1. Investment bankers, their analysts and orphaned IPOs Daniel Bradley, Clemson University Konan Chan, National Taiwan University Joonghyuk Kim, Korea University Ajai Singh, Case Western Reserve University 2004 NTU International Conference on Finance

2. December 2004NTU Conference on Finance2 Motivation Research coverage becomes an important issue recently –Loughran and Ritter (2004): research coverage becomes important over time, leading to significant underpricing –Krigman, Shaw, and Womack (2001): SEOs switch underwriters is to get more prestigious research coverage –SEC fine Merrill Lynch, among others, for 1.4 billion Why research coverage is important? –Alleviate the significant information asymmetry in IPOs –Increase company recognition, attract a larger customer base, and stimulate investment in the company –Potential conflict of interests

3. December 2004NTU Conference on Finance3 Motivation If important, –Does research coverage create value? –Where the value is from?

4. December 2004NTU Conference on Finance4 Previous Research Rajan and Servaes (1997) / Aggrawal, Krigman and Womack (2002) –underpricing attracts analyst following –Overoptimism (or momentum) from analysts result in future poor performance Cliff and Denis (2004) / Loughran and Ritter (2004) –Given gross spreads are fixed at 7%, IPOs don’t explicitly pay for analyst coverage –Underpricing is used to purchase the research coverage

5. December 2004NTU Conference on Finance5 Previous Research Michaely and Womack (1999) –Conflict of interest hypothesis: lead underwriters are issuing biased recommendations for their clients –lead underwriter recommendations are more optimistic compared to non-lead recommendations for the 1990-91 sample –the market discounts lead underwriter recommendations at the time of their release –poorer long-run performance for firms covered by lead than non-lead

6. December 2004NTU Conference on Finance6 Previous Research Bradley, Jordan, and Ritter (2003) –Confirmation hypothesis: higher firm quality if multiple analysts initiate coverage –76% of IPOs in 1996-2000 receive research coverage shortly after the end of quiet period, almost with a favorable report –The market responds positively to these recommendations –Market reaction is more favorable if 3 or more analysts initiate coverage –Market reaction is similar between lead and non-lead recommendation

7. December 2004NTU Conference on Finance7 Motivation and Objective Mixed results regarding the value of research coverage –Conflict of interest by Michaely and Womack (1999) –Confirmation in Bradley, Jordan, and Ritter (2003) We examine long-run performance of IPOs without research coverage at the end of quiet period and IPOs with research coverage –Orphans are IPOs which do not receive analyst coverage from their managing underwriters following the IPO quiet period expiration (25 days after offerings) –SEC prohibit firms and their underwriters from publishing opinions concerning valuation and earnings

8. December 2004NTU Conference on Finance8 Why Long-Run Returns? A large body of finance literature suggests that our market is slow to digest information –IPOs, SEOs, repurchases, mergers –Value strategy, momentum Analysts are generally looking at intermediate or long- term prospective of firms Compare with Michaely and Womack (1999) –They use 1990-91 sample which is relatively small compared to large population of IPOs –IPO pattern may change over time

9. December 2004NTU Conference on Finance9 Why End of Quiet Period? The first opportunity for affiliated analysts to issue opinions, thus the recommendations are most informative Initiations create more market impact than re-iterations Analysts’ recommendation are random, but end of quiet period is exogenous

10. December 2004NTU Conference on Finance10 Main Results In 1996-1998, orphans significantly underperform non- orphan –The outperformance of non-orphans is from multiple analyst coverage. –IPO firms outperform when the lead underwriter and another non-lead underwriter initiate coverage –This result is consistent with the confirmation hypothesis, but largely inconsistent with the conflict of interest hypothesis In the bubble period (1999-2000), both orphans and non- orphaned IPOs significantly underperform

11. December 2004NTU Conference on Finance11 Data and Methodology 1,731 IPOs from SDC in 1996-2000 Coverage data from Bradley, Jordan, and Ritter (2003) Buy-and-hold abnormal returns (BHARs) for 2-years Size- and book-to-market matched control firm as benchmark Skewness-adjusted t-statistics for testing, and

12. December 2004NTU Conference on Finance12 Summary Statistics Non-orphansOrphansDifference VariableNMeanN p-value Tech1,20657.752535.6.0001 Offer size ($mil)1,20680.952539.4.0001 Managers1,2063.15252.1.0001 Venture (%)1,20659.252526.7.0001 CM-rank1,2068.05255.8.0001 Underpricing (%)1,18145.252117.3.0001 Year19961997199819992000 Number of IPOs Non-orphan277186154326263 Orphan260142 52 49 22 % of Orphan48.443.325.213.17.7

