Underpricing In Initial Public Offerings: Evidence From The U.S Avgoustinos Filippoupolitis

A thesis submitted to the Department of Accounting and Finance of the Athens University of Economics and Business as partial fulfillment of the requirements for the Master‟s Degree Athens July, 2013 We approve the thesis of AVGOUSTINOS FILIPPOUPOLITIS ACADEMIC SUPERVISOR GEORGIOS LELEDAKIS ACADEMIC SUPERVISOR ATHANASIOS EPISKOPOS ACADEMIC SUPERVISOR SPYROS SPYROU “I hereby declare that this particular thesis has been written by me, in order to obtain the Postgraduate Degree in Accounting and Finance, and has not been submitted to or approved by any other postgraduate or undergraduate program in Greece or abroad This thesis presents my personal views on the subject All the resources I have used for the preparation of this particular thesis are mentioned explicitly with references being made either to their authors, or to the URL‟ s (if found on the internet).” Avgoustinos Filippoupolitis …… Underpricing in Initial Public Offerings: Evidence from the US Table of Contents Table of Contents List of Figures & Tables Abstract Πεξίιεςε ζηα Ειιεληθά Chapter 1: Introduction Chapter 2: Literature Review 2.1 Introduction 2.2 Going Public: Basic Considerations 2.2.1 Why and When Firms Go Public 2.2.2 How Firms Go Public 10 2.2.3 Costs of Going Public 13 2.3 Market Problems with the Pricing of IPOs 14 2.3.1 Short-Run Underpricing 14 2.3.2 Hot & Cold IPO Markets 16 2.3.3 Long-Run Underperformance 17 2.4 IPO Underpricing Theories 17 2.4.1 Assymetric Information Models 18 2.4.2 Institutional Explanations 21 2.4.3 Ownership and Control 23 2.4.4 Behavioral Explanations 24 2.5 How & Why Underpricing Changed Over Time 26 2.6 Discussion on Literature Review 27 Chapter 3: US IPO Market 29 3.1 Introduction 29 3.2 IPO Process in the US – Statutory Framework 29 3.3 US IPO Market Activity & Underpricing in the Literature 30 Chapter 4: Data, Research Methodology & Results 32 4.1 Introduction 32 4.2 Data & Sample 32 4.3 Sample Characteristics 33 4.4 Methodology 35 4.5 Results 42 4.5.1 The Degree of Raw and Market Adjusted Underpricing 42 4.5.2 Cross Sectional Regression Results 49 Chapter 5: Discussion 54 Chapter 6: Summary & Conclusions 56 Bibliography 57 Page | Underpricing in Initial Public Offerings: Evidence from the US List of Figures & Tables Figure 1: Initial IPO Returns in the US from 1980 -2002…………………………………… 31 Table 1: Equally weighted average initial returns for selected countries……………….…… 15 Table 2: Number of IPOs and aggregate proceeds per year……………………………… … 30 Table 3: Frequency of IPOs, US markets and gross proceeds per year….…………………… 33 Table 4: Frequency of IPOs and gross proceeds by industry….……………………………… 34 Table 5: Selected characteristics of the IPOs ….………………………………………… … 35 Table 6: Determinants of the performance of IPOs and hypotheses tested…… …………… 38 Table 7: Descriptive statistics for dependent and independent variables.……………….…… 40 Table 8: Correlation matrix.……………….………………………………………………… 41 Table 9: Underpricing of IPOs per year.……………….…………………………………… 43 Table 10: Descriptive statistics - underpricing……………….…………………………….… 43 Table 11: Distribution of raw and adjusted underpricing………………………….…….…… 44 Table 12: Raw and market adjusted initial returns by industry………………………….…… 45 Table 13: Raw and market adjusted initial returns by age group……………………… …… 45 Table 14: Raw and market adjusted initial returns by size……………….…………………….46 Table 15: Raw and market adjusted initial returns by exchange……………………… …… 46 Table 16: Raw and market adjusted initial returns by underwriter reputation……….….…… 46 Table 17: Raw and market adjusted initial returns by number of uses of proceeds…… …… 47 Table 18: Raw and market adjusted initial returns by hot/cold periods…….……………… 47 Table 19: Raw and market adjusted initial returns before and after the crisis ………… …… 47 Table 20: Raw and market adjusted initial returns for selected groups …….……………… 48 Table 21: Test of differences in mean returns …….……………………………………….… 49 Table 22: Cross sectional regression results…….…………………………………………… 51 Page | Underpricing in Initial Public Offerings: Evidence from the US Abstract This thesis covers a review of the literature regarding the initial public offerings‟ underpricing phenomenon Starting from a brief presentation of the basic considerations for a firm going public and an analysis of the market problems for the pricing of IPOs, an extensive presentation of the theoretical explanations of underpricing is made The empirical part of the thesis focused on the US IPO market and more specifically on the IPO activity from 2003 to 2012 By employing some of the explanations suggested in the IPO literature, the extent of underpricing during this period and the factors influencing underpricing are investigated One of