The Underpricing and Aftermarket Performance of Initial Public Offerings in the United States in the period 2002-2007.
Amsterdam Business School
Student Charlotte Bontje Number 10103783 Field finance Supervisor Ilko Naaborg Completion February 21, 2004
Abstract
Shares issued in an initial public offer are most of the time offered under their real value. So these shares show a large initial return on the first day trading (Ritter and Louhran, 2002). Ritter (1991) states that in the long run initial public offerings appear to be overpriced. This paper will investigate the influence of the level of underpricing on the aftermarket performance. The role of venture capital backed firms will also be included. IPOs are selected on the NASDAQ, AMEX and the NYSE stock exchange market in the time period 2002-2007. In this paper have venture capital firms an average underpricing of 11,15% and non-venture capital backed firms an average underpricing of 22,50%. The influence of the level of underpricing of an IPO on the aftermarket performance only has a significant negative result for the non-venture capital backed firms. Keywords: IPO, Underpricing, Underwriter, Aftermarket performance, Venture capital
Table of Contents 1. Introduction ... 2 2. Literature review ... 3 2.1. IPO ... 3 2.2. Underpricing ... 3 2.2.1. Underpricing process ... 5
2.2.2. Role of the underwriter ... 5
2.3. Underperformance ... 6
2.4. Venture capital ... 7
3. Methodology and Data ... 9
3.1. Methodology ... 9 3.1.1. Models ... 12 3.1.2. Dependent variables... 10 3.1.3. Independent variables ... 11 3.2. Data sources ... 12 3.2.1. Data selection ... 13 3.2.2. Data description ... 13 4. Empirical result ... 16 4.1. Empirical Results... 16
5. Conclusion and discussion ... 19
1. Introduction
In various theories there are documented explanations of the phenomenon underpricing in an initial public offer. Shares issued in an initial public offer are most of the time offered under their real value. So these shares show a large initial return on the first day trading (Ritter and Louhran, 2002). Underpricing is also known as ‘leaving money on the table’ for the issuing firm (Ritter and
Louhran, 2002). However, researchers have documented that at some point after going public the abnormal returns on the initial public offering may be negative. Ritter (1991) states that in the long run initial public offerings appear to be overpriced. The underpricing of the firm’s initial public offering gives, however a credible signal to investors that the company is good. This is because only good firms can be expected to recoup this loss after their performance is realized (Allen and Faulhaber, 1988).
In this paper the role of venture capital backed firms on the underpricing and aftermarket performance will be discussed. Brav and Gompers (1997) find that venture-backed firms do not significantly underperform in the long run, while the smallest non-venture capital backed firms do. The role of the level of underpricing on the aftermarket performance is however not mentioned in the research of Brav and Gompers (1997). Based on various studies, venture capital IPOs are said to be less underpriced than non-venture capital backed IPOs (Megginson and Weiss, 1991) . This paper will investigate the influence of the level of underpricing on the aftermarket performance. The aftermarket
performance will be measured by the buy and hold average return of five years. The expectation is that the more a stock in an IPO is underpriced, the more influence it has on the aftermarket underperformance.
This investigation will be done by an OLS-regression, whereby the IPOs are selected on the NASDAQ, AMEX and the NYSE stock exchange market in the time period 2002-2007. In this paper three datasets will be constructed: venture capital, non-venture capital backed firms and the total sample. Venture capital firms have an average underpricing of 11,15%, non-venture capital backed firms an average underpricing of 22,50% and the total sample an average underpricing
of 20,94%. The outcome of this paper is that only for non-venture capital backed firms the influence of the underpricing on the aftermarket performance result in a significant negative effect. The control variables size, age and offer price have no significant effect on the dependent variables underpricing and aftermarket performance for all data sets.
This paper is categorized as follow, in the next chapter the literature review on the underpricing, long run performance and the venture capital firms is done. In the third chapter the methodology and the data will be discussed. The models will be presented and an overview of the data will be given. The fourth chapter presents the empirical results. Finally in the last chapter a conclusion and a summary of this paper will be given.
