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Long-Term Underperformance of New Issues: Is Earnings Management the Villain?. S. Ghon Rhee K. J. Luke Distinguished Professor Of International Finance and Banking University of Hawai ‘ i. Two Major Anomalies: The New Issues Market. 1. Short-Term Underpricing
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Long-Term Underperformance of New Issues: Is Earnings Management the Villain? S. Ghon Rhee K. J. Luke Distinguished Professor Of International Finance and Banking University of Hawai‘i
Two Major Anomalies: The New Issues Market 1. Short-Term Underpricing Internet Bubble Period (1999-2000) a. Average first trading day return 1999: 72% and 2000: 56% b. 182 out of 803 IPOs: First trading day return of 100% or higher 2. Long-Term Underperformance a. US IPO firms overvalued by about 50% relative to its industry peers in 1980-1997. b. Only 12 out of 323 internet IPOs in 1999-2000: Trading above their offer price as of early 2001.
Long-Term Operating Performance of IPO and SEO Firms • Industry-adjusted operating return on assets: Usually peak prior to the offering • Industry-adjusted asset turnover and other long-term performance measures: Deteriorate over time after the offering • IPO and SEO firms expand their assets faster than their sales overtime…..Investment in negative NPV projects?
Which Anomaly Deserves More Attention? Long-term underperformance is a more serious issue a. Due to Welfare Implications for Investors b. Short-Term Underpricing is a one-day phenomenon and can be corrected to some degree
What Explains Long-Term Underperformance? • IPO and SEO firms exhibit unusually large and significant gains in operating performance one year prior to the offer date • SEO firms exhibit superb stock performance in the year prior to the offering >>>>>> Earnings Management which mislead investors to be over optimistic about the issuer’s prospects
Country Classification by Earnings Opacity Measure Rank 5 (Most Opaque): India, Indonesia, Japan, Korea, Greece Rank 4: Malaysia, Pakistan, Singapore, Taiwan, Turkey, S. Africa Rank 3: Hong Kong, Thailand, Austria, Finland, Germany, Ireland, Netherlands Rank 2: Australia, Denmark, France, Sweden, Switzerland, United Kingdom Rank 1 (Least Opaque): Belgium, Canada, Norway, Portugal, United States Source: Bhattacharya, Daouk, and Welker(2002)
How to Minimize Long-Term Underperformance of IPO and SEO Firms? • Better Financial Disclosure • Improved Accounting Reporting System • Monitoring over Underwriting Activities • Corporate Governance • Investor Education