Penny Stock IPOs*

Daniel J. Bradley
Clemson University
dbradle@clemson.edu

John W. Cooney, Jr.

Texas Tech University
jcooney@ba.ttu.edu

Steven D. Dolvin
University of Kentucky
sddolv2@uky.edu

Bradford D. Jordan
University of Kentucky
bjordan@uky.edu

First draft: October 10, 2002

This draft: June 4, 2003

JEL Classification: G24, G32

*
Bradley is from the College of Business and Behavioral Science, 324B Sirrine Hall, Clemson University, Clemson,
SC 29634. Cooney is from the Rawls College of Business Administration, Texas Tech University, Lubbock, TX
79409-2101. Dolvin and Jordan are from the Gatton College of Business and Economics, University of Kentucky,
Lexington, KY 40506-0034. Contact author: Brad Jordan, 859.257.4887, bjordan@uky.edu. The authors thank Ken
Cyree, Jay Ritter, Ajai Singh, and seminar participants at Texas Tech University and the 2002 Financial
Management Association meetings in San Antonio, TX.
 Abstract

We examine the similarities and differences between ordinary IPOs and penny stock IPOs.
Because of their scandal-plagued history, penny stock IPOs present an interesting opportunity for
studying the effects of informational asymmetries, moral hazard, and third party “certification”
in the IPO market. After controlling for a wide variety of issue and market characteristics, we
find that penny stock IPOs, as compared to ordinary IPOs, earn higher initial returns, are subject
to much longer lockup provisions, and have larger gross spreads, all of which are consistent with
larger degrees of informational asymmetry in these offerings. For penny stocks, the presence of a
venture capitalist reduces initial returns, lockup lengths, and gross spreads. Likewise, penny
stock IPOs with more prestigious underwriters have less underpricing. These results suggest that
third party “certification” is especially valuable for these issues.
 Penny Stock IPOs

1. Introduction

Initial public offerings (IPOs) have been studied extensively in the finance literature. It is

standard in such research to focus primarily on “ordinary” IPOs, and filters to eliminate various

types of offerings are almost always employed. Examples of the typical groups purged include

real estate investment trusts, spin-offs, unit offerings, reverse leveraged buyouts, closed-end

investment funds, American depositary receipts, and stocks with offer prices below some

minimum value. Most of the excluded subgroups have been examined independently; however,

there appears to be very little research on IPOs with low offer prices, or so-called “penny stock”

IPOs.1 This lack of research on low-priced IPOs is surprising given the prominent fraud and

manipulation that existed in the 1980s, which eventually lead to the adoption of the Penny Stock

Reform Act of 1990.

To address this gap, we examine the similarities and differences between penny stock IPOs

and ordinary IPOs in relation to the major findings of IPO research. Given their scandal-plagued

past, penny stock IPOs appear to be particularly suited to issues involving informational

asymmetries, moral hazard, and the effect of third party “certification.” The firms involved are

generally small, not listed on a major exchange, and face very limited disclosure and reporting

requirements. They are generally underwritten by low prestige investment banks, and they are

much less likely to be venture capital (VC) backed. In addition, there is likely to be little or no

institutional buying or analysis of these issues.

Based on the period 1990-1998, we find that penny stock issues exhibit higher initial returns

than ordinary IPOs, and the difference is economically and statistically significant after

1
For example, Schultz (1993) investigates unit offerings. Peavy (1990) examines closed-end investment fund IPOs.
Slovin, Shushka, and Ferraro (1995) study spinoffs. Ling and Ryngaert (1997) focus on real estate investment trust
IPOs, while Noronha and Yung (1997) study reverse LBOs.
controlling for a wide range of influences previously found to be related to underpricing. This

result is consistent with Fernando, Krishnamurthy, and Spindt (2002) who find that IPOs with

low offer prices are particularly underpriced. Issues underwritten by the lowest quality

underwriters are much more underpriced, on average, whereas VC-backed issues are less

underpriced, and both underwriter prestige and VC backing have a stronger effect on penny

stock IPOs than ordinary IPOs. These results are supportive of the hypothesis that third party

certification can reduce underpricing, particularly in situations where the degree of informational

asymmetry may be large.

We also find that penny stock IPOs typically exhibit much longer lockup periods than

ordinary IPOs. These longer lockups are consistent with the view that lockup restrictions serve as

a commitment mechanism to help alleviate moral hazard problems, as recently investigated by

Brav and Gompers (2003). Finally, while gross underwriting spreads for ordinary IPOs are

typically 7 percent [Chen and Ritter (2000)], we find that spreads for penny stock IPOs are

usually 10 percent. The higher gross spreads could serve, in part, to compensate underwriters for

the increased information asymmetry and related pricing risk associated with these low-priced

offerings. For ordinary IPOs, venture capitalist participation has little impact on lockup periods

and spreads. However, for penny stock IPOs, both lockup lengths and gross spreads are

substantially lower for VC-backed IPOs. This finding provides additional support for the

hypothesis that third-party certification is especially important for penny stock offerings.

In summary, our findings point to the usefulness of studying penny stock IPOs. While

researchers typically concentrate on higher-priced, and therefore less-risky, offerings, we show

that examination of penny stock offerings allows for a more complete analysis of the relation

between certification agents and the information asymmetry/moral hazard problems of IPOs. In

2
the future, IPO researchers interested in these, and related, questions should carefully consider

the basis for excluding low-priced offerings.

The rest of the paper proceeds as follows: section 2 provides background on the penny stock

market; section 3 presents the data; section 4 reports descriptive statistics and empirical results;

and section 5 concludes.

2. Background

The market for penny stocks has changed dramatically over the last few decades.

Historically, these stocks were traded over-the-counter or on regional exchanges with very

limited (if any) disclosure requirements. Particularly before the Penny Stock Reform Act of 1990

(PSRA), the penny stock market was plagued by unscrupulous broker-dealers and underwriters.2

“Boiler room” tactics were common, with unregistered “brokers” cold-calling primarily

unsophisticated investors and using high pressure sales techniques to induce investment.3

The term “penny stock,” as it is used in the financial press and IPO research, has no precise

meaning. In screening out low-priced issues, IPO researchers have used different filters. Bradley,

Jordan, and Ritter (2003) and Loughran and Ritter (2002) remove all issues with mid-file prices

below $8; Ljungqvist and Wilhelm (2003) and Ritter and Welch (2002) exclude stocks with offer

prices below $5; and Ritter (1991) eliminates issues with offer prices less than $1. In their study

of long-run price performance and mortality for Nasdaq-listed issues, Seguin and Smoller (1997)

classify an issue as a penny stock if the first listed price (as opposed to the initial offer price) is

less than $3. Also, many studies drop issues that are not in the Center for Research in Security

Prices (CRSP) database, which is effectively a screen on non-listed, lower-priced stocks.

2
As an example, see the New York State Attorney General’s (1997) report on microcap stock fraud.
3
For further information on the Penny Stock Reform Act and its effects, see Beatty and Kadiyala (2001).

3
 While there are differences across studies, the filters commonly used in recent IPO research

correspond relatively closely to the legal definition of a penny stock established by the PSRA.

