Equity IPOs Research Articles

Research on the Influencing Factors of Private Equity IPO Exit Returns

After more than three decades of rapid development of the private equity investment industry, China has now grown into an important pillar force indispensable to supporting the real economy. Among them, the exit link, as one of the three indispensable links in the operation of private equity funds, determines whether the private equity funds can realize value-added and exit smoothly, which is the ultimate goal of the whole investment activities. This paper compiles the relevant researches on the exit returns of listed companies in recent years, summarizes the factors and characteristics affecting the exit returns of China's IPOs, and the research results show that the realization of maximizing the exit returns of IPOs requires the joint efforts of investee companies, private equity investment institutions and macro policies.

Lifting the veil: The price formation of corporate bond offerings

Using newly available data on initial prices, this study is the first to analyze the price-updating process associated with corporate bond (CB) offerings. Similar to the case for equity IPOs, the evidence shows bookbuilding theories help explain the CB offering price. In particular, CB price updates reduce underwriters’ pricing errors. The partial adjustment phenomenon exists, and underwriters propose a lower initial price in cases of greater uncertainty. However, the CB price update has a large mean value and is smaller for lower-rated offerings, indicating part of the CB price update is unrelated to investors’ information production.

Assessing Gains from Primary Market Allocations in Corporate Bonds

Different market characteristics and investor behavior render the use of underpricing, widely used for equity IPOs, inadequate as a measure of gains from primary market allocations in corporate bonds. We propose a measure that reflects the illiquidity costs that investors save by avoiding acquiring the new bonds in secondary market and show that it can far exceed underpricing. We validate the measure by linking it to changes in secondary market liquidity arising from bond characteristics or induced by regulatory changes. We illustrate the value of the new measure by using it to document that “favoritism” in primary market allocations increases when secondary market liquidity is low.

Lifting the Veil: The Price Formation of Corporate Bond Offerings

Using newly available data on initial prices, this study is the first to analyze the price updating process associated with corporate bond (CB) offerings. Similar to the case for equity IPOs, the evidence shows that bookbuilding theories help explain the CB offering price. In particular, CB price updates reduce underwriters' pricing errors. The partial adjustment phenomenon exists, and underwriters propose a lower initial price in cases of greater uncertainty. However, the CB price update has a large mean value and is smaller for lower-rated offerings, indicating that part of the CB price update is unrelated to investors' information production.

The Many Faces of Status: Audience Segmentation and Competing Effects on Pricing

Different research traditions have proposed three distinct mechanisms in explaining the influence of status of a market intermediary on price formation – certification, Matthew effect and cognitive authority – though there has been little prior effort to disentangle those mechanisms conceptually or empirically. Focusing on the relationship between lead underwriter status and U.S. equity IPO underpricing, the present study argues that these mechanisms have countervailing effects operating via different audiences – respectively the buyers (institutional and retail investors), the intermediary’s peers (other investment banks) and the sellers (issuers). We then empirically identify these effects using directed acyclic graphs (DAG) reasoning and structural equation modeling of the U.S. equity IPOs from 1986 to 2010. Our key contribution is integrating the various status-related mechanisms into a single framework, and in the process resolving long-standing mixed results of financial economists about the relationship between underwriter status and IPO underpricing.

Do Banks Extract Informational Rents through Collateral?

This paper investigates if informational monopolies resulting from relationship lending and bank market concentration allow for rent extraction through collateral. Our identification strategy hinges on the notion that informational equalization shocks (such as equity IPOs) erode rent seeking opportunities, while competing theories do not rely on information asymmetries among lenders. Using a unique hand-collected database of 9,288 bank loans obtained by 649 listed Chinese firms, we find that collateral incidence is positively associated with relationship intensity and bank market concentration, while this effect is moderated for post-IPO loans. These results are obtained controlling for a large number of loan and firm characteristics, monetary policy variables and regional macroeconomic characteristics. We also demonstrate important cross-sectional variation among borrowing firms: rent extraction through collateral is significantly less pronounced for less risky firms. Our results hold for a battery of robustness tests, both included in the paper and in an Internet appendix (available upon request). Furthermore, we provide new evidence on the determinants of collateral in Chinese bank lending markets.

