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Diversity and pricing

Gender diversity boosts underpricing in IPOs due to higher institutional investor demand for diverse boards, finds new study co-authored at Cambridge Judge Business School.

Comprehensive viewpoint of diverse group of business executives sitting together at conference table and looking at camera.

Firms with gender-diverse boards going public through big investment banks have a bigger first-day pop in their stock returns – but this likely reflects higher institutional investor demand for diverse boards rather than higher profitability or better stock market performance, find a new study co-authored at Cambridge Judge Business School.

The study finds that gender-diverse IPOs handled by bulge bracket banks were significantly more underpriced, leaving an average $34 million more on the table than non-diverse IPOs on their issue date.

Raghavendra Rau.
Professor Raghavendra Rau

The study co-authored by Professor Raghavendra Rau, which looked at more than 1,400 initial public offerings during the period 2000-2018, follows a 2020 decision by Goldman Sachs, the top lead underwriter of US firms, that it would stop financing IPOs of companies in the US and Europe with only white male board members.

While the study finds little evidence to support the “superior firm hypothesis” for gender-diverse boards in terms of higher profitability or better stock market performance after an IPO, it finds that institutional investors “significantly increased” their demand for gender-diverse new issues in the last decade – perhaps as a result of “social pressure, an increased focus on corporate social responsibility, and the improved qualifications and experience of female board members.”

IPOs are an appropriate venue to study the effect of shareholder preference on IPOs because an IPO is the “only type of corporate transaction where investors can express their opinions about company valuation”, the authors say.

Specifically, an IPOs book-building process allows investors to “show that they value stocks differently from traditional valuation methods, such as discounted cash flows and earnings multiples, by incorporating a premium for diversity, for example. Because the underpricing of IPO shares reflects the difference between market valuations and the valuations by the investment bank, such a premium can be measured directly. There is no other event where this is empirically feasible. For example, shareholder opinions are typically not solicited before a merger.”

The study is divided into roughly two decades, 2000-2009 and 2010-2018, owing to two reasons: the influential 2003 law in Norway requiring boards to have at least 40% women came into full compliance by 2009; and in 2010 the US Securities and Exchange Commission began requiring companies to disclose the role diversity considerations play when they select directors.

“Consistent with the split in time periods, the gender diversity of IPO boards changes drastically between the two decades. Less than 35% of all 2000–2009 IPOs had gender-diverse boards, whereas nearly 50% of 2010–2018 IPOs did,” the study says.

The study is devised in a way to test for the relationship between gender diversity and three factors: IPO underpricing, stock returns in the first six weeks of trading, and stock returns during the five years after the IPO. The study also breaks down the findings on whether the IPO is underwritten by “bulge bracket” investment banks (including: Bank of America/Merrill Lynch; Barclays; CitiGroup; Credit Suisse; Deutsche Bank; Goldman Sachs; JP Morgan; Morgan Stanley; and UBS) and smaller investment banks.

“We showed that gender-diverse IPO’s had significantly more IPO underpricing in the 2010s than in the 2000s”, said study co-author Raghu Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge Business School. “This is an important finding: as underpricing occurs when the actual issue price is above the initial price range.

“The greater prevalence of underpricing in the past decade suggests increasing demand by institutional investors for including diverse firms in their portfolios. Gender-diverse IPOs end up leaving much more money on the table than non-gender diverse firms: gender-diverse bulge bracket IPOs leave an average of approximately $34 million more on the table due to underpricing than non-diverse IPOs on their issue date,” says Professor Rau.

The study concludes: “In January 2020, when Goldman Sachs announced that they would no longer underwrite IPOs with all-male boards, the bank justified this decision partially on the basis of economic reasons. It claimed that diverse IPOs earned higher returns than non-diverse IPOs, at least in recent years.

“In this paper, we show that investors, in particular institutional investors, indeed appear to value gender-diverse IPOs more highly and this effect shows up in the underpricing of IPOs underwritten by bulge bracket investment banks from 2010-2018. IPOs with at least one woman on the board are significantly more underpriced than IPOs with all male boards.”

The study – entitled “Are women underpriced? Board diversity and IPO performance” – is co-authored by Professor Raghavendra Rau of Cambridge Judge Business School, Dr Jason Sandvik of the A.B. Freeman School of Business at Tulane University, and Professor Theo Vermaelen of INSEAD.