2. Literature review 2.1 IPO
Firms choose to go public for many reasons. The main reason is the desire to raise equity capital for the firm and to create a public market in which the founders and other shareholders can convert some of their wealth into cash at a future date (Ritter and Welch, 2002). Going public has both advantages and disadvantages. Maksimovic and Pichler (2001) argues that public trading can add value to the firm, as it may result in more faith in the firm from other
investors, customers, creditors and suppliers. Also being first in an industry to go public sometimes confers a first-mover advantage. Roëll (1996) argues further in his article the advantages of an IPO for the motivation of management and employees, for the exploitation of mispricing and for the improving of the company and image publicity.
One of the disadvantages is the transaction costs of going public: the direct costs of going public, which are primarily investment banking fees, and the indirect costs of underpricing (Ritter, 1987). Further Roëll (1996) argues that, besides the disadvantages of transaction costs, there is also a danger of loss of control. Rydqvist and Hogholm (1995) find that the controlling parties on
2.2 Underpricing
Various theories have been written to give an explanation of the underpricing phenomenon. Underpricing is also known as ‘leaving money on the table’. The money left on the table is defined as the number of shares sold times the
differences between the first-day trading closing market price and the offer price (Ritter and Loughran, 2002). Ritter and Loughran state that this number is approximately twice as large as the fees paid to investment bankers and represents a substantial indirect cost to the issuing firm.
Most of the models explaining IPO underpricing are based on asymmetric information. One of them is Rock’s model (1986). In Rock’s model informed investors have better information about the new firm’s prospects than the issuer and his investment banker. Informed investors crowd out uninformed investors for the new issues that they alone know are most likely to be profitable. In general, the greater the uncertainty about the true price of the new shares, the greater the advantage of the informed investors and the deeper the discount the firm must offer to entice uninformed investors into the market (Rock, 1986).
Another of the many reasons for underpricing is high IPO activity, because underwriters encourage more firms to go public when public valuations turn out to be higher than expected and because underwriters discourage firms from filing or proceeding with an offering when public valuations turn out to be lower than expected (Ritter, 2002). This high IPO activity is called ‘hot issue’ market for initial public offerings. In the past there have been a number of periods in which initial public offerings of common stock have had extremely high returns
(Ibbotson and Jaffe, 1975). One of the hottest IPO markets ever was the end of the nineties. In this period both the number of initial public offerings and the level of initial return reached high peaks (Derrien, 2005). This IPO volume fluctuation is attributable almost entirely to the tech sector. Large numbers of IPOs by young Internet firms were issued in 1999 to 2000 (Ritter and Welch, 2002).
Ritter and Loughran (2002) discuss in their article the role of the
underwriter in the underpricing phenomenon. They argue that leaving money on the table is an indirect form of underwriter compensation, because investors are
willing to offer quid pro quos to underwriters to gain favourable allocations on hot deals.
The underpricing of the firm’s initial offering gives however a credible signal to investors that the company is good. This is because only good firms can be expected to recoup this loss after their performance is realized (Allen and Faulhaber, 1988). Allen and Faulhaber’s model shows that underpricing can signal favourable prospects for the firm. Bad firms run the risk that their true type may be revealed, in which case they don’t benefit from the underpricing.
Although offer prices are lowered, many firms withdraw their offering rather than proceed with their IPO. So there is a volume adjustment rather than a price adjustment (Ritter, 2002).
2.2.1 Underpricing process
Ritter and Beatty (1986) argue how the underpricing value of an initial public offer is enforced. They suggest that an issuing firm, which will go public once, cannot make a credible commitment by itself. They suggest that the offering price is below the expected market price once it starts trading. Instead, an issuing firm must hire an investment banker to take the firm public. This role for an investment banker is possible because an investment-banking firm
underwrites many offerings over time. Because of the repeat business with potential purchasers an investment banker can develop a reputation and earn a return on this reputation. Finally they argue that any investment banker, who ‘cheats’ on the underpricing value by persistently underpricing either by too little or by too much, will be penalized by the marketplace (Ritter and Beatty, 1986).