Entering the public bond market during the financial crisis: Underinvestment and asymmetric information costs

This paper investigates the impact of underinvestment and asymmetric information cost on the determinants and timing of a firm’s decision to issue its first-time public bond. Using a sample of non-convertible public bonds made by UK public and private companies between 2007 and 2011, the results show that the choice of capital source is strongly affected by the agency conflict. In particular, the agency cost in the form of underinvestment problems delays a firm’s entry to the public bond market. However, the results show that, unlike previous studies, private companies are more likely to enter the public bond market before undertaking their equity IPOs, supporting the pecking order theory under asymmetric information argument. The results also suggest that firms with less information asymmetry and those that establish a track record are more likely to undertake bond IPOs during the crisis, but private companies enter the public bond market earlier than the equity market. These results hold even after controlling for bank relationships and demands for external funds.

Do Banks Extract Informational Rents Through Collateral?

This paper investigates if relationship lending and bank market concentration permit informational rent extraction through collateral. We use equity IPOs as informational shocks that erode rent seeking opportunities. Using unique loan data from China, we find collateral incidence increases with relationship intensity and bank market concentration for pre-IPO loans, while these effects are moderated post-IPO. We further discover after an IPO, rent extraction is moderated for safe firms but intensified for risky firms. These results are not driven by differences or changes in financial risks. Ours is the first investigation on collateral determinants for China with loan-level data.

Commercial Bank IPO Underwriting Strategies and the Financial Crisis

The entry of commercial banks into underwriting business has been a subject of extensive research among practitioners and academic scholars. Studies have examined the two opposite sides of the debate. On one hand, there is the certification hypothesis and on the other the issues regarding conflict of interest. Despite the interest in the literature, research on commercial bank underwriting of equity IPOs is somewhat limited. This study examines commercial bank underwritten IPOs using recent data (i.e., from 2005 to 2012). We find that commercial banks, in order to attenuate potential conflict of interest and gain additional certification, co-led and co-managed 77 percent of IPOs they participated in with reputable investment banks prior to the financial crisis, and with investment banks in over 93 percent of their issues after the crisis. This strategy seemed to be effective as the banks not only maintained their share of IPO market during the financial crisis, but they also gained market share, at the expense of investment banks, after the credit crisis. In addition, in response to the credit crisis, commercial banks drastically reduced the number of IPOs where they were sole (only) lead underwriters. We find some evidence that commercial bank sole-led syndicates recorded lower gross spread relative to investment bank sole-led syndicates. Finally, commercial bank underwritten IPOs have lower underpricing than investment bank underwritten IPOs suggesting that the information effect outweighed the conflict of interest effect. Overall, the 2008 financial crisis has had a positive effect on commercial banks’ IPO underwriting business.

DEBT IPO WAVES, INVESTOR SENTIMENT, MARKET CONDITIONS, AND ISSUE QUALITY

AbstractWe examine the aggregate volume of straight debt initial public offerings (DIPOs) from 1970 to 2010. We find that aggregate DIPO activities display wave patterns. Both the number and total proceeds of DIPOs vary substantially over time. DIPO volume is significantly associated with yield spread, aggregate book‐to‐market ratio, stock return volatility, lagged equity IPO volume, and term spread, suggesting that investor sentiment and capital market conditions play significant roles in explaining time variations in DIPO volume. We also find that speculative‐grade DIPO issues synchronize with the business cycles, while investment‐grade issues display a steady or countercyclical pattern.

Capacity constraints and the winner's curse in multi-unit common value auctions

Abstract We explore the role of capacity constraints in establishing efficient pricing in multi-unit common value auctions in a setting relevant to auction-based equity IPOs. The method of inquiry is experimental economics. We find that sufficiently large capacity constraints mitigate the overbidding that plagues single-unit auctions and is one of the most robust laboratory findings. We also uncover a puzzling propensity for most bidders to place a portion of their bids at prices above their signals. This disequilibrium behavior persists with experience and in cases with substantial losses in previous auctions. Our results suggest caution is warranted in promoting auction based IPOs that allow unrestricted access by the non-professional investing public.