the findings of this study is that the average initial return for the US IPOs in the period in scope is 12% with a standard deviation of 22.4% No statistically significant difference has been found in the degree of underpricing for IPOs before and after the economic crisis in 2008, but the hypothesis that there is no statistically significant difference in underpricing between the years has been rejected at 1% level The variables tested for their relationship with the degree of underpricing are the firm size, the firm age, the industry, the offer price, the IPO gross proceeds, the time lag between offering and listing, the exchange of listing, the number of uses of proceeds in prospectus, the underwriter reputation ranking and the market condition All these variables seem to follow existing literature apart from the number of uses, the age and the underwriter reputation, which have the opposite from the hypothesized relationship Additionally, it has been concluded that the only statistically significant variables in influencing the degree of underpricing are the offer price, the number of uses of gross proceeds, the firm classification as high-technology and the listing on NASDAQ Using these variables together with the underwriter‟s reputation and market condition, a six factor model for the initial underpricing has been built with OLS regression analysis The model explains 9.78% of the total variation in underpricing Page | Underpricing in Initial Public Offerings: Evidence from the US Περίληψη στα Ελληνικά Σηα πιαίζηα ηεο παξνύζαο εξγαζίαο, πξαγκαηνπνηήζεθε κία αλαζθόπεζε ηεο ππάξρνπζαο βηβιηνγξαθίαο ζρεηηθά κε ην θαηλόκελν ηεο ππνηηκνιόγεζεο ζηηο αξρηθέο δεκόζηεο εγγξαθέο Ξεθηλώληαο από κία ζύληνκε παξνπζίαζε ησλ θηλήηξσλ γηα κηα αξρηθή δεκόζηα εγγξαθή θαη κία αλάιπζε ησλ πξνβιεκάησλ ηεο αγνξάο ζρεηηθά κε ηελ ηηκνιόγεζή ηεο, θαιύπηεηαη εθηελώο ην ζεσξεηηθό ππόβαζξν πνπ έρεη αλαπηπρζεί γηα ηελ εμήγεζε ηνπ θαηλνκέλνπ Γηα ηελ εκπεηξηθή κειέηε ηνπ θαηλνκέλνπ, επηιέρζεθε ε ακεξηθάληθε αγνξά αξρηθώλ δεκόζησλ εγγξαθώλ θαη πην ζπγθεθξηκέλα ε πεξίνδνο από ην 2003 έσο ην 2012 Χξεζηκνπνηώληαο θάπνηεο από ηηο εμεγήζεηο πνπ πξνηείλεη ε βηβιηνγξαθία, κειεηήζεθε ηόζν ν βαζκόο ηεο ππνηηκνιόγεζεο γηα ηε ζπγθεθξηκέλε πεξίνδν θαη ηε ζπγθεθξηκέλε αγνξά όζν θαη νη παξάγνληεο πνπ ηνλ επεξεάδνπλ Έλα από ηα επξήκαηα ηεο εξγαζίαο είλαη όηη ε κέζε απόδνζε θαηά ηελ πξώηε εκέξα δηαπξαγκάηεπζεο είλαη ίζε κε 12% κε ηππηθή απόθιηζε 22.4% Δελ βξέζεθε ζηαηηζηηθά ζεκαληηθή δηαθνξά κεηαμύ ηεο ππνηηκνιόγεζεο γηα αξρηθέο δεκόζηεο εγγξαθέο πξηλ θαη κεηά ηελ παγθόζκηα νηθνλνκηθή θξίζε ηνπ 2008 Παξόιαπηά, δηαπηζηώζεθε ζηαηηζηηθά ζεκαληηθή δηαθνξά ζηε κέζε ππνηηκνιόγεζε κεηαμύ ησλ δηαθνξεηηθώλ εηώλ ζε επίπεδν εκπηζηνζύλεο 1% Οη κεηαβιεηέο ησλ νπνίσλ εμεηάζηεθε ε επίδξαζε ζηελ ππνηηκνιόγεζε είλαη ην κέγεζνο ηεο εηαηξίαο, ε ειηθία, ν θιάδνο δξαζηεξηνπνίεζεο, ε πξνζθεξόκελε ηηκή, ην ύςνο ησλ θεθαιαίσλ πνπ αληιήζεθαλ, ε ρξνληθή πζηέξεζε κεηαμύ πξνζθνξάο θαη πξώηεο δηαπξαγκάηεπζεο, ην ρξεκαηηζηήξην, ν αξηζκόο ησλ ρξήζεσλ ησλ θεθαιαίσλ όπσο αλαγξάθνληαη ζην πξνζπέθηνπο, ε θήκε ηνπ αλαδόρνπ θαη νη ζπλζήθεο ηεο αγνξάο Γηα όιεο απηέο ηηο κεηαβιεηέο επηβεβαηώλνληαη νη ππνζέζεηο ηεο ππάξρνπζαο βηβιηνγξαθίαο, κε εμαίξεζε ηε ρξήζε ησλ θεθαιαίσλ, ηελ ειηθία θαη ηε θήκε ηνπ αλαδόρνπ γηα ηηο νπνίεο ηζρύεη ε αληίζεηε ζρέζε από απηή πνπ πξνηείλνπλ πξνεγνύκελεο έξεπλεο Επηπιένλ, έλα από ηα επξήκαηα ηεο εξγαζίαο είλαη όηη ε πξνζθεξόκελε ηηκή, ν αξηζκόο ησλ ρξήζεσλ ησλ θεθαιαίσλ, ε δξαζηεξηνπνίεζε ζηνλ θιάδν πςειήο ηερλνινγίαο θαη ε εγγξαθή ζηνλ NASDAQ είλαη νη κνλαδηθέο ζηαηηζηηθά ζεκαληηθέο κεηαβιεηέο Χξεζηκνπνηώληαο απηέο ηηο κεηαβιεηέο, δεκηνπξγήζεθε έλα κνληέιν παξαγόλησλ κε ηε ρξήζε παιηλδξνκήζεσλ Τν κνληέιν εμεγεί 9.78% ηεο ζπλνιηθήο δηαθύκαλζεο ηεο ππνηηκνιόγεζεο Page | Underpricing in Initial Public Offerings: Evidence from the US Chapter 1: Introduction Going public is an important decision in the life-cycle of a company Most companies go public through an initial public offering (IPO) of shares to investors so as to raise capital from the market on more favorable terms than if the companies were privately held The pricing of the initial public offerings is a difficult task, as there is no observable market price prior to the offering Since Ibbotson R G (1975) puzzled the researchers by first documenting the large underpricing of the initial public offerings; great effort – both theoretical and empirical – has been made to identify any patterns in underpricing as well as to explain the phenomenon through classic and behavioral finance The most well researched market is the IPO market in the United States (US) Most of the theories have been first tested by researchers using data from the US IPO market This thesis covers a review of the literature regarding the initial public offerings, focusing on the underpricing