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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?.

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recent developments in ipo research

Recent Developments in IPO Research

Jay R. Ritter

University of Florida

Oxford EFMA IPO Symposium

a few topics
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 vast majority of ipos list in the issuer s home market
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


demand is local
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
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

singapore has become a major center for small chinese companies to go public
Singapore has become a major center for small Chinese companies to go public

Number of Foreign IPOs in Singapore

Year All From China and Hong Kong

2004 14 13

2005 29 24

2006 32 29

The median proceeds in 2006 = $25.6 million

market conditions for ipos fluctuate between hot and cold
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

the number of u s ipos not including adrs has fluctuated between 63 to over 600 offerings per year
The number of U.S. IPOs (not including ADRs) has fluctuated between 63 to over 600 offerings per year
investor protection vs excessive regulation
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


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
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
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

Ebber's Offer Market First-day

IPO Date Shares Price Price Profit

McLeod 6/96 200,000 $20.00 $25.13 $1,026,000

Tag Heuer 9/96 5,000 $19.55 $20.00 $2,250

Qwest Communications 6/97 205,000 $22.00 $28.00 $1,230,000

TV Azteca 8/97 1,000 $18.25 $19.19 $900

Box Hill Systems 9/97 5,000 $15.00 $20.62 $28,100

Nextlink Communications 9/97 200,000 $17.00 $23.25 $1,250,000

China Mobile HK 10/97 2,000 $30.50 $28.00 -$5,000

Metromedia Fiber 10/97 100,000 $16.00 $21.38 $538,000

Teligent 11/97 30,000 $21.50 $25.63 $123,900

Earthshell 3/98 12,500 $21.00 $23.56 $32,000

Rhythms Netconnection 4/99 10,000 $21.00 $69.13 $481,300

Juno Online 5/99 10,000 $13.00 $11.63 -$13,700

Juniper Networks 6/99 5,000 $34.00 $98.88 $324,400

Focal Communications 7/99 5,000 $13.00 $19.50 $32,500

Williams Communications 10/99 35,000 $23.00 $28.06 $177,100

Radio Unica 10/99 4,000 $16.00 $27.44 $45,800

Chartered Semiconductor 10/99 5,000 $20.00 $33.19 $66,000

UPS 11/99 2,000 $50.00 $67.38 $34,800

KPNQwest 11/99 20,000 $20.81 $29.81 $180,000

Tycom Ltd 7/00 7,500 $32.00 $37.00 $37,500

Signalsoft 8/00 5,000 $17.00 $21.88 $24,400

corporate executive bribery an empirical analysis joint work with xiaoding liu
“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 is bundled with bookbuilding
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

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:


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.


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.

Many of the AIM listings have annual sales below $50 million, a category in which U.S. IPOs have underperformed in the past.

Fixed Price OfferingsBookbuildingInformation acquisition (Benveniste and Spindt (1989))Agency problems (Loughran and Ritter (2002, 2004))AuctionsHybrid Mechanisms

pricing and allocation
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 non-discriminatory manner (favoritism vs. pro rata)?
august 1992 shenzhen before the rioting started crowds waited for the new share subscription forms
August 1992, Shenzhen: Before the rioting started,crowds waited for the new share subscription forms
google s ipo
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
What went wrong?
  • Out of equilibrium disclosure strategy
  • First post-IPO earnings announcement on Oct. 21, 2004, with revenue up 105% from the year-earlier 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%


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

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