Innovation Potential, Insider Sales, and IPO Performance: How Firms Can Mitigate the Negative Effect of Insider Selling

At the time of an initial public offering (IPO), firms seek to maximize their stock market value. The authors theorize and show that a firm's innovation potential-firm outputs and activities that contribute to the development of future new products-can be used by the managers of IPO firms as a credible signal of the quality of the firm. Using a sample of 370 IPO firms from the consumer-packaged goods and pharmaceutical industries, and three metrics of innovation potential, the authors show that firms' innovation potential is (1) positively associated with the initial value of the IPO and with the first-day IPO returns and (2) negatively associated with the extent to which insiders sell their shares at the time of the IPO. The effectiveness of the three metrics of innovation potential as a signal of firm quality varies: patents have a stronger impact on insider sales than preannouncements and generic references to future innovation, while preannouncements have the strongest impact on first-day IPO returns. The article presents a nuanced view of the extent to which various firm stakeholders consider information about firms' innovation potential to be a credible signal that reduces the adverse selection present in IPO deals with insider sales.

Automated summary

During an IPO, companies aim to maximize their stock market value. The authors argue that a firm's innovation potential, which includes outputs and activities contributing to future product development, can serve as a credible signal of firm quality for IPO managers. Analyzing a sample of 370 IPO firms in consumer-packaged goods and pharmaceutical industries, the authors find that innovation potential is positively associated with IPO initial value and first-day returns, and negatively associated with insider share selling. The effectiveness of innovation potential as a signal varies based on metrics used. Patents have a stronger impact on insider sales, while preannouncements have the strongest impact on first-day returns.