phenomenon in particular Starting from a brief presentation of the basic considerations for a firm going public, which is followed by an analysis of the market problems for the pricing of IPOs, an extensive presentation of the theoretical explanations of underpricing is made Given the little consistency in the reported findings in academic literature regarding the correlates of underpricing, a discussion is attempted with the aim to identify promising areas for future research The empirical part of the thesis will focus on the US IPO market and more specifically on the IPO activity from 2003 to 2012, the least researched period in the literature It is the period following the technology bubble burst in the US (2000) and as reported by Gao, Ritter, & Zhu (2013), it is characterized by a significant drop in the average number of IPOs per year, with small firms having been affected the most By employing some of the explanations suggested in the IPO literature, the extent of underpricing during this period and the factors influencing underpricing are investigated Findings will be discussed in the context of existing literature for the pre and post-bubble periods In the next chapter, the literature on IPOs and the underpricing phenomenon is reviewed Chapter includes a brief presentation of the US IPO market Data and methodology are provided in chapter 4, together with the main results of the regression analysis In chapter 5, the findings are discussed and finally, chapter provides a summary and the conclusions Page | Underpricing in Initial Public Offerings: Evidence from the US Chapter 2: Literature Review 2.1 Introduction The aim of this chapter is to situate the dissertation focus within the context of the wider research regarding the initial public offerings and to exhibit what knowledge and ideas have been established on the topic At the end of the chapter, a critical review of the literature will be attempted including the identification of its strengths and weaknesses as well as gaps that could be the basis for future research 2.2 Going Public: Basic Considerations 2.2.1 Why and When Firms Go Public The academic literature presents a number of theories to explain why firms choose to go public Most of these theories are based on the efficient market hypothesis linking the decision to go public with managers‟ aim to maximize firm value First, raising capital to fund investment opportunities in a way that minimizes company‟s weighted average cost of capital is one of the key drivers for firms to go public (Scott, 1976) (Modigliani & Miller, 1963) According to the pecking order theory (Myers, 1984), firms decide to go public to gain access to capital when other cheaper sources of capital (internal equity and debt financing) have been depleted Second, the other key driver, which is not necessarily consistent with either the market efficiency or the value-maximization hypotheses, is to allow insiders including venture capitalists to cash out and perhaps diversify their holdings (Zingales, 1995) Third, according to Zingales (1995) going public can facilitate future acquisitions as it is much easier for a potential acquirer to spot a potential takeover when it is public In the same context, going public creates public shares which can be used as a “currency” in a takeover deal (Brau & Fawcett, 2006) Forth, going public may have strategic drivers such as to disperse the ownership of the firm (Chemmanur & Fulghieri, 1999), improve its position in the product market and deter new entrants into the industry (Jong, Huijgen, Marra, & Roosenboom, 2012), increase reputation and inspire more faith in the firm from other investors, customers, creditors and suppliers (Maksimovic & Pichler, 2001) and attract analyst attention and coverage In a survey of Chief Financial Officers (CFOs) in US public and private firms, performed by Brau & Fawcett (2006) and contrary to the standard theories, neither cost of capital nor capital availability motives ranked high among the drivers of going-public The creation of Page | Underpricing in Initial Public Offerings: Evidence from the US public shares for use in future acquisitions, the establishment of a market price/value of the firm, the enhancement of the reputation of the company and the dispersion of ownership were among the top drivers for IPO Bancel & Mittoo (2009) who surveyed CFOs from 12 European countries identified that enhanced visibility and financing for growth are the most important drivers with all other being similar to those of US CFOs The only difference is on the outside monitoring which is considered a major benefit for EU CFO‟s but a major cost for US CFOs As regards the timing of an IPO, there are two main explanations proposed by the theory; the life-cycle and the market timing theories According to the life-cycle