FACULTY OF ECONOMICS
MONEY THEORY AND MONETARY POLICY DEPARTMENT
Jacek Truszkowski
The Information Risk as Determinant of
the Long-Term Abnormal Performance of Polish IPOs
Doctoral Thesis
Advisor: Prof. dr hab. Wiesława Przybylska-Kapuścińska, prof. zw. UEP
Co-Advisor: dr Katarzyna Perez
POZNAŃ 2013
Summary
Although the Polish capital market has been operating for two decades the number of
initial public offerings (IPOs) have surged recently. In the last six years almost 600
companies were listed on Warsaw Stock Exchange (WSE), of which more than 200 were
publicly offered on the main market. This is the reason why WSE has become the European
leader in number of IPOs. Initial public offerings attract the attention of scientists, investors
and media, because they finish their first day of trading with an immediate average positive
return in excess of 10%, and in extreme cases even a few thousands percent. Although many
investors enjoy abnormal performance of IPOs in the short run, it is worth to look at those
who buy shares on secondary market just after IPO and keep them in their portfolios as a long
term investment. This is especially true for institutional investors such as mutual funds and
pension funds. The long term market performance of IPOs is very interesting, because in
many cases IPOs severely underperform the market and their peer groups both in profits and
stock returns, the initial years after the IPO. That means that investors may systematically be
overoptimistic about the prospects and earnings potential of the first time issuers. This
phenomena inspires academics to try to explain the long-term IPOs underperformance. The
first rigorous academic evidence of poor abnormal returns following IPO was delivered by
Ritter [1991], Loughran [1993], Loughran and Ritter [1995]. For example Loughran and
Ritter [1995] showed that the IPOs shares have been poor long-run investments for investors
during 1970 to 1990 in the USA – to generate the same wealth 5 years after the offering an
investor must buy shares of the issuers worth 44% more than shares of non-issuers. Ritter and
Welch [2002] pointed out that the average IPO in the USA underperformed the CRSP valueweighted market index by 23.4% and seasoned peer companies by 5.1%. More recently
researchers showed that underperformance extends to seasoned equity offering (SEO). Others
proved that underperformance is present in other countries than the USA (Ljungqvist [1997]).
Two pilot studies (Siwek [2005] and Sukacz [2005]) in a limited extent also demonstrated that
underperformance was present in Poland.
The main goal of this thesis is to test whether a cross-sectional variability of long-term
abnormal returns of IPO shares in Poland can be explained by errors in information risk
assessment by investors. In other words I try to answer whether information risk determines
abnormal returns over one year following an IPO. I examine whether differences in the longterm abnormal returns after initial public offerings can be explained by errors in information
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risk assessment at the time of the IPO. It is a more intriguing problem than just checking if
average abnormal rate of return was negative and statistically significant for a given IPOs
sample. Average underperformance may be manifestation of ‘bad luck’ (time scope and
composition of the research sample) or methodological problems caused by many biases.
Some researchers claim that underperformance following initial public offerings disappears
when excess (abnormal) returns are measured properly. For example Fama [1998, p. 285]
argues that long-term ‘anomalies are methodological illusions’. However, Loughran and
Ritter [2000] report that different methodologies have different statistical power, so it is
natural to get different results.
The literature reviewed indicates that relatively little attention has been paid to the
analysis of high degree of uncertainty, which investors face at the time of IPO. An extreme
uncertainty is present in the process of public offering because of lack or low quality of public
information available to investors. They have limited knowledge about the IPO company
prior to the offering and the only reliable source of information is prospectus. I agree with
Easley and O’Hara [2004], who argue that information risk may not be fully diversified and
affects asset pricing in equilibrium. Francis et al. [2004a] use this concept to explain financial
anomalies. Ecker [2009] focused attention solely on the information risk in IPO setting. He
claims that at the time of the initial public offering investors assess the information precision
of IPO companies but because of sparse data and no disclosures preceding the offering they
often make incorrect evaluation of information risk. Because investors are rational Bayesian
learners, as shown by Epstein and Schneider [2008], with dissemination of new information
they update their beliefs and replace their prior expectations with realized information risk.
The divergence between values of those two parameters is associated with differences in
abnormal long-run performance of IPO firms.
I tested two hypotheses to examine the relationship between cross-sectional
differences in abnormal long-term returns after Polish IPOs and errors in primary information
risk assessment in the thesis:

H1: The underestimation of information risk hypothesis – the initial
underestimation of information risk of IPO firms is positively related to negative
post-IPO long-term abnormal returns on Warsaw Stock Exchange.

