

in the likelihood that the manager is privately informed.

∗University of Houston; †C.T. Bauer College of Business at the University of Houston and

Coller School of Management at Tel AvivUniversity; ‡Rice University.

Accepted by Haresh Sapra. We thank an anonymous referee for very helpful

comments. We also thank Yakov Amihud, Karthik Balakrishnan, Jeremy Bertomeu,

Maria Correia, Eti Einhorn, Andrew Ellul, Michael Fishman, Tom George, Naftali

Langberg, Dor Lee-Lo, Hai Lu, Partha Mohanram, Ram Natarajan, Suresh Radhakrishnan,

Gordon Richardson, Tjomme Rusticus, Ronnie Sadka, Lakshmanan Shivakumar, Ahmed

Tahoun, Irem Tuna, Florin Vasvari, Tsahi Versano, Dan Weiss, and seminar participants at

the EAA 2013, London Business School, IDC, The University of Texas at Dallas, University of

Toronto, Baruch College, and the University of Houston for helpful comments and discus-

sions. Nisan Langberg is grateful for financial support from the Dan Suesskind Award for Best

Research Proposal, Henry Crown Institute of Business Research in Israel, and the Raymond

Ackerman Family Chair in Israeli Corporate Governance.

1365

Copyright C, University of Chicago on behalf of the Accounting Research Center,2016

1366 P.KUMAR,N.LANGBERG,AND K.SIVARAMAKRISHNAN

JEL codes: G14; G23; G32

Keywords: IPO markets; real investment; underpricing; private informa-

tion; informed trading

1. Introduction

Corporate insiders have a natural information advantage with respect

to their firms’ economic prospects but financial markets also provide

incentives for outside investors to generate and potentially profit from

value-relevant information. Indeed, aggregation of dispersed information

in security prices and its attendant effects on real investment are topics

of long-standing interest in the accounting and finance literatures. Theory

suggests that informed managers sometimes secure higher valuations from

direct disclosures to markets, but the presence of informed investors can

potentially affect such benefits significantly. This issue is of substantial in-

terest because there is considerable evidence of informed trading ahead of

several corporate disclosure events—such as announcements of earnings

forecasts, mergers and acquisitions, and initial public offerings (IPOs).

Prima facie, informed investors can affect incentives for disclosure in

conflicting ways. On one hand, if a manager’s private information is al-

ready present in financial markets (through a relatively high intensity of

informed traders), then disclosure will have low impact on security prices,

other things being equal—thereby reducing the manager’s incentive to dis-

close. On the other hand, it is well known that the presence of informed

traders raises adverse selection risk for uninformed traders, which can lead

to higher risk premium and lower security prices—thereby increasing the

incentive to disclose.1The resolution of these contending effects and the

consequent implications for equilibrium disclosure levels of firms have not

been addressed in the existing disclosure literature.

In this paper, we analyze managers’ disclosure strategies in the presence

of both informed and uninformed market participants. We focus on IPOs as

the setting for our study because IPO firms have considerable discretion

over what to disclose ahead of the IPO.2They also have a natural incen-

tive to limit underpricing through such disclosures (see, e.g., Ljungqvist

[2007]).3The literature shows that underpricing can arise because of

1See, for example, Garleanu and Pederson [2004] or even Akerlof [1970] and Milgrom

and Stokey [1982] on market failure.

2Beyond their importance as a financing milestone, IPOs are major disclosure events. Dur-

ing the IPO, firms often go beyond mandated disclosure requirements to provide detailed

information about their operations, financial performance, business plans, competitors, risks

and so forth (e.g., Ellis, Michaely, and O’Hara [1999]) in IPO prospectuses and/or during

“book building”—a process that involves meetings with potential investors to generate de-

mand for their IPOs.

3In particular, evidence suggests that such disclosures reduce information asymmetry and

lead to more accurate pricing. See, for example, Hanley and Hoberg [2010], Benveniste and