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Abstract:
We review the theory and evidence on IPO activity: why firms go public, why they reward first-day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective on the literature is three-fold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phenomena. Instead, we believe future progress in the literature will come from non-rational and agency conflict explanations. We describe some promising such alternatives.

IPOs

Abstract:
In the 1980s, the average first-day return on initial public offerings (IPOs) was 7%. The average first-day return doubled to almost 15% during 1990-1998, before jumping to 65% during the internet bubble years of 1999-2000 and then reverting to 12% during 2001-2003. We attribute much of the higher underpricing during the bubble period to a changing issuer objective function. We argue that in the later periods there was less focus on maximizing IPO proceeds due to an increased emphasis on research coverage. Furthermore, allocations of hot IPOs to the personal brokerage accounts of issuing firm executives created an incentive to seek rather than avoid underwriters with a reputation for severe underpricing.

Abstract:
In the 1980s, the average first-day return on initial public offerings (IPOs) was 7%. The average first-day return doubled to almost 15% during 1990-1998, before jumping to 65% during the internet bubble years of 1999-2000. Part of the increase can be attributed to changes in the risk composition of the companies going public and a realignment of incentives. We attribute much of the higher underpricing during the bubble period to a changing issuer objective function. We argue that in the later periods there was less focus on maximizing IPO proceeds due to both an increased emphasis on research coverage and allocations of hot IPOs to the personal brokerage accounts of issuing firm executives.

Initial public offerings, internet bubble, underwriter reputation, spinning

Abstract:
One of the puzzles regarding initial public offerings (IPOs) is that issuers rarely get upset about leaving substantial amounts of money on the table, defined as the number of shares sold times the difference between the first-day closing market price and the offer price. The average IPO leaves $9.1 million on the table. This number is approximately twice as large as the fees paid to investment bankers, and represents a substantial indirect cost to the issuing firm. We present a prospect theory model that focuses on the covariance of the money left on the table and wealth changes. Our reasoning also provides an explanation for a second puzzling pattern: much more money is left on the table following recent market rises than after market falls. This results in an explanation of hot issue markets. We also offer a new explanation for why IPOs are underpriced.

Initial public offerings, prospect theory, behavioral finance, hot issue markets

Abstract:
Stocks are short sale constrained when there is a strong demand to sell short and a limited supply of shares to borrow. Using data on both short interest, a proxy for demand, and institutional ownership, a proxy for supply, we find that constrained stocks underperform during 1988-2002 by a significant 215 basis points per month on an EW basis, although by only an insignificant 39 basis points per month on a VW basis. For the overwhelming majority of stocks, short interest and institutional ownership levels make short selling constraints unlikely.

Short Sales, Limits to Arbitrage, Short Selling

Abstract:
It is widely believed that economic growth is good for stockholders. However, the cross-country correlation of real stock returns and per capita GDP growth over 1900-2002 is negative. Economic growth occurs from high personal savings rates and increased labor force participation, and from technological change. If increases in capital and labor inputs go into new corporations, these do not boost the present value of dividends on existing corporations. Technological change does not increase profits unless firms have lasting monopolies, a condition that rarely occurs. Countries with high growth potential do not offer good equity investment opportunities unless valuations are low.

Economic Growth, Equity Premium Puzzle

Abstract:
This paper examines time series patterns of external financing decisions and shows that publicly traded U.S. firms fund a much larger proportion of their financing deficit with external equity when the cost of equity capital is low. The historical values of the cost of equity capital have long-lasting effects on firms' capital structures through their influence on firms' historical financing decisions. We also introduce a new econometric technique to deal with biases in estimates of the speed of adjustment towards target leverage. We find that firms adjust toward target leverage at a moderate speed, with a half-life of 3.7 years for book leverage, even after controlling for the traditional determinants of capital structure and firm fixed effects.

capital structure, market timing, static tradeoff, speed of adjustment

Abstract:
This paper examines time series patterns of external financing decisions and shows that publicly traded U.S. firms fund a much larger proportion of their financing deficit with external equity when the cost of equity capital is low. The historical values of the cost of equity capital have long-lasting effects on firms' capital structures through their influence on firms' historical financing decisions. We also introduce a new econometric technique to deal with biases in estimates of the speed of adjustment towards target leverage. We find that firms adjust toward target leverage at a moderate speed, with a half-life of 3.7 years for book leverage, even after controlling for the traditional determinants of capital structure and firm fixed effects.

capital structure, market timing, pecking order, static tradeoff, speed of adjustment, long difference

Abstract:
We examine over 7,400 analyst recommendations in the year after going public for IPOs from 1999-2000. Initiations at the end of the quiet period come almost exclusively from affiliated analysts, while initiations afterwards are predominantly from unaffiliated analysts. Once we control for timing, we find no evidence of a difference in market reaction to affiliated versus unaffiliated analyst initiations. Our results contradict prior findings that the market discounts recommendations from affiliated analysts, suggesting instead that the informational advantage possessed by affiliated analysts outweighs the greater conflicts of interest they may face. Finally, the amount of analyst coverage is related to the number of managing underwriters only for the smallest IPOs.

