Beatrice Presentation
March 2, 2004
Robert M. Hull,a, b Robert Kerchner,a
Sungkyu Kwak,a Rosemary Walker a
aSchool
of Business, Washburn University,
1700 SW College Avenue, Topeka, KS 66621
bCorresponding
author. Tel.: + 1-785-231-1010; fax: + 785-231-1063.
E-mail address: rob.hull@washburn.edu (R. Hull)
Earlier Version Published in Proceedings of:
American Financial Services, October 8, 2003
Final Version Published in:
Investment Management and Financial Innovation, 2005
Abstract
We examine the market’s response to IPOs surrounding the last
quarter of the year 2000. During this quarter, the financial press
began reporting insider accusations that investment bankers had
colluded with preferred clients to create profits in the IPO
aftermarket. We find that the underpricing associated with extreme
IPO aftermarket profits was sharply curtailed during this quarter.
Underpricing ceased altogether for the following quarter before
subsequently picking up. These findings become even more
pronounced after we compare IPO underpricing with that found for
firms undergoing seasoned offerings. We conclude that investment
bankers, for up to a six-month period, either ceased their alleged
aftermarket practices or drastically reduced their IPO profits to
pacify public sentiment.
JEL classifications: D82; G14; G32; G34
Key Words: Initial public offerings; Underpricing; IPO Bubble; Underwriter
compensation; Collusion; Seasoned Offerings



Underpricing refers to selling shares below their
fair value. Underpricing for IPOs, as measured by
first-day returns, is cyclical reaching heights of
60% to 80% during the buoyant markets of 1961,
1967-1968, 1980, and 1999-2000. In the United
States, first-day returns for IPOs averaged around
15% prior to 1999.
The unprecedented level of IPO underpricing for
1999-2000 is the most widely recognized feature
of what is now referred to as the “IPO bubble”.
This bubble can be likened to earlier bubbles such
as the 17th century tulip craze in Holland. At the
core of these bubbles is a compulsive demand by
zealous investors who often become subject to
price exploitation by opportunistic suppliers.
The end result for each bubble is absurdity. Can
we imagine how it would feel to save every penny
of earnings for seven years to buy a tulip bulb that
later would sell for less than one day’s wage?
IPO INFO






Underpricing refers to selling shares below their fair or true value.
Underpricing can be defined as the true price minus the offer price.
For SEOs, underpricing is measured ex-ante based on stock price data
prior to the offering, e.g., the closing market price the day before the
offer date
For IPOs, underpricing is measured ex-post based on the closing market
price at some designated time after the offering
Underpricing for IPOs, as measured by first-day returns, averaged 15%
prior to 1999.
Peaks for IPOs reach 60%-80% during 1961, 1967-1968, 1980, and 19992000.
The IPO bubble, like the 17th century tulip bubble or any bubble, has at
the core a compulsive demand by zealous investors who can become
subject to price manipulation by opportunistic suppliers.
Motivation for Research
• During the last quarter of the year 2000, the financial press
reported allegations that investment bankers operated
kickback schemes with preferred IPO clients when shares
were bought and sold in the IPO aftermarket.
• Allegedly, both the company (who raised less money) and
individual investors (who were not preferred clients and
consequently paid too much in the aftermarket) lost when
exorbitant profits were made through the manipulation of
stock prices.
• According to a complaint filed January 22, 2002 by the SEC,
underwriters extracted from clients (through excessive fees) a
large portion of the underpricing profits that those clients
made in the IPO aftermarket.
Purpose
We seek to empirically explore whether the
allegations of excessive IPO profits are rooted in
factual underpricing numbers during this period.
We do this by analyzing IPOs surrounding the last
quarter of 2000 when the serious allegations
began to surface. If these allegations are true (or
at least changed investment bankers behavior to
significantly lessen underpricing) then the profits
resulting from underpricing should begin
subsiding during the last quarter of the year 2000
when the allegations began hitting the financial
press.
Environmental Changes


First, the internal environment within a company changed
in the late 1990s. Wilhelm and Ljungqvist (2003) suggest
that the extreme underpricing in the late 1990s can be
least partially accounted for by a variety of marked changes
in pre-IPO ownership structure and insider selling behavior
over the period.