These guidelines define a penny stock as an issue that meets the following standards: (1) it is not

listed on a national market, (2) it is not issued by an investment advisor (i.e., it is not a mutual

fund), and (3) its offer price is below some minimum value.4 These are also the characteristics of

a non-covered security as identified by the Securities Act of 1933 and the Securities and

Exchange Act of 1934.

Sections 15 (ς240.3a51-1) and 17 (ς78c51(a)) of the Code of Federal Regulations (CFR)

provide additional guidelines on the minimum criteria. Specifically, the CFR identifies $5 as the

minimum price for classification as a penny stock; however, this price is net of commissions and

fees. Thus, in classifying an IPO as a penny stock, an issue with an offer price of exactly $5,

assuming it is not listed on a national market, would be considered a penny stock since

commissions and fees would reduce the effective price to below $5.5,6

In this study, we define a penny stock IPO as an issue that meets the following two criteria:

(1) it is not listed on a national exchange or market (i.e., not listed on the NYSE, AMEX, or

Nasdaq National Market), and (2) its offer price is at or below $5. These criteria are consistent

4
The PSRA does not state a precise minimum; however, it does refer to the Code of Federal Regulations, which
predominately uses $5 as the cutoff. Earlier regulations used $1 and $3 prices, which may explain the use of these
cutoffs in earlier IPO studies.
5
In principle, a firm could use a reverse stock split to reduce the number of shares outstanding (thus increasing the
offer price) to avoid penny stock status, but it is clear that many choose not to do so. There are several reasons firms
might prefer to issue at a lower price. First, some firms might prefer retail over institutional investors, and therefore
gravitate to a lower offer price [Fernando, Krishnamurthy, and Spindt (2002)]. Second, at least historically, penny
stock status reduced costly governmental reporting requirements. Finally, the reduction in shares would reduce float,
and, for these smaller issues, likely prevent national market listing.
6
Applying the legal definition may be somewhat subjective. For example, an issue with an offer price of $5.25 and a
spread of 10 percent would have a net price below $5. We find only six such issues in our sample. In keeping with
common research practice, we classify these as ordinary IPOs; however, we repeat all analyses with these issues
classified as penny stock IPOs and find our results to be unchanged. Also, based on the legal requirements, an IPO
issued as a penny stock may be “converted” to non-penny status with changes in bid prices, listing status, or market
maker coverage. Thus, our analysis is specific to IPOs classified as penny stocks at issuance.

4
with legal guidelines provided by securities regulators, as well as with a large portion of IPO

research.7

3. Data

A likely reason that penny stocks have not been closely studied is that relevant data can be

quite limited. Firm characteristics are not widely available in standard databases because penny

stocks have historically not been subject to significant reporting requirements. Other

information, such as detailed financial statements and earnings forecasts, can be similarly

difficult to obtain. Fortunately, Thomson Financial’s Securities Data Company (SDC) database

captures prospectus information for penny stock IPOs, so this is the primary data source we use.

For ordinary IPOs, we collect closing prices on the first day of trading using the CRSP database.

For penny stock IPOs, we hand-collect the closing price on the first trading day after issuance

from the Standard & Poor’s Daily Stock Price Record.8

Our main sample covers the period from 1990 to 1998—the period from the implementation

of the PSRA to the beginning of the IPO “bubble” period.9 We eliminate real estate investment

trusts, closed-end investment funds, spin-offs, mutual-to-stock conversions (e.g., S&Ls and

certain insurance companies), American depositary receipts, and unit offerings, leaving a sample

of 243 penny stock IPOs and 3,200 ordinary IPOs.

7
In practice, there are complications to the definition we use. For example, according to the CFR, firms with
sufficient net tangible assets are not classified as penny stocks even if their offer price is less than $5. However, lack
of accounting data prevents us from considering the issuing firm’s net tangible assets. Blind pools (blank check/shell
offerings) may be classified as penny stock issues even with offer prices above $5. Unit offerings are IPOs that
include a package of a share (or shares) of stock and warrants. Thus, a unit offering with an offer price above $5
may also be legally classified as a penny stock if the warrant value is large enough or if multiple shares are issued in
the unit.
8
CRSP only reports prices for approximately one-half of our penny stock sample (i.e., those stocks listed on the
Nasdaq SmallCap market). The prices reported on CRSP consistently match those from Standard & Poor’s.
9
There are only four penny stock IPOs during the 1999-2000 period, preventing meaningful analysis. As we
illustrate later, inclusion of this period distorts the picture of ordinary versus penny stock IPOs, particularly as it
relates to underpricing.

5
4. Descriptive statistics and empirical results

4.1 Descriptive statistics

Table 1 provides basic descriptive statistics on firm and offering characteristics for penny

stock and ordinary IPOs over the 1990-1998 period. The reported t-statistic is a test for equality

of means assuming unequal variances (results are very similar if equal variances are assumed).

As the first line indicates, the average offer price for ordinary IPOs ($11.96) is, of course, much

larger than that for penny stock IPOs ($4.36), and, because of our classification criteria, a t-test is

not meaningful in this case. The next four variables in Table 1 are size measures. As would be

expected, market capitalization, total assets, and book equity are all larger for ordinary issues;

however, net income is not statistically different between the two groups. Sample sizes are

limited for total assets and net income because of missing data.

Insert Table 1 about here

The next entry in the table, HT, is a dummy variable taking on a value of 1 for “high-tech”

firms, and zero otherwise.10 Therefore, the mean is the percentage of firms in our sample with a

high-tech orientation. Approximately 38 percent of ordinary IPOs are high-tech firms, compared

to 31 percent of penny stock IPOs, which is significantly different at the 5 percent level. The

variable VC is also a dummy variable, indicating the presence of venture capital (VC) backing.

Only 16 percent of penny stock IPOs are VC-backed compared to 41 percent for ordinary IPOs

(statistically different at the 0.01 percent level). The variable CM Rank represents the Carter and

Manaster (1990) underwriter prestige variable, which ranges from 1 (lowest prestige) to 9

10
We obtain the underlying “high-tech” classification codes from SDC. While a relatively large number of specific
codes are used, most fall under the 2-digit classifications of 28 (biotechnology and drugs), 35 (computer and
related), 36 (electronics and communication), 38 (medical equipment), and 73 (software).

6
(highest prestige).11 With a mean underwriter prestige of 2.72 compared to 6.99, it is clear that

penny stocks are primarily issued by lower-ranked underwriters, while ordinary IPOs are issued

by higher-ranked underwriters.

The next two variables examine listing status. National is a dummy variable taking on a

value of one if the offer is listed on a national exchange (i.e., NYSE, AMEX, or Nasdaq National

Market), and zero otherwise. SmallCap is a dummy variable equal to one if the issue is listed on

the Nasdaq SmallCap Market.12 Due to our definition of a penny stock issue, there are no penny

stocks nationally listed. However, approximately 57 percent of penny stock IPOs are listed on

the Nasdaq SmallCap Market, with the remainder listed on the OTC Bulletin Board (OTCBB),

the pink sheets, regional exchanges, or else unlisted. There are a few ordinary IPOs (3 percent)

listed on the Nasdaq SmallCap Market; however, the vast majority (over 94 percent), are

nationally listed.13

The next three variables in Table 1 are those that have been most closely examined in the

IPO literature: initial returns (percentage change from the offer price to the closing price on the

first day of trading), lockup length, and gross underwriting spread. Penny stocks have higher

initial returns (21.5 percent versus 15.1 percent), larger gross spreads (9.7 percent versus 7.2

percent), and longer lockup periods (442 days versus 212 days). In each case, the difference is

statistically significant and economically meaningful. In the next few sections, we explore these

differences in greater detail.

