Does financial literacy play a role in IPO underpricing?
New research shows that greater financial literacy, or investment smarts, reduces the likelihood of Initial Public Offerings (IPOs) being underpriced when they are first offered to institutional and retail investors.
The findings are contained in an article published recently in the Journal of Financial and Quantitative Analysis. The article was co-authored by Kiridaran (Giri) Kanagaretnam, Professor of Accounting and Ron Binns Chair in Financial Reporting, Banking and Governance at Schulich, together with Gerald Lobo, the Arthur Andersen Chair of Accounting at the University of Houston’s C.T. Bauer College of Business; Lim Chee Yeow, an Associate Professor at the School of Accountancy, Singapore Management University; and Jason Jia, an Assistant Professor at Wilfrid Laurier University and a Schulich PhD graduate.
The researchers examined the relationship between financial literacy and IPO underpricing for a large sample of 14,831 IPOs from 34 countries over the 1998 to 2020 period. They used two measures of financial literacy that captured individuals’ basic financial knowledge, including the ability to invest in stocks, bonds, and mutual funds.
“Financial literacy is important for the efficient functioning of financial markets,” says Kanagaretnam. “Financially literate individuals possess fairly advanced financial knowledge and are therefore better able to seek out higher-level financial news and analyst reports, which may disclose additional information.”
The research study is one of the first to document the relationship between citizens’ financial literacy and IPO underpricing and provides evidence that highlights the role of financial literacy in mitigating capital market inefficiencies.