H2: The overestimation of information risk hypothesis – the initial overestimation
of information risk of IPO firms is positively related to positive post-IPO longterm abnormal returns on Warsaw Stock Exchange.
The detailed objectives of the thesis is to verifying H1 and H2 are as follows:
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
showing the rationale for going public and the process of conducting an IPO in
Poland,

review three stylized facts concerning IPOs: (1) initial underpricing, (2) cycles in
IPO volume and returns and (3) long-run underperformance,

identification and analysis of theories being offered to explain long-term abnormal
performance of IPOs,

critical analysis of long-term event studies methodology and its advantages and
limitations in IPO setting,

showing the concept of information risk, its consequences for asset pricing and
methods of measurement,

empirical verification of hypotheses about the relationship between and
information risk and abnormal long-term return from IPOs conducted in Poland in
years 2006–2011.
The thesis consists of six chapters. First chapter shows rationale for going public and
reviews in detail the main stages involved in conducting an IPO process in Poland. It
highlights the most important differences between emerging and developed IPO markets. It
also presents the most important aspects of the IPO process, which has a significant impact on
the future market stock price performance – determining the value of an IPO company,
pricing and allocating its shares. Second chapter describes IPO market and provides a review
of the three main apparent puzzles related to IPOs: (1) initial underpricing, (2) cycles in IPO
volume and returns and (3) long-run underperformance. The intention of presenting the last
phenomena was introduction to further discussion of poor abnormal returns following an IPO.
The third chapter reviews the literature relating to long-term underperformance. It presents the
main theories that have been proposed to explain this stylized fact and also other theories
which have implications for long-term performance. It also discusses the empirical evidence
assessing the robustness of each of those explanations. The fourth chapter focuses on the
event study methods that can be used to calculate abnormal returns. I review three main
building blocks of long-term event studies: determination of the correct expected returns, the
methodology of measurement of abnormal returns over long horizons and the test statistics
used for accepting or rejecting the null hypothesis that mean abnormal performance equals
zero. The fifth chapter presents the concept of information risk. It shows consequences of
information risk for asset pricing (its effect on cost of capital and expected rates of return). It
introduces empirical measures of information risk – especially e-loading, which is then used
in empirical analysis. The last chapter presents empirical analysis, which examines whether
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the cross-sectional variability of the abnormal rates of return of initial public offerings can be
explained by errors in accessing information risk by investors. Its last section concludes the
thesis, shows its implications, discusses its delimitations, limitations and proposes
recommendation for future research.
I use a sample of IPOs conducted on Warsaw Stock Exchange during 2006-2011. I
analyze only IPOs that are primary offerings, where a joint stock company sells new (and
outstanding securities) main WSE market. It yields a sample of 147 IPOs. I do not analyze
secondary offerings, sometimes also called IPOs, which are sale of previously issued shares
held by the original founders (owners) of a company. I also exclude from my sample all
companies listed on Polish alternative market NewConnect, which is organized and regulated
primarily by the Warsaw Stock Exchange. This was due to avoiding bias in the results and
consistency reasons, because of limited scope of information in a preliminary registration
document and financial reporting and information disclosure requirements on NewConnect
market in comparison the WSE main market.
A number of data sources was used. Most data on IPOs and comparable firms were
manually processed from: (a) WSE Cedula – an official WSE daily electronic bulletin with
quotations and market indicators, (b) yearly WSE Fact Books, (c) analytical reports published
by Polish investment firms. Time series of returns for all companies listed on WSE were
manually calculated. Time series of prices were obtained from WSEInfospace which provides
official WSE quotation archives.
I use event study methodology, which examine the behavior of firms’ stock prices
after corporate events. To measure risk-adjusted abnormal performance of IPO-firms shares I
use the calendar-time portfolio approach (also known as the Jensen-alpha approach). This
methodology was first used in finance by Jaffe [1974] and Mandelker [1974]. I use the new
variant of the calendar-time approach, where calendar-time portfolio returns for firms
experiencing an IPO are calculated, and calibrated whether they are abnormal in a multifactor
regression. This approach analyzes periodical returns (eg. daily or monthly) of portfolio,
