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TheIPOMarket
JayR.RitterUniversityofFlorida
March2006
Terminology:
First-dayreturn=100%x(Closingprice–offerprice)/offerprice
First-dayreturna.k.a.“underpricing〞
Moneyonthetable= numberofsharessoldx(closingprice–offerprice)
Table1
SummaryStatisticsfor6,816IPOswithOfferPrice³$5.00
Average,2001Dollars
Period
Mean
First-day
Return
MoneyLeft
ontheTable
GrossProceeds
1980-1989
7%
$2.7million
$42million
1990-1998
15%
$10million
$72million
1999-2000
65%
$82million
$161million
2001-200511%
$20million
$223million
1980-2005
18%
$17million
$86million
Academicexplanationsforunderpricing
The“winner’scurse〞or“GrouchoMarxtheorem〞(Rock)
Ifyouareunsureofthefairvalueofsharesbeingsold, andthereisexcessdemand,themostoptimisticinvestors arelikelytogettheshares
Thus,conditionalongettingtheshares,youfindout thatyouareprobablyoveroptimisitic
Theneedtogiveinstitutionsanincentivetoinvestigatea companyandbuyitsshares(BenvenisteandSpindt)Thesearegoodexplanationsifwewereseekingtoexplainwhy,onaverage,underpricingis5-10%
Thesearenotgoodexplanationswhenwearetryingtoexplainwhyunderpricingis15%ormore
Table2
TheEffectofUnderpricingontheWealthandOwnershipofPre-issueShareholders
Assumptions:
Pre-issuesharesoutstanding: 15.6millionshares
GrossproceedsofIPO: $78million
Post-issuemarketcap: $280.8million
#ofsharessoldbypre-issueshareholders: zero
Strategy1
Strategy2
Offerpriceandnumberofsharesoffered: 7.8mat$10.00 6.0mat$13.00
Post-issuesharesoutstanding: 23.4million 21.6million
Marketpricepershare: $12.00 $13.00
Moneyleftonthetable: $15.6million zero
Post-issuewealthofpre-issueshareholders: $187.2million $202.8million
Post-issue%offirmownedby
pre-issueshareholders: 66.7% 72.2%
UnderpricingandallocationsarerelatedTherearethreeframeworksforviewingdiscretioninallocationsTheinformationacquisitionview(BenvenisteandSpindt) Underwritersfavorregularinvestorswhoprovideinformation aboutdemand,resultinginmoreaccuratepricingThe“pitchbook〞view,inwhichunderwritersseekoutbuy-and-holdinvestorsTherent-seekingview,whereunderwriterstrademoneyleftonthetableforquidproquos(commissionbusiness) Biasedanalystrecommendationsappealtoissuingfirmsand makethemwillingtoleavemoneyonthetableWhydoissuersputupwithsevereunderpricing?
OninternetIPOs,underwritersknewtheywereoverpriced Butwhydidtheiranalystsputout“buy〞recommendations?
Issuerstupidity Thepublicityisworthit Capitalcanberaisedinafollow-onoffering
Prospecttheory Whenpeoplegetgoodnewsabouttheirwealthincreasing, theydon’tbargainashardatthepricingmeeting
Analystlustandspinning Issuersseekoutunderwriterswhereinfluentialanalysts willbebullish SpinningofhotIPOstoexecutivesScandals:
Spinning:AllocatinghotIPOstothepersonalbrokerageaccounts oftopexecutivesinreturnforcompanybusiness Globalsettlementbansspinningbymajorunderwriters
Laddering:Requiringthepurchaseofadditionalsharesinthe aftermarketinreturnforIPOs
Analystconflictsofinterest:Giving“buy〞recommendationsin returnforunderwritingandM&Abusiness
CommissionbusinessinreturnforIPOs:Underwritersallocated IPOsprimarilytoinvestorsthatgeneratedalotofcommissions onothertradesExampleofkickbackswithcommissionbusiness:CreditSuisseFirstBoston(CSFB)receivedcommissionbusinessequaltoasmuchas65%oftheprofitsthatsomeinvestorsreceivedfromcertainhotIPOs,suchastheDecember9,1999IPOofVALinux
TheVALinuxIPOinvolved5.06millionshares
Offerprice: $30.00 Closingmarketprice: $239.25 Capitalgain: $209.25
Grossspread: $2.10
Iftheinvestorthentradedsharestogeneratecommissionsofone-halfofthisprofitthetotalunderwritercompensationpersharewas$2.10plus$104.625,or$106.725
Accordingtoparagraph58oftheSEC’sJanuary22,2002settlementwithCSFB,aninstitutionalcustomerthathadreceiveda12,500shareallocationofVALinuxfromCSFBpaidCSFBatleast$565,000byengaginginthefollowingtransactions:CommissionBusinessinReturnforIPOs: Whatifamutualfundpays5¢persharefortradeswith GoldmanSachsratherthan2¢persharewithanECN?Exampleofspinning:SalomonSmithBarney'sallocationsofIPOstoBernieEbbers,otherWorldComexecs,andothertelecomexecs
Ebber's Offer Market First-dayIPO Date Shares Price Price ProfitMcLeod 6/96 200,000 $20.00 $25.13 $1,026,000TagHeuer 9/96 5,000 $19.55 $20.00 $2,250QwestCommunications 6/97 205,000 $22.00 $28.00 $1,230,000TVAzteca 8/97 1,000 $18.25 $19.19 $900BoxHillSystems 9/97 5,000 $15.00 $20.62 $28,100NextlinkCommunications 9/97 200,000 $17.00 $23.25 $1,250,000ChinaMobileHK 10/97 2,000 $30.50 $28.00 -$5,000MetromediaFiber 10/97 100,000 $16.00 $21.38 $538,000Teligent 11/97 30,000 $21.50 $25.63 $123,900Earthshell 3/98 12,500 $21.00 $23.56 $32,000RhythmsNetconnection 4/99 10,000 $21.00 $69.13 $481,300JunoOnline 5/99 10,000 $13.00 $11.63 -$13,700JuniperNetworks 6/99 5,000 $34.00 $98.88 $324,400FocalCommunications 7/99 5,000 $13.00 $19.50 $32,500WilliamsCommunications 10/99 35,000 $23.00 $28.06 $177,100RadioUnica 10/99 4,000 $16.00 $27.44 $45,800CharteredSemiconductor 10/99 5,000 $20.00 $33.19 $66,000UPS 11/99 2,000 $50.00 $67.38 $34,800KPNQwest 11/99 20,000 $20.81 $29.81 $180,000TycomLtd 7/00 7,500 $32.00 $37.00 $37,500Signalsoft 8/00 5,000 $17.00 $21.88 $24,400
WherehavetheNASDandSECbeen?
WhileIPOstendtogouponthefirstdayoftrading,inthelongrun,onaveragetheyhavetendedtounderperform.
Butthereisastrongcross-sectionalpattern:IPOsthathadannualsalesoflessthan$50millionseverelyunderperform,whereasthosethathadachievedannualsalesof$50milliondon’tunderperform.Buy-and-holdstockreturnsareskewed:therearesomebigwinners,butmoststocksunderperform.Thisisespeciallytruewithyoungcompanies,wherethereisevengreaterrightskewness.Annualreturnsinthefiveyearsaftergoingpublicfor6,858IPOsfrom1970-2002,withreturnsthroughDecember
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