Issuer Expenses and Legal Liability in Initial Public Offerings
![handle is hein.journals/jlecono39 and id is 549 raw text is: ISSUER EXPENSES AND LEGAL LIABILITY IN
INITIAL PUBLIC OFFERINGS*
RANDOLPH P. BEA TTY and IVO WELCH
Southern Methodist University University of California,
Los Angeles
ABSTRACT
Issuers of initial public offerings (IPOs) face numerous decisions, of which the
selection and compensation of experts-the legal counsel, the auditor, and the in-
vestment banker-are among the most important. Our article investigates the role
of the entire IPO coalition (including the legal counsel). In a comprehensive sample
of 823 firm-commitment offerings from 1992 to 1994, we examine how expert
compensation, IPO underpricing, and IPO underpricing uncertainty are related to
(1) expert quality (we provide in the text our directly comparable ranking of the
top 50 experts in each category in December 1994), (2) legal caution and liability,
(3) nonlegal risk signals, and (4) one another. The results are contrasted with similar
results from the 1980s.
I. INTRODUCTION
AN issuer of an initial public offering (IPO) faces numerous decisions,
of which the selection and compensation of experts--the legal counsel,
the auditor, and the investment banker-are among the most important. The
issuer's available trade-offs are likely to be determined not only by differ-
ences in the functions of the three experts but also by the experts' differing
legal exposure. These legal differences are in turn specified in the provis-
ions of the Securities Act of 1933, which can cause differing asymmetric
information scenarios. For example, the legal counsel is generally not only
involved at a later stage in the IPO process than the auditor but is also held
to lower legal standards. The auditor is fully liable for any material omis-
sion in the audited financial statements of the registration statement, while
law firms are typically exempt from Section 11 liability. As such, the preva-
lent uncertainty may be different: the issuer may have to be more concerned
with the quality of the legal advice than vice versa, while the auditor may
have to be more concerned with the quality of the issuer than vice versa.
One focus of our analysis is the empirically observable riskiness of the
* We express our thanks to Jeremy Stein, Jay Ritter, Roni Michaely, Michael Vetsuypens,
Ravi Bushan, and Thomas G. E. Williams for their generous comments.
[Journal of Law and Economics, vol. XXXIX (October 1996)]
© 1996 by The University of Chicago. All rights reserved. 0022-2186/96/3902-0007$01.50](ViewImageLocal?handle=hein.journals/jlecono39&div=23&collection=&method=preview&ext=.png&size=3)
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Issuer Expenses and Legal Liability in Initial Public Offerings
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