theory, companies go public when they need to raise equity to fund growth and create a public and liquid market for firm ownership (Brau & Fawcett, 2006) According to market timing theories, a firm goes public in a bull market so as to achieve a more favorable pricing (Lucas & McDonald, 1990), avoids issuing in periods where few other good-quality firms issue (Choe, Masulis, & Nanda, 1993) and try to benefit from “windows of opportunity”, when investors are overoptimistic (Ritter & Welch, 2002) The market timing theory suggests that during this “window of opportunity”, high investor sentiment results in temporary industry or market-wide overvaluation of shares and lower cost of equity Finally, firms decide to go public when information asymmetry between firm insiders and investors is not severe otherwise it can be very costly to issuers (Draho, 2004) 2.2.2 How Firms Go Public For a firm to go public, there are a number of steps/decisions that need to be made which are more or less common in all equity markets These steps are summarized by Ljungqvist A (2008) as follows: the choice of the market, the choice of the underwriter, the initial price setting, the production of initial prospectus, the marketing of the offer, the final pricing of the offer, the allocation of shares and the aftermarket services First, the firm needs to choose the market where its stocks will be traded In the past, companies would almost always choose to have their shares traded on their domestic stock exchange but this has changed over the years with the globalization of the markets and the irrelevance of the national boundaries in investment decisions In addition, many traditional exchanges have created new segmented markets aiming, for example, at young firms with high growth potential and characterized by less stringent entry requirements Page | 10 Underpricing in Initial Public Offerings: Evidence from the US Table 14: Raw and Market Adjusted Initial Returns by Size (2003-2012) Total Assets ('000 USD) 0-10,000 10,000-30,000 30,000-50,000 50,000-100,000 100,000-500,000 >500,000 Total Number of IPO’s 88 139 112 130 249 188 906 RIR (%) 0.9% 12.9% 17.6% 16.1% 12.6% 10.0% 12.1% St.Dev RIR 8.3% 21.0% 22.4% 21.1% 28.2% 18.5% 22.5% St.Dev MAIR 9.4% 21.0% 22.4% 21.0% 28.1% 18.6% 22.5% MAIR (%) 1.1% 12.9% 17.5% 16.1% 12.5% 9.9% 12.1% If initial underpricing is viewed by listing board, it can be suggested that firms listed on American experience considerably lower underpricing compared to firms listed on NYSE or NASDAQ As presented in Table 15, the average MAIR for firms on American in 1.5% whilst 11.5% and 12.8% for firms on NYSE and NASDAQ respectively However, NASDAQ IPOs have higher degree of dispersion around the mean (Standard Deviation of 24.2%) Table 15: Raw and Market Adjusted Initial Returns by Exchange (2003-2012) Exchange NYSE American NASDAQ Total Number of IPO’s 266 43 611 920 RIR (%) 11.5% 1.4% 12.9% 12.0% St.Dev RIR 18.9% 7.4% 24.2% 22.4% MAIR (%) 11.5% 1.5% 12.8% 11.9% St.Dev MAIR 18.8% 7.7% 24.2% 22.4% Table 16: Raw and Market Adjusted Initial Returns by Underwriter Reputation (2003-2012) Underwriter Ranking 1.001 2.001 3.001 4.001 5.001 6.001-6.501 7.001-7.501 8.001-8.501 9.001 Total Number of IPO’s 15 13 15 53 38 95 191 480 905 RIR (%) 2.0% 4.0% -1.4% 1.7% 7.5% 8.0% 8.9% 10.8% 14.2% 11.6% St.Dev RIR 21.8% 8.8% 6.8% 7.3% 12.6% 13.0% 18.7% 19.3% 20.9% 19.5% MAIR (%) -0.1% 4.9% -0.4% 2.0% 7.3% 8.1% 8.6% 10.5% 14.3% 11.6% St.Dev MAIR 22.8% 8.0% 6.7% 7.6% 12.4% 12.9% 18.8% 19.3% 20.9% 19.5% Page | 46 Underpricing in Initial Public Offerings: Evidence from the US Table 17: Raw and Market Adjusted Initial Returns by Number of Uses of Proceeds (2003-2012) Number of Uses of Proceeds 10 Total Number of IPO’s 45 77 154 189 200 117 83 43 10 920 RIR (%) 9.4% 13.6% 9.7% 11.9% 11.3% 11.2% 13.9% 19.4% 20.4% 11.1% 12.0% St.Dev RIR 13.1% 41.9% 17.1% 17.8% 18.5% 21.2% 23.2% 31.1% 22.7% 19.6% 22.4% MAIR (%) 9.0% 13.9% 9.5% 12.0% 11.4% 10.9% 13.9% 19.3% 20.5% 10.2% 11.9% St.Dev MAIR 12.8% 41.8% 17.2% 17.7% 18.6% 20.9% 23.3% 31.5% 22.5% 20.3% 22.4% Table 18: Raw and Market Adjusted Initial Returns by Hot/Cold Periods (2003-2012) Hot/Cold Period Hot Neutral Cold Total Number of IPO’s 258 637 25 920 RIR (%) 11.4% 12.1% 13.3% 12.0% St.Dev RIR 18.7% 23.7% 22.9% 22.4% MAIR (%) 11.3% 12.0% 15.4% 11.9% St.Dev MAIR 18.8% 23.7% 22.0% 22.4% Table 19: Raw and Market Adjusted Initial Returns before and after the 2008 crisis (2003-2012) Period Before 2008 crisis After 2008 crisis Total Number of IPO’s 637 283 920 RIR (%) 11.1% 14.0% 12.0% St.Dev RIR 18.0% 29.9% 22.4% MAIR (%) 11.0% 13.9% 11.9% St.Dev MAIR 18.0% 29.9% 22.4% In Table 16, the raw and market adjusted initial returns by underwriter ranking are presented Contrary to the existing literature suggesting that more prestigious underwriters underprice