Do Underwriters Have an Information Advantage? Evidence from Institutional Investor Holdings around IPO-Related Securities Class Action Announcements

We examine whether institutional investors, and specifically underwriters, have an information advantage over other market participants in new public companies. We focus our attention on a sample of publicly traded firms that have become the target of an IPO-related securities class action lawsuit filed under Section 11 of the 1933 Securities Act between January 1991 and December 2006 and a matched sample of similar non-sued firms. By comparing aggregate institutional holding changes in sued and non-sued firms as well as holding revisions by different types of institutions that are classified based on their involvement in the IPO process, we find evidence suggesting that institutions are able to identify eventual litigation targets and, moreover, that lead underwriters are more proactive in their trading decisions than unaffiliated institutional investors. We conclude that lead underwriters retain an information advantage in the firms they take public and that they capitalize on this information by closing out or reducing their holdings in sued firms prior to the eventual litigation date. Furthermore, our results indicate that informed pre-litigation selling is accompanied by an increased divergence of analyst opinions about sued firms. Analysts affiliated with lead underwriters are somewhat reluctant to reduce their earnings forecasts or downgrade sued firms – a pattern that is inconsistent with their otherwise aggressive trading behavior. JEL Classification: G11, G12, G14, G18, K22