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
Why?
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
falling
Some blame the Sarbanes-Oxley (SOX) Act of 2002
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
Number of IPOs
800
80
700
70
600
60
500
50
400
40
300
30
200
20
100
10
0
0
Calendar Year
Average First-Day Returns, %
Number of Offerings and Average First-day Returns on US IPOs, 1980-2007
Percentage of U.S. IPOs from non-U.S. Issuers, 1994-2007
30
Percentage of IPOs
25
20
15
10
5
0
1994
1995
1996
1997
1998
1999
2000
2001
Calendar Year
2002
2003
2004
2005
2006
2007
Percentage of U.K. AIM IPOs from non-U.K. Issuers, 1995-2006
Percentage of IPOs
40
30
20
10
0
1995
1996
1997
1998
1999
2000
2001
Calendar Year
2002
2003
2004
2005
2006
Singapore has become a major center for small Chinese
companies to go public
Year
2004
2005
2006
Number of Foreign IPOs in Singapore
All
From China and Hong Kong
14
29
32
13
24
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
-25
Calendar Year
150
30
125
25
100
20
75
15
50
10
25
5
0
0
-5
Average First-day Returns, %
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
90
19
89
19
88
19
87
19
86
19
85
19
84
19
83
Number of IPOs
Number of Offerings and Average First-day Returns on French IPOs, 1983-2007
200
80
150
60
100
40
50
20
0
0
-50
-20
Calendar Year
Average First-day Return, %
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
Number of IPOs
Number of Offerings and Average First-day Returns on German IPOs, 1980-2007
-10
Calendar Year
50
100
40
80
30
60
20
40
10
20
0
0
-20
Average First-day Return, %
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
90
19
89
19
88
19
87
19
86
19
85
Number of IPOs
Number of Offerings and Average First-day Returns on Italian IPOs, 1985-2007
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
Number of IPOs
500
90
400
80
70
300
60
50
200
40
30
100
20
10
0
0
Calendar Year
Average First-Day Returns, %
Number of Offerings and Average First-day Returns on UK IPOs, 1980-2007
100
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?
30%
20%
Average first-day returns
Average first-day returns on (mostly) European IPOs
50%
40%
10%
0%
Swi tzerland
Singapore
Sweden
Germany
Greece
Poland
Italy
Uni ted States
Finl and
Uni ted Kingdom
Hong Kong
Israel
Belgium
Spa in
Turkey
Fra nce
Netherl ands
Norway
Chi le
Denmark
Canada
Aus tria
Country
170%
160%
150%
140%
130%
120%
110%
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Average first-day returns
Average first-day returns on (mostly) non-European IPOs
Chi na (A shares)
Indi a
Mal ays ia
Kor ea
Brazil
Japan
Taiwan
Thailand
Sou th Afric a
Swi tzer land
Singapore
Iran
New Zealand
Aus trali a
Uni ted States
Hong Kong
Mex ico
Israel
Nig eria
Tur key
Chi le
Canada
Country
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
common?
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
Date
Ebber's
Shares
Offer
Price
Market
Price
First-day
Profit
McLeod
6/96
Tag Heuer
9/96
Qwest Communications 6/97
TV Azteca
8/97
Box Hill Systems
9/97
Nextlink Communications 9/97
China Mobile HK
10/97
Metromedia Fiber
10/97
Teligent
11/97
Earthshell
3/98
Rhythms Netconnection 4/99
Juno Online
5/99
Juniper Networks
6/99
Focal Communications
7/99
Williams Communications10/99
Radio Unica
10/99
Chartered Semiconductor10/99
UPS
11/99
KPNQwest
11/99
Tycom Ltd
7/00
Signalsoft
8/00
200,000
5,000
205,000
1,000
5,000
200,000
2,000
100,000
30,000
12,500
10,000
10,000
5,000
5,000
35,000
4,000
5,000
2,000
20,000
7,500
5,000
$20.00
$19.55
$22.00
$18.25
$15.00
$17.00
$30.50
$16.00
$21.50
$21.00
$21.00
$13.00
$34.00
$13.00
$23.00
$16.00
$20.00
$50.00
$20.81
$32.00
$17.00
$25.13
$20.00
$28.00
$19.19
$20.62
$23.25
$28.00
$21.38
$25.63
$23.56
$69.13
$11.63
$98.88
$19.50
$28.06
$27.44
$33.19
$67.38
$29.81
$37.00
$21.88
$1,026,000
$2,250
$1,230,000
$900
$28,100
$1,250,000
-$5,000
$538,000
$123,900
$32,000
$481,300
-$13,700
$324,400
$32,500
$177,100
$45,800
$66,000
$34,800
$180,000
$37,500
$24,400
IPO
“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:
Date
Commission
Per Share
Security
Number
of Shares
12/9/99
$2.75
AT&T
50,000
12/9/99
$2.70
Citigroup
50,000
12/9/99
$1.25
Compaq
100,000
12/9/99
$0.50
K Mart
50,000
12/9/99
$0.80
Kroger Co.
