1. Recent Developments in IPO Research
Jay R. Ritter
University of Florida
Oxford EFMA IPO Symposium

2. A few topics The international competition for new listings
Why are IPOs underpriced?
Do IPOs underperform in the long run?
How are IPOs sold?

3. The international competition for new listings

4. The vast majority of IPOs list in the issuer’s home market
Every year from , 90-97% of IPOs list in the issuer’s home market
Why? 4

5. Demand is local Some IPOs list in more than one market (cross-listing)
Mainly very large IPOs, including privatizations
Cross-listings have been rapidly declining, partly due to better clearing mechanisms in the EU
Many Chinese companies list abroad (Singapore, London, New York)
For attracting foreign investors, a Hong Kong listing is common 5

6. Some moderate-size and small firms list abroad rather than at home
Hong Kong’s market share has been rising
AIM’s market share has been rising
The market shares of the NYSE and NASDAQ have been falling
Some blame the Sarbanes-Oxley (SOX) Act of 2002 6

7. Number of Offerings and Average First-day Returns on US IPOs, 1980-2007

8. 8

9. 9

10. Singapore has become a major center for small Chinese companies to go public
Number of Foreign IPOs in Singapore
Year All From China and Hong Kong
The median proceeds in 2006 = $25.6 million 10

11. Market conditions for IPOs fluctuate between hot and cold
French IPO volume has fluctuated between 4 and 121 IPOs per year
German IPO volume has fluctuated between zero and 175 IPOs per year
Italian IPO volume has fluctuated between zero and 42 IPOs per year
UK IPO volume has fluctuated between 12 and 264 IPOs per year 11

12. Number of Offerings and Average First-day Returns on French IPOs, 1983-200712

13. Number of Offerings and Average First-day Returns on German IPOs, 1980-200713

14. Number of Offerings and Average First-day Returns on Italian IPOs, 1985-200714

15. Number of Offerings and Average First-day Returns on UK IPOs, 1980-200715

16. The number of U.S. IPOs (not including ADRs) has fluctuated between 63 to over 600 offerings per year 16

17. Investor protection vs. excessive regulation
Jensen and Meckling (1976 JFE)
Investors price protect themselves
Shleifer and Vishny (1997 JF)
La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998 JPE)
Laws and their enforcement matter

18. Why are IPOs underpriced?

19. 19

20. 20

21. Asymmetric Information-based Explanations for Underpricing
The “winner’s curse” or “Groucho Marx theorem” (Rock (1986))
If you are unsure of the fair value of shares being sold,
and there is excess demand, the most optimistic investors
are likely to get the shares
Thus, conditional on getting the shares, you find out
that you are probably overoptimisitic
The need to give institutions an incentive to investigate a
company and buy its shares (Benveniste and Spindt (1989)) 21

22. These are good explanations if we were seeking to explain why,
on average, underpricing is 5-10%
These are not good explanations when we are trying to explain
why underpricing is 15% or more 22

23. Underpricing and allocations are related
There are three frameworks for viewing discretion in allocations
The information acquisition view (Benveniste and Spindt), in
which underwriters favor regular investors who provide
information about demand, resulting in more accurate pricing
The “pitchbook” view, in which underwriters seek out
buy-and-hold investors
The rent-seeking view, in which underwriters trade money left
on the table for quid pro quos (commission business)
Biased analyst recommendations appeal to issuing firms
and make them willing to leave money on the table 23

24. IPO Underpricing
Is it equilibrium compensation for risk-bearing or providing information?
Is it excessive, with rent-seeking behavior common?

25. Loughran and Ritter’s (2004 FM) issuer objective function:
α1·IPO Proceeds + α2·Proceeds from Future Sales + (1-α1-α2)·Side Payments

26. Why do issuers put up with severe underpricing?
On internet IPOs, underwriters knew they were overpriced
But why did their analysts put out “buy” recommendations?
Issuer stupidity
The publicity is worth it
Capital can be raised in a follow-on offering
Prospect theory
When people get good news about their wealth increasing,
they don’t bargain as hard at the pricing meeting
Analyst lust and spinning
Issuers seek out underwriters where influential analysts
will be bullish
Spinning of hot IPOs to executives 26

27. soft dollar commissions on other trades
Scandals (SLAC):
Spinning: Allocating hot IPOs to the personal brokerage accounts of top executives in return for company business
Laddering: Requiring the purchase of additional shares in the aftermarket in return for IPOs
Analyst conflicts of interest: Giving “buy” recommendations in return for underwriting and M&A business
Commission business in return for IPOs: Underwriters allocated IPOs primarily to investors that generated
soft dollar commissions on other trades 27

28. Academic Evidence on SLAC Problems :
Spinning: Xiaoding Liu and Jay Ritter’s
“Corporate Executive Bribery: An Empirical Analysis”
Laddering: Grace Hao’s 2007 JFE paper “Laddering in
Initial Public Offerings”
Analyst conflicts of interest: Mike Cliff and David Denis’s
2004 JF paper and Liu-Ritter paper
Commissions: Jon Reuter’s 2006 JF paper 28

