International Review of Economics and Finance 20 (2011) 367–375

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International Review of Economics and Finance

j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / i r e f

IPO underpricing: A social comparison perspective

Chih-Hsiang Chang ⁎
Department of Finance, College of Management, National University of Kaohsiung, Kaohsiung, Taiwan, ROC

a r t i c l e i n f o a b s t r a c t

Available online 25 November 2010 This paper studies a social comparison perspective on IPO underpricing. The social comparison
theory in behavioral psychology suggests that when people do not know how to make a
JEL classification: decision or are exposed to new information, they refer to the behavioral norm of the public or
G11 the behavior of others to frame their decisions. I argue that when IPO firms and underwriters
G14 are uncertain about an IPO firm's intrinsic values, they refer to similar IPO issuing firms in the
G24 same industry that went public earlier to determine the IPO offer price. Using a sample of
Taiwan IPOs, I find evidence that supports the social comparison explanation of IPO
Keywords:
underpricing.
IPO underpricing
Behavioral finance
© 2010 Elsevier Inc. All rights reserved.
Social comparison

1. Introduction

It is well known that initial public offerings (IPOs) are underpriced. McDonald and Fisher (1972), Ibbotson (1975), Ritter
(1984), Koh and Walter (1989), Kim, Krinsky, and Lee (1995), Mohan and Chen (2001), Loughran and Ritter (2004), Kerins,
Kutsuna, and Smith (2007), Krishnamurti and Thong (2008), Chambers and Dimson (2009), among others, consistently document
that, on average, the offer price of IPO shares are substantially lower than the closing price on the first day of trading. The first-day
abnormal returns of IPO shares, on average, are statistically and economically significant. Ljungqvist (2007) calculates that in the
US, the average for IPO underpricing has been approximately 19% since the 1960s.
There are two strands of literature that explain the IPO underpricing puzzle. The first strand focuses on the concepts of rational decision
making from traditional finance perspectives. Among the voluminous studies in this area, many lean toward information asymmetry in
capital markets as the underlying reason for underpricing. Rock (1986) proposes a winner's curse model based on information
asymmetry. Rock (1986) assumes that investors are informationally heterogeneous; that is, some investors (better-informed) know more
than others (ordinary investors) about the quality of IPO firms. Hence, better-informed investors only bid on the attractive IPO offerings
and leave the overpriced IPOs to ordinary investors. Therefore, to entice the continued participation of ordinary investors, IPO firms use
IPO underpricing to compensate for losses by ordinary investors due to the winner's curse. Many studies offer evidence to support the
information asymmetry explanation of IPO underpricing. For instance, Lam and Yap (1998) point out that the first-day price behavior of
the Singaporean-tendered IPOs is consistent with the information asymmetry explanation. Schenone (2004) documents that IPO firms
with a pre-IPO banking relation with a prospective underwriter have, on average, approximately 17% less IPO underpricing. An and Chan
(2008) study a sample of IPO firms with and without credit ratings and find that IPO firms with credit ratings one year before their IPO
have, on average, 22% less underpricing than those without pre-IPO credit ratings. Hence, a prior banking relation or credit worthiness
information helps alleviate information asymmetry in the IPO market place and reduces the magnitude of IPO underpricing.
The second strand of literature relies on behavioral finance concepts to explain IPO underpricing. Thaler (1985) suggests that
individuals cannot evaluate all outcomes as a whole so they make decisions through several reference points, which he refers to as
mental accounts. Individuals respond differently to different mental accounts. In the IPO pricing decision process, for example,

⁎ Department of Finance, National University of Kaohsiung, No. 700, Kaohsiung University Road, Nanzih District, Kaohsiung 811, Taiwan, ROC. Tel.: +886 7
5919505; fax: +886 7 5919329.
E-mail address: cch@nuk.edu.tw.

