Why are stock exchange IPOs so underpriced and yet outperform in the long run?

•We investigate the level of underpricing and the long-term stock market performance of financial exchange IPOs.•We find that despite being more underpriced, the financial exchanges outperform a control sample of regular IPOs.•Stock exchange IPO underpricing is positively related to the IPO's long-run stock returns.•Both underpricing and long-run returns of the sample firm are positively related to proxies of the signaling hypothesis.

We investigate the level of underpricing and the long-term stock market performance of financial exchange initial public offerings (IPOs) and find that, despite being more underpriced, the financial exchange IPOs significantly outperform the market indexes and a control sample of regular IPOs. Thus, contrary to the findings in prior studies, we find that stock exchange IPO underpricing is positively related to the firm's long-run stock returns. We argue, among others, that the lack of managerial ownership of shares in the stock exchange firms creates a situation where management is not constrained to significantly underprice their initial issues to signal their firms’ prospects, because they do not directly bear the cost of leaving too much money on the table. Interestingly, both underpricing and long-run returns of stock exchange IPOs are related to proxies of the signaling hypothesis. On the basis of additional tests involving the stock exchange IPOs and a sub-sample of regular IPOs that also outperformed the market in the long run, we are able to rule out the quasi-monopoly hypothesis as a possible explanation for the strong long-run performance of stock exchange IPOs.