less, it is observed that initial returns increase with increasing underwriter reputation In this context, highest ranking underwriters (9.001) exhibit the highest average MAIR of all groups (14.3%) with the highest standard deviation (20.9%) Another finding is that contrary to the existing literature and as illustrated in Table 17, higher number of uses of gross proceeds does not seem to be related to lower initial underpricing In addition to this, hot and cold period as defined by the volume of IPOs does not seem to be associated with underpricing (Table 18) Hot periods which would be Page | 47 Underpricing in Initial Public Offerings: Evidence from the US expected to experience higher underpricing have an average MAIR of 11.3% while cold period which would be expected to have lower underpricing have an average MAIR of 15.4% Between 2003 and 2012, 23 cold and 15 hot periods have been identified, with all hot periods having happened before 2008 crisis Finally, if IPOs are categorized into two groups with reference to 2008 global financial crisis, it is observed that pro-crisis IPOs have lower MAIR (11.0%) compared post-crisis IPO (MAIR of 13.9%) (Table 19) Post-crisis IPOs exhibit a higher dispersion around the mean with the standard deviation of the returns reaching 29.9% Table 20: Raw and Market Adjusted Initial Returns for Selected Groups (2003-2012) Groups Number of IPO’s Macro Period Before 2008 crisis After 2008 crisis Industry Classification High Tech Non-High Tech Underwriter Reputation Low (1.001-6.501) High (7.001-9.001) Listing NASDAQ Non-NASDAQ Hot-Cold Period Hot Cold RIR (%) St.Dev RIR MAIR (%) St.Dev MAIR 637 283 11.1% 14.0% 18.0% 29.9% 11.0% 13.9% 18.0% 29.9% 186 734 18.5% 10.3% 22.5% 22.1% 18.3% 10.3% 22.3% 22.1% 139 766 5.6% 12.7% 12.1% 20.4% 5.7% 12.7% 12.0% 20.4% 611 309 12.9% 10.0% 24.2% 18.1% 12.8% 10.1% 24.2% 18.0% 258 25 11.4% 13.3% 18.7% 22.9% 11.3% 15.4% 18.8% 22.0% In addition to the findings previously analyzed, the sample of 920 companies has been divided into groups with the aim to assess whether the difference in their means is statistically significant or not As presented in Table 20, the sample has been divided into groups based on the IPO date (before or after 2008 crisis), industry classification (high technology or non- high technology firm), underwriter reputation (low and high ranking underwriters), listing (NASDAQ and non-NASDAQ listing) and IPO volume per period (hot and cold period) In Table 21, it can be observed that the level of underpricing does not differ for IPOs that took place before or after the crisis T-test shows that the difference of almost three percent in the mean RIR and MAIR is not statistically significant The same conclusion can be Page | 48 Underpricing in Initial Public Offerings: Evidence from the US drawn for hot and cold IPOs, for which the differences in mean RIR (1.9%) and in MAIR (4.1%) are not statistically significant Table 21: Test of Differences in Mean Returns Parametric Test Methods T-Test for Differences in Means Before / After the 2008 Crisis High Tech / Non High Tech Firms Underwriter Reputation NASDAQ / Non NASDAQ Listing Hot / Cold Period RIR (%) Statistics t- stat -1.499 -4.377 -5.540 -1.864 -0.585 Probability p-value 0.135 0.000 0.000 0.063 0.564 MAIR (%) Statistics t- stat -1.570 -4.352 -5.419 -1.809 -0.715 p-Value p-value 0.117 0.000 0.000 0.071 0.481 The results for the High Tech firms show that the level of underpricing for this sample does differ for IPOs of High Tech firms and non-High Tech firms Test show that the difference of almost 8% in mean RIR and MAIR is statistically significant at 1% level and therefore, industry does influence the degree of underpricing This is consistent with the IPO literature suggesting that High Tech firms experience higher underpricing due to their riskier nature Results also show that the underpricing level is extremely lower for IPOs of non-reputable underwriters compared to IPOs of reputable underwriters The difference of 7.1% in mean RIR and MAIR is statistically significant at 1% level as suggested by the t-test performed This finding is contradictory to the main body of the IPO literature which suggests that IPO of reputable underwriters are less underpriced and may lead to the rejection of the respective hypothesis that was described in the previous section As refers to whether NASDAQ listing affects initial underpricing, it can be suggested that the differences in the mean RIR (2.9%) and MAIR (2.7%) are statistically significant at 10% level This finding is consistent with the hypothesis that NASDAQ is more attractive for riskier and more volatile stocks and has lower listing requirements, all leading to higher underpricing for NASDAQ IPOs 4.5.2 Cross Sectional Regression Results The univariate and multiple regression results