1059-0560/$ – see front matter © 2010 Elsevier Inc. All rights reserved.
doi:10.1016/j.iref.2010.11.017
368 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375

pre-issue shareholders realize that a lower IPO offer price can harm their interest in the issuing firm and result in discontent.
However, they understand that after going public, the IPO price will surge and the resulting satisfaction will reduce the discontent
caused by the underpricing of the IPO. Accordingly, Thaler (1985) suggests that if there are big gains and minor losses, then
decision making should be integrated to ensure a big gain and a minor loss. In such a case, discontent of loss is rendered and its
utility maximized. Thus, IPO underpricing is the result of the mental accounting process of pre-issue shareholders. Combining the
prospect theory with the mental accounting theory of Thaler (1985), Loughran and Ritter (2002) argue that an IPO issuing firm
fails to get upset about leaving money on the table in the form of large first-day returns because they tend to sum the small wealth
loss due to IPO underpricing with the large wealth gain on retained shares as prices soar after going public. Loughran and Ritter
(2002) and Ljungqvist and Wilhelm (2005) offer evidence to support the behavioral finance explanation of IPO underpricing.
Besides behavioral finance, behaviorism in psychology also explores other decision-making processes of individuals in
uncertain situations. The social comparison theory in behavioral psychology suggests that when people do not know how to make
a decision or are exposed to new information, they refer to the behavioral norm of the public or the behavior of others to frame
their decisions. The social comparison theory was originally developed by Festinger (1954) to explain how individuals evaluate
their attitudes toward an issue. The theory proposes that individuals prefer to evaluate self and self characteristics based on
objective standards. When the standards are not available, they compare themselves with society or others around them and look
for alternative comparison standards.
The social comparison theory has been applied to finance in the past. Fox and Dayan (2004), for instance, apply the social
comparison theory to illustrate that when investing, investors are not only influenced by their past successes or failures, but they
also compare their experiences with others when it comes to decision making. I argue that the degree of information asymmetry
between issuing firms and investors is high. Pre-issue shareholders and underwriters likely have some, but incomplete, knowledge
regarding the intrinsic value of their IPO firm. Thus, they compare their IPO firms with their ‘peers’ in the same industry that went
public earlier. Similarly, investors likely have little knowledge about the intrinsic value of the IPO firm. Therefore, when investors
make IPO subscription decisions, they compare their IPO prospect with other recent IPOs in the same industry. Thus, it is possible
to apply the social comparison theory to explain IPO underpricing. Specifically, I use the social comparison theory to explain how
issuing firms (or underwriters) determine the IPO offer prices and to discuss how investors respond to information regarding an
IPO offer price. This study represents a first attempt to relate the social comparison theory to IPO research.
Using a sample of Taiwan IPOs, I show that the social comparison theory explains IPO underpricing. Specifically, the results
suggest that the price earnings (PE), price-book (PB), market capitalization to total assets (MA), market capitalization to operating
income (MO) ratios, and first-day abnormal returns of the IPO firm are positively correlated to the same variables in other IPO
firms in the same industry that went public earlier. IPO firms heavily rely on their ‘peers’ in the IPO decision-making process when
setting their offer price, which contributes to IPO underpricing. In addition, when explaining the first-day IPO abnormal returns
with information asymmetry, mental accounting, and social comparison variables, the social comparison variables continue to be
significant determinants of first-day IPO abnormal returns. The evidence suggests that the social comparison theory is a viable
alternative to explain IPO underpricing.
The paper is organized as follows. Section 2 briefly discusses the IPO market in Taiwan and shows IPO underpricing in Taiwan.
Section 3 discusses the social comparison theory explanation of IPO underpricing, and Section 4 concludes the paper.

