The Performance of Initial Public Offerings and the Cross Section of Institutional Ownership

Abstract

The paper examines the relation between the cross section of institutional ownership in IPOs and subsequent returns. We find that the level of institutional ownership shortly after the IPO and subsequent changes in holdings forecast future performance up to three years after the issue date. IPOs in the highest institutional ownership quintile outperform IPOs in the lowest quintile by roughly 1% a month after adjusting for risk. Controlling for market conditions, return predictability is limited to 'hot markets' characterized by high volume of IPOs and large first day returns. The performance of IPOs widely held by institutions does not reflect initial 'undervaluation' and subsequent price correction. Rather, institutional investors hold stocks with high growth expectations that experienced a strong price run-up in the past. The findings are consistent with institutional investors acting as momentum traders and enjoying high profits in periods where 'sentiment' is high.