IPO, analyst, quiet period, bubble

Abstract:
In an accelerated seasoned equity offering (SEO), an issuer foregoes the investment bank’s marketing efforts in return for a lower fee. To explain why many issuing firms choose a higher cost fully marketed offer, we posit that the marketing effort flattens the issuer’s short-run demand curve. Alternatively stated, with a fully marketed offer, the issuer is paying investment bankers to create demand, making the elasticity of demand at the time of issuance an endogenous choice variable. Empirical analysis shows that both the pre-issue elasticity of the issuing firm’s demand curve and the offer size are important determinants of the offer method choice. We find evidence of a large transitory increase in the elasticity of demand for issuers conducting fully marketed SEOs.

marketing of securities, follow-on offerings, seasoned equity offerings

Abstract:
Using a sample of 56 companies going public in 1996-2000 in which top executives received allocations of other hot initial public offerings (IPOs) from the bookrunner, a practice known as spinning, we examine the consequences of spinning. The 56 IPOs had first-day returns that were, on average, 23% higher than similar IPOs. The profits collected by these executives were only a small fraction of the incremental amount of money left on the table by their companies when they went public. These companies were dramatically less likely to switch investment bankers in a follow-on offer: only 6% of issuers whose executives were spun switched underwriters, whereas 31% of other issuers switched. These findings suggest that the spinning of executives accomplished its goal of affecting corporate decisions.

Spinning, IPOs, SEOs, Underpricing

Abstract:
We examine how investment banks use initial public offerings (IPOs) in relation to their affiliated mutual funds. The dumping ground hypothesis predicts that the lead underwriter allocates cold IPOs to its affiliated funds so that more deals can be completed when demand for these IPOs is weak. Affiliated funds may also receive more cold IPOs because the lead underwriter uses allocations of hot IPOs to unaffiliated funds to gain trading commission business. The nepotism hypothesis predicts that the lead underwriter allocates hot IPOs to its affiliated funds to boost their performance and thus attract more money. We find little evidence supporting the dumping ground hypothesis, although there is some evidence supporting the nepotism hypothesis, especially during the internet bubble period of 1999-2000.

Initial public offerings, mutual funds, IPO allocations

Abstract:
We examine how investment banks use initial public offerings (IPOs) in relation to their affiliated mutual funds. The dumping ground hypothesis predicts that the lead underwriter allocates cold IPOs to its affiliated funds so that more deals can be completed when demand for these IPOs is weak. Affiliated funds may also receive more cold IPOs because the lead underwriter uses allocations of hot IPOs to unaffiliated funds to gain trading commission business. The nepotism hypothesis predicts that the lead underwriter allocates hot IPOs to its affiliated funds to boost their performance and thus attract more money. We find little evidence supporting the dumping ground hypothesis, although there is some evidence supporting the nepotism hypothesis, especially during the internet bubble period of 1999-2000.

Initial public offerings, mutual funds, IPO allocations

Abstract:
Underwriters using bookbuilding have discretionary power for allocating shares of initial public offerings (IPOs). Commissions paid to underwriters by investors are one of the determinants of IPO allocations. We test the hypothesis that investors trade liquid stocks in order to affect their IPO allocations. Consistent with this hypothesis, we find that money left on the table by IPOs affects the trading volume of the 50 most liquid stocks close to the offer date. For an IPO that leaves $1 billion on the table, in the six days ending on the day that trading commences there is abnormal volume in the 50 most liquid stocks of 2.7 to 4.1%, although only during the internet bubble period is this statistically significant.