are summarized in Table 22 Page | 49 Underpricing in Initial Public Offerings: Evidence from the US Initially, a multiple regression including all explanatory variables and MAIR as the dependent variable is run ([Regression 1]) The regression model uses 882 observations as 4% of the initial sample of 920 IPOs was missing some data The results show that adjusted R2 of [Regression 1] is 0.09556 and F- value is significant at 1% significance level The regression indicates that PRICE and TECH variables have coefficients -1.543 and 0.070 that are statistically significant at 1% level, USES has coefficient 0.046 that is statistically significant at 5% level and MRKT has coefficient 3.916 that is statistically significant at 10% level All variables but USES, AGE and UWR have the expected sign This means that the positive/negative relationship of these variables with underpricing is consistent with the hypotheses The finding regarding UWR as analyzed in the previous section is confirmed by the regression analysis results as well SIZE, FIN, PROC, TLAG, NASDAQ, COLD and HOT are not statistically significant and they don‟t seem to affect underpricing level The results of [Regression 1] could be affected by multicollinearity given the number of the explanatory variables included in the model As illustrated in Table 8, the only variables that are highly correlated are PROC with PRICE (the correlation co-efficient for this pair is -0.64), followed by AGE and SIZE with correlation co-efficient of 0.53 and UWR and PROC with correlation co-efficient of 0.52 Therefore, the inclusion of both PROC and PRICE in the final model should be avoided Given that regression coefficient values and their statistical significance can change depending on the other variables in the model, a series of univariate regressions (from [Regression 2] to [Regression 9]) is performed in order to discern the impact of each variable individually, re-assess significance and re-confirm hypotheses tested Dependent variable is regressed only against the non-dummy independent variables Based on the simple regression models, it is observed that signs are as predicted by the full regression model with the exception of PROC and SIZE which seem to have a positive relationship with the level of underpricing if regressed alone, not supported though by existing literature In terms of significance, PRICE and UWR co-efficients are statistically significant at 1% level, MRKT as 5% level and PROC, USES and SIZE at 10% level The co-efficients of all other variables remain statistically not significant Page | 50 Underpricing in Initial Public Offerings: Evidence from the US Table 22: Cross Sectional Regression Results Dependent Variable: MAIR Regression 1: All Variables Regression 2: Uni-variate INTERCEPT Regression 4: Uni-variate Regression 5: Uni-variate Regression 6: Uni-variate Regression 7: Uni-variate Regression 8: Uni-variate Regression 9: Uni-variate Regression 10: Significant/No Dummies Regression 11: Significant/All Dummies Regression 12: Stepwise Regression GRPROC TLAG USES SIZE Explanatory Variable AGE UWR VAR HOT COLD FIN TECH NASDAQ 0.259 -1.543*** -0.008 0.000 0.046** -0.004 0.005 0.007 3.916* 0.004 -0.037 -0.010 0.070*** 0.021 (1.178) (-6.139) (-0.689) (-0.577) (2.286) (-1.026) (0.594) (1.585) (1.716) (0.276) (-0.816) (-0.550) (4.269) (1.350) Adj R2 0.09556 0.222*** -1.213*** (11.471) Regression 3: Uni-variate PRICE (-5.722) -0.162 0.015* (-1.098) (1.912) 0.122*** 0.000 (10.34) (-0.292) 0.063* 0.034* (1.825) (1.679) 0.009 0.006* (0.138) (1.796) 0.116*** 0.002 (5.891) (0.302) -0.032 0.019*** (-1.032) (4.853) 0.081*** 4.436** (3.910) (1.962) 0.392** -1.568*** -0.016* 0.065*** -0.003 0.010** 3.314* (2.010) (-6.335) (-1.651) (3.354) (-0.806) (2.095) (1.674) 0.07505 0.274 -1.563*** -0.009 0.042** -0.003 0.007 3.665 0.003 -0.038 -0.012 0.071*** 0.022 (1.251) (-6.240) (-0.787) (2.084) (-0.717) (1.428) (1.618) (0.236) (-0.857) (-0.679) (4.332) (1.402) 0.043 -1.362*** 0.051*** 0.005 3.074 (0.826) (-6.674) (2.744) (1.287) (1.583) 0.073*** 0.029** (4.608) (2.099) 0.09529 0.09793 Notes: ***, **, * Significant at 1%, 5%, 10% level respectively Page | 51 Underpricing in Initial Public Offerings: Evidence from the US Based on the simple regression models, only statistically significant variables are kept and are all regressed against the independent variable without including the dummy variables ([Regression 10]) The signs of the co-efficients are the same as in [Regression 1], but the levels of significance have changed PRICE and USES are statistically significant at 1%, UWR at 5% and PROC and MRKT at 10% The co-efficient of SIZE is not statistically significant Overall, the regression has an adjusted R2 of 0.0705 with an F- value statistically significant at 1% level By adding the dummy variables in the regression model ([Regression 11]), the adjusted R2 increases to 0.09529 but the co-efficient signs remain the same as in the previous multiple regression models Out of the non-dummy variables, only PRICE and USES are statistically significant, the former at 1% level and the latter at 5% level Out of the dummy variables, only TECH‟s co-efficient is statistically significant at 1% level In order to improve more the explanatory power of the model, we run a stepwise regression (stepwise forwards) ([Regression 12] in Table 22) The resulting model is of the following structure: (4) The model has an adjusted R2 of 0.0973 and statistically significant F-value at 1% This means that the model explains 9.73% of the total variability of underpricing about its mean value, while regression F-statistic rejects very strongly the null hypothesis that all coefficient values on explanatory variables are zero The adjusted R2 have the higher value compared to the other multiple regressions previously run All coefficients on explanatory variables have the expected sign with the exception of UWR and USES PRICE remains highly statistically significant at 1% level together with USES and TECH NASDAQ is statistically significant at 5% level while UWR and MRKT are not statistically significant There are three types of robustness checks that should ideally be considered when assessing the model described above These are reverse causality, endogeneity and omitted variable bias For example, issuers who expect that underpricing will be high due to various reasons, prefer listing on NASDAQ which will have lower listing costs and less listing requirements The model above also treats underwriter choice as exogenous However, one could suggest that underwriter‟s choice may be better treated as endogenous to a firm‟s Page | 52 Underpricing in Initial Public Offerings: Evidence from the US characteristics Additionally, the low adjusted R2 does not necessarily mean that there is an omitted variable bias in the model However, there is a large number of variables in the literature supposed to explain the degree of initial underpricing of IPOs, which have not been included in the model, such as retained ownership, underwriter earning forecast and its accuracy, number of risks identified in prospectus, venture capital backing, pre-offer demand, offer price revision as well as allocation of shares to institutional and private investors Page | 53 Underpricing in Initial Public Offerings: Evidence from the US Chapter 5: Discussion In this chapter, the most important findings of the study will be discussed in light of the existing research literature and the limitations of the study that may affect the validity or generalization of the results will be highlighted It has been concluded that the degree of IPO underpricing during 2003-2012 is at 12% on average This finding is consistent with Loughran & Ritter (2004) that reported that after reaching 65% during 1999-2000 (“the internet bubble”), underpricing dropped to 12% during 2001-2003 (“the post-bubble period”) Apart from the IPO volume, which also dropped considerably after 2008 and can further support the economies of scale hypothesis introduced by Gao, Ritter, & Zhu (2013), the global economic crisis does not seem to have affected the levels of underpricing in a statistically significant way As refers to the relationship between the degree of underpricing and proxies of ex-ante uncertainty, the study confirms previous research findings for company size, industry classification, offer price, amount of gross proceeds, time lag between offering and listing, listing on NASDAQ, market conditions and cold and hot periods The only hypotheses not confirmed are those associated with the age, the underwriter reputation and the number of uses of gross proceeds Although age is not statistically significant in any of the regressions run, it is worth noting that there is no evidence that age has a negative relationship with underpricing, which is contradictory to the main body of the IPO literature A plausible explanation for this deviation is that when company characteristics are used to measure ex-ante uncertainly, we tend to ignore the information production that takes place in the IPO market during the book-building period Supporting this argument further, this study shows that other company characteristics analyzed (i.e size) not also explain the degree of underpricing With regards to the relationship between underpricing and the number of uses of gross proceeds, the findings in this study not support McGuiness (1992) hypothesis but confirms Beatty and Ritter (1986) view that a large number of uses of proceeds may increase uncertainty As presented in the previous section, the number of uses of gross proceeds significantly affects the underpricing level of the US IPOs during 