IPO Underpricing in the United
States:
The influence of the financial crisis
Author:
Joost Delaere
Student number:
10977430
Supervisor:
S. Arping
University of Amsterdam
Direction:
Finance & Organisation
Date:
January 31, 2018
Abstract
This thesis researched the effect of the financial crisis on IPO underpricing. The used sample consisted of 520 firms, initiating their IPO in the United States between the years 2004-2012. Average IPO underpricing is found to be 6.9% higher during the financial crisis period, compared to the overall sample timespan. The performed OLS regression results empirical prove that the degree of IPO underpricing is indeed positively related to the financial crisis. As a second test, the relationship between the determinants of asymmetric information and the financial crisis has been examined. A negative relationship between firm size and underpricing, and the number of shares offered and underpricing, is found during the financial crisis. Statement of Originality This document is written by Joost Delaere. I declare to take full responsibility for the contents of this document. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Table of Contents
Abstract ... 2
1.
Introduction ... 4
1.1 Introduction ... 4 1.2 Research question ... 5 1.3 Thesis outline ... 52.
Literature review & theory ... 6
2.1 Initial public offering (IPO) ... 6 2.2 Underpricing ... 6 2.2.1 The winner’s curse ... 7 2.2.2 The investment banker’s power hypothesis ... 7 2.2.3 Signalling hypothesis ... 8 2.3 The financial crisis ... 9 2.4 Hypotheses ... 102 Methodology ... 13
2.1 Data ... 13 2.2 Variables ... 14 2.3 Multicollinearity ... 16 2.4 Methodology ... 163.
Empirical research ... 17
3.1 Descriptive statistics ... 17 3.2 Regression analysis ... 18 3.3 Discussion results ... 214.
Conclusion ... 22
References ... 24
Appendix A: Three-digit High Technology sector SIC codes ... 27
1. Introduction
1.1 Introduction
Companies can apply multiple methods to raise funds. One of the most common ways is to initiate a public offering. This is the phenomenon of a firm going from private to public, by ways of selling its equity in forms of financial instruments to the public. This process is called the initial public offering (IPO). Generally, the firm sells its equity in the form of common stock listed at a stock exchange market. On average, most initial public offerings (IPO’s) are valued beneath their market value, or in other words, are underpriced (Ibbotson & Jaffe, 1975). Leading to the issuer selling their equity at a discount to the public, and thereby missing out on capital. IPO underpricing is a widely studied phenomenon. These studies show evidence that, as mentioned, IPO’s are on average underpriced and underpricing averages at 16% (Ibbotson & Jaffe, 1975). In his theory, Rock (1986) states that some investors have to coop with imperfect information regarding the value of a firm, while some investors own complete information. For the issuers to attract uninformed investors, issuers have to compensate them for their lack of information, in the form of a discount. Resulting in the underpricing of an IPO (Ibbotson & Ritter, 1995). A great deal of theories has been developed to rationalise IPO underpricing. Almost all these theories base asymmetric information as the core complication influencing an IPO. Since asymmetric information results in a loss of capital for the issuing firm, researching this is lucrative. Multiple studies done (Lin & Smith, 1998; Booth & Chua, 1996), show evidence, backing up the theory that under-pricing is caused by information asymmetry between the issuer and investor. These studies have done so, by researching the proxies of asymmetric information. Ng ( 2016) states that a particular crisis can be described in terms of crisis-uncertainty. As the crisis grows and uncertainty’s arise, it becomes harder for issuers as well as for investors to accurately predict the impact of the crisis on the value of the firms. This is due to the fact that crisis-uncertainty influences the quality and quantity of information negatively (Milliken, 1987). So when crisis uncertainty is high, the information provided to the public is of less value. Thus, the limited availably of information, caused by the crisis, will have to be discounted in the issuing price. Resulting in an increase of IPO underpricing (Ng, 2016). Findings in this research are consistent with this theory. This thesis will research the influence of cyclical changes in the economy, on the behaviour of IPO underpricing, and the separate effect on the proven proxies of asymmetric information. The cyclical effect will be represented by the financial crisis that struck in December 2007 (Zwiers, bolt, van Ham, & van Kempen, 2016). By providing a more in depth full research on the impact of the financial crisis on IPO underpricing and separately on the proxies of asymmetric information, thisthesis will be able to contribute to existing literature/research done on the IPO underpricing phenomenon. Findings in this research provide evidence proving the theory stated by existing literature, that during the financial crisis the degree of underpricing increases.
