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Recent Developments in IPO Research - University of Florida by cuiliqing


									Recent Developments in IPO Research

                    Jay R. Ritter
                 University of Florida

Oxford EFMA IPO Symposium
A few topics
  •   The international competition for new listings
  •   Why are IPOs underpriced?
  •   Do IPOs underperform in the long run?
  •   How are IPOs sold?
The international competition for new listings
The vast majority of IPOs list in the issuer’s home market

Every year from 1995-2006, 90-97% of IPOs list in the
  issuer’s home market

Demand is local
 Some IPOs list in more than one market (cross-listing)
   Mainly very large IPOs, including privatizations
   Cross-listings have been rapidly declining, partly due to better
   clearing mechanisms in the EU

 Many Chinese companies list abroad (Singapore, London, New York)
   For attracting foreign investors, a Hong Kong listing is common
Some moderate-size and small firms list abroad
rather than at home
 Hong Kong’s market share has been rising

 AIM’s market share has been rising

 The market shares of the NYSE and NASDAQ have been

 Some blame the Sarbanes-Oxley (SOX) Act of 2002
Number of Offerings and Average First-day Returns on US IPOs, 1980-2007
Singapore has become a major center for small Chinese
companies to go public

            Number of Foreign IPOs in Singapore
 Year        All  From China and Hong Kong

 2004         14               13
 2005         29               24
 2006         32               29

 The median proceeds in 2006 = $25.6 million
Market conditions for IPOs fluctuate between hot and cold

French IPO volume has fluctuated between 4 and 121
IPOs per year

German IPO volume has fluctuated between zero and
175 IPOs per year

Italian IPO volume has fluctuated between zero and 42
IPOs per year

UK IPO volume has fluctuated between 12 and 264
IPOs per year
Number of Offerings and Average First-day Returns on French IPOs, 1983-2007
Number of Offerings and Average First-day Returns on German IPOs, 1980-2007
Number of Offerings and Average First-day Returns on Italian IPOs, 1985-2007
Number of Offerings and Average First-day Returns on UK IPOs, 1980-2007
The number of U.S. IPOs (not including ADRs) has
fluctuated between 63 to over 600 offerings per year
Investor protection vs. excessive regulation

 Jensen and Meckling (1976 JFE)
       Investors price protect themselves

 Shleifer and Vishny (1997 JF)
 La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998 JPE)
        Laws and their enforcement matter
Why are IPOs underpriced?
Asymmetric Information-based Explanations for Underpricing

   The “winner’s curse” or “Groucho Marx theorem” (Rock (1986))

      If you are unsure of the fair value of shares being sold,
      and there is excess demand, the most optimistic investors
      are likely to get the shares

      Thus, conditional on getting the shares, you find out
      that you are probably overoptimisitic

   The need to give institutions an incentive to investigate a
   company and buy its shares (Benveniste and Spindt (1989))
These are good explanations if we were seeking to explain why,
on average, underpricing is 5-10%

These are not good explanations when we are trying to explain
why underpricing is 15% or more
Underpricing and allocations are related
There are three frameworks for viewing discretion in allocations

   The information acquisition view (Benveniste and Spindt), in
       which underwriters favor regular investors who provide
       information about demand, resulting in more accurate pricing
    The “pitchbook” view, in which underwriters seek out
       buy-and-hold investors

    The rent-seeking view, in which underwriters trade money left
       on the table for quid pro quos (commission business)
       Biased analyst recommendations appeal to issuing firms
       and make them willing to leave money on the table
IPO Underpricing

• Is it equilibrium compensation for risk-bearing or
  providing information?

• Is it excessive, with rent-seeking behavior
Loughran and Ritter’s (2004 FM) issuer objective function:

  α1·IPO Proceeds + α2·Proceeds from Future Sales + (1-α1-α2)·Side Payments
Why do issuers put up with severe underpricing?

   On internet IPOs, underwriters knew they were overpriced
     But why did their analysts put out “buy” recommendations?

   Issuer stupidity
      The publicity is worth it
      Capital can be raised in a follow-on offering

   Prospect theory
      When people get good news about their wealth increasing,
      they don’t bargain as hard at the pricing meeting

   Analyst lust and spinning
     Issuers seek out underwriters where influential analysts
     will be bullish
     Spinning of hot IPOs to executives
Scandals (SLAC):

   Spinning: Allocating hot IPOs to the personal brokerage
   accounts of top executives in return for company business

   Laddering: Requiring the purchase of additional shares in
   the aftermarket in return for IPOs

   Analyst conflicts of interest: Giving “buy” recommendations
   in return for underwriting and M&A business

   Commission business in return for IPOs: Underwriters
   allocated IPOs primarily to investors that generated
   soft dollar commissions on other trades
Academic Evidence on SLAC Problems :

   Spinning: Xiaoding Liu and Jay Ritter’s
   “Corporate Executive Bribery: An Empirical Analysis”

   Laddering: Grace Hao’s 2007 JFE paper “Laddering in
   Initial Public Offerings”

   Analyst conflicts of interest: Mike Cliff and David Denis’s
   2004 JF paper and Liu-Ritter paper

   Commissions: Jon Reuter’s 2006 JF paper
Example of spinning: Salomon Smith Barney's allocations of IPOs to Bernie Ebbers

                                Ebber's       Offer     Market        First-day
IPO                    Date     Shares        Price      Price            Profit