Second, the external environment affecting management
changed as investors clamored for more IPOs. This demand
created a situation where underwriters could more easily
dictate the terms of the IPO and collude with preferred
customers to jointly capitalize on the anticipated stock price
run-up in the IPO aftermarket.
Economic Justification
 In a red-hot IPO market, it becomes more
imperative to gather truthful input from
investors. Price support can overcome the fact
investment bankers in the countries like the U.S.
cannot price discriminate.
 Greater IPO underpricing leads to a less
favorable market reaction for subsequent
offerings.
 U.S. underwriters behave strategically in the
allocation of IPOs allocating favorable IPOs to
customers who partake in unfavorable IPOs.
Prior Research
 Underpricing for IPOs has been well documented and is more
extreme than that found for SEOs. There is overwhelming
international evidence of underpricing in IPOs. As measured by the
difference between the offer price and the first day of trading,
underpricing averages about 15% in industrialized countries and
about 60% in emerging markets.
 SEOs have not always focused on underpricing. One exception is
Hull and Kerchner (1996) who find that underpricing is 2.97% of
offer value (for example, for every $100 of equity raised, the
companies lose $2.97 due to underpricing). However, when just
small OTC firms (which are more similar in size to IPO firms) are
examined, they find that underpricing is 4.26% of the value of the
new offering. The findings of Hull and Kerchner (2000) suggest
underpricing should be greater for small IPO companies.
Underpricing Measures

Initial Public Offerings (IPOs)
Ex-Ante Measure: Offer Price Minus Average Price File Range
Ex-Post Measure: Offer Price Minus Closing Price One Week After the
Offer Date

Seasoned Public Offerings (SEOs)
Ex-Ante Measure: Offer Price Minus Closing Price the Day Before Offer
Date
Ex-Post Measure: Offer Price Minus Closing Price One Week After the
Offer Date

Two Underpricing Computations
We will compute both dollar underpricing and percentage underpricing
Testable Hypotheses
We hypothesize that there should be a drastic reduction in
IPO underpricing during the last quarter of 2000. To
determine the extent of the reduction, we shall compare
the last quarter of 2000 with the two previous quarters
and the two following quarters. To help accurately weigh
any excessive profits, we will contrast IPOs with SEOs.
What happens in the SEO aftermarket serves as a
benchmark when conducting tests.
Table 1: Descriptive statistics for total period
Key Variable
Offer Price
Ex-Ante Price
Ex-Post Price
New Shares
Offer Value
Stock Value
Firm Value
IPOs (n=246)
SEOs (n=351)
$14.85 ($14.00)
$35.73 ($28.50)
$15.24 ($14.00)
$37.13 ($29.56)
$20.55 ($15.63)
$36.96 ($29.38)
16.52M (6.00M)
12.43M (4.50M)
$256M ($83M)
$407M ($137M)
$770M ($195M) $5264M ($1168M)
$1058M ($241M) $8048M ($1591M)
Offer Value as a
% of Firm Value 49.31% (32.92%)
9.09% (7.01%)
Table 2: Descriptive Statistics for Quarters
Quarter
Offering
Type (n)
Offer Price
Ex-Ante Price
Ex-Post Price
Mean (Median)
Mean (Median)
Mean (Median)
4/1/006/30/00
IPOs (n=85)
SEOs (n=70)
$13.97 $13.00 $15.21 $15.00 $20.44 ($15.50)
$35.43 $30.50 $37.21 $32.04 $36.35 ($32.72)
7/1/00
-9/30/00
IPOs (n=63)
SEOs (n=52)
$16.38 $15.00 $15.13 $13.00 $27.15 ($21.25)
$44.06 $35.00 $45.30 $37.19 $45.45 ($36.69)
12/31/00
IPOs (n=52)
SEOs (n=72)
$14.03 $13.25 $15.16 $14.00 $15.82 ($14.60)
$39.65 $30.41 $41.95 $32.57 $41.39 ($33.34)
1/1/013/31/01
IPOs (n=20)
SEOs (n=68)
$11.40 $11.50 $13.56 $13.50 $12.29 ($11.90)
$33.97 $26.09 $34.90 $26.88 $34.97 ($28.01)
4/1/016/30/01
IPOs (n=26)
SEOs (n=89)
$18.32 $15.50 $17.09 $15.00 $20.69 ($17.56)
$29.28 $23.68 $30.09 $23.81 $30.41 ($24.60)
10/1/00-
Table 3: Underpricing results for total period
Key Variable
.