1.2 Research question
A substantial amount of literature is created on the phenomenon of IPO underpricing, asymmetric information and even the relationship with cyclical behaviour of the economy. This thesis will combine these aspects of the economy and research the relationship between them. To narrow the research down, the sample selection is represented by firm located in the United states, initiating their IPO between the years 2004 and 2012. “Rising delinquencies in the subprime mortgage market in the United States triggered turbulences in the subprime mortgage-backed securities market” (Craigwell, Lorde, & Moore, 2013)The chaos quickly spread to other markets and financial institutions, and eventually across borders and economies. Resulting in a global financial crisis (Carmassi, Gros, & Micossi, 2009)Due to its relevance to the global financial crisis, the United States has been chosen as region of research. To be able to accurately determine the influence of the financial crisis on IPO underpricing, two contrary timelines must be compared. One of economic downturn, represented by the financial crisis, and one during a peaking business cycle, represented by the times prior to the financial crisis. Firms initiating their IPO before the August 2007 and after or during 2004 are labelled as “IPO’s before the crisis”. Firms initiating their IPO after and during August 2007, the year the crisis began (Kolb, 2011), and before or during December 2009, the year the crisis approximately ended (Kolb, 2011), are labelled as “IPO’s during the crisis”. With all the details of this research logicized, the research question will be the following: “What influence does the financial crisis have on IPO under-pricing and asymmetric information in the United States during the years 2004 till 2012?”1.3 Thesis outline
Chapter 2 will give an overview on the theory relevant to this thesis and will review existing literature. Multiple studies will be reviewed and connected. Expectations will be made, accounted by literature results, and these will be formulated in hypotheses. Chapter 3 will provide a description of the methodology used to test the hypotheses. In chapter 4 the results of the descriptive- and regression analysis will be elaborated. The final chapter, chapter 5, will present a conclusion.2. Literature review & theory
2.1 Initial public offering (IPO)
An initial public offering is simply the sales of a firm’s stock to the public and the establishment of a public market for the firm’s securities (Bochner, Avina, & Cheng, 2016)The IPO is a milestone in the life of a company. Multiple new opportunities, challenges and risks arise as a public firm. But some of these new opportunities can also be achieved in other ways then going public, like issuing private equity or recapitalization. To pursue an IPO, the board and executives must overthink what method applies best for the firm and has to weight the advantages and disadvantages of an IPO carefully (Allison, Hall, & McShea, 2008). The most essential benefit of an IPO Is the capital raised by an IPO, and additionally the improved access to the financial market and higher liquidity for investors (Allison et al., 2008). An IPO signals that the firm is expecting a period of growth by successfully utilizing the newly capital raised (Abraham, Harris, & Auerbach, 2016). Along with these benefits come significant consequences, like the increased exposure to liability’s, increased focus on corporate governance, the increased transparency, resulting in the obligation of disclosure of sensitive company information, and the SEC filling obligation (Allison et al., 2008). In case that the firm has evaluated the benefits over the costs of an IPO, and has weighted an IPO over the alternative ways of raising capital, the IPO process will begin. Players involved in this process are the company’s board and executive managers, the managing underwriters, the company’s council and auditor members, and the financial printer (Bochner et al., 2016).2.2 Underpricing
Short term performance of an IPO is measured by percentage change of offer price versus first day closing price, also called the initial return. The best known abnormality associated with the IPO process, is the frequent happening of large initial returns (Ibbotson and Ritter, 1995). Almost all studies show evidence that on average IPO’s first day closing price outperform the offer price. This phenomenon is expressed by IPO underpricing. IPO underpricing has been a mystery until the year 1978. Due to this unexplained phenomenon, multiple economists have dedicated their time researching and rationalising IPO underpricing. Multiple theories have been developed to explain this phenomenon. Most of these theories rationalising IPO underpricing, state the relationship between the adverse selection, signalling and moral hazard effect, caused by asymmetric information, on IPO underpricing (Beatty & Ritter, 1986; Carter & Manaster, 1990; Rock, 1986). These theories assume that there are threeplayers in the IPO market, the issuing firm, the underwriter, and the investor, of which an odd distribution of information exists. 