2. IPOs in Taiwan

2.1. Overview of Taiwan's IPO market

The IPO data are from the Taiwan Economic Journal database, specifically the first 11 IPOs listed on the Taiwan Stock Exchange
Corporation (TSEC) on February 9, 1962. A sample of these IPO firms includes Taiwan Cement, Wei Chuan Corporation, Chang Hwa
Bank, among others. Since 1990, the industrial structure of Taiwan has transformed into an information technology-focused
structure and the number of IPOs in Taiwan has steadily increased. Table 1 indicates that there are 1558 IPOs in Taiwan for the full
sample (1962 to 2009) with an average 10.59% IPO mean returns on the first day.
A closer look at Table 1 suggests that the number of IPOs soars in the late 1990s to early 2000s, while the mean first-day IPO
returns during the same period are low. This is inconsistent with Guo, Brooks, and Shami (2010), which indicates that the features
of a hot IPO market include a large volume of new offerings and high underpricing. The reason of the low mean returns in the late
1990s to early 2000s may attribute to the Asian financial crisis in 1997 and the burst of the Internet bubble. Chambers and Dimson
(2009) show that the capitalization weighted mean first-day returns of British IPOs during the Internet bubble burst (2001–2003)
and a hot IPO market (2004–2007) are lower than those over the entire period (1917–2007). In addition, the mean first-day IPO
returns in Table 1 are unusually high in recent years. The mean returns are approximately 53%, 62%, 30%, and 87% in 2006, 2007,
2008, and 2009, respectively. I speculate that the reason for the unusually high IPO returns is that IPOs have been exempt from the
7% daily price limit regulation in the first five trading days after going public since March 1, 2005.1 The TSEC contends that
removing the restriction of the 7% price limit on IPOs helps improve the market trading mechanism and market efficiency in IPO
markets.

1
Before October 11, 1989, the price limits in the Taiwan Stock Exchange were 5% of the closing price on the preceding trading day.
 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375 369

Table 1
First-day returns and the number of IPOs in Taiwan. This table presents the number of IPOs in Taiwan and the average first-day IPO returns. IPO data is from the
Taiwan Economic Journal database. The first-day returns on IPOs = (the closing price on the first day an IPO goes public − the offer price of IPOs) / the offer price of
IPOs.

Year Number Number of IPOs with Average first-day The standard deviation of
of IPOs offer price information returns on IPOs first-day returns on IPOs

1962 13 5 0.0499 0.0001

1963 6 3 0.0500 0.0001
1964 5 0 – –
1965 5 1 0.0500 –
1966 2 1 0.0499 –
1967 2 0 – –
1968 2 1 0.0496 –
1969 2 0 – –
1970 0 0 – –
1971 3 1 0.0500 –
1972 4 0 – –
1973 9 2 0.0498 0.0003
1974 2 1 0.0498 –
1975 4 3 0.0500 0.0002
1976 7 4 0.0500 0.0003
1977 5 2 0.0497 0.0001
1978 6 3 0.0297 0.0521
1979 8 4 0.0498 0.0002
1980 5 1 0.0499 –
1981 6 4 0.0498 0.0002
1982 7 7 0.0437 0.0158
1983 4 0 – –
1984 3 2 0.0500 0.0001
1985 5 4 0.0304 0.0382
1986 6 1 0.0497 –
1987 12 10 0.0466 0.0180
1988 23 20 0.0397 0.0140
1989 19 18 0.0578 0.0139
1990 22 20 0.0522 0.0345
1991 29 27 0.0631 0.0105
1992 37 35 0.0598 0.0249
1993 28 24 0.0581 0.0295
1994 33 31 0.0647 0.0117
1995 67 67 0.0371 0.0451
1996 74 74 0.0482 0.0430
1997 62 57 0.0568 0.0307
1998 97 92 0.0389 0.0491
1999 117 114 0.0261 0.0534
2000 115 106 0.0249 0.0566
2001 116 112 0.0313 0.0548
2002 147 143 0.0389 0.0518
2003 106 105 0.0106 0.0582
2004 98 97 0.0236 0.0577
2005 63 61 0.1163 0.3174
2006 45 45 0.5335 0.5445
2007 52 52 0.6181 1.1633
2008 36 36 0.3035 0.2837
2009 39 39 0.8705 0.7808
Total/average 1558 1435 0.1059 0.3432

2.2. IPO underpricing in Taiwan

Following McDonald and Fisher (1972) and Ritter (1991), I use the event study method to examine short-term price
performance of IPOs after going public. The industry index is used to mitigate the differences in operating risk among IPO issuing
firms. Similar to previous studies, the abnormal return (AR) of stock i on day t is equal to the return of stock i on day t minus the
return of the industry index of stock i on day t. The equation is as follows:

ARi;t =Ri;t −RI;t ; t =1; 2; 3; …; 21; ð1Þ

where Ri,t is the return of stock i on day t; RI,t is the return on the TSEC industry sector index that stock i belongs to for day t; and
ARi,t refers to the AR of stock i on day t. After acquiring the AR of stock i on day t, I calculate the average abnormal return (AAR) on
370 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375

day t for all samples after going public and use the t-test of McDonald and Fisher (1972) to examine if AAR on day t is significantly
different from zero. The equations are shown as follows:

H0 : AARt = 0;

H1 : AARt ≠0;

pffiffiffiffi
AARt N
t= ; where the degree of freedom of t−distribution is N−1; and ð2Þ
St

1 N
AARt = ∑ ARi;t ; t =1; 2; 3; …; 21; ð3Þ
N i=1

Table 2
The stock price performance of IPOs after going public. This table presents the average abnormal return (AAR) and cumulative average abnormal return (CAAR) of
IPOs. I follow McDonald and Fisher (1972) and Ritter (1991) and use an event study method to examine short-term price performance of IPOs after going public. I
use the industry index in Taiwan to mitigate the differences in operating risk among IPO issuing firms. Panel A presents the full sample and Panel B presents the
sub-sample. t(AAR) and t(CAAR) are, respectively, the t-statistic for AAR and CAAR. *, **, and *** refer to significance at the 10%, 5%, and 1% levels, respectively.

Day AAR CAAR t (AAR) t (CAAR)

Panel A: full sample (N = 1291)

1 0.0908*** 0.0908*** 13.3017 46.6593
2 0.0242*** 0.1150*** 15.2533 43.9263
3 0.0165*** 0.1315*** 11.2573 40.8533
4 0.0145*** 0.1460*** 10.7561 39.1897
5 0.0135*** 0.1595*** 10.3096 38.2413
6 0.0115*** 0.1710*** 8.5984 37.3928
7 0.0104*** 0.1814*** 8.9722 36.7099
8 0.0072*** 0.1886*** 6.3837 35.6941
9 0.0037*** 0.1923*** 3.4508 34.2961
10 0.0036*** 0.1959*** 3.5208 33.1433
11 0.0023** 0.1983*** 2.3647 31.9721
12 0.0036*** 0.2019*** 3.7335 31.1608
13 0.0027*** 0.2045*** 2.8771 30.3300
14 0.0026*** 0.2072*** 2.8660 29.6011
15 0.0009 0.2081*** 1.0472 28.7202
16 0.0013 0.2094*** 1.4863 27.9809
17 0.0012 0.2106*** 1.3728 27.3003
18 −0.0003 0.2103*** −0.3268 26.4927
19 0.0006 0.2110*** 0.7724 25.8631
20 0.0006 0.2116*** 0.6991 25.2762
21 0.0005 0.2120*** 0.5470 24.7183

Panel B: sub-sample (after March 1, 2005; 208 IPOs)

1 0.3878*** 0.3878*** 11.1055 47.8672
2 0.0029 0.3907*** 0.5974 34.0556
3 −0.0048 0.3859*** −1.2665 27.4502
4 0.0016 0.3875*** 0.5231 23.8663
5 0.0032 0.3907*** 0.9246 21.5178
6 0.0044 0.3951*** 0.9839 19.8627
7 0.0023 0.3973*** 0.8326 18.4933
8 −0.0005 0.3968*** −0.2045 17.2756
9 −0.0029 0.3939*** −1.1452 16.1664
10 0.0036 0.3975*** 1.4333 15.4781
11 −0.0045* 0.3931*** −1.9497 14.5914
12 0.0055** 0.3985*** 2.2635 14.1637
13 0.0031 0.4017*** 1.3549 13.7153
14 0.0005 0.4022*** 0.2404 13.2329
15 0.0036 0.4057*** 1.6025 12.8980
16 0.0008 0.4065*** 0.3605 12.5126
17 0.0004 0.4069*** 0.1671 12.1498
18 −0.0012 0.4057*** −0.5813 11.7738
19 0.0008 0.4065*** 0.3777 11.4813
20 −0.0003 0.4062*** −0.1410 11.1821
21 −0.0011 0.4051*** −0.5479 10.8826
 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375 371

where AARt is the AAR on day t for all IPOs, N is the number of samples, and

1 N  2
2
St = ∑ ARi;t −AARt :
N−1 i = 1

In addition to the examination of whether AAR on day t is significantly different from zero, I also calculate the cumulative
average abnormal return (CAAR) of IPOs from day 1 to day t and use the t-test proposed by Ritter (1991) to examine whether CAAR
is significantly different from zero. The equations are shown as follows:

