Faizal.Gillani
Article Review: The Long-Run Performance of Initial Public Offerings
- Jay R. Ritter
Summary:
There have been several studies about the two-anomalies in the pricing of Initial public offerings (IPO’s) of common stock. These two anomalies are the short-run under pricing phenomenon, and the “hot issue” market phenomenon. In this article Jay R. Ritter entitled The Long-Run Performance of Initial Public Offerings he proposes a third phenomenon about IPO’s in the long-run considered as 3 years. He presented this study of IPO’s underperforming in the three years after going public. He took a sample of 1,526 IPOs that went public between from 1975-1984 and compared them to similar firms based on its size and industry. The goal is to prove that IPO’s significantly underperformed their counterpart and the possible reasons for this long-run phenomenon. As per the article there are three possible explanations for the underperformance such as risk mis-measurement, Bad luck or fads and over optimism of investors.
Important items in the Article:
· The aftermarket performances of IPO’s were compared to their matching firms evaluating them in two measures, Monthly portfolio rebalancing using Cumulative average adjusted returns (CAR) and 3-Year buy and hold returns set for both IPO’s and the matching firms. The bench marks are defined with the formulation of the value weighted indexes of NASDAQ and NYSE. The monthly rebalancing is important criteria in order to consider the fact that delisted firms are allocated equally to the surviving members of the portfolio.
· Mis-measurement of the risk of the IPO’s could mean that the firm’s betas had many errors to figure out accurately the level of risk involved.
· Fads can be a possible explanation for IPO’s underperformance in the long-run. This suggests that many firms go public near the peak of industry-specific fads. Just as the business, nature of the IPO starts to lose public interest the investors expect better returns.
· Returns appear to be abnormal compared to investor’s expectation. It is said that the investors take an unexpected risk and the market does not give them an expected outcome.
· Over optimism is also mentioned as being an excuse for IPO’s not living up to expectations in the first initial ten years. Investors may believe the NPV’s of growth opportunities for the IPO firm are more than they should actually be. This may be done through spin tactics from the underwriters to the initial investment.
Overall Impression:
The article was very well researched and provided empirical. It analyzed different bench marks to come to a conclusion. Even though it did not figure out one specific cause for under performance of IPO’s it provided a trend of some reason that might have affected. Having said that it lacked information on the economic conditions of the 10 year period as Inflation plays an important role in company’s performance in a particular year. Additionally, the 5 yr performance of IPO by Abbott briefed in the research creates a dilemma of concluding the facts into a decision of the 3yr plan by Ritter. The study is too old to judge the current situation of IPO’s as the market trends, financial conditions and several other factors have changed a lot and might not be a deciding factor in the current scenario.
