Cutting the 'Gordian Knot:' Director ownership, underpricing, and stock liquidity in IPO firms

Current management research on IPOs has examined how board composition and ownership structures affect IPO underpricing, while largely overlooking their implications for the long-term stock liquidity of the IPO firm. This is a significant oversight, given the many benefits to IPO issuers from having a liquid stock (e.g., reduced cost of capital, increased external monitoring, etc.). This study theoretically integrates the literatures on board ownership, underpricing, and stock liquidity using a signaling perspective, and finds that while the monitoring and incentive effects of high outside director equity help reduce underpricing (thereby solving a short-term problem by leaving less money on the table), they also reduce stock liquidity during the three years following the IPO (thereby creating a long-term problem). Underpricing is found to be positively associated with liquidity, suggesting that there are expected benefits from underpricing that need to be traded off against the upfront costs of leaving more money on the table. Finally, while the inside director equity-underpricing association is expectedly negative, there is no evidence to suggest that inside director equity affects post-IPO liquidity. Taken together, these findings convey a fuller picture of the long-term implications of underpricing and board ownership at IPO for stock liquidity, an important yet underrated measure of a firm's stock market performance.