IPOs (n=246)
mean (median)
Ex-Ante Underpricing  –$28.3 ($0.0)
(Offer Price – Ex-Ante Price)(New Shares)
Ex-Ante Underpr. %age  –1.2%
SEOs (n=351)
mean (median)
.
–$13.4 (–$3.5)
.
(0.0%)
–3.5% (–3.0%)
(Offer Price – Adjusted Ex-Ante Price)(Adjusted Ex-Ante Price) .
Adj. Ex-Post Underpr.
 –$40.1 (–$13.5) –$11.1 (–$3.4)
(Offer Price – Adjusted Ex-Post Price)(New Shares)
.
Adj. Ex-Post Und. %age  –34.8% (–13.0%) –4.9% (–3.1%)
(Offer Price – Adjusted Ex-Post Price)(Offer Price)
.
Adj. Ex-Post Underpr.*  –$11.8 (–$4.0)
–$2.4 (–$0.2)
(Ex-Ante Price* – Adjusted Ex-Post Price)(New Shares)
.
Adj. Ex-Post Und. %age*  –42.5% (–4.5%)
–1.2% (–0.3%)
(Ex-Ante Price* – Adjusted Ex-Post Price)(Offer Price)
.
Table 4: Underpricing by quarters:
dollar change results
Quarter Offering
Type (n)
4/1/006/30/00
Ex-Ante
Underpricing
Adjusted
Ex-Post
Underpricing
Adjusted Ex-Post
Underpricing if
Offer Price Set at
Ex-Ante Price
IPOs (n=85)
SEOs (n=70)
-$7.3M; -$4.0M
-$13.9M; -$5.1M
-$46.6M; -$13.6M
-$4.0M; -$1.2M
-$39.9M; -$2.0M
+$15.5M; -$0.0M
7/1/00
IPOs (n=63)
-9/30/00 SEOs (n=52)
+$11.7M; +$7.8M
-$5.9M; -$2.1M
-$73.0M; -$33.2M
-$13.6M; -$1.8M
-$82.7M; -$46.3M
-$10.6M; +$1.6M
10/1/00- IPOs (n=52)
12/31/00 SEOs (n=72)
-$39.2M; -$6.9M
-$31.7M; -$5.0M
-$10.1M; -$7.2M
-$13.4M; -$5.4M
+$29.6M; -$0.0M
+$18.1M; -$3.1M
1/1/013/31/01
IPOs (n=20)
SEOs (n=68)
-$337M; -$8.8M
-$7.4M; -$3.6M
+$4.4M; -$3.3M
-$13.5M; -$6.2M
+$338M; +$7.3M
+$0.0M; +$2.0M
4/1/016/30/01
IPOs (n=26)
SEOs (n=89)
+$65.8M; +$7.4M
-$7.3M; -$2.6M
-$33.2M; -$13.0M
-$11.5M; -$2.5M
-$91.1M; -$21.1M
-$5.0M; -$0.6M
Table 5: Underpricing by quarters:
percentage change results
Quarter
Offering
Type (n)
Ex-Ante
Underpricing
Percentage
Adjusted Ex-Post
Underpricing
Percentage
Adjusted Ex-Post
Underpricing if
Offer Price Set at
Ex-Ante Price
4/1/006/30/00
IPOs (n=85)
SEOs (n=70)
-7.42%; -7.69%
-5.13%; -4.80%
-37.65%; -12.87%
-3.23%; -1.72%
-37.37%; +1.50%
+2.13%; +1.15%
7/1/00
IPOs (n=63)
-9/30/00 SEOs (n=52)
+11.10%; +8.33%
-2.72%; -2.76%
-64.26%: -32.39%
-4.16%; -1.54%
-96.87%; -51.02%
-1.38%: +2.39%
10/1/0012/31/00
-5.97%; -7.69%
-3.39%; -3.27%
-14.95%; -6.86%
-6.37%; -4.24%
-9.51%; +1.60%
-2.90%; -1.19%
IPOs (n=52)
SEOs (n=72)
1/1/013/31/01
IPOs (n=20)
SEOs (n=68)
-11.52%; -10.42%
-3.41%; -2.50%
-8.13%; -4.65%
-6.14%; -5.26%
+1.97%; +4.47%
-2.49%; -1.53%
4/1/016/30/01
IPOs (n=26)
SEOs (n=89)
+6.57%; +4.37%
-3.00%; -2.79%
-14.52%; -8.38%
-4.39%; -3.22%
-23.23%; -9.75%
-1.23%; -0.29%
Exhibit 2. Mean Difference Results
for Adjusted Ex-Post Underpricing
Q1
Q2
Q3
Q4
Q5
Total
Period
IPO Mean
$46.62M
(n = 85)
$73.14M
(n = 63)
$10.10M
(n = 52)
+$4.36M
(n = 20)
$33.16M
(n = 26)
$40.12M
(n = 246)
SEO Mean
$3.95M
(n = 70)
$13.56M
(n = 52)
$13.36M
(n = 72)
$13.53M
(n = 68)
$11.58M
(n = 89)
$11.10M
(n = 351)
Mean
Difference
$42.67M
$59.58M
+3.26M