IPOs, brokerage commissions

Abstract:
The presence of venture capital in the ownership structure of U.S. firms going public has been associated with both improved long-term performance and lower underpricing at the time of the IPOs. In Japan, we find the long-run performance of venture capital-backed IPOs to be no better than that of other IPOs, with the exception of firms backed by foreign owned or independent venture capitalists. Many of the major venture capital firms in Japan are subsidiaries of securities firms that may face a conflict of interest when underwriting the venture capital-backed issue. When venture capital holdings are broken down by their institutional affiliation, we find that firms with venture backing from securities company subsidiaries do not perform significantly worse over a three-year time horizon than other IPOs. On the other hand, we find that IPOs in which the lead venture capitalist is also the lead underwriter have higher initial returns than other venture capital-backed IPOs. The latter result suggests that conflicts of interest influence the initial pricing, but not the long-term performance, of initial public offerings in Japan.

Abstract:
We review the theory and evidence on IPO activity: why firms go public, why they reward first-day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective is threefold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phenomena. Instead, we believe future progress in the literature will come from nonrational and agency conflict explanations. We describe some promising such alternatives.

Abstract:
We review the theory and evidence on IPO activity: why firms go public, why they reward first-day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective on the literature is three-fold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phenomena. Instead, we believe future progress in the literature will come from non-rational and agency conflict explanations. We describe some promising such alternatives.

Abstract:
Using a longer time period and both NYSE-Amex and Nasdaq stocks, this paper examines short interest and stock returns in more detail than any previous study and finds that many documented patterns are not robust. While equally weighted high short interest portfolios generally underperform, value weighted portfolios do not. In addition, there is a negative correlation between market returns and short interest over our whole period. Finally, inferences from short time periods, such as 1988-1994 when the underperformance of high short interest stocks was exceptional or 1995-2002, when high short interest Nasdaq stocks did not underperform, are misleading.

Abstract:
Determines the "hot issue" market of 1980 to result primarily from natural resource firms. The hot issue market extending from January 1980 to March 1981 is characterized by an average initial return of 48.4% on unseasoned new issues of common stock, as compared to the 16.3% average initial return of the cold issue period for the remainder of 1977-1982. To analyze the hot issue market, monthly average initial returns are calculated using 1977-82 data of SEC-registered initial pubic offerings as reported in Going Public: The IPO Reporter (1975-82), which continues Ibbotson and Jaffe's (1975) study of the previous 1960-76 period. An equilibrium phenomenon explanation is rejected, since when analyzed separately, startup natural resource-related firms saw a significant boom in returns - 110.9% as compared to 18.3% in the cold issue period - whereas a hot issue market is barely perceptible in other markets. The possibility that the hot issue market resulted from a high percentage of underpriced high-risk offerings, according to Rock's (1982) model, is also rejected, since the data shows that natural resource issues had the same relation between risk and expected initial return as did non-natural resource issues during the cold issue market, and then dramatically increased in the hot issue market. Thus, the explanation lies in a nonstationarity in the risk-initial return relation for natural resource firms, and points to differing activity by market segment. This study implies that the best time for issuing firms to go public is during the unstable, high-volume period immediately following a hot issue market for their industry. (CJC)

Industry sectors, Stock offerings, Rates of return, Initial public offerings (IPO), Natural resources, Risk assessment, Underpricing

Abstract:
Two anomalies have been documented in the performance of initial public offerings (IPOs): (1) in the short-run they are underpriced, and (2) they are subject to the "hot issue" market phenomenon. This analysis identifies a third anomaly: in the long-run, IPOs appear to be overpriced. Examined a sample of 1,526 IPOs offered in the 1975-84 period. Several measures were devised to evaluate long-run performance of IPOs. Found that in the three years after going public, the firms significantly underperformed a comparable set of firms. The IPOs returned 34.5 percent, while a control sample returned 61.9 percent. Possible explanations include risk mismeasurement, bad luck, and fads or over-optimism. Found there is considerable variation in underperformance year-to-year. Those firms going public in high-volume years suffered most -- the underperformance is concentrated among young growth companies going public in the high-volume years of the early 1980s. This pattern is consistent with firms going public when investors are irrationally over optimistic about earning potential of young firms in certain industries; firms exploit these "windows of opportunity" or go public near the peak of industry-specific fads. (TNM)

Startups, Initial public offerings (IPO), Securities offerings, Valuation, Underpricing, Market value

