IPO pricing as a function of your investment banks' past mistakes: The case of Facebook

On May 18, 2012 Facebook held its initial public offering (IPO), raising over $16 billion making it one of the largest IPOs in history. To the surprise of many investors, there was no underpricing―the stock closed the first day of trading flat from its offer price. The Facebook IPO was described as not only disappointing but also detrimental to the broader market. We explore why one IPO should have such widespread consequences. We document that the IPO market was silent for 41 days following Facebook. When it re-opened 41 days later, the average level of underpricing increased from 11% pre-Facebook to 20% post-Facebook. The common blame was an overall increase in risk-aversion among investors. We offer an alternative explanation. We show that the entire increase in underpricing is concentrated in the IPOs of the Facebook lead underwriters. We find no statistical difference in underpricing pre- and post-Facebook for non-Facebook underwriters. We argue that investment bank loyalty to their institutional investor client based propelled the Facebook underwriters to increase underpricing to compensate for the perceived losses on Facebook.