Cash flow uncertainty and IPO underpricing: evidence from income guarantee in Thai REITs
| DOI | https://doi.org/10.1108/JPIF-07-2020-0085 |
| Published date | 05 January 2021 |
| Date | 05 January 2021 |
| Pages | 590-608 |
| Author | Kanis Saengchote,Chittisa Charoenpanich |
Cash flow uncertainty and IPO
underpricing: evidence from
income guarantee in Thai REITs
Kanis Saengchote
Department of Banking and Finance,
Faculty of Commerce and Accountancy, Chulalongkorn University,
Bangkok, Thailand, and
Chittisa Charoenpanich
Bank of Ayudhya Public Company Limited, Bangkok, Thailand
Abstract
Purpose –The purpose of this article is to investigate the relationship between cash flow uncertainty and the
underpricing of real estate investment trust (REIT) initial publicofferings (IPOs) using hand-collected data on
income guarantee in Thailand from January 2005 to December 2019.
Design/methodology/approach –This article uses linear regression to determine the relationship between
underpricing (initial return) and proxy for cash flow uncertainty (income guarantee), controlling for other
factors. Because issuers can use several actions to signal their quality under asymmetric information, the joint
decisions are analyzed as simultaneous equations and estimated using three-stage least square (3SLS) to
address potential endogeneity concern.
Findings –This article finds that underpricing, on average, is negatively related to income guarantee, which is
a proxy for ex ante cash flow uncertainty. The relationship is economically and statistically significant and
robust to simultaneous equations estimation. Further investigation shows that REITs with income guarantee
tend to have lower systematic risk (measured by CAPM beta) and returns, making the nature of some REITs
more debt-like than equity-like.
Practical implications –For issuers, the result suggests that offering income guarantee (which is more
costly for assets with lowerquality) can be a useful signal of asset quality to investors and reduce IPO discount.
For institutional and retail investors, the results are informative about the risk-return tradeoffs in REIT IPO
investment opportunities. Income guarantees makes REIT exposure more fix income-like,so there is a need to
consider the credibility of the guarantor as well.
Originality/value –This article is the first to use income guarantee as an ex ante measure of cash flow
uncertainty and explicitly investigates its linkage to IPO underpricing. This aspect of uncertainty and IPO
underpricing remains little-studied in the academic literature. It also contributes to the growing literature of
REIT IPOs in Asia.
Keywords Initial public offerings, REITs, Cash flow uncertainty
Paper type Research paper
1. Introduction
One of the most studied aspects of initial public offerings (IPOs) is how price is formed and
determined. It is widely documented that IPOs tend to be underpriced, [1] which seems
difficult to rationalize at first as it suggests that issuers willingly “leave money on the table”.
To provide the readers with some context, Ritter (2020) find that the 8,610 IPOs in the US
between 1980 and 2019 are underpriced on average by 18%, representing more than USD 172
billion left on the table from the aggregate USD 937 billion raised. While there are many
potential reasons behind this phenomenon, the leading explanations are centered on
information asymmetry, particularly adverse selection in the spirit of Akerlof (1970) and
Leland and Pyle (1977). The central idea behind adverse selection is that uncertainty in asset
JPIF
39,6
590
JEL Classification —G23, G32
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1463-578X.htm
Received 28 July 2020
Revised 21 December 2020
Accepted 22 December 2020
Journal of Property Investment &
Finance
Vol. 39 No. 6, 2021
pp. 590-608
© Emerald Publishing Limited
1463-578X
DOI 10.1108/JPIF-07-2020-0085
quality can lead to an equilibrium outcome where issuers (sellers) intentionally price their
assets below their fundamental value. The two main aspects of uncertainty that affect value
are cash flow and discount rate (risk), but this issue remains little-studied because of the
difficulty in estimating ex ante uncertainty [2].
In this article, we investigate the relationship between cash flow uncertainty and IPO
underpricing through IPOs of real estate investment trusts (REITs). Similar to stocks, REITs
are publicly traded companies that own or operate real estate-related investment
opportunities [3] and also undergo the IPO process. While REIT future cash flows are also
uncertain, investment restrictions make their uncertainly lower than stocks. In fact, studies of
REIT IPOs find that the degree of underpricing is considerably less. Compared to the double
digit average initial returns (IR) of stock IPOs, REIT IPOs are always single digit: for example,
Buttimer et al. (2005) find 2.47% for US REITs, Chan et al. (2013) 3.24% for international
REITs in 14 countries and Brobert (2016) 3.94% in 26 countries [4]. One aspect of Thai REITs
that makes them a unique setting for our research topic is that 60% of REIT issuers offer
some form of guarantee (for example, minimum revenue/occupancy guarantee or sale-and-
leaseback with guaranteed income over a fixed period), which effectively mitigate concerns
over adverse selection [5]. In other words, the income guarantee provides an ex ante measure
to delineate IPOs based on future cash flow uncertainty.
We find that REIT IPOs where issuers offer income guarantee are substantially less
underpriced by 9–10% in our three-stage least square (3SLS) regression that addresses
potential endogeneity concerns by estimation of simultaneous equations. We further
investigate the risk and return profile of REITs with and without income guarantee and find
that REITs with guarantee have significantly lower systematic risk, with some appearing
more debt-like than equity-like. To our knowledge, our article is the first to use income
guarantee as an ex ante measure of cash flow uncertainty and explicitly investigates its
linkage to IPO underpricing. Our result contributes to the relatively scant literature on IPO
underpricing and uncertainty (for example, Lowry et al., 2010) and the growing literature on
REIT IPOs in Asia (for example, Wong et al., 2013;Ooi et al., 2019).
The rest of this article is organized as follows. In the next section, we review research
related to REIT IPOs and cash flow uncertainty and hypothesize our main prediction.
In section 3, we provide a brief background on Thai REITs to familiarize the readers. Data
sources, sample construction strategy, as well as empirical methodology are described in
section 4. We present our main result in section 5 and further investigate the influence of
income guarantee on REIT risk and return in section 6.Section 7 concludes our article.
2. Literature review and research hypotheses
As IPOs are essentially partial sales of assets, information asymmetry plays an important
role in their pricing. The adverse selection problem that arises from uncertainty in asset
quality, documented in the influential article by Akerlof (1970) and is the central idea behind
many economic transactions such as auction, insurance and financial intermediation, is one of
the most popular explanations behind IPO underpricing. In adverse selection-based models
(for example, Rock, 1986;Allen and Faulhaber, 1989;Welch, 1989), issuers price IPOs below
their fundamental value to increase the success of the transaction, either as compensation for
gathering private information or signal firm quality. Issuers can also use ownership retention
as a signal of quality independently (Leland and Pyle, 1977) or jointly with underpricing
(Grinblatt and Hwang, 1989). The distinction between the informed and uninformed (insiders
and outsiders) highlights underwriters’important role in bridging the asymmetry and hence
the influence of underwriter’s reputation on underpricing (Beatty and Ritter, 1986). In the
book-building process, lead underwriters can reward institutional investors for their
information production in the form of underpriced allocation (Benveniste and Spindt, 1989;
Cash flow
uncertainty
and IPO
underpricing
591
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