2.2.2 Role of the underwriter
In line with Rock (1986), he suggest that IPO returns are required by uninformed investors as compensation for the risk of trading against superior information, is the theory of Manaster and Carter (1990). They show that IPOs with more
informed investor capital require higher returns. The underwriter reputation in the market reveals the expected level of ‘informed’ activity. Prestigious
to acquire information and fewer informed investors. So prestigious underwriter are associated with IPOs that have lower returns (Manaster and Carter, 1990). 2.3 Underperformance
A lot of research has documented the underperformance of an IPO in the long run. The outcome of most of these researches suggests that, at some point after going public, the abnormal returns on initial public offerings may be negative. Ritter (1991) states that in the long run initial public offerings appear to be overpriced. He finds evidence that in the 3 years after going public these firms significantly underperformed in a set of comparable firms matched by size and industry. Ritter (1991) used in his research a sample of 1,526 IPOs that went public in the United States in the period 1975-84.
The underperformance of an IPO is of interest to investors for several reasons. The volume of IPOs displays large variations over time. If the high volume periods were associated with poor long-run performance, this would indicate that issuers are successfully timing new issues to take advantage of ‘ windows of opportunity’ (Ritter, 1991). Another important reason is that the cost of external equity capital for companies going public depends not only upon the transaction costs incurred in going public, but also upon the returns that investors receive in the aftermarket. To the degree that low returns are earned in the aftermarket, the cost of external equity capital is lowered for these firms (Ritter, 1991).
Further, Ritter (1991) argues that there are several explanations for this underperformance. The most important ones are risk mismeasurement, bad luck and over optimism. Underperformance is concentrated in relatively young
growth companies, this pattern does not rule out bad luck being the cause of underperformance. It is consistent with a scenario of firms going public when investors are irrationally over-optimistic about the future potential of certain industries (Ritter, 1991). If investor sentiment is an important factor in the underperformance of IPOs, small IPOs may be more affected (Brav and Gompers, 1997). Individuals are more likely to hold the shares of small IPO firms. Many institutions such as pension funds and insurance companies refrain from holding shares of very small companies. Taking a meaningful position in a small firm may
make an institution a large block-holder in the company. The SEC restricts trading by 5 percent and shareholders institutions may want to avoid this level of ownership (Brav and Gompers, 1997). To avoid that risk, mismeasurement could account for the poor long- run performance, alternative bench market portfolios are used in the research of Ritter (1991).
There is also a strong relation between age of the firm and aftermarket performance. Ritter (1991) finds on average higher initial return for younger firms than for established firms. While noting that risky issues require higher average initial returns and that age is a proxy for this risk. Thus
underperformance is concentrated among relatively young growth companies. Specially those firms going public in times of ‘hot’ market, for example in the high volume years of the 1980s (Ritter 1991).
However, Brav and Gompers (1997) argue that underperformance is not exclusively an IPO effect. They find that when issuing firms are matched to size and book-to-market portfolios, that exclude all recent firms that have issued equity, IPOs do not perform any different than non-issuing firms.
Underperformance is a characteristic of small, low book-to-market firms regardless of whether they are IPOs firms or not (Brav and Gompers, 1997). 2.4 Venture capital
Barry et al. (1990) state that the venture-capital industry provides risk capital to companies that offer high potential returns, so they focus on young and high-risk entrepreneurial ventures. Venture capitalists are typically active investors who try to ‘add value’ through ongoing longer-term involvement with continuing business development. Venture capitalists usually take concentrated equity positions in the companies they fund and exercise significant influence on management (Barry et al, 1990).
