Do Industry Growth Prospects Drive IPO Stock Performance?

Abstract

We examine the relation between an ex ante measure of IPO growth prospects – the industry-level long-term analyst earnings growth forecast – and short- and long-run IPO returns, using a sample of 7,570 IPOs from 1982 to 2007. The use of an industry-level, rather than firm-level growth measure allows the examination of the fullest set of IPOs. We find that before the Internet bubble period (1999-2000), IPOs in industries with high growth prospects earn high first-day and long-run returns up to three years after the IPO. Industry growth has the largest economic impact on IPO long-run performance among all factors we consider, and this effect is strongest among IPOs with sparse firm-level information. However, during the Internet bubble period, the effect of industry growth on long-run performance dramatically reverses so that IPOs in high-growth industries underperform in the long run. For both the short-run and long-run returns in both periods, the industry growth effects are stronger when returns are value-weighted, suggesting that the effects are stronger for larger IPOs which are more representative of their industries. Our results are most consistent with investors’ tendency to underreact to growth prospects of the IPO in normal times, which leads to superior long-run performance for firms in high-growth industries; and their tendency to overreact to the same information during a pronounced market bubble. In the post-bubble period, there is some evidence that the negative relation between industry growth and long-run performance lingers, with much reduced magnitude. In addition, post-bubble IPO withdrawals are more likely to be observed in high growth industries, in contrast with the negative association between withdrawal and industry growth prior to and during the bubble. Therefore, post-bubble investors appear to have a distaste for IPOs in high growth industries, presumably a spill-over effect of the Internet bubble bursting.