29. Example of spinning: Salomon Smith Barney's allocations of IPOs to Bernie Ebbers
Ebber's Offer Market First-day
IPO Date Shares Price Price Profit
McLeod 6/96 200,000 $20.00 $25.13 $1,026,000
Tag Heuer 9/96 5,000 $19.55 $20.00 $2,250
Qwest Communications 6/97 205,000 $22.00 $28.00 $1,230,000
TV Azteca 8/97 1,000 $18.25 $19.19 $900
Box Hill Systems 9/97 5,000 $15.00 $20.62 $28,100
Nextlink Communications 9/97 200,000 $17.00 $23.25 $1,250,000
China Mobile HK 10/97 2,000 $30.50 $ $5,000
Metromedia Fiber 10/97 100,000 $16.00 $21.38 $538,000
Teligent 11/97 30,000 $21.50 $25.63 $123,900
Earthshell 3/98 12,500 $21.00 $23.56 $32,000
Rhythms Netconnection 4/99 10,000 $21.00 $69.13 $481,300
Juno Online 5/99 10,000 $13.00 $ $13,700
Juniper Networks 6/99 5,000 $34.00 $98.88 $324,400
Focal Communications 7/99 5,000 $13.00 $19.50 $32,500
Williams Communications 10/99 35,000 $23.00 $28.06 $177,100
Radio Unica 10/99 4,000 $16.00 $27.44 $45,800
Chartered Semiconductor 10/99 5,000 $20.00 $33.19 $66,000
UPS 11/99 2,000 $50.00 $67.38 $34,800
KPNQwest 11/99 20,000 $20.81 $29.81 $180,000
Tycom Ltd 7/00 7,500 $32.00 $37.00 $37,500
Signalsoft 8/00 5,000 $17.00 $21.88 $24,400

30. “Corporate Executive Bribery: An Empirical Analysis” (joint work with Xiaoding Liu)
IPOs in which the executives are being spun are underpriced about 18% more than other IPOs, holding everything else constant
Firms that are involved in spinning are much less likely to switch underwriters for their next public equity offering (5% vs. 31%)

31. Analyst coverage

32. Analyst Coverage Is Bundled with Bookbuilding
Degeorge, Derrien, and Womack (July 2007 RFS)
“Analyst Hype In IPOs: Explaining the Popularity of Bookbuilding”

33. What are the most important qualities of a good analyst?
a) Accurate earnings forecasts
b) Timely buy and sell recommendations
c) Insightful written reports
d) Setting up meetings with management
e) Accessibility/responsiveness of phone calls
f) Industry knowledge

35. Example of kickbacks with commissions: Credit Suisse First
Boston (CSFB) received commission business equal to as much
as 65% of the profits that some investors received from certain
hot IPOs, such as the December 9, 1999 IPO of VA Linux
The VA Linux IPO involved 5.06 million shares
Offer price: $30.00
Closing market price: $239.25
Capital gain: $209.25
Gross spread: $2.10
If the investor then traded shares to generate commissions of
one-half of this profit the total underwriter compensation per
share was $2.10 plus $ , or $ 35

36. According to paragraph 58 of the SEC’s January 22, 2002 settlement with CSFB, an institutional customer that had received a 12,500 share allocation of VA Linux from CSFB paid CSFB at least $565,000 by engaging in the following transactions: 36

37. Where were the regulators during the internet bubble?
At first… 37

38. 38

39. But then…

41. And then…

43. Long-run performance of IPOs

44. While IPOs tend to go up on the first day of trading, in the long run, on average they have tended to underperform.
But there is a strong cross-sectional pattern in the U.S.: IPOs that had annual sales of less than $50 million severely underperform, whereas those that had achieved annual sales of $50 million don’t underperform.
Buy-and-hold stock returns are skewed: there are some big winners, but most stocks underperform. This is especially true with young companies, where there is even greater right skewness. 44

45. Annual returns in the five years after going public for U. S
Annual returns in the five years after going public for U.S. 6,973 IPOs from Style-matched firms match on market cap and book-to-market. 45

46. 46

47. Many of the AIM listings have annual sales below $50 million, a category in which U.S. IPOs have underperformed in the past. 47

48. How are IPOs sold?

49. Fixed Price Offerings Bookbuilding
Fixed Price Offerings Bookbuilding Information acquisition (Benveniste and Spindt (1989)) Agency problems (Loughran and Ritter (2002, 2004)) Auctions Hybrid Mechanisms

50. Pricing and Allocation
Is the offer price set before or after information about the state of demand is acquired?
Are shares allocated in a discriminatory or non-discriminatory manner (favoritism vs. pro rata)?

51. August 1992, Shenzhen: Before the rioting started, crowds waited for the new share subscription forms

52. 52

53. Andreas Trauten’s paper this morning
Google’s IPO
Andreas Trauten’s paper this morning
“Why the Google IPO might stay exotic–
an experimental analysis of offering mechanisms”
File price range of $ /share
Auction result: $85/share offer price
Closing first-day price of $100.33/share

54. What went wrong? Out of equilibrium disclosure strategy
First post-IPO earnings announcement on Oct. 21, 2004, with revenue up 105% from the year-earlier quarter: price jumped 15.4%
Second post-IPO earnings announcement on Feb. 1, 2005 , with revenue up 101% from the year-earlier quarter: price jumped 7.3%

55. Summary Hot and Cold markets will continue
Hot and Cold markets will continue
Issuers still put up with underpricing
Long-run underperformance is restricted to
companies going public with less than
$50 million in annual sales
In the U.S., auctions are becoming (slightly) more common, although bookbuilding has
become the dominant method internationally 55

56. Regulatory reform has changed the game a little
Summary (continued)
Regulatory reform has changed the game a little
Spinning has been nearly eliminated
Laddering continues to occur
Analyst lust will continue
Commission business in return for IPOs is still allowed
Underwriters still have an incentive to underprice
The academic literature still focuses too much on
asymmetric information models rather than agency
models