Ž . Journal of Empirical Finance 8 2001 375–401 www.elsevier.comrlocatereconbase The valuation of IPO and SEO firms Gary Koop a , Kai Li b, ) a Department of Economics, UniÕersity of Glasgow, Glasgow, G12 8RT, UK b Faculty of Commerce, UniÕersity of British Columbia, 2053 Main Mall, VancouÕer, BC, Canada V6T 1Z2 Accepted 8 June 2001 Abstract Ž . We examine the pricing of initial public offering IPO and seasoned equity offering Ž . SEO firms using a stochastic frontier methodology. The stochastic frontier framework models the difference between the maximum possible value of the firm and its actual market capitalization at the time of the offering as a function of observable firm character- istics. Using a new data set, we find that commonly used pricing factors do indeed influence valuation. Ceteris paribus, firms in industries with great earnings potential are more highly valued, and IPO firms are underpriced. Theories regarding underwriter reputation or windows of opportunity for equity issuance are not supported in our empirical results. q 2001 Elsevier Science B.V. All rights reserved. JEL classification: G30, Corporate finance—general; G32, Financing policy; G14, Information and market efficiency; C11, Bayesian analysis; C15, Statistical simulation methods Keywords: Misvaluation; Underpricing; Stochastic frontier; Bayesian inference; Gibbs sampling 1. Introduction Valuation plays a central role in corporate finance for several reasons. First, corporate control transactions such as hostile takeovers and management buyouts require the valuation of equity. Second, privately held corporations that need to set a price for their initial public offerings, or public firms that require further equity financing, must first establish the value of their equity. Finally, the estimated equity value is important in setting the capital structure of these issuing firms. ) Corresponding author. Tel.: q 1-604-822-8353; fax: q 1-604-822-4695. Ž . E-mail address: kai.li@commerce.ubc.ca K. Li . 0927-5398r01r$ - see front matter q 2001 Elsevier Science B.V. All rights reserved. Ž . PII: S0927-5398 01 00033-0