2.2.1 The winner’s curse Rock (1986), with his article “why new issues are underpriced?”, laid the foundation of many studies rationalising IPO underpricing. He developed a model that incorporates asymmetric information with the IPO market, in order to explain underpricing. This model assumes that there are two parties in the investors market, the informed and the uninformed. The informed investor has perfect information about the realized value of the new issue (IPO). The uninformed investor has imperfect information about the realized value of the new issue. The informed investor will only subscribe to the good issues, the IPO’s that are undervalued. The uninformed investor will, because of is lack of information on the IPO’s, subscribe to both the good and the bad issues. Due to the oversubscription of the good issues, the offered stocks are divided between the two parties. While the bad issues are completely appointed to the uninformed party. Resulting in the uninformed party buying a disproportional amount of bad issues over good issues. This is referred to as the winner’s curse. Upon realising this, the uninformed party will withdraw from the market. Rock concludes, that for the uninformed investor to participate in the market, the issuers have to compensate them for their lack of information, in the form of a discount. Explaining why IPO’s are on average underpriced. Coakley, Instefjord, and Shen (2006) tested this model in China and Koh and Walter (1989) tested this model in Singapore. They both found evidence supporting the winner’s curse theory. 2.2.2 The investment banker’s power hypothesis Baron (1982) presented a theory for investment banking advice and the distribution of new issues, based on information asymmetry between the issuer and the investment banker. Baron assumes that the investment banker has superior information about the demand for the IPO, compared to the issuer. The issuers lack of information, causes the demand for advice and distribution of an investment banker. Since the investment bank’s effort to distribute the new issues is unobservable for the issuer, the investment bank has an incentive to undervalue a new issue to reduce his effort. The issuer can prevent such a situation by only employing an investment banker for his services. In this case the investment banker sets an offer price, based on his expertise of the capital market. To use this service, the investment banker must be compensated for his superior information. The model indicates that whenever the investment banker has superior information over the issuing firm, an incentive is created for the investment banker to value the offer price beneath its market value, resulting in underpricing.
2.2.3 Signalling hypothesis IPO underpricing has been explained by signalling theories. signalling is a method to indicate a firm’s quality to the public. Firms underprice their IPO to signal their quality to the public. Multiple signalling models have been developed, all assuming that the firm has superior information compared to the investor. Welch (1989) states that high quality firms tend to underprice their new issues, to reveal low quality firms in the market. Welch assumes that low quality firms try to imitate high quality firms in the market, to deceive investors. By underpricing their IPO’s, High quality firms try to reveal these imitating low quality firms. They hope that the underpricing costs, in addition with the imitation costs, are to much to bear for the low quality firms. High-quality firms are able to do this, since their marginal costs of underpricing are substantially lower than that of low quality firms. High quality firms that have identified themselves in the market, are able to offer a higher seasoned equity offering. Welch concludes that high quality firms underprice, to profit from the higher price they can obtain at a seasoned offering. Welch supported his theory by researching a dataset of 1028 IPO firms. He observed that only 288 firms issued a total of 395 seasoned offerings. However, these seasoned offerings produced 3.4 times more proceeds than the initial offerings did. Allen’s adn Faulhaber’s (1999) signalling model extents the assumption that underpicing is cyclical and industry specific. The cyclical effect of underpricing was empirical proven by Ibbotson and Jaffe (1975) and refers to a so called “hot issue” market. Ritter (1984) provided empirical evidence suggesting that underpricing is industry specific. Firms tend to signal their high future dividend yields by underpricing their new issue. Investors know that only high quality firms can carry these loss of proceeds. Grinblatt and Hwang (1989) support the signalling theories mentioned above. They state that the degree of retained stocks and the offer price reveal the unobservable intrinsic value of the firm. All the signalling theories and models developed are consisted with each other. High quality firms underprice to leave a good taste to the public. After signalling that they are a good investment, and performing well, the firm will profit from the seasoned offerings of retained stock. Although Welch found evidence that a proportion of IPO companies conduct a seasoned offering, the signalling hypothesis can not be supported. The signalling hypothesis can be tested by finding a relationship between underpricing and long-run performance. Empirical evidence supporting or rejecting this hypothesis are in conflict. Alvarez and Gonzalez (2005) found evidence in the Spanish market confirming the signalling hypothesis. While Garfinkel (1993), Jegadeesh and Titman (1993), and Michaely and Shaw (1994) found evidence that firms whose IPO’s where underpriced, return to the re-issue market far less frequently. These conflicting findings create doubt concerning the relevance of signalling in the underpricing phenomenon (Ibbotson and Ritter, 1995).