which contains all IPO stocks bought on the IPO date and held for as long as analyzed period
of time (eg. 3 years). The measure of the post-IPO abnormal returns of the sample of IPOfirms is estimated intercept coefficient from the regression of calendar-time portfolio returns
against factor returns. To measure expected rate of return I apply the Fama and French [1993]
three-factor model to the series of calendar time portfolio’s daily returns. I apply valueweighted portfolios returns following Brav and Gompers [1997].
The calendar-time methodology is strongly recommended by Fama [1998] and
Mitchell and Stafford [2000], as superior to standard procedures where abnormal returns are
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simply accumulated over long periods, what can be source of serious bias [Barber and Lyon
1997, Kothari and Warner 1997]. The distribution of this abnormal return estimator is better
approximated by the normal distribution, allowing for classical statistical inference.
Furthermore, forming calendar-time portfolios accounts for cross-correlations of event-firms
abnormal returns.
I evaluate information risk (information precision) for each IPO in the sample and
comparable firms with the returns-based earnings quality metric – e-loading, proposed by
Ecker et. al. [2006]. It is a slope coefficient on an information-precision mimicking portfolio
from an asset pricing regression. To form the portfolio I use accruals quality measure (AQ)
proposed by Dechow and Dichev [2002] and later improved by McNichols [2002]. In the
Dechow and Dichev [2002] model accruals quality is measured by how closely working
capital accruals map into operating cash flow realizations. Empirically it means that working
capital accruals are regressed on cash from operations in the current period, prior period and
future period accruals is an inverse. The measure of accruals quality is standard deviation of
five regression residuals (the unexplained portion of the variation in working capital) from
consecutive fiscal years for a given company. I use the cross-sectional approach proposed by
Francis et. al. [2005] and Ecker et al. [2006], in which Dechow and Dichev [2002] model is
estimated annually for each sector groups.
In order to examine two directional hypotheses about the relationship of abnormal
long-term return from IPOs and information risk I use the two-stage procedure. In the
preliminary stage I estimate all necessary parameters to measure information risk in next step.
In the main stage I test H1 and H2. Firstly, I measure the expected information risk parameter
for each IPO in my sample. I use the sector average e-loading to proxy for an IPO firm’s
expected information precision risk parameter due to the lack of time series of returns for IPO
at time of public offering,. The e-loadings for each comparable firm are obtained from Fama
and French [1993] model extended by AQfactor (representing information risk) regressed on
daily excess returns over the one year preceding the IPO. Secondly, I measure the realized
information precision risk parameter for each IPO in my sample. I use e-loading from
extended three-factor asset pricing model regression over the first year after IPO. Next I
calculate differences between expected and realized information precision risk and based on
error sign I form two calendar time portfolios. In the first (second) portfolio there are IPOs,
where investors underestimate (overestimate) the information precision risk. Finally, I
measure abnormal returns for each calendar time portfolio by estimating intercept coefficient
from the regression of calendar-time portfolio returns against augmented three-factor Fama
and French [1993] model.
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I found that an investor buying each IPO from my sample on its first trading day and
holding it for the next year would have earned negative average annual return of –3.22%. The
result is insignificant with a high statistical p-value of 0.6436. Although the evidence of
average long-term underperformance on Polish market is not conclusive, it is in line with the
empirical evidence for average underperformance of IPOs. Notwithstanding, even if there is
on average underperformance, individual IPOs have either positive or negative long-term
abnormal returns. Therefore I test two hypotheses. The first one assumes the initial
underestimation of information risk of IPO firms, which is positively related to negative postIPO long-term abnormal returns on Warsaw Stock Exchange. For the 1-year period the
abnormal average annual return for appropriate IPO calendar-time portfolio is (–7.25%). The
second hypothesis assumes the initial overestimation of information risk of IPO firms, which
is related to positive post-IPO long-term abnormal returns on Warsaw Stock Exchange. The
intercept from extended Fama and French [1993] model for the portfolio of IPOs with
overestimated information risk is positive and the annualized average abnormal return is
1.59%. The signs of abnormal returns for both hypotheses were consistent with the
assumptions and economically valuable but in statistical terms the result are insignificantly
different from zero.
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