13. December 2004NTU Conference on Finance13 Long-Run Returns (%) NRawt-statBHARt-stat FF  t-stat 1996-2000 Non-orphan1206 -2.18-0.29-4.60-0.59 -0.70-1.14 Orphan525 0.520.14-9.43-1.03 -0.70-0.87 Difference -2.70-0.264.830.38 0.01 1996-1998 Non-orphan617 50.626.5039.013.65 -0.44 -0.80 Orphan454 3.790.62-5.09-0.51 -1.27 -2.16 Difference 46.833.1444.102.62 0.832.02 1999-2000 Non-orphan589 -57.49-7.00-50.28-9.19 -0.30-0.24 Orphan71 -20.36-0.97-37.17-1.69 -0.60-0.35 Difference -37.13-3.61-13.11-0.60 0.300.21

14. December 2004NTU Conference on Finance14 Long-Run Returns (%) by Underpricing Coveraget-stat UnderpricingYesNop-value 1996-1998 Mean53.4-8.32.22 HighMedian0.9-15.20.027 Mean23.2-2.41.31 LowMedian12.4-7.50.032 1999-2000 Mean-57.6-99.72.11 HighMedian-41.2-63.20.189 Mean-43.1-10.9-0.86 LowMedian-25.2-26.70.682

15. December 2004NTU Conference on Finance15 Long-Run Returns (%) by Reputation Coveraget-stat ReputationYesNop-value 1996-1998 Mean61.719.30.84 HighMedian5.0-4.70.632 Mean28.6-10.62.50 LowMedian7.2-14.50.003 1999-2000 Mean-36.0-61.51.38 HighMedian-29.0-50.50.430 Mean-72.2-26.3-1.23 LowMedian-44.6-32.20.218

16. December 2004NTU Conference on Finance16 Long-Run Returns (%) by Venture Capital Coveraget-stat Venture CapitalYesNop-value 1996-1998 Mean69.4-10.42.07 YesMedian7.0-16.70.009 Mean12.1-3.30.95 NoMedian4.6-8.40.118 1999-2000 Mean-60.6-79.90.49 YesMedian-38.6-55.60.159 Mean-23.7-15.3-0.21 NoMedian-19.9-23.80.972

17. December 2004NTU Conference on Finance17 Long-Run Returns (%) by High Tech Coveraget-stat High TechYesNop-value 1996-1998 Mean64.015.91.50 YesMedian8.3-8.80.097 Mean15.2-15.81.70 NoMedian2.9-10.70.029 1999-2000 Mean-60.3-41.8-0.53 YesMedian-38.3-48.00.404 Mean-29.9-33.00.33 NoMedian-24.9-19.10.737

18. December 2004NTU Conference on Finance18 Long-Run Returns (%) by # of Analysts # analystsNMeant-statMedianp-value 1996 to 1998 0454-5.09-0.56-10.130.017 13079.870.960.680.680 2 or more31067.872.9310.580.034 1999 to 2000 071-37.17-1.82-32.210.001 171-39.19-2.57-22.970.004 2 or more518-51.80-6.61-36.260.000

19. December 2004NTU Conference on Finance19 Long-Run Returns (%) by Affiliation and # of Analysts Affiliation# analystsNMeant-statMedianp-value 1996-1998 Lead only11945.520.38-11.340.609 Co-lead only111317.341.424.800.166 Co-lead only2 or more186.080.14-15.580.317 Both2 or more29271.682.9412.260.018 1999-2000 Lead only151-26.63-1.35-13.060.156 Co-lead only120-71.24-3.86-61.260.003 Co-lead only2 or more32-49.76-3.41-31.740.004 Both2 or more486-51.94-6.26-36.620.000

20. 1996-1998Full sampleLeadNo lead Intercept-33.58-5.09-31.50-31.05-38.32-6.58 (0.009)(0.578)(0.008) (0.003)(0.483) Lead35.9311.79 (0.022)(0.561) VC21.7118.5218.2232.92-35.64 (0.291)(0.355)(0.361)(0.145)(0.053) HighRep32.5727.7626.9538.9014.11 (0.155)(0.222)(0.224)(0.144)(0.362) HighUnder12.4611.2310.7612.42-7.19 (0.442)(0.494)(0.508)(0.497)(0.650) Tech34.7933.9333.8935.5633.61 (0.093)(0.102) (0.129) One14.97-2.335.261.6624.29 (0.278)(0.900)(0.721)(0.926)(0.136) Twomore72.9644.8456.2154.177.58 (0.003)(0.070)(0.007)(0.011)(0.871)

21. December 2004NTU Conference on Finance21 Robustness Winsorized returns –Reduce the concern of outliers/skewness of long-run returns Industry matching –Use industry, size, BM matched control firm –Control potential bias of industry clustering –Reduce the dependence problem in long-run buy-and- holdreturns Rating strength –Focus on only ‘strong buy’ and ‘buy’

22. December 2004NTU Conference on Finance22 Conclusion During 1996-1998, non-orphans outperform orphans –The outperformance is mainly due to the multiple analysts –Support confirmation hypothesis, but not support the conflict of interest hypothesis In the 1999-2000 bubble, there is no difference between the long-run performance of orphans and non-orphans –Over 90% of IPOs get analyst coverage in 1999-2000 –Given almost everyone received research coverage, any selectivity or informational value that coverage has, was not noticeable during the bubble period