H0 : CAAR1;t = 0;
H1 : CAAR1;t ≠0;

Table 3
The social comparison explanation of IPO underpricing. I present the results of the social comparison explanation of IPO underpricing in Panels A through D. Based
on the social comparison theory, when individuals do not understand a situation well, their decision-making process often refers to the general behavior of the
public. If the social comparison phenomena impact the determination of the offer price of the IPO issuing firms and underwriters, there should be a significant
positive correlation between the price earnings (PE) ratio (or other indicators of price rationality) of the new IPO and other IPOs in the same industry that went
public earlier. Besides the PE ratio, I also use price-book (PB), market capitalization to total assets (MA), and market capitalization to operating income (MO) ratios
to robustly check the price rationality. Specifically, the PE, PB, MA, and MO ratios of Company i in the previous quarter before going public (offer price of Company i
is used in the ratios) and those of Companies j, k, and l that went public earlier than Company i in the same industry for a regression analysis to examine the
plausibility of the social comparison explanation of IPO underpricing. I also add a dummy variable for IPOs that occur after March 1, 2005 to account for the
removal of the 7% price limit. Adj-R2 is the adjusted coefficient of determination. *, **, and *** refer to significance at the 10%, 5%, and 1% levels, respectively.

Variable Estimated coefficient t-statistic p-value

Panel A:
PEi = ω + ν1PEj + ν2PEk + ν3PEl + ν4Di + λi
Intercept 89.9106*** 13.4023 b 0.0001
PEj 0.0150 0.5064 0.6127
PEk 0.0609** 2.0957 0.0363
PEl −0.0117 −0.3949 0.6930
Di −47.2903*** −4.2433 b 0.0001
F-statistic 6.6209***
Adj-R2 0.0195
N 1132

Panel B:
PBi = δ + θ1PBj + θ2PBk + θ3PBl + θ4Di + πi
Intercept 1.2854*** 11.9987 b 0.0001
PBj 0.2161*** 7.4212 b 0.0001
PBk 0.1967*** 7.1203 b 0.0001
PBl 0.0984*** 3.3607 0.0008
Di −0.1011 −0.9470 0.3438
F-statistic 52.1901***
Adj-R2 0.1440
N 1218

Panel C:
MAi = ρ + α1MAj + α2MAk + α3MAl + α4Di + ψi
Intercept 0.9147*** 13.1805 b 0.0001
MAj 0.1698*** 5.9877 b 0.0001
MAk 0.1566*** 5.6773 b 0.0001
MAl 0.0784*** 2.7760 0.0056
Di 0.1228 1.4675 0.1425
F-statistic 29.0972***
Adj-R2 0.0833
N 1238

Panel D:
MOi = τ + γ1MOj + γ2MOk + γ3MOl + γ4Di + ζi
Intercept 72.7656*** 9.9400 b 0.0001
MOj 0.0735** 2.0682 0.0389
MOk 0.0289 0.8388 0.4018
MOl 0.0470 1.5389 0.1241
Di −10.9563 −0.8411 0.4005
F-statistic 2.3057*
Adj-R2 0.0047
N 1098
372 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375

pffiffiffiffi
CAAR1;t N
t = pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi ; ð4Þ
t ×var +2 × ðt−1Þ×cov
and
t
CAAR1;t = ∑ AARj ; ð5Þ
j=1
21
∑ S2t
where CAAR1, t is the CAAR of IPOs from day 1 to day t, var = t =21
1
, and cov is the first-order autocovariance of the AARt series.
Eqs. (1) to (5) use 21 days in the calculations.
Table 2 presents the AAR and CAAR of Taiwan IPOs. Given the lift of the 7% price limit on March 1, 2005, both the results for the
full sample (Panel A), as well as the sub-sample (after March 1, 2005) (Panel B), are presented. Both Panels A and B of Table 2
suggest that the first trading day of an IPO in Taiwan exhibits significant positive AAR and CAAR, which is expected for IPOs.