Barry et al (1990) conclude in their paper that the presence of venture capitalists in the offering firm certifies the quality of the issue through their investment in financial and reputational capital. They suggest that larger venture capitalists tend to use the same underwriters with great frequency, so VC backed firms are able to attract higher quality underwriters and auditors as well as a larger institutional following than non-VC backed firms. By reducing the
asymmetry of information between the issuing firm, investors and financial specialists such as underwriters and auditors, venture capitalists are able to lower the costs of going public. Further, find Barry et al. (1990) evidence of significantly lower underpricing and underwriter compensation for VC backed IPOs than for non-VC backed IPOs, holding offering size, underwriter quality, and firm age constant. The certification may thus cause lower underpricing and higher long run performance.
Megginson and Weiss (1991) offer evidence that venture-backed firms go public earlier than non-venture capital backed firms, because venture capitalists certify the quality of offerings. Venture capitalists repeatedly bring companies to the IPO market and can credibly commit not to offer overpriced shares. So both researches, Megginson and Weiss (1991) and Barry et al (1990), conclude that there is a negative relationship between venture capital backed firms and underpricing.
Instead, the grandstanding model predicts a positive relationship
between venture capital backed firms and underpricing. Gompers (1996) finds that younger companies have more uncertainty and hence greater underpricing. Also he finds that young venture capital firms incurring costs by bringing IPOS to market earlier than established venture capital providers. The percentage of equity held by young venture capital investors is therefore lower than
established venture capital investors. One of the incentives to bring IPOs earlier to the market is to establish a track record and raise new capital (Gompers, 1996).
If venture backed firms perform better on average than non-venture capital backed companies those markets should incorporate these expectations into the price of the offering and long-run stock price performance should be similar for the two groups (Brav and Gompers, 1997). Barry et al (1990), and Megginson and Weiss (1991) find evidence that markets react favourably to the presence of venture capital financing at the time of an IPO. Brav and Gompers (1997) find that venture-backed companies do not significantly underperform in the long run, while the smallest non-venture capital backed firms do. They find that venture-backed IPOs outperform non-venture backed IPOs using equal weighted returns.
In this research we investigate what the influence is of the level of underpricing on the aftermarket performance. Also we test the role of the venture capital firms in this process. This results in the following hypotheses. The first hypothesis assumes that the level of underpricing has no influence on the aftermarket performance. The aftermarket performance will be measured for a time period of five years after an IPO. The second hypothesis will focus on the performance of venture capital firms versus non-venture capital backed firms. According to various theories venture backed IPOs are less underpriced
(Megginson and Weiss, 1991). The second hypothesis assumes that level of underpricing has no influence on the aftermarket performance of venture capital backed firms.
3. Methodology and Data
In section 3.1 the methodology that is used for testing the two hypotheses is dicussed. First the independent and dependent variables will be described and they should be measured. Also the model that is used for the OLS-regression will be presented. Section 3.2 will present the data that is used in this thesis. Also the data selection, data sources and the descriptive data will be presented.
3.1. Methodology 3.1.1 Models
To test the hypotheses mentioned in chapter two we use an OLS-regression model. First a model is constructed for testing the influence of the venture capital firms on the level of underpricing. This model is in line with various researches, mentioned in chapter 2, that suggest that the independent variables in this model will influence the underpricing phenomenon.
(1) Underpricing= β0+β1Offer price+β2Age+β3Size+β4Dummy variable venture
capital + ε
This model calculate the influence of the independent variables on the underpricing for the total sample, venture capital and non-venture capital
backed firms. The dummy variable is included to measure the role of the venture capital firms on the underpricing phenomenon.
Further, is there a model constructed that will calculate the influence of the level of underpricing on the aftermarket performance of 5 year. This model included also three control variables and a dummy variable.
(2) Aftermarket performance= β0+β1Underpricing+β2Offerprice+β3Age+β
4-Size+β5Dummy variable venture capital+ ε
3.1.2 Dependent variables
The dependent variable in the first model is the level of underpricing. This is known as the percentage increase from the offering price to the first available closing price.