2.3 The financial crisis
“A crisis is an unexpected event that creates uncertainty and poses a direct or perceived threat to the goals and norms of an organization or society” (Boettke & Christopher, 2011, pp. 185) It all started in the United States’ subprime mortgage crisis. Many mortgages where originated by lenders with the intention of selling them. Creating an incentive for lenders to irresponsibly hand out mortgages. These mortgages where pooled and securitized, and eventually sold to financial institutions August 2007 (Kolb, 2011). The burst of the United States housing-bubble caused al securities attached to the real estate to plumed. Most financial institution in the world, possessed these securities, causing the U.S. housing crisis to spread (Nordic Council of Ministers, 2013). Resulting in the global financial crisis to start in August 2007 (Kolb, 2007). A limited amount of studies is dedicated to the relationship of a crisis to the degree of underpricing. Market conditions can have a significant impact on the valuation and success of an IPO (Bochner, Avina, & Cheng, 2016). Ibbotson and Jaffe (1975), researched the so-called “hot issue” markets. Hot issue markets are periods in which the first month performance of newly issued stocks are abnormally high. A hot issue is similar to IPO underpricing in a way that it is defined by the performance of a newly issued stock. In their research they discovered cyclical patterns in the IPO market, stating that in some periods initial performance is significantly higher than in others. In a follow-up study Ritter (1984) tested the hot issue market phenomenon, suggested by Ibbotson and Jaffe (1975), during the time period 1960-1982. He came to the conclusion that the “hot issue” market phenomenon reoccurred multiple times during this period, and will keep on existing. Due to the similarity of Ibbotson’s and Jaffe’s (1975), and Ritter’s (1984) research to the research done in this thesis, some predictions can be made regarding the relationship of business cycles with initial performance. Firms always choose a hot market over a cold market to go public (Ljungqvist, Nanda, Singh, & Rajdeep, 2006). Claiming that more IPO’s occur during high optimism. Due to the fact that firms exploit the opportunity to gain additional surplus from the presence of irrational exuberant investors. During a cold market, there are no irrational exuberant investors present. So prices are set by rational investors at true value. Suggesting that during a cold market, less underpricing occurs. This suggestion is contradictory to most theories explaining the impact of a crisis on IPO underpricing, presumably by the fact that the appearance of a cold market is not by definition an economical crisis. Geng Cui and Chan (2016) studied the impact of a crisis on IPO underpricing in China. Information provided during a crisis is of lower volume and of less quality. Uncertainty caused by a crisis, regarding the reliability of information will be further discounted in the IPO price. Their studyresulted in the suggestion that IPO’s facing a crisis have, a higher degree of underpricing than IPO’s before the crisis. Although, must be stated that their definition of a crisis consists of economic crisis’s, as well as environmental crisis’s. They both have a different impact on underpricing. Ljungqvist and Wilhelm (2003) researched IPO underpricing during the dot-com bubble. They found empirical evidence stating that IPO underpricing was significantly higher during the dot-com bubble burst, compared with the years prior to it. Their results are suggested to be caused by the unique firm characteristics during these periods, which motivated pricing behaviour. Additionally, Dorsman and Gounopoulos (2013) provided evidence suggesting that the degree of underpricing is higher during a financial crisis. They conducted a research on the impact of the financial crisis on the performance of Dutch IPO’s. Stating that the higher degree of underpricing was attributed by the underwriters attempt to create demand as well as rewarding investors for their participation.