Debt IPO Waves

We examine aggregate volume of straight debt IPOs issued by nonfinancial firms over an extended period of 1970 to 2010. We find that aggregate debt IPO activities display wave patterns. Similar to equity IPOs, both the number and total proceeds of debt IPOs vary substantially over time. We explore possible explanations for the debt IPO waves with four groups of variables - capital market conditions, investor sentiment, information asymmetry, and interest rates. Our results indicate that debt IPO volume is significantly associated with term spread, stock return volatility and interest rates, suggesting that bond market conditions and information asymmetry play significant roles in explaining time variations in debt IPO volume. However, we do not find a significant role for investor sentiment. We also document that debt IPOs and equity IPOs are mutually Granger caused, suggesting that debt IPOs and equity IPOs tend to move together.

Long-Run Underperformance And The Offering Price Clustering Phenomenon

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt; mso-pagination: none;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">The study proposes a new informational role for the offering price of an equity IPO.<span style="mso-spacerun: yes;">  </span>Offering prices are quoted either in whole prices (e.g., $2, $11, $19, etc) or fractional prices (e.g., $2.35, $11.15, $15.75, etc).<span style="mso-spacerun: yes;">  </span>Using Jay R. Ritter’s sample of 1,526 IPOs issued during the period 1975 to 1984, the study examines the relation between the presence of whole price clusters and long-run underperformance.<span style="mso-spacerun: yes;">  </span>The results indicate that fractional offering prices are associated with better long-run performance.<span style="mso-spacerun: yes;">   </span></span></span></p>

Marketing Financial Claims

We examine a comprehensive set of 540 pre-IPO analyst reports made available to investors and the broker's sales force in the course of marketing equity IPOs in France over the period 1990-2002. Exploiting exogenous variation in the behavior of affiliated and independent analysts caused by wellknown conflicts of interest, we find that analyst reports are used to hype the issuer's stock in harder to-place offerings, i.e., when more stock is reserved for allocation to retail investors. Moreover, retail (but not institutional) demand is stimulated by hype, and this demand boost in turn enables the underwriting bank to increase the offer price for the benefit of its corporate client. Over the first year of trading, hyped stocks underperform non-hyped stocks by a wide margin. These results underscore the marketing (as opposed to information production) role of research analysts. They also suggest that analysts sometimes pander to certain psychological biases retail investors may be prone to, consistent with recent theoretical models.

Bookbuidling, Auctions, and the Future of the IPO Process

Auction theorists predict that bookbuilding, long the standard process for selling equity IPOs in the U.S., is about to give way to an Internet‐based IPO auction process that is both more efficient and more fair. The promise of auctions is that, by using an electronic platform that gives all investors the opportunity to bid on IPOs, the underpricing of IPOs and commissions to underwriters will be reduced, leading to an increase in net proceeds to issuers.Largely missing from such arguments, however, is an appreciation of why bookbuilding has dominated U.S. practice (and continues to supplant auctions in IPOs in most countries outside the U.S) and the role of undepricing in the IPO process. Rather than canvassing all investors, bookbuilding involves eliciting expressions of interest from institutional investors, and then allocating shares mainly according to the strength of their professed interest. In contrast to auctions, which allocate shares according to a set of explicit rules, bookbuilding involves a set of implicit “rules” that provide considerable room for judgment by the underwriter. This does not mean that the rules are arbitrary or not well understood by participants, particularly after thousands of IPOs conducted over the better part of two centuries. But to manage the exchange of information between issuers and investors, and the potential conflicts of interest in representing both groups, such rules must be administered by an intermediary with a considerable stake in protecting its reputation for fair dealing. Investment banks that deal with both issuers and the investment community on a regular basis are well positioned to perform this function.The underpricing of IPOs is best viewed not as a transfer of wealth from issuers to favored investors but rather as compensation to the large influential investors that play a major role in the price discovery process. By opening the process to all comers, auctions will discourage these large investors from bidding aggressively because less sophisticated investors will be able to “free ride” on their research and due diligence. To the extent this happens, auctions may suc ceed in reducing underpricing (in fact, they may even lead to over pricing), but they will also reduce the net proceeds for issuers.Nevertheless, recent advances in communications technology and auction theory will undoubtedly reshape current securities underwriting practices. In particular, Internet auctions are likely to replace bookbuilding in debt IPOs and less risky equity issues (say, IPOs of LBOs). But the argument that Bookbuilding will be completely cast aside in favor of largely untested alternatives fails to appreciate a successful institutional response to major market imperfections, some of which can never be wholly eliminated. Especially in the case of risky (first‐time) equity IPOs, there will continue to be an important role for managing the information exchange between issuers and investors that is critical to the IPO process.