11
We use Carter-Manaster ranks as updated by Jay R. Ritter. The ranks are described in Loughran and Ritter (2003).
12
The Nasdaq SmallCap Market has less restrictive listing requirements than the Nasdaq National Market,
including, among other things, a $4 minimum price for initial listing rather than a $5 minimum. Details are available
at www.nasdaq.com.
13
Data on listing status are unavailable for 18 issues.

7
 In Figure 1, we take a closer look at the Carter-Manaster ranks. The figure shows the

percentages of ordinary and penny stock IPOs underwritten by underwriters of each rank.

Because the underwriter ranks are ordinal, the t-test in Table 1 may not be well specified;

however, Figure 1 clearly shows that there are two distinct clusters, one in the highest ranks for

ordinary IPOs and one in the lowest ranks for penny stock IPOs.

Insert Figure 1 about here

4.2 Initial returns

Figure 2 contains plots of initial returns by year for ordinary and penny stock IPOs. As

shown, from 1990-1998, penny stock IPOs are more underpriced in every year except 1998. The

1998 result may be due, in part, to the beginning of the IPO “bubble” period, during which there

were very few penny stock IPOs and, at the same time, extraordinarily large initial returns for

ordinary IPOs.14 In fact, if the 1999-2000 period is included in our sample, ordinary IPOs are

more underpriced, on average, than penny stock IPOs (23.2 percent compared to 21.4 percent),

but this is misleading because, as we noted earlier, there were almost no penny stock IPOs during

the 1999-2000 period.

Insert Figure 2 about here

Our results thus far indicate that penny stock IPOs are more underpriced, but they do not

control for issue features other than the offer price. Conceivably, the greater underpricing could

be attributable to factors other than penny stock status; therefore, we need to control for

important determinants of underpricing identified by previous studies. To do this, we estimate

the following multiple regression:

14
For example, theglobe.com (an “ordinary” IPO) went public in November of 1998 with a first day gain of 606
percent.

8
 Initial = α + β1PS + β2VC + β3Over + β4HT + β5National + β6SmallCap + β7CM2
+…+ β14CM9 + β15Secondary + β16LnSize + β17Integer + β18IPOLag
+ β19NasLag + β20Multiple + β21PartU + β22PartD + ε (1)

where:

Initial = return from the offer price to the closing stock price on the first day of trading;
PS = dummy variable equal to one if the issue is a penny stock, zero otherwise;
VC = dummy variable equal to one if the issue is VC-backed, zero otherwise;
Over = “overhang,” measured as pre-IPO shares retained divided by total shares offered;
HT = dummy variable equal to one if the issue is high-tech, zero otherwise;
National = dummy variable equal to one if the offering is listed on the NYSE, AMEX, or
Nasdaq National Market, zero otherwise;
SmallCap = dummy variable equal to one if the offering is listed on the Nasdaq SmallCap
Market, zero otherwise;
CM2...CM9 = dummy variables equal to one if the underwriter has a prestige ranking in the
relevant category, zero otherwise (a Carter-Manaster (1990) rank of 1 is the
omitted category);15
Secondary = percentage of shares offered that are secondary shares;
LnSize = natural logarithm of the offer size;
Integer = dummy variable equal to one if the offer price is an integer, zero otherwise;
IPOLag = an underpricing index defined as the average initial return for all IPOs in the
sample on calendar days –1 to –30 before the issue date;
NasLag = average daily return on the Nasdaq composite for the twenty-one trading days
(one month) prior to the issue;
Multiple = dummy variable equal to one if the issue has more than one class of common
shares, zero otherwise;
PartU = percentage difference between the offer price and the original mid-file price if the
adjustment is positive, zero otherwise; and,
PartD = percentage difference between the offer price and the original mid-file price if the
adjustment is negative, zero otherwise.

Variables similar to those in eq. (1) (other than PS) are widely used in various recent studies

of IPO underpricing [e.g., Bradley and Jordan (2002), Habib and Ljungqvist (2001), and Smart

and Zutter (2002)]. For ordinary IPOs, VC-backed issues tend to be more underpriced during our

time period, although the effect may be due to industry focus. Issues with greater overhang are

also typically more underpriced, as are firms in “high-tech” industries. Listing status, particularly

15
We specify a series of dummy variables because the use of a single variable (with values equal to underwriter
ranks) makes the implicit assumption that there is equivalence in effects between each level. Our approach allows
the data to make that determination.

9
for penny stocks, should serve as an information proxy, as firms that are listed should be more

transparent. Contrary to earlier findings [e.g., Carter and Manaster (1990)], numerous recent

studies find that firms associated with “prestigious” lead underwriters are more underpriced in

the 1990s [e.g., Beatty and Welch (1996) and Cooney, Singh, Carter, and Dark (2002)].

We include the percentage of secondary shares sold in the IPO as Habib and Ljungqvist

(2001) find a negative relation between initial returns and this variable. The natural log of the

size of the deal is a common conditioning variable, but it also controls for the possibility that

penny stock status is purely an offering price size effect. A recent study by Bradley, Cooney,

Jordan, and Singh (2002) finds that IPOs priced on an integer exhibit greater underpricing. The

lag variables proxy for investor sentiment and the existence of a “hot” IPO market. The inclusion

of Multiple is motivated by Smart and Zutter (2002), who find that IPOs with multiple share

classes are less underpriced. Finally, PartU and PartD control for the well-known “partial

adjustment” phenomenon first documented by Hanley (1993). We include separate variables for

upward and downward adjustments because recent studies find evidence of an asymmetric effect

(upward adjustments have a much greater impact). Our results are presented in Table 2.

Insert Table 2 about here

Regression (1) in Table 2 examines all IPOs over the time period. The coefficient on PS is

7.53 percent and is highly significant (p = 0.06 percent). Listing status, whether National or

SmallCap, does not have a significant effect on underpricing. However, our ability to separately

evaluate the effect of national listing is limited by the fact that the variable PS captures almost

the same information (the only exceptions are companies that are not listed on a national market

10
even though they have offer prices above $5).16 With the exception of Multiple, VC, and the

underwriter prestige variables, the coefficients for the remaining variables are generally

consistent with most recent research. Over, HT, LnSize, Integer, IPOLag, NasLag, PartU, and

PartD are all significant at any conventional level with signs consistent with previous research.