3. Social comparison explanation of IPO initial underpricing

3.1. Social comparison explanation

IPO pre-issue shareholders, managers, and underwriters may not be able to accurately evaluate the intrinsic value of an IPO.
When determining the IPO offer price, the IPO stakeholders can refer to what other companies have done recently. Based on the
social comparison theory, when individuals do not understand a situation very well, their decision-making process often refers to
the general behavior of the public. If the social comparison phenomena does impact the determination of the offer price for IPO
issuing firms and underwriters, there should be a significant positive correlation between the PE ratio (or other indicators of price
rationality) of the new IPO and other IPOs in the same industry that went public earlier.
Besides the PE ratio, I also use PB, MA, and MO ratios to robustly check the price rationality. For regression analysis to examine
the plausibility of the social comparison explanation of IPO underpricing, I use the PE, PB, MA, and MO ratios of Company i in the
previous quarter before going public (with offer price of Company i used in the ratios) and those of Companies j, k, and l in the
same industry that went public earlier than Company i (the first, second, and third companies closest to the time that Company i is
to go public). A dummy variable for IPOs that occur after March 1, 2005 is added to account for the removal of the 7% price limit.
The regression models are shown as follows:

PEi =ω+ ν1 PEj + ν2 PEk +ν3 PEl +ν4 Di + λi ; ð6Þ

PBi = δ +θ1 PBj +θ2 PBk +θ3 PBl +θ4 Di +πi ; ð7Þ

MAi =ρ+ α1 MAj +α2 MAk + α3 MAl +α4 Di + ψi ; ð8Þ

and
MOi = τ+γ1 MOj +γ2 MOk + γ3 MOl + γ4 Di +ζi ; ð9Þ

where

PEi (j, k, l) the PE ratio of Company i (j, k, l) in the previous quarter before going public;
PBi (j, k, l) the PB ratio of Company i (j, k, l) in the previous quarter before going public;
MAi (j, k, l) the MA ratio of Company i (j, k, l) in the previous quarter before going public;

Table 4
The impact of social comparison on investors' reaction to IPO offer price. Regarding the social comparison perspective of investors’ reacting to IPO offer price, I
contend that investors also refer to first-day IPO underpricing in the same industry that went public earlier during their decision-making process for an IPO.
Therefore, I regress IPO first-day abnormal returns of Company i on the first-day abnormal returns of Companies j, k, and l in the same industry that went public
earlier. I include a dummy variable to account for removing the 7% price limit after March 1, 2005. Adj-R2 is the adjusted coefficient of determination. *, **, and ***
refer to significance at the 10%, 5%, and 1% levels, respectively.

Dependent variable = IPO first-day abnormal return of company i

Variable Estimated coefficient t-statistic

Intercept 0.0129** 2.2217

ARj,1 0.4246*** 13.9512
ARk,1 0.0990*** 3.0954
ARl,1 0.0777** 2.5671
Di 0.1661*** 9.6488
F-statistic 271.9935***
Adj-R2 0.4672
N 1237
 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375 373

MOi (j, k, l) the MO ratio of Company i (j, k, l) in the previous quarter before going public;
Di a dummy variable that takes on a value of one if the IPO is after March 1, 2005, zero otherwise;
ω, δ, ρ, and τ intercepts;
ν, θ, α, and γ regression coefficients; and
λi, πi, ψi, and ξi random error terms.