100,000
12/10/99
$0.50
Kroger Co.
125,000
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
underperform.
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
skewness.
20
Annual Percentage Returns
18
16
14
12
10
8
6
4
2
0
Style Matched
First
Year
Second
Year
IPOs
Third
Year
Fourth
Year
Fifth
Year
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.
3-year buy-and-hold style-adjusted returns
6,424 U.S. IPOs from 1980-2003. Style-adjusted returns exclude the opening day return.
Style controls for market capitalization and book-to-market.
30%
25%
20%
15%
10%
5%
0%
0-9
10-19
20-49
50-99
-5%
-10%
-15%
-20%
-25%
-30%
Annual Sales, $millions
100-499
500-up
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
Bookbuilding
Information acquisition (Benveniste and Spindt (1989))
Agency problems (Loughran and Ritter (2002, 2004))
Auctions
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 nondiscriminatory manner (favoritism vs. pro rata)?
August 1992, Shenzhen: Before the rioting started,
crowds waited for the new share subscription forms
51
The Growth of IPO Auctions in the U.S.
Name of IPO (ticker)
1999: (3 out of 476 IPOs)
Ravenswood Winery (RVWD)
Salon.com (SALN)
Andover.net (ANDN)
2000: (1 out of 381 IPOs)
Nogatech (NGTC)
2001: (2 out of 80 IPOs)
Peet's Coffee (PEET)
Briazz (BRZZ)
2002: (1 out of 66 IPOs)
Overstock.com (OSTK)
2003: (2 out of 63 IPOs)
RedEnvelope (REDE)
Genitope (GTOP)
2004: (2 out of 174 IPOs)
New River Pharmaceuticals (NRPH)
Google (GOOG)
2005: (5 out of 161 IPOs)
B of I Holding (BOFI)
Morningstar (MORN)
CryoCor (CRYO)
Avalon Pharmaceuticals (AVRX)
Dover Saddlery (DOVR)
2006: (2 out of 156 IPOs)
Traffic.com (TRFC)
FortuNet (FNET)
2007: (3 out of 159 IPOs)
Interactive Brokers Group (IBKR)
Clean Energy Fuels (CLNE)
NetSuite (N)
Date of IPO
Gross
Spread
Gross
Proceeds
19990408
19990622
19991208
4.00%
5.00%
6.50%
$10.5 million
$26.2 million
$72.0 million
20000518
6.50%
$42.0 million
20010125
20010502
6.50%
6.00%
$26.4 million
$16.0 million
20020529
4.00%
$39.0 million
20030925
20031029
6.00%
7.00%
$30.8 million
$33.3 million
20040805
20040819
7.00%
2.81%
$33.6 million
$1,666.4 million
20050315
20050502
20050714
20050928
20051117
6.00%
2.00%
7.00%
7.00%
5.00%
$35.1 million
$140.8 million
$40.8 million
$28.9 million
$27.5 million
20060125
20060131
6.00%
4.50%
$78.6 million
$22.5 million
20070504
20070525
20071219
1.88%
5.85%
5.75%
$1,200.4 million
$120.0 million
$161.2 million
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 yearearlier 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%
Summary
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
models