VC backing is negative, albeit significant at the 16 percent level, which is in contrast to

recent studies (which exclude low-priced IPOs), but consistent with earlier results in Megginson

and Weiss (1991). The majority of the underwriter prestige variables are negative and

significant, which is also in contrast to more recent findings. Since the lowest quality group (rank

1) is the omitted case, these results suggest that moving from a rank 1 underwriter to an

underwriter of higher prestige significantly reduces the initial return. Interestingly, the

coefficients are largest (in absolute value) for mid-tier underwriters, suggesting a “U”-shaped

relation.17

In summary, after controlling for a wide range of important issue features, we continue to

find that penny stock IPOs are much more underpriced. Also, contrary to most recent research,

we find that the inclusion of penny stock IPOs in the sample leads to negative coefficients on the

certification variables, VC backing (but only marginally significant) and underwriter prestige.18

In unreported results, we repeat regression (1) of Table 2 after dropping all IPOs with initial

mid-file prices at or above $10. Our motivation for this analysis is the possibility that lower-

priced IPOs are simply more underpriced than higher priced ones and that penny stock status per

16
We conduct a robustness check by running the regression without the variable National. Our primary findings are
unchanged.
17
Dolvin (2003) addresses this relation in more detail.
18
Lee and Wahal (2002) conclude that VC backing is an endogenous variable. Thus, we repeat all analyses in this
study using a two-stage least squares framework. Results as reported here are robust to this specification. We also
conduct robustness tests by including year dummy variables in all analyses. We find our conclusions to be
unchanged.

11
se is not important. We find that the coefficient on PS is relatively unchanged (6.76) and still

significant (p = 0.0142).19

An interesting result from the lower-priced sample is that the coefficient on VC is more than

three times as large in absolute value (-4.15 versus -1.17) and significant at the five percent level,

suggesting that VC certification is more important for lower-priced issues. The coefficients on

the underwriter prestige variables are similar in most cases, but, for the highest ranked

underwriters, the coefficient is numerically and statistically close to zero, again suggesting a

non-linear relation.

An important aspect of the analysis on the lower-priced sample is our use of the original mid-

file price as the cutoff. If we were to use the final mid-file price or the offer price, a potentially

serious bias is created because of the partial adjustment phenomenon. Specifically, firms with

offer prices originally below (above) $10, but subsequently adjusted to more (less) than $10,

would be excluded (included). The resulting sample would have a downward bias to its

measured underpricing because firms with downward adjustments would be overrepresented

relative to firms with upward adjustments.

The $5 price cutoff used for penny stock status creates a similar, but unavoidable, problem.

However, in this case, the effect is that we will be biased against finding greater underpricing for

penny stock IPOs. That is, our estimates of the difference in underpricing may be downward

biased. In fact, during the 1990-1998 period, there were 41 issues in our sample that met this

criterion (i.e., had an original mid-file price above $5, but a final offer price of $5 or less).

It is conceivable that the control variables used in our Table 2 regressions affect ordinary

IPOs and penny stock IPOs differently. Therefore, we estimate regression (1) from Table 2

19
We also repeat the analysis for all stocks with a mid-file below $7 and penny stock status remains significant at
the 7 percent level.

12
separately for ordinary and penny stock IPOs. The results from this analysis are presented in

columns (2) and (3), respectively, of Table 2. Additionally, column (4) reports the t-statistics for

difference tests between the marginal effects (i.e., the estimated coefficients) in each of these

regressions. The findings of the ordinary IPO analysis [column (2)] are generally consistent with

those from the entire sample [column (1)], with the exception that neither underwriter prestige

nor VC backing are significant in reducing underpricing.

Examining the results from the penny stock sample, only VC backing, the first two

underwriter prestige dummy variables, lagged IPO return, and partial upward adjustments are

significant in predicting initial returns. In many cases, however, the coefficients in the two

regressions are numerically very similar. In fact, as column (4) shows, the hypothesis that the

coefficients are identical can be rejected only for VC and the first two underwriter prestige

dummies. The effect of VC backing is economically much larger for the penny stock IPOs (-6.70

versus -0.86).20 When taken in conjunction with the importance of underwriter prestige, this

evidence suggests that third-party certification is of greater importance in the penny stock

market, which is consistent with the notion that certification matters more when informational

asymmetry is more severe.

4.3 Lockup lengths

Almost all IPOs are subject to a lockup agreement, which essentially restricts insiders from

selling shares for a pre-specified time period after the IPO. Bradley, Jordan, Roten, and Yi

(2001) and Field and Hanka (2001) document that the length of the lockup period for ordinary

IPOs has become very standardized at 180 days. In fact, Bradley, Jordan, Roten, and Yi (2001)

report that over 90 percent of their sample has a lockup time of exactly 180 days. However, as

20
Based on Bradley and Jordan (2002), industry concentration is a potential issue for VC-backed IPOs. For the
penny stock sample, however, there are no industries in which VC backing is especially prevalent.

13
indicated in Table 1, penny stock IPOs have much longer average lockups, 442 days, versus 212

days for ordinary IPOs. Table 3 contains a more detailed analysis of lockup lengths for ordinary

and penny stock IPOs, broken out by VC- and non-VC-backed issues.21

Insert Table 3 about here

Brav and Gompers (2003) examine the role of lockups and conclude that these agreements

serve as a commitment device designed to alleviate moral hazard problems associated with

asymmetric information between issuers and purchasers. Those firms with greater potential

problems must accept longer lockup times. Consistent with this idea, Table 3 shows that penny

stock IPOs have much longer lockup periods, with only 23 percent being at or below 180 days,

compared to 85 percent of ordinary IPOs. Additionally, we find that VC-backed firms in the

penny stock IPO market have an average lockup period of 346 days, versus 464 days for non-

VC-backed firms, which is statistically different at the one percent level. These findings again

support the proposition that VC backing reduces informational asymmetry, particularly in the

penny stock IPO market.22

As a further analysis, we estimate the following regression:

Lockup = α + β1PS + β2VC + β3LnSize + β4CM2 +..+ β11CM9

+ β12BM + β13Primary + β14Perlock + ε (2)

In eq. (2), Lockup is the lockup time in days for each issue. VC, LnSize, and CM2…CM9 are as

previously defined. BM is the book-to-market ratio immediately after the offer; Primary is the

21
Bradley, Jordan, Roten, and Yi (2001) document that reported lockup periods of zero days are generally data
errors. Thus, in all analyses related to lockup periods, we drop issues with reported lockup periods of zero.
22
We conduct a similar analysis by comparing issues with the lower quality underwriters (ranks 1-3) to those with
higher quality underwriters (ranks 4-9). Not surprisingly, given the results in Table 3, we find those IPOs (both
penny stock and ordinary) with higher quality underwriters have shorter lockup periods on average.

14
percentage of the shares offered that are primary; and Perlock is the percentage of the shares that

are under lockup. This particular specification follows Brav and Gompers (2003).23

If penny stocks are more information problematic, we would expect a positive coefficient on

PS. If the certification hypothesis is correct, we would expect negative coefficients on VC and

the underwriter prestige variables. Firms that are larger or have higher book-to-market ratios are

often considered to be less information problematic; thus, we expect negative coefficients on

these variables. Brav and Gompers (2003) suggest that the greater the percentage of primary

shares that are offered, the less concerned management will be about the subsequent lockup

period; thus, we expect a positive coefficient on Primary. The percent of shares locked up may

be an alternative to the length of lockup and, thus, have a negative relation. Table 4 presents the

results of this analysis.