+17.89M
$21.58M
$29.02M
t statistic
2.33
2.70
+0.25
+0.35
2.10
3.25
Significant
Level
0.021
0.008
0.804
0.729
0.043
0.001
Exhibit 3. Mean Difference Results for
Adjusted Ex-Post Underpricing Percentage
Q1
Q2
Q3
Q4
Q5
Total
Period
IPO Mean
37.65%
(n = 85)
64.26%
(n = 63)
14.95%
(n = 52)
8.13%
(n = 20)
14.52%
(n = 26)
34.82%
(n = 246)
SEO Mean
3.23%
(n = 70)
4.16%
(n = 52)
6.37%
(n = 72)
6.14%
(n = 68)
4.39%
(n = 89)
4.87%
(n = 351)
Mean
Difference
34.42%
60.10%
8.58%
1.99%
10.13%
29.95%
t statistic
4.49
5.05
2.05
0.51
2.03
6.95
Significant
Level
<0.001
<0.001
0.044
0.617
0.053
<0.001
Exhibit 4. Mean Difference Results When IPO Adjusted ExPost Underpricing Tested Against SEO Ex-Ante Underpricing
Q1
Q2
Q3
Q4
Q5
Total
Period
IPO
Mean
$46.62M
(n = 85)
$73.14M
(n = 63)
$10.10M
(n = 52)
+$4.36M
(n = 20)
$33.16M
(n = 26)
$40.12M
(n = 246)
SEO
Mean
$13.92M
(n = 70)
$5.90M
(n = 52)
$31.72M
(n = 72)
$7.35M
(n = 68)
$7.34M
(n = 89)
$13.44M
(n = 351)
Mean
Difference
$42.67M
$67.24M
+21.62M
+11.71M
$25.82M
$26.68M
t statistic
2.56
3.47
+1.47
+0.23
2.64
3.14
Significant
Level
0.012
0.001
0.144
0.820
0.014
0.002
Exhibit 5. Mean Difference Results When Non-Technology IPO Adjusted ExPost Underpricing Tested Against SEO Ex-Ante Underpricing
Q1
Q2
Q3
Q4
Q5
Total
Period
IPO
Mean
$48.21M
(n = 29)
$110.38M
(n = 25)
$5.13M
(n = 26)
-$11.36M
(n = 16)
$34.58M
(n = 22)
$44.35M
(n = 118)
SEO
Mean
$10.05M
(n = 37)
$5.23M
(n = 35)
$26.79M
(n = 54)
$6.52M
(n = 50)
$6.13M
(n = 71)
$11.19M
(n = 247)
Mean
Difference
$38.16M
$105.15M
+21.66M
-4.84M
$28.45M
$33.16M
t statistic
1.47
2.57
+1.00
-1.13
2.54
2.79
Significant
Level
0.153
0.017
0.319
0.264
0.019
0.006
Exhibit 6. Quarterly Results for Adjusted Ex-Post Underpricing (upper hand) and Adjusted
Ex-Post Underpricing Percentage (lower hand) with t statistic followed by significant
level in first row and turnaround in second row (M = million)
Q1
Q1
Q2
Q3
Q4
1.16; 0.248
$26.52M
+2.49; 0.014
+$36.52M
+0.98; 0.340
+$50.98M
+0.87; 0.389
+$13.46M
+3.01; 0.003
+$63.04M
+1.43; 0.166
+$77.50M
+1.85; 0.067
+$39.98M
+0.28; 0.782
+$14.46M
1.84; 0.087
$23.06M
Q2
1.92; 0.058
26.61%
Q3
+2.71; 0.008
+22.70%
+4.00; <0.000
+49.31%
Q4
+3.53; 0.001
+29.52%
+4.56; <0.000
+56.13%
+1.27; 0.210
+6.82%
Q5
+2.59; 0.011
+23.13%
+3.92; <0.000
+49.74%
+0.07; 0.947
+0.43%
Q5
0.73; 0.476
$37.52M
1.03; 0.309
6.39%
6.3.4 Evidence from statistical tests summarized
•
•
•
•
•
We have attempted to look at and analyze the hard numbers to get to the root
of any excessive profit taking in the IPO aftermarket. While evidence from our
many tests is not always in agreement as pertains to all details, our tests do
point toward several general findings. These findings are summarized below.
First, we find that Q1 and Q2 manifest bubble-like underpricing that surpasses
