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Investing in Security Price Informativeness: The Role of IPO Underpricing

I develop a theory in which firms enhance the information content of their future stock prices by using underwriters to direct underpriced IPO allocations to information-producing investors. Sufficiently large allocations and the promise of future, profitable IPO participation provide incentives for investors to produce information after the IPO. Increasing underpricing strengthens these incentives, resulting in a more informative post-IPO price and higher firm value. Firms' desires for more informative post-IPO pricing lead to new rationales for IPO underpricing and the intermediating role of underwriters. Empirical tests support the theory's novel implications.