Reforming the Bookbuilding Process for IPOs

The controversy over IPOs has raised questions about whether retail investors are being unfairly denied access to shares in IPOs and whether the new Internet auction methods might provide a fairer and more efficient way to allocate shares. This article argues that much of the popular concern may be misdirected. By and large, bookbuilding is well designed to accomplish price discovery in a cost‐effective way. And standard auctions, which have been all but abandoned in a number of countries, have generally proved disappointing for equity IPOs (although they have been successful for bond offerings). The authors propose a “hybrid” form of securities issuance that would retain the advantages of bookbuilding while incorporating a public offer “tranche” for retail investors and other measures designed to increase transparency.

Negotiation and the IPO Offer Price: A Comparison of Integer vs. Non-Integer IPOs

AbstractWe investigate the pricing of 4,989 equity IPOs with offer dates between 1981 and 2000. Approximately three-fourths of these IPOs have integer offer prices. Average initial returns for IPOs with integer offer prices are significantly higher (24.5%) than those priced on the fraction of the dollar (8.1%). This result is robust through time and after conditioning for other effects known to influence initial returns. We hypothesize that integer vs. fractional dollar IPOs are the result of negotiations between the issuing firm and underwriter. Under this negotiation hypothesis, the frequency of integer pricing should be an increasing function of the offer price and the degree of uncertainty surrounding the value of the firm. Empirical evidence, supportive of the negotiation hypothesis, is presented.

Valuation uncertainty and IPOs: Investment bank versus commercial bank underwriters

This paper tests commercial bank underwriting for the existence of a conflict of interest versus a certification role. Our tests compare samples of equity IPOs underwritten by both commercial and investment banks. We examine the degree of asymmetric information present in the market for these issues by examining their microstructure trading characteristics. Our results show that greater information asymmetry is present in the after-market when a commercial bank acts as underwriter. The asymmetry resolves itself as the market learns more about each issue, deciding which ones may have involved a conflict. This is consistent with greater uncertainty about the value of commercial-bank-underwritten IPOs, and is also consistent with the market perceiving a possible conflict of interest on the part of commercial banks.

Information Production and IPO Offering Price Clusters: Further Evidence Explaining Underpricing and Long-Run Underperformance

We propose a new informational role for the offering price of an equity IPO. Offering prices are quoted either in whole prices (e.g., $2, $11, $19, etc) or fractional prices (e.g., $2.35, $11.15, $15.75, etc). Using Jay R. Ritter's sample of 1,526 IPOs issued during the period 1975 to 1984, we find the presence of offering price clusters around whole prices. Using the same sample, we examine the relation between these clusters, initial underpricing and long-run underperformance. The results indicate that fractional offering prices are associated with lower initial underpricing and better long-run performance. Our tests indicate that offering price clusters serve as a proxy for the quality of information produced by underwriters.

THE MARKET'S PRICING OF DEBT IPOs

Based on the authors' recent study published in the Journal of Financial Economics, this article summarizes new evidence on the first‐day and aftermarket price performance of a firm's first public offer of bonds after its equity IPO. Unlike equity IPOs, such bond IPOs are not underpriced on average. However, bonds that are more equity‐like (junk bonds) are underpriced at the initial offer whereas high‐grade debt is actually overpriced. This finding supports the view that riskier debt issues have a larger equity component and, as a consequence, a higher degree of information asymmetry.The authors' study also showed that less prestigious underwriters are associated with more underpriced offers, and that the issuer's stock market listing plays an important role in determining the first‐day price performance of bond IPOs. The degree of underpricing is lower for bonds issued by firms whose equity is listed on NYSE/AMEX than for bonds issued by firms listed on Nasdaq. Finally, the aftermarket performance for the full sample and various subsamples is consistent with bond market efficiency in the sense that, once prices adjust after the first day of trading, there are no clearly exploitable opportunities for excess returns.