Factors affecting the underpricing of junior mining initial public offerings in a “hot issue” market

Abstract

The pricing of Initial Public Offerings (IPOs) is an area of interest to practitioners and academics alike given the empirical regularity of investors in IPOs making very large first day returns. These first day returns are as a result of share underpricing. Academics have explained the underpricing phenomenon in terms of ex ante uncertainty, namely the risk of pricing, off take and issuing of such shares. In an attempt to predict the degree of the phenomenon much work has been done in linking underpricing to company, issue and market related factors that are known prior to the listing (ex ante as opposed to ex post information). In the case of junior mining companies, underpricing is exacerbated by a lack of financial information making these issues difficult to value since such unseasoned companies have no past earnings history on which to base predictions of future earnings. Given this context, this study identified relevant factors from secondary sources which could be used to proxy the level of ex ante uncertainty and therefore correlate with the degree of underpricing. The analysis firstly sought to ensure that underpricing exists for the issues, market and time period of interest. Secondly the presence of a “hot issue” period (Ritter, 1984), which is exclusive to the natural resources sector, was investigated. Finally the relationship between underpricing and the relevant factors was explored using hypothesis testing about means and regression analysis. It was found that underpricing does indeed exist for junior mining listings on the Toronto Venture Exchange (TSX-V) between 2005-2007. This said no evidence of the “hot issue” period could be found. In terms of linking company, issue and market related factors to the degree of underpricing this study failed to identify any significant predictors. It is argued that junior mining listings on the TSX-V may be a special case since some of these factors have successfully been used, by other researchers, to predict the degree of underpricing of mining IPOs. The fact that junior mining IPO’s listed on the TSX-V show a constant degree of underpricing over time implies that investors do not build market specific factors (market sentiment and commodity price) into the listing price. Rather investors seem to demand a constant degree of underpricing regardless of the market situation to compensate them for the “unknown” exploration risk.