2003-2012 Page | 54 Underpricing in Initial Public Offerings: Evidence from the US Additionally, by not being able to confirm the negative relationship between underwriter reputation and underpricing for the period in scope, this study is closer to Beatty and Welch (1996) view that better underwriters are associated with higher underpricing and higher underpricing dispersion The argument that holds in the literature is that agents that participate in the IPO market repeatedly can build up reputation capital to certify that an issue is priced fairly This could reduce the extent of the winner‟s curse and consequently underpricing However, as suggested by Ljungqvist A (2008), valuation uncertainly and the extent of the winner‟s curse are not the same and it is not obviously true that more prestigious investment banks underwrite less uncertain offerings The regression analyses showed that in the case of US IPOs during 2003-2012, price, number of uses of gross proceeds, high technology classification, listing on NASDAQ are among the most relevant determinants of the degree of underpricing Price is among the variables that exhibit high statistical significance for explaining the degree of underpricing As suggested by Ljungqvist A (2008), issuers may choose to set a low price to encourage information production which would not be completed at the final pricing but carried over into the after-market The price level of an IPO is also related to other choices the firm makes, including the choice of underwriter and ownership structure and it is possible that firms and their underwriters pick the IPO price level as an explicit signal of the firm‟s quality (Fernando, Krishnamurthy, & Spindt, 2002) Furthermore, it has been evidenced that as documented in previous research studies high technology classification and listing on NASDAQ also significantly affect the degree of underpricing of the IPOs According to Clarkson & Simunic (1994), the actual initial return of an IPO would be predictable if there is a strong positive relationship between ex-ante uncertainty and the underpricing level It is concluded that for the period in scope, this relationship does not hold as proxies of age, gross proceeds, size and time to listing are not statistically significant Moreover, the model constructed could only explain less than 10% of IPO underpricing This may weakly suggest that there are other variables, beyond ex-ante uncertainty, such as agency conflicts, investor sentiment and other behavioral explanations, that have been omitted from the model that could increase its explanatory power Page | 55 Underpricing in Initial Public Offerings: Evidence from the US Chapter 6: Summary & Conclusions The target of this dissertation was to study the complex and well documented phenomenon of IPO underpricing Starting from a brief presentation of the basic considerations for a firm going public which was followed by an analysis of the market problems for the pricing of IPOs, an extensive presentation of the theoretical explanations of underpricing was made Given the little consistency in the reported findings in academic literature regarding the correlates of underpricing, a discussion was attempted with the aim to identify promising areas for future research The empirical part of the thesis focused on the US IPO market and more specifically on the IPO activity from 2003 to 2012 It has been concluded that the degree of IPO underpricing during 2003-2012 is at 12% on average and has been affected neither by the economic crisis of 2008 nor by the cycles in the volume of IPOs (hot and cold periods) The industries with the higher underpricing were High Technology and Consumer Staples This study also tried to shed some light on empirical evidence regarding the determinants of initial performance of IPOs in the US market The explanatory variables tested cover an extensive range cited in the literature and are mostly related to ex-ante uncertainly proxies Based on the regression analysis performed, the 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Journal of Empirical Finance, 14(3), 287-309 Zingales, L (1995) Insider Ownership and the Decision to Go Public Review of Economic Studies, 62, 425-448 Page | 60 ... 41 Underpricing in Initial Public Offerings: Evidence from the US In order to determine which of these variables explain the initial underpricing in the US market during 2003-2012 and if the. .. | Underpricing in Initial Public Offerings: Evidence from the US Abstract This thesis covers a review of the literature regarding the initial public offerings‟ underpricing phenomenon Starting... explanations/theories regarding the initial underpricing phenomenon and most theories have undergone rigorous empirical testing These are the Page | 17 Underpricing in Initial Public Offerings: Evidence from