It is calculated as follows:
Underpricing = (First day closing price- Offer price) Offer price
The dependent variable in the second model is the aftermarket performance. The aftermarket performance will be measured for a time period of five years. Brav and Gompers (1997) find that venture-backed firms do indeed outperform nonventure-backed IPOs over a five-year period, but only when returns are weighted equally. They used a sample of 934 venture-backed IPOs from 1972-1992 and 3,407 nonventure-backed IPOs from 1975-1972-1992 in the United States.
In this paper the aftermarket performance will be measured by the buy and hold average return for five years. This is in line with the research of Ritter (1991). Ritter uses a relative wealth ratio to measure the aftermarket
performance. The ratio measures the total return from a buy and hold strategy where a stock is purchased at the first day closing market price after going public and held for several years or until its delisting.
The buy and hold return for firm over a period s months, it is calculated as follows:
R i,s = ∏ (1+ri,t) – 1
For the average return of the portfolio with the amount of initial public offering over five years in months then equals:
Rs= 1/n ∑ Ri, s
The average market return is calculated in the same way as the average return of the portfolio. The relative wealth ratio is therefore:
Relative wealth ratio= 1+Rs
1+Rm
A wealth ratio less than 1 indicates that the IPOs underperformed, while a ratio greater than 1 indicates IPOs outperforming the bench market of matching firms (Ritter, 1991). In this paper only the buy and hold average return for each firm over a period of five years will be used as measurement for the aftermarket performance.
3.1.3 Independent variables
A lot of variables could influence the level of underpricing. This thesis has used three independent variables and one dummy variable that could influence the level of underpricing. For the aftermarket performance the influence of the level of underpricing, the control variables and the dummy variable will be calculated. These independent variables are verified in the literature review in paragraph two or here below.
The first independent variable in the first model is the offer price. In general, the greater the uncertainty about the true price of the new shares, the greater the advantage of the informed investors and the greater the discount the firm must offer to entice uninformed investors into the market (Rock, 1986). So, this research predicts a negative relation between the offer price and the level of underpricing.
The second independent variable is the age of the firm. There is a strong relation between age and aftermarket performance. The survey of Ritter (1991) shows a higher initial return for younger firms on average. While noting that
risky issues require higher average initial returns and age is a proxy for this risk. So, this research predicts a negative relation between the age of the firm and the level of underpricing. The age of the firm will be measured by the IPO date minus the date of incorporation of the firm.
The third independent variable is the size of the firm. The size will be measured by the number of employees at the date of the IPO. The (ln) of the firm size will be included in the regression model for controlling the level of
asymmetry. If investor sentiment is an important factor in the
underperformance of IPOs, small IPOs may be more affected (Ritter, 1991). The expectation is that the variable size has a negative relationship with the level of underpricing.
The dummy variable venture capital backed is also included in the models. Venture capitalists repeatedly brings companies to the IPO market and can credibly commit not to offer overpriced shares. So the researchers
Megginson and Weiss (1991) and Barry et al (1990), conclude that there is a negative relationship between venture capital backed firms and underpricing. Instead, the grandstanding model state that there is a positive relationship between venture capital backed firms and underpricing. According to Gompers (1996) younger companies have more uncertainty and hence greater
underpricing. In his investigation all regressions, IPOs backed by young venture capital firm, are associated with greater underpricing. In line with Megginson and Weiss (1991) and Barry et al (1990) this paper expect a negative
relationship between venture capital backed firms and underpricing.
3.2 Data sources
To investigate the influence of underpricing on the aftermarket performance and the role of the venture capital firms, this paper has selected IPOs in the United States from 2002 until 2007. The stocks that are used, are traded on the AMEX, NASDAQ and the NYSE stock exchange market. The data is retrieved from Bureau van Dijk’s Zephyr. Besides information about all initial public offerings, this database also has information and data about mergers and acquisitions. In this database the initial public offerings are selected for the proposed period and exchanges markets. The venture capital investments are also selected. After the
IPO selection the sample is divided into two separate groups, venture capital firms versus non-venture capital backed firms.