Insert Table 4 about here

Similar to Table 2, we separately report the results for all IPOs [column (1)], ordinary IPOs

[column (2)], and penny stock IPOs [column (3)]. Additionally, we report the t-statistic from a

difference test between the marginal impacts of each variable in the ordinary and penny stock

markets [column (4)]. The findings are generally consistent with our expectations and are in line

with our earlier results.

The results in regression (1) show that penny stock status increases lockup lengths by an

economically and statistically significant 85 days, which is consistent with a greater degree of

informational asymmetry for these issues. VC backing reduces lockup times for both penny stock

and ordinary IPOs; however, regressions (2) and (3) show that the effect is much greater for

23
Brav and Gompers (2003) use the natural log of lockup length as the dependent variable, but we choose to use
actual lockup length for ease of interpretation of the results. We also conduct the analysis using the natural log of
lockup length, and our findings are unchanged.

15
penny stock IPOs. Specifically, VC backing reduces the lockup period by 101 days for penny

stock IPOs, but only 11 days for ordinary IPOs. Thus, the certification effect associated with VC

backing appears to be stronger for the penny stock IPO market, again suggesting that

certification is important, but primarily for issues where information asymmetry problems are

most severe.

Within each group, issues that are larger tend to have shorter lockup periods, which is also

consistent with our expectations. This effect is much stronger for penny stock IPOs. Penny stock

IPOs with higher book-to-market ratios have shorter lockups. The negative coefficient on

PerLock is consistent with the hypothesized tradeoff between lockup length and the percentage

of shares locked up, and, once again, the effect is more pronounced for penny stock IPOs.

For ordinary IPOs, underwriter certification effects (i.e., lower lockup lengths) only exist for

higher-ranked underwriters, and the lower-ranked underwriters (Carter-Manaster ranks of 2 or 3)

are actually associated with longer lockup periods relative to underwriters with a rank of 1 (i.e., a

“negative” certification effect). For penny stock IPOs, underwriters do not appear to provide a

significant certification benefit related to lockup length. Further, in comparing penny stock IPOs

to ordinary IPOs, the t-statistics for the difference tests of the first two underwriter rank

coefficients (i.e., Carter-Manaster ranks 2 and 3) are negative and significant, so the “negative”

certification effect appears to be limited to the ordinary IPOs.24

4.4 Gross spreads

Referring back to Table 1, average gross spreads are approximately 2.5 percentage points

higher for penny stock IPOs compared to ordinary IPOs. Our result for ordinary IPOs is similar

24
As previously mentioned, lockup lengths are relatively standard. Thus, as a robustness check, we repeat the
analysis of lockup lengths using an ordered probit model, where the dependent variable takes on a value of 0 if
lockup length is less then 180 days, 1 if it is exactly equal to 180 days, and 2 if it is greater than 180 days. Results
are consistent with those reported. Additionally, we repeat the OLS regression using all issues with original mid-file
prices below $10 and below $7, and, once again, our results are robust.

16
to Chen and Ritter (2000), who find that over 90 percent of moderate-sized equity IPOs from

1995 to 1998 have gross spreads equal to 7 percent. As shown in Figure 3, we find that penny

stock IPOs have a similar clustering around 10 percent. In fact, over the 1990-1998 period, 78

percent of penny stock issues have gross spreads of exactly 10 percent.

Insert Figure 3 about here

Figure 3 also illustrates that the percentage of penny stock IPOs with spreads exactly equal to

10 percent is greater than the percentage of ordinary IPOs with spreads of exactly 7 percent. The

percentage of penny stock IPOs with a 10 percent spread is approximately equal to 80 percent in

every year of our sample, whereas the percentage of ordinary IPOs with a 7 percent spread is

approximately 50 percent in 1990, increasing to approximately 70 percent in 1998. Thus, we find

that a single fixed spread does not characterize the IPO market. Rather, IPO spreads tend to

cluster around two amounts: 7 percent for ordinary IPOs and 10 percent for penny stock IPOs.25

Larger spreads for penny stock IPOs are consistent with the existence of a large fixed cost

component to the underwriting process. However, it is also possible that the larger spread

partially compensates the investment bank for the increased information asymmetry of penny

stock offerings. For ordinary IPOs, investment banks gather information from institutional

investors during the book-building process. This process supplements their own estimates of the

issuing firm’s value and can help in the pricing decision. It is unlikely that large institutions

would be active purchasers of penny stock IPOs [Fernando, Krishnamurthy, and Spindt (2002)].

Forced to rely more on retail investors, the pricing of these issues is inherently more risky.

As an additional analysis, we model gross spreads as follows:

25
In unreported results, we examined spreads from the 1980s as well. For penny stocks, 85 percent of penny stock
issues have a gross spread equal to 10 percent in the 1980s. Thus, it appears that penny stock gross spreads have
remained relatively constant through time. In contrast, as discussed in Chen and Ritter (2000), the clustering of
ordinary IPO spreads is a more recent phenomenon.

17
 Spread = α + β1PS + β1VC + β2LnSize + β3CM2 +…+ β10CM9
+ β11National+ β12SmallCap + ε (3)

Results are reported in Table 5. Similar to previous tables, we conduct the analysis separately for

all IPOs [column (1)], ordinary IPOs [column (2)], and penny stock IPOs [column (3)],

subsequently testing the difference between the effects in the ordinary and penny stock markets

[column (4)].26 If the spread is indeed compensation for informational asymmetry, we would

expect that VC backing and market listing would reduce the spread due to their potential

certification roles. Higher prestige underwriters may be able to attract lower risk offerings,

allowing them to charge lower fees. The variable LnSize serves as a control variable and also as a

test of economies of scale, which would imply a negative relation if scale economies are present.

Insert Table 5 about here

After controlling for the other variables, penny stock status significantly increases gross

spread, which is consistent with larger amounts of informational asymmetry and pricing risk.27

Thus, spreads are higher for penny stock IPOs even after taking into account that they are

typically smaller offerings. The coefficient on LnSize is negative and significant for all groups,

indicating scale economies exist. VC backing is also negatively related to gross spreads in all

groups; however, the effect is only economically significant in the penny stock market. Hence,

our results for penny stocks are consistent with those in Megginson and Weiss (1991)—venture

capitalist participation is associated with lower initial returns and gross spreads. However, we

extend their finding by concluding that this certification effect from venture capitalist

participation is stronger and more relevant in markets where informational asymmetry is more

26
Recall from the discussion in section 4.1 that there is a relation between penny stock status and national listing.
Thus, for regression (2), National is practically the intercept. For robustness, we repeat each regression without
National, and we find similar results.
27
As a robustness check, we repeat regression (1) on all IPOs with initial mid-file prices below $10 and below $7.
Penny stock status remains significant in both.

18
severe, i.e., penny stock IPOs. Finally, examination of the Carter-Manaster variables show that

IPOs with higher-prestige investment banks have lower spreads, consistent with the high-prestige

banks’ ability to attract lower-risk offerings.28

5. Conclusion

IPO researchers routinely screen out lower-priced issues and/or IPOs not included in the

CRSP database. The filters used generally correspond closely to the legal definition of a penny

stock as provided by the Penny Stock Reform Act (PSRA) of 1990. As a consequence of this

almost universal practice, penny stock IPOs have been largely ignored in the IPO literature.

