Long-run Underperformance Research Articles

Shareholder investment horizons and the market for corporate control

This paper investigates how the investment horizon of a firm's institutional shareholders impacts the market for corporate control. We find that target firms with short-term shareholders are more likely to receive an acquisition bid but get lower premiums. This effect is robust and economically significant: Targets whose shareholders hold their stocks for less four months, one standard deviation away from the average holding period of 15 months, exhibit a lower premium by 3%. In addition, we find that bidder firms with short-term shareholders experience significantly worse abnormal returns around the merger announcement, as well as higher long-run underperformance. These findings suggest that firms held by short-term investors have a weaker bargaining position in acquisitions. Weaker monitoring from short-term shareholders could allow managers to proceed with value-reducing acquisitions or to bargain for personal benefits (e.g., job security, empire building) at the expense of shareholder returns.

Initial Public Offerings in the Tourism Industry: an International Analysis of Taiwan

ABSTRACT This study investigates the short-run and long-run price performances of tourism-related IPOs that listed on Taiwan's two stock exchanges between 1982 and 2002. Taiwan's tourism industry has seen an increasing number of firms going public in recent years. Results are consistent with other studies that IPOs are generally underpriced. The degree of underpricing is more severe when the stock is purchased at the initial offer price. However, it is still smaller than the overall IPO markets in Taiwan, as well as the tourism IPOs in the U.S. After removal of outliers, the island's tourism IPOs perform poorly one year after IPO relative to the market benchmark, while the overall IPO markets show no abnormal return one year after IPO. Moreover, both the magnitude of short-run underpricing and long-run underperformance exhibit wide variations among the sample firms.

The timing of initial public offerings

We study the dynamics of IPOs by examining the tradeoff between an entrepreneur's private benefits, which are lost whenever the firm is publicly traded, and the gains from diversification. We characterize the timing dimension of the decision to go public and its impact on firm value and the evolution of firm risk over time. By endogenizing the timing of the decision to go public, we explain the clustering of IPOs and buyouts in time, the industry concentration of IPO waves, the high incidence of reprivatization of recent IPOs, and the long-run underperformance of recently issued stock relative to the shares of longer-listed companies.

Pseudo Market Timing: a Reappraisal

The average firm going public or issuing new equity underperforms the market in the long run. This underperformance could be related to the endogeneity of the number of new issues, if new issues cluster after periods of high abnormal returns on new issues. In such a case, ex-post measures of new issue abnormal returns may be negative on average, despite the absence of ex-ante abnormal returns. We evaluate this endogeneity problem in event studies of long-run performance. We argue that it is unlikely that the endogeneity of the number of new issues explains the long-run underperformance of equity issues.

Long-run abnormal return after IPOs and optimistic analysts' forecasts

This empirical study examines whether the optimistic forecasts of analysts explain the long-run abnormal return following initial public offerings (IPOs). Consistent with prior research, this paper concludes that the analysis of earning forecasts for firms going public has an upward bias. While the usually calculated buy-and-hold abnormal return is not significantly negative on average, a proper control for risk confirms the long-run underperformance hypothesis for the 1-year period following IPOs. The risk-adjusted return is positively correlated to the surprise effect and earning forecast revisions, and appears to be the response to new information about the true earnings perspectives.

Prospect Theory and the Long-Run Performance of IPO Stocks

We offer a new explanation for the long-run underperformance of IPO stocks using prospect theory. According to this theory, uncertain outcomes enter an investor's utility function through a nonlinear transformation of their probabilities. Small probability events are given more weight than in expected utility theory, whereas median and large probability events are given less weight. IPO stocks have more extreme positive returns; hence they are valued more in prospect theory than in expected utility theory. We test our theory with Ritter's (1991) IPO sample. Using parameter values consistent with previous experimental studies, we find investors value IPOs the same as seasoned stocks in a prospective utility setting, even though the formers' long-run average returns are much lower than the latters'.

Is there an SEO Puzzle?

The long-run underperformance of stocks after seasoned equity offerings (SEOs) is a major challenge to the efficient market hypothesis. We reexamine the SEO underperformance anomaly using the propensity score matching method on a sample of around 2000 offerings between 1986 and 1998. While underperformance characterizes equal-weight and buy-and-hold returns if traditional matching methods are used, the underperformance is economically and statistically insignificant when we match issuers to non-issuers by propensity scores. Our results suggest that SEO underperformance manifests statistical inadequacies of traditional matching methods rather than an anomaly challenging the efficient market hypothesis.

