Bakke, EinarLeite, Tore EThorburn, Karin S2023-05-222018-09-282016-09-282017-08-28https://repository.upenn.edu/handle/20.500.14332/34547Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a rational explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)’s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This “incentive effect” receives strong empirical support in a sample of 6300 IPOs in 1983–2012. Controlling for the incentive effect, the positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is held to be most informative, effectively resolving the predictability puzzle.© 2016. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/IPOunderpricingbookbuildingpublic informationprivate informationpartial adjustmentBusinessFinance and Financial ManagementArticle