McLeod                  6/96    200,000     $20.00       $25.13      $1,026,000
Tag Heuer               9/96      5,000     $19.55       $20.00          $2,250
Qwest Communications 6/97       205,000     $22.00       $28.00      $1,230,000
TV Azteca               8/97      1,000     $18.25       $19.19            $900
Box Hill Systems        9/97      5,000     $15.00       $20.62         $28,100
Nextlink Communications 9/97    200,000     $17.00       $23.25      $1,250,000
China Mobile HK        10/97      2,000     $30.50       $28.00         -$5,000
Metromedia Fiber       10/97    100,000     $16.00       $21.38       $538,000
Teligent               11/97     30,000     $21.50       $25.63       $123,900
Earthshell              3/98     12,500     $21.00       $23.56         $32,000
Rhythms Netconnection 4/99       10,000     $21.00       $69.13       $481,300
Juno Online             5/99     10,000     $13.00       $11.63        -$13,700
Juniper Networks        6/99      5,000     $34.00       $98.88       $324,400
Focal Communications    7/99      5,000     $13.00       $19.50         $32,500
Williams Communications10/99     35,000     $23.00       $28.06       $177,100
Radio Unica            10/99      4,000     $16.00       $27.44         $45,800
Chartered Semiconductor10/99      5,000     $20.00       $33.19         $66,000
UPS                    11/99      2,000     $50.00       $67.38         $34,800
KPNQwest               11/99     20,000     $20.81       $29.81       $180,000
Tycom Ltd               7/00      7,500     $32.00       $37.00         $37,500
Signalsoft              8/00      5,000     $17.00       $21.88         $24,400
“Corporate Executive Bribery: An Empirical Analysis”
           (joint work with Xiaoding Liu)

  • IPOs in which the executives are being spun
    are underpriced about 18% more than other
    IPOs, holding everything else constant

  • Firms that are involved in spinning are much
    less likely to switch underwriters for their next
    public equity offering (5% vs. 31%)
Analyst coverage
  Analyst Coverage Is Bundled with Bookbuilding

Degeorge, Derrien, and Womack (July 2007 RFS)
  “Analyst Hype In IPOs: Explaining the Popularity of Bookbuilding”
What are the most important qualities of a good analyst?

   a) Accurate earnings forecasts
   b) Timely buy and sell recommendations
   c) Insightful written reports
   d) Setting up meetings with management
   e) Accessibility/responsiveness of phone calls
   f) Industry knowledge
Example of kickbacks with commissions: Credit Suisse First
Boston (CSFB) received commission business equal to as much
as 65% of the profits that some investors received from certain
hot IPOs, such as the December 9, 1999 IPO of VA Linux

The VA Linux IPO involved 5.06 million shares

   Offer price:           $30.00
   Closing market price: $239.25
   Capital gain:         $209.25

    Gross spread:           $2.10

If the investor then traded shares to generate commissions of
one-half of this profit the total underwriter compensation per
share was $2.10 plus $104.625, or $106.725
According to paragraph 58 of the SEC’s January 22, 2002
settlement with CSFB, an institutional customer that had received
a 12,500 share allocation of VA Linux from CSFB paid CSFB at
least $565,000 by engaging in the following transactions:
Where were the regulators during the internet bubble?

At first…
But then…
And then…
Long-run performance of IPOs
While IPOs tend to go up on the first day of trading, in the long run,
on average they have tended to underperform.

But there is a strong cross-sectional pattern in the U.S.: IPOs that
had annual sales of less than $50 million severely underperform,
whereas those that had achieved annual sales of $50 million don’t
Buy-and-hold stock returns are skewed: there are some big
winners, but most stocks underperform. This is especially true
with young companies, where there is even greater right
Annual returns in the five years after going public for U.S. 6,973 IPOs from 1970-2003. Style-matched
firms match on market cap and book-to-market.
Many of the AIM listings have annual sales below $50 million, a
category in which U.S. IPOs have underperformed in the past.
How are IPOs sold?
Fixed Price Offerings
     Information acquisition (Benveniste and Spindt (1989))
     Agency problems (Loughran and Ritter (2002, 2004))

Hybrid Mechanisms
Pricing and Allocation

• Is the offer price set before or after information
  about the state of demand is acquired?

• Are shares allocated in a discriminatory or non-
  discriminatory manner (favoritism vs. pro rata)?
August 1992, Shenzhen: Before the rioting started,
crowds waited for the new share subscription forms

Google’s IPO
 • Andreas Trauten’s paper this morning
     “Why the Google IPO might stay exotic–
     an experimental analysis of offering mechanisms”
 • File price range of $108-135/share
 • Auction result: $85/share offer price
 • Closing first-day price of $100.33/share
What went wrong?
• Out of equilibrium disclosure strategy
• First post-IPO earnings announcement on Oct.
  21, 2004, with revenue up 105% from the year-
  earlier quarter: price jumped 15.4%
• Second post-IPO earnings announcement on
  Feb. 1, 2005 , with revenue up 101% from the
  year-earlier quarter: price jumped 7.3%
  Hot and Cold markets will continue

  Issuers still put up with underpricing

  Long-run underperformance is restricted to
   companies going public with less than
   $50 million in annual sales

  In the U.S., auctions are becoming (slightly)
   more common, although bookbuilding has
   become the dominant method internationally
Summary (continued)
   Regulatory reform has changed the game a little
    Spinning has been nearly eliminated
    Laddering continues to occur
    Analyst lust will continue
    Commission business in return for IPOs is still allowed

   Underwriters still have an incentive to underprice

   The academic literature still focuses too much on
   asymmetric information models rather than agency

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