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(1986) winner’s curse.
Rock’s
(1986)
studies
have explained
that investors
are divided
into two
groups, informed investors and uninformed investors. As a general rule of
thumb however,
investors
are typically
uninformed.
These uninformed
investors
have
limited
access
to
information
about
the
company’s prospects,
than
the
issuer
and
its
underwriter.
Despite
this
wide
gap
in information
differences,
some
investors
are willing
to
participate
in
an
IPO
when
the
offer
price
is
low.
Informed
investors
on
the
other
hand,
are
only
willing
to
participate
in
an
IPO
when
they
know
the
chances
are
good
that
the
company
will
perform
well
and
generate
positive
returns
in the
long
run,
while
the
uninformed
investors
will
mostly
be
participating
in
shares
that
have
been
left
by
the
informed
investors.
This
imposes
a
‘winner’s
Curse’
on
the
uninformed
investors.
In an
attractive
offering,
the
informed
investors
will
increase
their
demand
for
the
shares,
and
in
an
unattractive offering
uninformed
investors
will receive all the shares that they have bid.
Issuers
will always
have
better
information
about
the
company’s
financial
condition
than
outside
investor.
When
a
company
wants
to
go
public,
issuers
will
signal
the
true
value
of
the
shares
by
discounting
the
prices
of
the
issues,
and
keeps a fraction
of
the
share
for
their
own
portfolio
(Grinblatt
&
Hwang,
1989). Within the signal models, when a
fraction of shares being kept by
insiders,
it
will
signal
the
true
value
of
the
company.
This
model
will
convey
insider’s
private
information
about
the
company
to
the
outside
investors.
Since
in
signaling theory, the
issuer discounted the
issue shares, therefore,
in
the
initial
market
trading
day,
which
will
results
in
initial
return,
will
provide
a
signal of the true quality of the IPO.
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