Financial Wealth, Socioemotional Wealth and IPO Underpricing in Family Firms: A Two-Stage Gamble Model

There are competing theoretical explanations and conflicting empirical evidence for the IPO underpricing phenomenon in family firms. The behavioral agency model predicts that loss-averse family firms discount their shares more than non-family firms in order to minimize losses of socioemotional wealth (SEW). By contrast, the endowment effect in prospect theory suggests that family owners maximize their financial wealth (FW) by including SEW in their perceptions of firm value and demanding a higher IPO price to relinquish it. We reconcile these seemingly incompatible predictions by adding insights on the dynamic properties of the reference point in decision framing. Conceiving IPO pricing as a two-stage gamble, we theorize that initial SEW losses entailed by the listing decision increase the disposition of family owners to underprice IPO shares to possibly offset these losses, or to “break even”. In doing so, we advance the behavioral agency model with the aversion to loss realization logic to explain how the decision frames and preferences of family owners change during the IPO process, depending on initial losses of current SEW and new expectations of future SEW. Our analysis of 1,807 IPOs in Europe supports our theoretical expectations, clarifying the trade-off between FW and SEW and explicating the dynamic properties of mixed gambles in family firms.