The Role of Transitory Shocks in Equity Financing: Evidence from IPOs

Abstract

Building on the idea that transitory shocks should not have long-run effects on dividends and prices, we use cointegration techniques to decompose stock market shocks into permanent and transitory shocks. We present a simple model that demonstrates the distinctive effects of transitory shocks on managers’ decision on going public and the degree of ownership dilution, and test the model predictions. We find that IPO volume increases after stronger transitory shocks. Firms that go public after stronger transitory shocks underperform more severely on average, but are more likely to be delisted for both good and bad reasons, implying that they are ex ante riskier, not worse, firms. We also find that during the book-building period, issuers tend to increase ownership dilution after transitory shocks. The findings suggest that issuers can effectively distinguish transitory stock market shocks from permanent ones and make strategic decisions to maximize their own interests in response to each type of shock.

Keywords: Permanent-transitory decomposition, initial public offerings, long-run performance

JEL Classification: G02, G12, G32