historical norms of 15% and are statistically significant from SEO ex-ante and
ex-post underpricing values. Profit taking possibilities for Q2 indicate the
investment bankers and preferred clients could have made over half as much
money as raised by IPOs.
Second, we find that the allegations occurring in Q3 do not fully impact ex-post
underpricing until Q4. Heavy losses in the IPO aftermarket are avoided by
judiciously setting the offer price below ex-ante levels especially for larger
offering. Some of our tests even indicate there is overpricing especially for Q4.
Third, we find that underpricing returns to its historical average of 15% by Q5.
This is achieved by a huge turnaround in mean difference when IPO ex-post
underpricing is compared to SEO underpricing. The sharpness of the turnaround
indicates that the allegations had an effect that did not last more than six
months. The underpricing could have returned to bubble levels experienced
earlier if offer prices had been set nearer to ex-ante prices. Thus, conditions
appear to have changed such that underwriters can no longer get their bubble
profits.
Fourth, we find no consistent evidence that high-tech firms are driving the
profit taking even though they may be energizing it. For the dollar underpricing
tests, our conclusions are actually strengthened if we delete high-tech
observations. For percentage tests, conclusions are weakened.
• Fifth, we conclude that our evidence supports our research hypothesis:
underpricing for IPOs fell due to the allegations of misconduct.
However, the fall was from bubble levels with a return to normal
historical levels.
Summary & Conclusion
We examine stock offerings for the two quarter prior to and after the
quarter (10/1/00 to 12/31/00) during which allegation are made that
investment bankers and preferred clients made exorbitant profits
through manipulating stock prices in the IPO aftermarket. We find that
IPO profits disappeared. In some case, investment bankers probably
even sustained losses. However, any total industry losses were
minimized because the number of IPOs fell dramatically. Any fall in
underwriting profits were short-lived because the potential for profits in
the aftermarket began surfacing within six months of the accusations.
We can attribute the resurfacing of profits to several factors. First, no one
really knows or can prove if stock prices were manipulated. After things
quieted down, investment bankers returned to work in an attempt to
restore profits. Second, the markets realize that investment bankers
must make profits to stay in business. The market only requires that
investment bankers police themselves so that the companies they
serve and potential investors (other than preferred clients) are not taken
to the “cleaners” on a regular basis.
Celebrate & Relax. It’s Over!