An examination of initial public offerings (IPOs) that went public in Canada between 1971 and 1983 and subsequently traded on the Toronto Stock Exchange indicates that Canadian IPOs, like their U.S. counterparts, are on average underpriced. The average degree of underpricing ranged from 9 to 11.5 per cent, concentrated in the first three days from issuance. The level of underpricing varied significantly across firms, however. Approximately 40 per cent of the sample issues were actually overpriced.
Tests indicate that underpricing was significantly related to three variables—trading volume, business sector of the firm and the use to which funds from the offering were put. Underpricing was greater, the thinner the trading in the security (as measured by the number of days traded divided by the number of days listed over the first 200 trading days). IPO underpricing was more pronounced for firms in the industrial sector than for firms in other sectors of the economy. Issues raising funds for pure investment purposes (e.g., acquisition, exploration and research) experienced more underpricing than issues raising funds for other purposes. The evidence suggests that underpricing was not related to issue-specific measures of risk such as variance or beta.