Further, the database Datastream is used to come up with other relevant data that is needed for the OLS-regression. The size is measured by the amount of employees at the IPO date, this is found in Datastream. Also the stock prices of the firms over a period of five years is come from this database. So for each firm the buy and hold average return is measured for five years started from the IPO date.
Some data on the independent variables and dependent are missing, so these initial public offering will not be included in the sample. Also firms delisted before the five year holding period are not included,
3.2.1 Data selection
In this research, there is a sample selected of 633 initial public offerings in the period 2002-2007. Due missing data on the dependent and independent variables, some IPOs in this period are not included in the final regression. So after the selection, the sample consists of 497 initial public offerings. In this research the focus lies on the influence of venture capital backed versus non-venture capital backed firms. Therefore two datasets are constructed. The dataset of venture capital backed firms consist of 92 IPOs. The remaining 405 IPOs are non-venture capital backed firms.
3.2.2 Data description
In this part there will be an overview given of the several descriptive statistics of our data. First the amount of initial public offerings in each year and venture capital deals will be presented.
Figure 1: Overview IPOs
Next, the underpricing phenomenon will be discussed. In the total sample, venture and non-venture capital backed firms, the average underpricing is 20,94%. The average underpricing for venture capital backed firms is 11.15%, while the average underpricing for non-venture capital backed firms is 22,50%. Also is seen the large difference between the minimal and maximal value of underpricing. For non-venture capital firms the minimal value is -92,41%, while the maximal value is 71%.
The buy and hold average return for the total sample is -13,77%. For venture capital backed firms 5,09% and for nonventure capital backed firm’s -23,55%. The aftermarket return is underperformed for all datasets compared with the initial return.
In the table below the other variables are presented and some general statistics. The Ln(SIZE) is the Ln of the amount of employees at the IPO date. The Ln(AGE) is the Ln of the IPO date minus the firm date of incorporation. The offer price is given in USD.
0 20 40 60 80 100 120 140 160 180 200 2002 2003 2004 2005 2006
Initial Public Offerings Venture capital deals
Table 1: Total sample general statistics
Total sample Ln(SIZE) Ln(AGE) Underpricing Offer price Buy and hold return
Mean 5,9061 11,42 0,2094 14,7844 -0,1377 Min 1 0 -0,9240 5 -0,2275 Max Std. Dev. 11,7519 2.0357 34,92 1.4375 1,856 0.4282 85 6.848614 240,006 11.1912 Table 2: Venture capital general statistics
Venture capital
Ln(SIZE) Ln(AGE) Underpricing Offer price Buy and hold return
Mean 4,9781 11,42 0,1166 11,8316 -0,0505 Min 1,0986 0 -0,7215 6 -0,1154 Max Std. Dev. 11,1704 1.3399 106,95 0.8268 0,8833 0.2408 24 3.9126 2,2163 0.3568 Table 3: Non-Venture Capital general statistics
Non-venture capital
Ln(SIZE) Ln(AGE) Underpricing Offer price Buy and hold return
Mean 6,1169 14,3789 0,2250 14,7844 -0,2355 Min 1 0 -0,9241 5 -0,2275 Max Std. Dev. 11,7519 6.1642 106,95 1.1463 1,856 0.0465 85 15.8542 240,006 0.9159 To check for correlation between the variables this paper constructed a
correlation matrix. To avoid multicollinearity, correlation coefficient between variables with a value higher than 0.7 or lower than -0.7, will be excluded in the regression.
Table 4: Correlation matrix for VC and non-VC backed firms Offer
price
AGE Size Underpricing
Offer price 1.00 Age 0.2583 1.00 Size Underpricing -0.1018 -0.0489 -0.0466 -0.0455 1.00 -0.0082 1.00
In this correlation matrix are there no variables with a value higher than 0,7 or lower than -0,7, so there is no multicollinearity. No variables will be excluded in this paper.