The data are from the Taiwan Economic Journal databank. The data are available from February 9, 1981 to December 31, 2009
only, and some firms have missing information. The final samples for PE, PB, MA, and MO ratios of the IPOs reduce to 1132, 1218,
1238, and 1098 observations, respectively.
The results are shown in Table 3, Panels A through D. In Panel A, the PEk coefficient is significantly larger than zero, indicating
that when Company i determines its IPO offer price, it refers to the PE ratio of Company k in the same industry that went public
earlier (the second closest company to the time that Company i is to go public). In Panels B through D of Table 3 (i.e., PB, MA, and
MO ratios), the findings are similar to Panel A, i.e., the offer price of Company i is positively correlated with the offer price of other
companies that went public earlier in the same industry.
In summary, the results in Table 3 indicate that when issuing firms determine an IPO offer price, they refer to the offer price (as
reflected in PE, PB, MA, and MO ratios) of other IPOs in the same industry that went public earlier.
In addition to how issuing firm managers refer to the IPO offer price of other IPOs in the same industry that went
public earlier, social comparison can also explain how outside investors make investment decisions on IPOs. Given the
argument that investors also refer to first-day IPO underpricing in the same industry that went public earlier during their
decision-making process for an IPO, I adopt a method similar to the above social comparison explanation to examine
whether the social comparison phenomena exists in the reaction of investors to an IPO offer price. The regression model is
as follows:

ARi;1 =κ+ η1 ARj;1 +η2 ARk;1 + η3 ARl;1 +η4 Di + ϑi ; ð10Þ

where ARi (j, k, l ),1 is the first-day abnormal return of Company i (j, k, l) after going public; κ is the intercept; η1, η2, η3, and
η4 are regression coefficients; Di is the dummy variable to account for the 7% price limit regulation; and ϑi is an error
term.
The results in Table 4 indicate significant positive values for the coefficients of ARj,1, ARk,1, and ARl,1 and the existence of social
comparison in the reaction of investors to an IPO offer price. Investors make their purchasing decisions for the IPO (Company i)
according to the first-day abnormal return of other companies (j, k, l) in the same industry that went public earlier. As expected,
the dummy variable is positive and significant, suggesting that the abnormal return is higher after the removal of the price limits
after March 1, 2005.

Table 5
IPO underpricing and information asymmetry, mental accounting, and social comparison variables. This table presents the findings from a regression model to
include information asymmetry, mental accounting, and social comparison variables that explain IPO first-day abnormal returns. I follow An and Chan (2008) and
use credit rating information and the age of the IPO issuing firm to account for information asymmetry between an IPO firm and the investment public. To account
for a possible mental accounting explanation of IPO underpricing, I use the market capitalization to total assets (MA) and market capitalization to operating
income (MO) ratios relative to the industry ratios of the IPO firms. Instead of the stock price, I use the IPO offer price to calculate MA and MO ratios. To capture the
social comparison explanation of IPO underpricing, I use MASi, and ARj,1 (the abnormal returns of another IPO in the same industry that went public earlier)
variables. The MASi variable is calculated as the relative MA ratio between Company i and Company j that went public earlier adjusted for the abnormal return. I
also use a dummy variable (value 1 after March 1, 2005) to account for the regulation change. Adj-R2 is the adjusted coefficient of determination. *, **, and *** refer
to significance at the 10%, 5%, and 1% levels, respectively.

Dependent variable = IPO first-day abnormal returns of company i

Variable Standardized estimated coefficient t-statistic

Intercept 0.0000 3.8282

CDi −0.0787** −2.4434
log(age)i −0.1067*** −2.9069
MAi − I −0.0020 −0.0538
MOi − I −0.0220 −0.5939
MASi 0.1893*** 5.4827
ARj, 1 0.2697*** 6.8998
Di 0.3247*** 8.6708
F-statistic 92.9493***
Adj-R2 0.4737
N 716
374 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375

3.2. Robust analysis

How does the social comparison explanation succeed in comparison with the information asymmetry and mental accounting
explanations? I study a regression model to include information asymmetry, mental accounting, and social comparison variables
that tests the predictive ability of these variables on IPO underpricing. The model is as follows:

ARi;1 = Ψ+Γ1 CDi +Γ2 logðageÞi + Γ3 MAi−I +Γ4 MOi−I + Γ5 MASi +Γ6 ARj;1 +Γ7 Di + Φi ; ð11Þ

where the following apply:

ARi, 1 the first-day abnormal return of Company i;

CDi the credit rating dummy variable (value of one if the IPO firm has a credit rating one year before IPO);
log(age)i the natural log of the age of the firm;
MAi − I the MA ratio difference between Company i and the industry;
MOi − I the MO ratio difference between Company i and the industry;
MAi
MASi MAj × ARj;1 , where MAi(MAj) is the MA ratio of Company i(j);
ARj, 1 the first-day abnormal return of Company j, which is the earlier IPO return of another firm in the same industry of
Company i;
Di a dummy variable with the value of one if the IPO occurs after March 1, 2005;
Ψ intercept;
Γ regression coefficients; and
Φi a random error term.

