We review the theory and evidence on IPO activity: why firms go public, why they reward first-day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective is threefold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phenomena. Instead, we believe future progress in the literature will come from nonrational and agency conf lict explanations. We describe some promising such alternatives. From 1980 to 2001, the number of companies going public in the United States exceeded one per business day. The number of initial public offerings ~IPOs! has varied from year to year, however, with some years seeing fewer than 100 IPOs, and others seeing more than 400. These IPOs raised $488 billion ~in 2001 dollars! in gross proceeds, an average of $78 million per deal. At the end of the first day of trading, their shares traded on average at 18.8 percent above the price at which the company sold them. For an investor buying shares at the first-day closing price and holding them for three years, IPOs returned 22.6 percent. Still, over three years, the average IPO underperformed the CRSP value-weighted market index by 23.4 percent and underperformed seasoned companies with the same market capitalization and book-to-market ratio by 5.1 percent. In a nutshell, these numbers summarize the patterns in issuing activity, underpricing, and long-run underperformance, which have been the focus of a large theoretical and empirical literature. We survey this literature, focusing on recent papers. Space constraints force us to take a U.S.-centric point of view and to omit a description of the institutional aspects of going public. The interested reader can consult Ellis, Michaely, and O’Hara ~2000!,

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A Review of IPO Activity, Pricing, and Allocations

We examine the impact of liquidity shocks by exploiting cross-bank liquidity variation induced by unanticipated nuclear tests in Pakistan. We show that for the same firm borrowing from two different banks, its loan from the bank experiencing a 1 percent larger decline in liquidity drops by an additional 0.6 percent. While banks pass their liquidity shocks on to firms, large firms-particularly those with strong business or political ties-completely compensate this loss by additional borrowing through the credit market. Small firms are unable to do so and face large drops in overall borrowing and increased financial distress.

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Tracing the Impact of Bank Liquidity Shocks: Evidence from an Emerging Market

We review the theory and evidence on IPO activity: why firms go public, why they reward first-day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective on the literature is three-fold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phenomena. Instead, we believe future progress in the literature will come from non-rational and agency conflict explanations. We describe some promising such alternatives.

/pdf/a-review-of-ipo-activity-pricing-and-allocations-2mevvmaldb.pdf

A Review of IPO Activity, Pricing and Allocations

This article investigates the effect of bank lending frictions on employment outcomes. I construct a new data set that combines information on banking relationships and employment at 2,000 nonfinancial firms during the 2008–9 crisis. The article first verifies empirically the importance of banking relationships, which imply a cost to borrowers who switch lenders. I then use the dispersion in lender health following the Lehman crisis as a source of exogenous variation in the availability of credit to borrowers. I find that credit matters. Firms that had precrisis relationships with less healthy lenders had a lower likelihood of obtaining a loan following the Lehman bankruptcy, paid a higher interest rate if they did borrow, and reduced employment by more compared to precrisis clients of healthier lenders. Consistent with frictions deriving from asymmetric information, the effects vary by firm type. Lender health has an economically and statistically significant effect on employment at small and medium firms, but the data cannot reject the hypothesis of no effect at the largest or most transparent firms. Abstracting from general equilibrium effects, I find that the withdrawal of credit accounts for between one-third and one-half of the employment decline at small and medium firms in the sample in the year

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The Employment Effects of Credit Market Disruptions: Firm-level Evidence from the 2008–9 Financial Crisis

We examine corporate financial and investment decisions made by female executives compared to male executives Male executives undertake more acquisitions and issue debt more often than female executives Further, acquisitions made by firms with male executives have announcement returns approximately 2% lower than those made by female executive firms, and debt issues also have lower announcement returns for firms with male executives Female executives place wider bounds on earnings estimates and are more likely to exercise stock options early This evidence suggests men exhibit relative overconfidence in significant corporate decision-making compared to women

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2088860_code341401.pdf?abstractid=1263990&rulid=181537&mirid=5

Gender and Corporate Finance: Are Male Executives Overconfident Relative to Female Executives?

We provide causal evidence that adverse capital shocks to banks affect their borrowers' performance negatively. We use an exogenous shock to the U.S. banking system during the Russian crisis of Fall 1998 to separate the effect of borrowers' demand of credit from the supply of credit by the banks. Firms that primarily relied on banks for capital suffered larger valuation losses during this period and subsequently experienced a higher decline in their capital expenditure and growth rates as compared to firms that had access to the public-debt market. Consistent with an adverse shock to the supply of credit, crisis-affected banks decreased the quantity of their lending and increased loan interest rates in the post-crisis period significantly more than the unaffected banks. Our results suggest that the global integration of financial sector can contribute to the propagation of financial shocks from one economy to another through the banking channel.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1982118_code454685.pdf?abstractid=1982118

The Effect of Banking Crisis on Bank-Dependent Borrowers

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.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID281199_code010825670.pdf?abstractid=281199&rulid=9223549&mirid=5

Are Ipos Really Underpriced

An originate-to-distribute (OTD) model of lending, where the originator of a loan sells it to various third parties, was a popular method of mortgage lending before the onset of the subprime mortgage crisis. We show that banks with high involvement in the OTD market during the pre-crisis period originated excessively poor quality mortgages. This result is not explained away by differences in observable borrower quality, geographical location of the property or the cost of capital of high and low OTD banks. Instead, our evidence supports the view that the originating banks did not expend resources in screening their borrowers. The effect of OTD lending on poor mortgage quality is stronger for capital-constrained banks. Overall, we provide evidence that lack of screening incentives coupled with leverage induced risk-taking behavior significantly contributed to the current sub-prime mortgage crisis.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1982109_code454685.pdf?abstractid=1982109&mirid=5&type=2

Originate-to-Distribute Model and the Subprime Mortgage Crisis

While IPOs have been underpriced by more than 10% during the past two decades, we find that in a sample of more than 2,000 IPOs from 1980 to 1997, the median IPO was significantly overvalued at the offer price relative to valuations based on industry peer price multiples. This overvaluation ranges from 14% to 50% depending on the peer matching criteria. Cross-sectional regressions show that "overvalued" IPOs provide high first-day returns, but low long-run risk-adjusted returns. These overvalued IPOs have lower profitability, higher accruals, and higher analyst growth forecasts than "undervalued" IPOs. Ex post, the projected high growth of overvalued IPOs fails to materialize, while their profitability declines from pre-IPO levels. These results suggest IPO investors are deceived by optimistic growth forecasts and pay insufficient attention to profitability in valuing IPOs. Copyright 2004, Oxford University Press.

Are IPOs Really Underpriced

We undertake a broad-based study of the effect of managerial risk-taking incentives on corporate financial policies and show that CEOs' and CFOs' risk-taking incentives significantly influence their firms' financial policies. In particular, we find that CEOs' risk-decreasing (-increasing) incentives are associated with lower (higher) leverage and higher (lower) cash-balances. CFOs' risk-decreasing (-increasing) incentives are associated with safer (riskier) debt-maturity choices and higher (lower) earnings-smoothing through accounting accruals. We exploit the stock-option expensing regulation of 2004 to establish a causal link between managerial incentives and corporate policies. Our findings have important implications for optimal corporate compensation design.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1458117_code282594.pdf?abstractid=989224

Amiyatosh Purnanandam

Papers

The Effect of Banking Crisis on Bank-Dependent Borrowers

Are Ipos Really Underpriced

Originate-to-Distribute Model and the Subprime Mortgage Crisis

Are IPOs Really Underpriced

CEOs vs. CFOs: Incentives and Corporate Policies