4. Empirical result 4.1. Empirical Results
This part will discuss the results generated by the OLS-regressions. Also will this chapter try to answer the hypotheses. The first hypothesis assumes that the level of underpricing has no influence on the aftermarket performance. According to various theories venture backed IPOs are less underpriced. The second hypothesis assumes that level of underpricing has no influence on the aftermarket performance of venture capital backed firms. First the results of the OLS regressions will be presented. The first OLS regression measured the
influence of the independent variables and the dummy variable on the level of underpricing. The second OLS regression measured the influence of the level of underpricing on the aftermarket performance.
The first OLS regression is measured for two datasets, venture capital and non-venture capital backed firms. The influence of the independent variables and the dummy variable venture capital on underpricing is presented below:
Table 5: output OLS regression model 1
Venture capital Non-venture capital Coefficient t-value
(prob.) Coefficient t-value (prob.)
LNsize 0,0281 1.33 (0,188) -0,0045 -0.73 (0.466) LNage -0.0343 -1.06 (0,291) -0,0032 -0.38 (0.702) Offer price -0,0017 -0.24 (0.813) -0.0005 -0.30 (0,767) Note: *,**,*** shows the level of significance at a 10%, 5% and 1% level.
The influence of the independent variables: size, age of the firm and offer price on the underpricing have no significant effect for venture and non-venture capital backed firms. The variable size has a positive effect on the underpricing for venture capital firms. The variable age of the firm and offer price have a negative effect on underpricing for both venture and non-venture capital firms. The influence of the venture capital firms in comparison with non-venture capital backed firms on underpricing is not significant. Venture capital firms have in this paper an average underpricing of 11,66%, while non-venture capital backed firms have an average underpricing of 22,5%.
In the second OLS regression the buy and hold average return for a period of five years is measured for the total sample size, venture and non-venture capital backed firms. The influence of the independent variables, size, age, price and underpricing are presented below:
Table 6: output OLS regression model 2
Total Sample Venture capital Non-venture capital Coefficient t-value
(prob.) Coefficient t-value (prob.) Coefficient t-value (prob.) Underpricing -0,858583 -0.62 0,533 0,052111 0.31 0,761 -6,878344 -2.73*** 0,007 LNsize 0,0442936 0.17 0,869 -0,012234 -0.38 0,708 0,0098936 0.03 0,974 LNage 0,1105381 0.28 0,777 0,0189482 0.38 0,703 0,0347345 0.08 0,933 Offer price -0,060549 -0.75 0,456 0,0011905 0.11 0,914 -0,066171 -0.73 0,465 Note: *,**,*** shows the level of significance at a 10%, 5% and 1% level.
The influence of the control variable age on the aftermarket is for all datasets positive. However the influence of the variable has no significance effect on the
aftermarket performance. The founded positive relationship is in line with the research of Ritter (1991). He states that age a proxy of risk measurement is of an initial public offer. Further he concludes that underperformance is concentrated among relatively young companies. Older companies are less sensitive for investor sentiment and market movements, so a positive effect.
The influence of the control variable size has on the sample size and non-venture capital backed firms a positive effect, while for the non-venture capital backed firms there is a negative effect. For all databases the influence of the variable size is not significant. On average have venture capital backed firms a smaller amount of employees at the IPO date. Follows Brav and Gompers (1997) are small IPO firms more affected if investor sentiment is an important factor in the underperformance of IPOs. Individuals are more likely to hold the shares of small IPO firms. But small individual investors may be more likely to suffer from asymmetric information. This can be an explanation of the negative relationship of the aftermarket performance of venture backed capital firms and the amount of employees.
The influence of the independent variable underpricing has on the non-venture capital backed firms and the total sample size a negative relationship with the aftermarket performance. However in this research there is a positive relationship between underpricing and aftermarket performance for venture capital backed firms. Only for the non-venture capital backed firms, the variable underpricing has a significant effect. This is measured by a significance level of one percent. On average are venture capital backed firms in this research less underpriced than non-venture capital backed firms. This is in line with the
certification model of Megginson and Weiss (1991). Venture capitalist repeatedly brings companies to the IPO market and can credibly commit not to offer
overpriced shares. The certification may thus cause lower underpricing and higher long run performance of VC firms in comparison with non-VC firms. This can explain the positive relationship of venture capital backed firms in this research with and underpricing and aftermarket performance.