Is the Long-run Underperformance of Seasoned Equity Issues Irrational? Evidence from Spain

We investigate if the long-run underperformance in the year after the SEO is related to behavioural biases that led investors to adjust their pre-issue over optimism slowly. We also examine the existence of arbitrage costs that preclude mispricing from being corrected rapidly by sophisticated investors who act as arbitrageurs. Our findings support the contention that small SEO firms are overpriced at the time of the issue and imply that their post-underperformance is related to arbitrage costs, where transaction costs play an important role although holding costs do not.

The Impact of Stock Exchange Regulation on Corporate Performance of the European New Markets

Several European countries have launched new secondary markets in order to facilitate the financing of innovative companies with high growth potential. This article analyses whether these ‘Euro.NMs’ fulfil their role of promoting start-up firms by providing liquidity and a device for separating ownership and control quickly after the creation of the high risk/high growth business. First, it charts the rise and fall of the Eruo.NMs. Their early success was remarkable. However, since 2000, the markets have suffered from the decline in technology stocks, with losses on some markets exceeding 80%. It appears that further consolidation is inevitable given the failure of the Euro.NMs to continue to attract listings. Secondly, the paper demonstrates that there are significant performance discrepancies across the Euro.NMs. Evidence from first day trading shows that firm and industry characteristics, rather than differences in listing and disclosure requirements, are the primary determinants. Thirdly, the authors examine evidence on the long-run underperformance of Euro.NMs, suggesting that underperformance is strongly related to industry.

Private Benefits and Minority Shareholder Expropriation (or What Exactly are Private Benefits of Control?)

Our study examines private benefits of control in founding-family owned firms, by analyzing a unique sample of 105 IPOs of family firms on German stock exchanges from 1970 to 2011. First, we show that substantial private benefits of control exist in these firms and we empirically determine the nature of these private benefits. Second, we confirm that the separation of cash flow rights and voting rights via dual-class shares is used to create controlling shareholder structures in order to preserve private benefits of the family. In doing so, we analyze the effect of different types of private benefits on dual-class adoption. Third, we show that the market cares about private benefits of control and find a significant long-run underperformance by dual-class IPO shares.

Investor Response to Sell-Side Analyst Revisions in IPO Recommendations: Do They Correct Expectations?

This paper tests for investor optimism in IPO firms by examining excess returns around sell-side-analyst revisions of recommendations. I pose the corrections hypothesis and the learning hypothesis. According to the corrections hypothesis, if investors correct their initially optimistic expectations, they should react more negatively to analyst upgrades and downgrades of IPO firms relative to benchmark non-IPO firms. A competing hypothesis is the learning hypothesis, which posits that investors should respond more positively to upgrades and more negatively to downgrades of IPO firms relative to benchmark non-IPO firms, because they learn more from all information events about new, immature firms. Examining benchmark performance-adjusted-excess-returns around all revisions issued in the first 3 years after IPO issue, I find that investors do learn more from analyst revisions for IPO firms. However the magnitude of the response to upgrades and downgrades is asymmetric. The negative response around downgrades dominates the positive response around upgrades. Overall, the abnormal return in the 3-days around all revisions is -1.80%. This correction is economically significant, and contributes 15.67% to the long-run underperformance of IPO firms. This result is robust to different specifications of benchmark firms.

Hot Markets, Investor Sentiment, and IPO Pricing

We model an IPO company's optimal response to the presence of sentiment investors and short sale constraints. Given regulatory constraints on price discrimination, the optimal mechanism involves the issuer allocating stock to 'regular' institutional investors for subsequent resale to sentiment investors, at prices the regulars maintain by restricting supply. Because the hot market can end prematurely, carrying IPO stock in inventory is risky, so to break even in expectation regulars require the stock to be underpriced - even in the absence of asymmetric information. However, the offer price still exceeds fundamental value, as it capitalizes the regulars' expected gain from trading with the sentiment investors. This resolves the apparent paradox that issuers, while shrewdly timing their IPOs to take advantage of optimistic valuations, appear not to price their stock very aggressively. The model generates a number of new and refutable empirical predictions regarding the extent of long-run underperformance, offer size, flipping, and lock-ups.

The Long-Run Underperformance of Post-Listing Stock Returns: The Evidence of Earnings Management

This paper explores the puzzle of underperformance during post-listing period by investigating whether managers manipulate earnings before their stocks switch from the NASDAQ to the NYSE and the AMEX, and from the AMEX to the NYSE during the period 1990-1997. Evidence indicates that managers manipulate earnings during the year prior to having their stocks switch to new trading locations. I find a negative relationship between pre-listing discretionary current accruals and subsequent earnings changes and stock returns. Such negative relationship is specially pronounced for small-and-aggressive firms than large-and-conserve firms. The negative relationship remains even after controlling the potential bias for high-performance firms and is common to all switching firms, especially for those switching to the NYSE.