An and Chan (2008) use credit rating information and the age of the IPO issuing firm to account for information asymmetry
between the IPO firm and the investment public.2 Thus, I use these two variables to proxy for the information asymmetry
explanation. When an IPO firm has a credit rating before going public and it has a longer operating history, the information
asymmetry between the IPO firm and the investment public regarding the IPO firm quality is smaller. Thus, it is expected that the
CD and log(age) variables are negatively related to the first-day IPO abnormal return.
To account for the possible mental accounting explanation of IPO underpricing, I use the MA and MO ratios relative to the
industry ratios of the IPO firms. Instead of stock price, I use the IPO offer price to calculate the MA and MO ratios. If an IPO firm
leaves substantial money on the table (IPO underpricing), then the MA and MO ratios of the IPO issuing firm would be significantly
lower than those of the industry average. Therefore, it is expected that the signs MAi − I and MOi − I will be negative and significant.
To capture the social comparison explanation of IPO underpricing, I use MASi and ARj,1 variables. ARj,1 captures the impact of the
first-day abnormal returns of another IPO in the same industry that went public earlier. The MASi variable is calculated as the
relative MA ratio between Company i and Company j, the company that went public earlier, adjusted for the abnormal return. If the
social comparison theory is valid, the coefficients of the ARj,1 and MASi variables will be positive and significant. The dummy
variable (value 1 after March 1, 2005) is expected to be positive and significant.
To compare the three possible explanations of IPO underpricing, I estimate standardized coefficients for Eq. (11). The
standardized coefficients allow us to compare the magnitude of the coefficients and examine which variables contribute more to
IPO underpricing. Because some companies do not have complete information, the final sample for Eq. (11) is 716.
The findings for Eq. (11) are presented in Table 5. The variables on information asymmetry (credit rating and IPO firm age) and
social comparison (ARj,1 and MASi) carry the correct signs, and they are all statistically significant in explaining IPO underpricing.
The dummy variable for the removal of the 7% price limit, as expected, is also significant. The mental accounting variables (MAi − I
and MOi − I), however, are not significant. When comparing the magnitude of the estimated coefficients, the social comparison
variables are relatively larger than the information asymmetry variables. My findings suggest that the social comparison theory is a
viable alternative for explaining IPO underpricing.

4. Conclusion

Using Taiwan's IPO market as an example, this paper investigates whether the social comparison theory can explain the
behavior of IPO issuing firms and the investors. The argument is that when issuing firm insiders (managers, pre-issue
shareholders, and underwriters) cannot accurately evaluate an IPO's intrinsic value, they use the information of other IPOs in the
same industry that went public earlier to determine an IPO offer price. Likewise, investors refer to the first-day abnormal returns of
other IPOs in the same industry that went public earlier as a reference when determining whether or not to invest in an IPO.
The findings suggest that IPO offer-price setting and first-day IPO abnormal returns are positively correlated with IPO firm
peers that went public earlier. In addition, when information asymmetry, mental accounting, and social comparison variables are

2
Chambers and Dimson (2009) also apply the age of the IPO issuing firm to account for the ex ante uncertainty of a firm's value.
 C.-H. Chang / International Review of Economics and Finance 20 (2011) 367–375 375

put together to explain IPO first-day abnormal returns, the social comparison variables continue to be significant. Thus, the
findings suggest that the social comparison theory is a viable alternative explanation for IPO underpricing.

Acknowledgments

The author is grateful to Kam C. Chan for helpful comments and suggestions and to I-Fan Ho for gathering the data.

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