We compare penny stock and ordinary IPOs, focusing on three variables heavily researched

in the IPO literature: initial returns, lockup periods, and gross spreads. For the post-PSRA era,

after controlling for a wide range of issue and market characteristics, we find that penny stock

IPOs (1) are more underpriced; (2) have much longer lockup periods; and (3) are associated with

larger gross spreads. All of these differences are economically meaningful and consistent with

higher degrees of asymmetric information in penny stock IPOs. Further, our findings indicate

that differences between penny stock and ordinary IPOs cannot simply be explained by a size

effect.

We explore the effect of venture capital (VC) backing and underwriter prestige on penny

stock IPOs. Contrary to some recent studies that focus on higher-priced IPOs, we find that VC

backing is associated with lower initial returns, shorter lockup periods, and lower gross spreads

for penny stock IPOs. We also find that penny stock IPOs with more reputable investment banks

28
Based on the clustering of spreads at 7 percent for ordinary IPOs and 10 percent for penny stock IPOs, we conduct
a robustness check using an ordered probit, where the dependent variable for ordinary (penny stock) IPOs takes on a
value of 0 if the spread is less than 7 (10) percent, 1 if it is equal to 7 (10) percent, and 2 if it is above 7 (10) percent.
The results of this analysis are consistent with those reported. VC backing and more prestigious underwriters
significantly decrease the probability of having a higher spread, and the effect is much more significant for penny
stock IPOs.

19
have lower initial returns. These results are consistent with the hypothesis that third-party

“certification” is valuable, particularly in situations where severe informational asymmetry

and/or the significant possibility of fraud may exist.

As these findings suggest, penny stock IPOs are a previously untapped and potentially rich

resource for IPO researchers, particularly those interested in the effects of third-party

certification. In the future, we recommend that IPO researchers carefully consider the rationale

for excluding low-priced IPOs.

20
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market, Purdue University working paper.

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Journal of Law and Economics 39, 545-603.

Bradley, D., J. Cooney, B. Jordan, and A. Singh, 2003, Negotiation and the IPO offer price: A
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Bradley, D. and B. Jordan, 2002, Partial adjustment to public information and IPO underpricing,
Journal of Financial and Quantitative Analysis 37, 595-616.

Bradley, D., B. Jordan, and J. Ritter, 2003, The quiet period goes out with a bang, Journal of
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Bradley, D., B. Jordan, I. Roten, and H. Yi, 2001, Venture capital and IPO lockup expiration: An
empirical analysis, Journal of Financial Research 24, 465-494.

Brav, A. and P. Gompers, 2003, The role of lock-ups in initial public offerings, Review of
Financial Studies 16, 1-29.

Carter, R. and S. Manaster, 1990, Initial public offerings and underwriter reputation, Journal
of Finance 45, 1045-1067.

Chen, H. and J. Ritter, 2000, The seven percent solution, Journal of Finance 55, 1105-1131.

Cooney, J., A. Singh, R. Carter, and F. Dark, 2002, IPO initial returns and underwriter
reputation: Has the inverse relationship flipped in the 1990s?, Texas Tech University working
paper.

Dolvin, S., 2003, The underwriter certification effect, University of Kentucky working paper.

Fernando, C., S. Krishnamurthy, and P. Spindt, 2002, Who cares about the level of share prices?
Evidence from initial public offerings, University of Oklahoma working paper.

Field, L. and G. Hanka, 2001, The expiration of IPO share lockups, Journal of Finance 56, 471-
500.

Habib, M. and A. Ljungqvist, 2001, Underpricing and entrepreneurial wealth losses in IPOs:
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Hanley, K., 1993, The underwriting of initial public offerings and the partial adjustment
phenomenon, Journal of Financial Economics 34, 231-250.

21
Lee, P. and S. Wahal, 2002, Grandstanding, certification and the underpricing of venture capital
backed IPOs, Emory University working paper.

Ling, D. and M. Ryngaert, 1997, Valuation uncertainty, institutional involvement, and the
underpricing of IPOs: The case of REITs, Journal of Financial Economics 43, 433-456.

Ljungqvist, A. and W. Wilhelm, 2003, IPO pricing in the dot-com bubble, Journal of Finance
58, 723-752.

Loughran, T. and J. Ritter, 2002, Why don’t issuers get upset about leaving money on the table
in IPOs?, Review of Financial Studies 15, 413-443.

Loughran, T. and J. Ritter, 2003, Why has underpricing increased over time?, University of
Florida working paper.

Megginson, W. and K. Weiss, 1991, Venture capitalist certification in initial public offerings.
Journal of Finance 46, 879-903.

New York State Attorney General, 1997, Report on microcap stock fraud, Bureau of Investor
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Noronha, G. and K. Yung, 1997, Reverse LBO underpricing: informational asymmetry or price
support? Journal of Applied Business Research 13, 67-77.

Peavy, J., 1990, Return on initial public offerings of closed-end funds, Review of Financial
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Ritter, J., 1991, The long-run performance of initial public offerings, Journal of Finance 46, 3-
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Seguin, P., and M. Smoller, 1997, Share price and mortality: An empirical evaluation of newly
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Slovin, M., M. Sushka, and S. Ferraro, 1995, A comparison of the information conveyed by
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22
Table 1: Firm characteristics

This table provides basic summary statistics for penny stock and ordinary IPOs for the 1990-
1998 period. Real estate investment trusts, closed-end investment funds, spin-offs, mutual-to-
stock conversions (e.g., S&Ls), American depositary receipts, and unit offerings are excluded.
Market cap, Total assets, Equity, and Net income are in millions of dollars. Equity is book
equity. HT is a dummy variable equal to one if the issue is classified as high-tech, zero
otherwise. VC is a dummy variable equal to one if the issue is venture capital-backed, zero
otherwise. CM rank is the Carter-Manaster underwriter prestige ranking. National is a dummy
variable equal to one if the issue is listed on the NYSE, AMEX, or Nasdaq National Market, zero
otherwise. SmallCap is a dummy variable equal to one if the issue is listed on the Nasdaq
SmallCap market, zero otherwise. Initial return is the percentage difference from the offer price
to the closing price on the first day of trading. Gross spread is the percentage spread paid to the
underwriter. Lockup is the number of days spent in lockup. Data are from Thomson Financial’s
Securities Data Company New Issue database, the Center for Research in Security Prices
database, and Standard and Poor’s Daily Stock Price Record from 1990 to 1998. t-statistics are
for a difference in means test and are calculated assuming unequal variances.