To give an answer of the second hypothesis, this paper states that the level of underpricing has a negative effect on the aftermarket performance in the total sample. However this effect is not significant. For non-venture capital
backed firms the level of underpricing has a significant negative effect on the aftermarket performance. So the more a stock in an IPO is underpriced, the lower is the aftermarket performance relative to the initial return of the first day trading. Venture backed capital firms has according this paper a positive relation with underpricing and aftermarket performance. However this effect is not significant. So on basis of the results in this thesis, there is a difference between the influence of the level of underpricing on the aftermarket performance of venture capital backed firms and non-venture capital backed firms.
5. Conclusion and discussion
Brav and Gompers (1997) suggest that if venture backed firms perform better on average than non-venture capital backed companies those markets should
incorporate these expectations into the price of the offering and long-run stock price performance should be similar for the two groups. However Barry et al (1990) and Megginson and Weiss (1991) find evidence that markets react favourably to the presence of venture capital financing at the time of an IPO.
In this paper two hypotheses were tested. The first hypothesis assumes that the level of underpricing has no influence on the aftermarket performance. The second hypothesis will focus on the performance of venture capital firms versus non-venture capital backed firms. According to various theories venture backed IPOs are said to be less underpriced (Megginson and Weiss, 1991). The second hypothesis assumes that level of underpricing has no influence on the aftermarket performance of venture capital backed firms.
To test the hypotheses, two models are constructed. The first model measured the influence of the venture capital firm on the level of underpricing. The second model calculates the influence of the level of underpricing on the aftermarket performance. A dummy variable is included into the models to measure the role of the venture capital firm on the underpricing and the aftermarket performance. This paper has taken a sample of 633 IPOs in the United States traded on the AMEX, NYSE or NASDAQ in the period 2002-2007. After the selection of the data, 497 IPOs are included in the sample. 92 IPOs are venture backed and the remaining 405 non-venture capital backed firms. In the
models three independent variables are used: size, offer price and the age of the firm. A dummy variable is also used. The average underpricing for the total sample of IPOs is 20,94%. For venture capital backed firms 11.15%, and the average underpricing for non-venture capital backed firms is 22,50%. The influence of the independent variables on the level of underpricing is not significant for all datasets. Based on this paper the venture capital IPOs are less underpriced than non-venture capital backed IPOs.
The influence of the level of underpricing of an IPO on the aftermarket performance only has a significant negative result for the non-venture capital backed firms. The average underpricing for non-venture capital backed firms was the highest in this paper, compared with the total sample and venture capital backed firms. So the more a stock in an IPO is underpriced, the more influence it has on the aftermarket underperformance. This result is consistent with the research of Ritter (1991). Ritter (1991) states that in the long run initial public offerings appear to be overpriced. He found evidence that in the 3 years after going public these firms significantly underperformed in a set of
comparable firms matched by size and industry. This paper has however used an aftermarket performance of 5 years and not used a set of comparable firms.
For the sample size and venture capital backed firms there is no a
significant effect of the influence of the level of underpricing on the aftermarket performance. This is in line with the investigation of Brav and Gompers (1997). They argue that underperformance is not exclusively an IPO effect. They find that when issuing firms are matched to size and book-to-market portfolios, exclude all recent firms that have issued equity, IPOs do not perform differently from non-issuing firms.
The influence of the venture capital firms in this paper have no significant effect on the dependent variables. In this paper are venture backed IPOs less underpriced than non-venture capital backed IPOs. This underpricing has however no significant effect on the aftermarket performance. Based on this paper, firms choosing to go public with a venture capital backed firm have no significant benefit on the aftermarket performance.
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