Are Ipos Really Underpriced?
Review of Financial Studies, Vol. 17, pp. 811-848, 2004
57 Pages Posted: 26 Aug 2001 Last revised: 2 Jan 2011
Date Written: May 1, 2002
This paper studies the valuation of initial public offerings (IPO) using comparable firm multiples. In a sample of more than 2000 IPOs from 1980 to 1997, we find that the median IPO is overvalued at the offer by about 50% relative to its industry peers. This overvaluation is robust over time, across technology and non-technology IPOs, to different price multiples, industry classifications, and matching firms. In the cross-section, overvalued IPOs earn 5% to 7% higher first day returns than undervalued IPOs but earn 20% to 50% lower returns over the next five years. The long-run underperformance of overvalued IPOs is robust to various benchmarks, return measurement methodologies and the Fama-French three-factor model. Overvalued IPOs exhibit higher sales growth rates only temporarily but earn persistently lower profit margins and return on assets than undervalued IPOs over the next five years suggesting that any projected growth opportunities implicit in the initial valuation fail to materialize subsequently. Our results suggest overvaluation is the likely source of the long-run underperformance of IPOs and provide support for behavioral theories based on investor overreaction.
Keywords: IPO Overpricing, Underpricing, Valuation, Multiples, Behavioral, Overconfidence, Long run return
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