Long-run Stock Performance of Equity-Issuing Firms: The Case of Private Placements in Singapore

We find that Singapore listed firms which have conducted private placements subsequently experience long-run stock underperformance. The long-run underperformance is more severe for small firms and firms with a higher book-to-market ratio. This suggests that small firms and firms with poorer growth prospects are more likely to time the issue when the stock is temporarily overvalued. Further more, we find a positive relation between the long-run stock performance and the change in ownership concentration of the issuing firms, which is consistent with the alignment-of-interests hypothesis. We do not find evidence supporting the earnings-management hypothesis.

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.

Pseudo Market Timing and the Long-Run Performance of IPOs

Numerous studies document long-run underperformance by firms following initial public offerings or seasoned offerings. In this paper I show that such underperformance is very likely to be observed ex-post in an efficient market. The premise is that more firms issue equity at higher stock prices even though they cannot predict future returns. Ex-post, issuers will seem to time the market because there will usually be more offerings at market peaks than when stock prices are low. Simulations based on observed market parameters suggest that even when ex-ante expected abnormal returns are zero, median ex-post underperformance for equity issuers will be significantly negative and very close to what is actually observed.

Are IPOs Underpriced?

This paper studies the valuation of initial public offerings (IPO) using comparable firm multiples. In a sample of more than 2000 IPOs from 1980 to 1997, we find that the median IPO is overvalued at the offer by about 50% relative to its industry peers. This overvaluation is robust over time, across technology and non-technology IPOs, to different price multiples, industry classifications, and matching firms. In the cross-section, overvalued IPOs earn 5% to 7% higher first day returns than undervalued IPOs but earn 20% to 50% lower returns over the next five years. The long-run underperformance of overvalued IPOs is robust to various benchmarks, return measurement methodologies and the Fama-French three-factor model. Overvalued IPOs exhibit higher sales growth rates only temporarily but earn persistently lower profit margins and return on assets than undervalued IPOs over the next five years suggesting that any projected growth opportunities implicit in the initial valuation fail to materialize subsequently. Our results suggest overvaluation is the likely source of the long-run underperformance of IPOs and provide support for behavioral theories based on investor overreaction.

Divergence of Opinion, Uncertainty, and the Quality of Initial Public Offerings

Using a sample of 2,025 initial public offerings (IPOs) from 1993-1996, we examine the relation between the divergence of opinion among investors and the long-run performance of IPOs. We focus on three opening-day proxies for the uncertainty about an IPO: opening bid-ask spread, the time of first trade, and the flipping ratio. After controlling for issue quality, we find all three variables provide significant predictive ability to explain long-run IPO returns. Specifically, a large opening spread, a late opening trade, and a high flipping ratio are associated with poor long-run returns. Our findings are consistent with Miller (1977), who demonstrates that divergence of opinion leads to both short-run overvaluation and long-run underperformance of IPOs.

Is the Market Optimistic about the Future Earnings of Seasoned Equity Offering Firms?

The leading explanation for the post-issue long-run stock return underperformance of sea? soned equity offering firms is that investors have optimistic expectations regarding future earnings and the underperformance occurs as these expectations are corrected over time. To directly test this hypothesis, we examine investors' reaction to quarterly earnings an? nouncements over a five-year period following the offering for a large sample of seasoned equity issuing firms. In general, our evidence suggests that investors are not disappointed by earnings announcements that follow seasoned equity offerings. This result is not sen? sitive to widening the window over which earnings announcement returns are computed. This result also holds true for subsets of equity issuing firms classified as glamour issuing firms, Nasdaq listed issuing firms, and hot market issuing firms. The choice of these three subsets is predicated by extant evidence that these firms are likely to convey relatively more unfavorable information through their earnings announcements. Overall, our findings are inconsistent with the optimistic expectations hypothesis.

Board ownership and IPO returns

This study examines the role of the board of directors for IPO pricing irregularities. Theory suggests that initial underpricing may be the result of asymmetric information and the long-run underperformance may be the result of managerial mismanagement of new funds due to agency conflicts. A strong board of directors can potentially reduce both asymmetric information and agency problems. We find that the structure of the board is related to IPO pricing anomalies. Initial returns are directly related to share ownership by insiders and the percentage of independent outsiders, and long-run returns are directly related to share ownership by insiders.