Ordinary IPOs Penny stock IPOs

Variable N Mean Std dev N Mean Std dev t-statistic
Offer price 3200 11.96 4.40 243 4.36 0.85 na
Market cap 3200 43.97 55.85 243 5.76 2.40 38.25
Total assets 1243 784.58 3328.1 45 40.55 60.89 7.85
Equity 2776 61.90 238.28 222 5.24 2.45 12.52
Net income 1238 -7.89 225.47 45 -2.32 12.64 -0.83
HT 3200 0.38 0.49 243 0.31 0.46 2.29
VC 3200 0.41 0.49 243 0.16 0.36 10.20
CM rank 3200 6.99 2.18 242 2.72 1.22 48.74
National 3182 0.94 0.25 243 0 0 na
SmallCap 3182 0.03 0.17 243 0.57 0.50 -16.85
Initial return (%) 2950 15.13 24.08 238 21.49 28.05 -3.40
Gross spread (%) 3197 7.19 0.92 241 9.68 0.80 -45.96
Lockup (days) 3003 211.55 113.27 197 441.79 229.06 -14.00

23
Table 2: Regression results: Initial returns

This table provides the results of OLS regressions of initial returns as follows:

Initial = α + β1PS + β2VC + β3Over + β4HT + β5National + β6SmallCap + β7CM2

+…+ β14CM9 + β15Secondary + β16LnSize + β17Integer + β18IPOLag
+ β19NasLag + β20Multiple + β21PartU + β22PartD + ε

where:

Initial =return from the offer price to the closing stock price on the first day of trading;
PS =dummy variable equal to one if the issue is a penny stock, zero otherwise;
VC =dummy variable equal to one if the issue is VC-backed, zero otherwise;
Over =“overhang,” measured as pre-IPO shares retained divided by total shares offered;
HT =dummy variable equal to one if the issue is high-tech, zero otherwise;
National =dummy variable equal to one if the offering is listed on the NYSE, AMEX, or
Nasdaq National Market, zero otherwise;
SmallCap = dummy variable equal to one if the offering is listed on the Nasdaq SmallCap
Market, zero otherwise;
CM2...CM9 = dummy variables equal to one if the underwriter has a prestige ranking in the
relevant category, zero otherwise (a Carter-Manaster (1990) rank of 1 is the
omitted category);
Secondary = percentage of shares offered that are secondary shares;
LnSize = natural logarithm of the offer size;
Integer = dummy variable equal to one if the offer price is an integer, zero otherwise;
IPOLag = an underpricing index defined as the average initial return for all IPOs in the
sample on calendar days –1 to –30 before the issue date;
NasLag = average daily return on the Nasdaq composite for the twenty-one trading days
(one month) prior to the issue;
Multiple = dummy variable equal to one if the issue has more than one class of common
shares, zero otherwise;
PartU = percentage difference between the offer price and the original mid-file price if the
adjustment is positive, zero otherwise; and,
PartD = percentage difference between the offer price and the original mid-file price if the
adjustment is negative, zero otherwise.

Regression (1) looks at all IPOs over the period. Regression (2) looks only at ordinary IPOs, and
regression (3) looks only at penny stock IPOs. Column (4) reports the t-statistics for a difference
test between the coefficients from regressions (2) and (3). A significant coefficient indicates a
different marginal impact between the penny stock and ordinary markets. Real estate investment
trusts, closed-end investment funds, spin-offs, mutual-to-stock conversions (e.g., S&Ls),
American depositary receipts, and unit offerings have been eliminated. Data are from Thomson
Financial’s Securities Data Company New Issue database, the Center for Research in Security
Prices database, and the Standard and Poor’s Daily Stock Price Record from 1990 to 1998.

24
Table 2 - continued

Variable (1) (2) (3) (4)

* *
Intercept 12.28 6.38 28.98 na
*
PS 7.53 na na na
*** ***
VC -1.17 -0.86 -6.70 -1.63
* *
OVER 0.70 0.70 0.93 0.19
* *
HT 4.80 4.89 4.74 -0.05
National 1.66 3.08 0 na
SmallCap -0.26 2.67 -1.51 -0.92
** * *
CM2 -6.49 0.13 -17.56 -2.96
** **
CM3 -3.45 0.87 -12.20 -2.14
CM4 -2.64 1.16 -9.39 -1.43
*
CM5 -7.49 -3.88 -10.51 -0.95
**
CM6 -6.50 -2.44 0 na
***
CM7 -4.73 -0.68 0 na
***
CM8 -4.82 -0.87 0 na
CM9 -2.36 1.47 0 na
Secondary -0.03 -0.03 -0.08 -0.32
* *
LnSize -2.02 -1.81 -4.46 -0.61
* *
Integer 3.20 3.01 4.81 0.53
* * **
IPOLag 0.18 0.16 0.39 1.36
* *
NasLag 0.52 0.54 0.27 -0.87
Multiple 1.58 1.66 0 na
* * *
PartU 0.71 0.71 0.61 -0.62
* *
PartD 0.24 0.24 0.16 -0.49
N 3146 2927 219
Adjusted R2 .2712 .2829 .0956

*, **, and *** indicate significance at the 1, 5, and 10 percent levels, respectively.

25
Table 3: Lockup time distribution by VC backing

The following table provides the distribution of lockup times for ordinary and penny stock IPOs
over the period 1990-1998. A comparison is done for VC-backed firms versus non-VC-backed
firms. Real estate investment trusts, closed-end investment funds, spin-offs, mutual-to-stock
conversions (e.g., S&Ls), American depositary receipts, and unit offerings have been eliminated.
Data are from Thomson Financial’s Securities Data Company New Issue database from 1990 to
1998.

Panel A: Ordinary IPOs

VC-backed Non-VC-backed Combined
Days in Firms Cumulative Firms Cumulative Firms Cumulative
Lockup percentage percentage Percentage
<90 1 0.08 5 0.28 6 0.20
90 32 2.59 58 3.54 90 3.15
91-179 75 8.48 53 6.52 128 7.35
180 1,071 92.61 1,312 80.31 2,383 85.46
181-359 41 95.83 51 83.18 92 88.48
360-366 36 98.66 153 91.79 189 94.67
367-540 10 99.45 71 95.78 81 97.32
541-549 3 99.69 15 96.62 18 97.91
550-719 0 99.69 1 96.68 1 97.94
720-732 4 100.00 54 99.72 58 99.84
>732 0 100.00 5 100.00 5 100.00

Total 1,273 100.00 1,778 100.00 3,051 100.00

Mean 187 days 230 days 212 days

Panel B: Penny stock IPOs

VC-Backed Non-VC-backed Combined
Days in Firms Cumulative Firms Cumulative Firms Cumulative
lockup percentage percentage percentage
<90 0 0.00 1 0.63 1 0.51
90 1 2.70 10 6.88 11 6.09
91-179 2 8.11 2 8.13 4 8.12
180 12 40.54 17 18.76 29 22.84
181-359 1 43.24 4 21.26 5 25.38
360-366 7 62.16 39 45.64 46 48.73
367-540 8 83.78 33 66.27 41 69.54
541-549 1 86.48 7 70.65 8 73.60
550-719 0 86.48 0 70.65 0 73.60
720-732 4 97.30 43 97.50 47 97.46
>732 1 100.00 4 100.00 5 100.00

Total 37 100.00 160 100.00 197 100.00

Mean 346 days 464 days 442 days

26
Table 4: Regression results: Lockup length

This table provides the results of OLS regressions of lockup length as follows:

Lockup = α + β1PS + β2VC + β3LnSize + β4CM2 +..+ β11CM9

+ β12BM + β13Primary + β14Perlock + ε

where:

Lockup = lockup time in days;

PS = dummy variable equal to one if the issue is a penny stock, zero otherwise;
VC = dummy variable equal to one if the issue is VC-backed, zero otherwise;
LnSize = natural logarithm of the offer size;
CM2..CM9= dummy variables equal to one if the underwriter has a prestige ranking in the
relevant category, zero otherwise (a Carter Manaster (1990) rank of 1 is the
omitted category);
BM = book-to-market ratio immediately after offer;
Primary = percentage of shares offered that are primary; and,
PerLock = percentage of shares that are subject to the lockup provision.

