Underpricing and IPO Proceeds: A Note

Every equilibrium model of IPO underpricing predicts a positive relationship between ex ante uncertainty about firm value and the extent to which entrepreneurs will issue shares at a discount to their subsequent market value. Since ex ante uncertainty is unobservable, the empirical literature has used a number of proxies for such uncertainty. The purpose of this note is to show that a popular proxy, the inverse of gross flotation proceeds, may be inappropriate for the purpose of testing the positive relation predicted by theory. We prove that an inverse relation between underpricing and IPO proceeds holds true because of dilution, even as uncertainty remains unchanged.