Abstract:
Examines the underpricing of initial public offerings (IPOs) and the impact of this underpricing on investor uncertainty and on the investment bankers who take the firms public. The firms going public lack the credibility to assert that the offering price is below the expected market price because they only go public once. As a result, these firms seek the help of investment bankers who, through their underwriting process, take many firms public. Data used in the analysis were collected from 1,028 firms that went public between 1977 and 1982. Support is shown for the proposition that the greater the investor uncertainty in the value of the stock, the greater the underpricing is expected to be. The results further show that investment bankers who cheat on underpricing equilibrium by underpricing too much or too little are penalized by the market. Three conditions must be met for investment bankers to be willing to strive for underpricing equilibrium. These are: (1) uncertainty as to the market price of the stock when it beings trading, (2) reputation capital of the investment banker that cannot be repaired, and (3) decline in return on reputation capital if investment banker cheats on underpricing. Given these results, it becomes evident that investment bankers enforce the underpricing equilibrium. (SRD)

Credibility, Reputation, Uncertainty, Underpricing, Initial public offerings (IPO), Investment bankers, Investors, Investment banks

Abstract:
We examine over 7400 analyst recommendations made in the year after going public for IPOs from 1999 to 2000. Initiations of coverage at the end of the quiet period come almost exclusively from affiliated analysts, whereas initiations afterward are predominantly from unaffiliated analysts. Contrary to previous findings, we find no evidence that the market discounts recommendations from affiliated analysts once we control for recommendation characteristics and timing. Moreover, analyst coverage in the first year is not affected by underpricing, and after the flurry of initiations at the end of the quiet period, the number of analysts covering a firm during the following 11 months is unrelated to the number of managing underwriters.

Abstract:
Newly public companies are subject to a "quiet period" restricting insiders and affiliated underwriters from issuing earnings forecasts and research reports regarding the firm for a specified period following the initial public offering (IPO). As soon as this quiet period ends, the analysts of managing underwriters typically initiate research coverage with favorable recommendations, and the market responds positively even though this information is predictable. In this article, we discuss previous findings regarding price patterns and analyst initiations at the end of the quiet period and introduce new evidence based on recent trends in the IPO market. We discuss trading implications and examine the effect of new regulatory requirements that extend the quiet period from 25 to 40 calendar days post-IPO.

Analyst initiations, Analyst recommendations, Quiet period, Initial Public Offerings

Abstract:
We examine the expiration of the IPO quiet period, which occurs after the 25th calendar day following the offering. For IPOs during 1996 to 2000, we find that analyst coverage is initiated immediately for 76 percent of these firms, almost always with a favorable rating. Initiated firms experience a five-day abnormal return of 4.1 percent versus 0.1 percent for firms with no coverage. The abnormal returns are concentrated in the days just before the quiet period expires. Abnormal returns are much larger when coverage is initiated by multiple analysts. It does not matter whether a recommendation comes from the lead underwriter or not.

Abstract:
Defenders of market efficiency argue that anomalies involving long-term abnormal returns are not robust to alternative methodologies. We argue that because various methodologies use different weighting schemes, the magnitude of abnormal returns should differ, and in a predictable manner. Three problems are identified that cause low power in value-weighted three-factor time series regressions when abnormal returns following managerial actions are being estimated. We illustrate the sensitivities in the context of the new issues puzzle as well as with simulations. More generally, multifactor models as currently used do not, and cannot, test market efficiency.

Market efficiency, Anomalies, New issues puzzle, Risk factors

Abstract:
Companies issuing stock during 1970 1990, whether an initial public offering (IPO) or a seasoned equity offering (SEO), have been poor long run investments for investors. During the five years after the issue, investors have received average returns of only 5% per year for companies going public and only 7% per year for companies conducting an SEO. Book to market effects account for only a modest portion of the low returns. An investor would have had to invest 44% more money in the issuers than in non issuers of the same size to have the same wealth five years after the offering date.

Abstract:
Recent studies have documented that firms conducting seasoned equity offerings have inordinately low stock returns during the five years after the offering, following a sharp run-up in the year prior to the offering. This paper documents that the operating performance of issuing firms shows substantial improvement prior to the offering, but then deteriorates. The multiples at the time of the offering, however, do not reflect an expectation of deteriorating performance. Issuing firms are disproportionately high-growth firms, but issuers have much lower subsequent stock returns than nonissuers with the same growth rate.

Abstract:
Recent studies have documented that firms conducting seasoned equity offerings have inordinately low stock returns during the five years after the offering, following a sharp run-up in the year prior to the offering. This paper documents that the operating performance of issuing firms shows substantial improvement prior to the year of the offering, but then deteriorates, especially for smaller issuers. The multiples at the time of the offerings do not reflect an expectation of deteriorating performance, consistent with the hypothesis that the stock price run-up reflects a capitalization of transitory improvements. The sample contains 1,406 seasoned equity offerings during the 1979-1989 period.