Regression (1) looks at all IPOs. Regression (2) looks only at ordinary IPOs, and regression (3)
looks only at penny stock IPOs. Column (4) reports the t-statistics for a difference test between
the coefficients from regressions (2) and (3). A significant coefficient indicates a different
marginal impact between the penny stock and ordinary markets. Real estate investment trusts,
closed-end investment funds, spin-offs, mutual-to-stock conversions (e.g., S&Ls), American
depositary receipts, and unit offerings have been eliminated. Data are from Thomson Financial’s
Securities Data Company New Issue database from 1990 to 1998.

27
Table 4 - continued

Variable (1) (2) (3) (4)

* *
Intercept 366.55 339.35 315.55 na
*
PS 84.62 na na na
* * * *
VC -16.35 -11.03 -101.49 -4.05
* * *** *
LnSize -15.96 -12.71 -74.90 -2.80
* * *
CM2 37.77 77.77 -33.32 -3.39
* * ***
CM3 40.18 59.07 2.80 -1.67
CM4 -19.55 -6.74 -4.66 0.06
* * **
CM5 -118.95 -112.50 -38.50 1.94
* *
CM6 -145.83 -132.60 0 na
* *
CM7 -142.89 -129.65 0 na
* *
CM8 -135.88 -125.00 0 na
* *
CM9 -127.07 -117.26 0 na
*** *
BM -2.03 3.64 -189.13 -3.81
** * **
Primary 0.27 0.24 4.21 2.29
** *** * *
PerLock -0.04 -0.02 -0.69 -6.79
N 2648 2470 178
Adjusted R2 .4030 .3519 .0945

*, **, and *** indicate significance at the 1, 5, and 10 percent levels, respectively.

28
Table 5: Regression results: Gross spread

This table provides the results of OLS regressions of gross spreads as follows:

Spread = α + β1PS + β1VC + β2LnSize + β3CM2 +..+ β10CM9

+ β11National+ β12SmallCap + ε

where:

Spread = gross underwriting spread;

PS = dummy variable equal to one if the issue is a penny stock, zero otherwise;
VC = dummy variable equal to one if the issue is VC-backed, zero otherwise;
LnSize = natural logarithm of the offer size;
CM2..CM9 = dummy variables equal to one if the underwriter has a prestige ranking in the
relevant category, zero otherwise (a Carter Manaster (1990) rank of 1 is the
omitted category);
National = dummy variable equal to one if the offering is listed on the NYSE, AMEX, or
Nasdaq National Market, zero otherwise; and,
SmallCap = dummy variable equal to one if the offering is listed on the Nasdaq SmallCap
Market, zero otherwise.

Regression (1) looks at all IPOs. Regression (2) looks only at ordinary IPOs, and regression (3)
looks only at penny stock IPOs. Column (4) reports the t-statistics for a difference test between
the coefficients from regressions (2) and (3). A significant coefficient indicates a different
marginal impact between the penny stock and ordinary markets. Real estate investment trusts,
closed-end investment funds, spin-offs, mutual-to-stock conversions (e.g., S&Ls), American
depositary receipts, and unit offerings have been eliminated. Data are from Thomson Financial’s
Securities Data Company New Issue database from 1990 to 1998.

29
Table 5 - continued

Variable (1) (2) (3) (4)

* * *
Intercept 9.85 9.70 10.89 na
*
PS 0.61 na na na
* ** * *
VC -0.06 -0.04 -0.51 -4.37
* * *
LnSize -0.45 -0.44 -0.56 -1.10
** **
CM2 0.06 0.19 -0.18 -2.32
***
CM3 0.04 0.12 -0.17 -1.80
* * *
CM4 -0.71 -0.72 -0.55 0.89
* * * *
CM5 -1.12 -1.14 -0.45 3.72
* *
CM6 -1.22 -1.18 0 na
* *
CM7 -1.21 -1.17 0 na
* *
CM8 -1.10 -1.06 0 na
* *
CM9 -1.09 -1.05 0 na
*
National -0.16 -0.09 0 na
* * *
SmallCap 0.26 0.40 0.12 -2.45
N 3420 3179 241
Adjusted R2 .7286 .6249 .4275

*, **, and *** indicate significance at the 1, 5, and 10 percent levels, respectively.

30
Figure 1: Distribution of IPOs by Carter-Manaster underwriter rank

The following figure provides the percentage distribution of initial public offerings from the
1990-1998 period by Carter-Manaster (1990) rank, where 9 is the highest rank. Ordinary IPOs
are shown first, penny stock IPOs next. Real estate investment trusts, closed-end investment
funds, spin-offs, mutual-to-stock conversions (e.g., S&Ls), American depositary receipts, and
unit offerings have been eliminated. Data are from Thomson Financial’s Securities Data
Company New Issue database from 1990 to 1998.

Distribution of IPOs by CM Rank

50%
Percent of Total IPOs

40%
30%
20%
10%
0%
1 2 3 4 5 6 7 8 9
CM Rank

Ordinary IPOs Penny Stock IPOs

31
Figure 2: Initial returns by year

This figure shows initial returns by year. Initial return is the percentage difference between the
closing price on the first day of trading and the offer price. Ordinary IPOs are shown first, penny
stock IPOs next. Real estate investment trusts, closed-end investment funds, spin-offs, mutual-to-
stock conversions (e.g., S&Ls), American depositary receipts, and unit offerings have been
eliminated. Offer prices are obtained from Thomson Financial’s Securities Data Company New
Issue database from 1990 to 1998, and closing prices are obtained from the Center for Research
in Security Prices database and Standard and Poor’s Daily Stock Price Record.

Initial Return by Year

35%
30%
Percent Return

25%
20%
15%
10%
5%
0%
1990 1991 1992 1993 1994 1995 1996 1997 1998
Year
Ordinary IPOs Penny Stock IPOs

32
Figure 3: Percentage of fixed gross spreads by year

This figure presents the percentage of penny stock IPOs with gross spreads exactly equal to 10
percent and the percentage of ordinary IPOs with gross spreads exactly equal to 7 percent for
each of the nine years in our sample. Ordinary IPOs are shown first, penny stock IPOs next.
Real estate investment trusts, closed-end investment funds, spin-offs, mutual-to-stock
conversions (e.g., S&Ls), American depositary receipts, and unit offerings have been eliminated.
Data are from Thomson Financial’s Securities Data Company New Issue database from 1990 to
1998.

Fixed Gross Spreads

100%

80%
Percent Fixed

60%

40%

20%

0%
1990 1991 1992 1993 1994 1995 1996 1997 1998
Year
Ordinary IPOs Penny Stock IPOs

33