2.4 Hypotheses
Studies providing evidence of mutual degree, explaining IPO underpricing, for other causes then asymmetric information, remain non-existent. Thus, thesis will recognize asymmetric information as the cause of IPO underpricing, and will build further on this assumption, since there is sufficient evidence confirming this. By linking the asymmetric information theory with the literature reviewing the impact of an economical crisis on the degree of underpricing certain expectations can be made. Empirical evidence states that during an economical crisis, IPO underpricing increases (Ljungqvist and Wilhelm, 2003; Dorsman & Gounopoulos, 2013). Theory suggest that information supply is of lower volume and of lesser quality during a crisis. The link between these assumption is formulized in the following hypothesis: H1: The relationship between the financial crisis and IPO underpricing is positive Additionally, to explaining the cause of asymmetric information to the degree of asymmetric underpricing, reviewing existing literature should identify proxies that determine asymmetric information. These proxies could be issue-, firm-, or market specific factors. By having either a mitigating or accentuating effect on asymmetric information, these proxies contribute on the degree of underpricing. If the financial crisis indeed has a significant positive relationship with underpricing, and thus asymmetric information, it is logical to assume that the financial crisis is separately related to the asymmetric information proxies. No existing literature studied this relationship yet. By doing so, results can have a valuable attribution to existing knowledge.Firm size In existing literature, firm size is associated with asymmetric information. Tajuddin, Abdullah, and Taufil-Mohd (2017) researched 254 IPO’s over a period of 11 years in Malaysia. The findings of their study stated that firm size is negatively correlated with IPO performance. Large firms have better performance records, which reduces information asymmetry, and thus do not have to underprice their IPO to attract investors. These findings are in alignment with multiple other study’s, researching the effect of firm size on IPO performance (Mezhoud & Boubaker, 2011; Tajuddin et al., 2015). Yanxiang Gu (2003) did research on the relationship between firm size and IPO returns. His study provided evidence on the relationship between firm size and IPO return to being positive. Bundoo (2007) found empirical evidence in Mauritius’s market suggesting that big firms indeed experience a high degree of underpricing. Stating that bigger firms experience a high degree of underpricing is in line with the signalling hypothesis. Big firms underprice their IPO, to signal their value to the public (Welch, 1989). However, there is little evidence supporting the signalling hypothesis. These conflicting results are difficult to address. Yanxiang Gu (2003) used yearly earnings as proxy for firm size, which might explain his deviating results. Although, multiple other studies, using market capitalization as firm size proxy, provide similar evidence. This thesis will use market capitalization as firm size proxy. Expectations are derived from the literature by assuming that the signalling hypothesis is poorly supported. Resulting expectations are formalized in the following hypothesis: H1: Firm size has an additional negative influence on IPO underpricing, during the financial crisis. Age of the firm Young firms are limited to the amount of historical financial data they are able to offer (Boudriga, Ben Slama, & Boulila, 2009). This lack of assessment is in line with the asymmetric information theory suggested by Rock (1986). It can be suggested that age-at-IPO is negatively correlated with IPO underpricing. (Clark, 2002)conducted evidence consistent with this suggestion. A significant negative relationship between the age-at-IPO and aftermarket performance was found. A Limitation to this finding was that young technology firms outperformed older ones. This might be explained by the trade-off between the pre-IPO learning curve and opportunity cost related with delay to market. The better the idea the higher the opportunity costs. High potential technology
firms will logically go public in a young stage, to exploit their deal breaking idea (Jovanovic & Rousseau, 2001). Results are formalized in the following hypothesis: H2: Age of the firm at IPO has an additional negative influence on IPO underpricing, during the financial crisis. offer price Once the total value of the IPO is estimated, the firm can choose any combination of number of stocks and offer price. Due to this fact, both values should have little economic significance (Fernando, Krishnamurthy, & Spindt, 2002). Fernando et al. argue that firms do not set the offer price in an arbitrary way. Gompers and Metrick (2001) found evidence contradicting this statement. He observed that the post IPO ownership-structure has influence on the offer price. Institutional investors tend to prefer higher valued offer prices over low valued offer prices. Field (1995) states that institutional investors and long-term IPO performance are positively related. Linking the results from Gompers and Metrick (2000) and Field (1995) suggests that high offer prices are more likely to perform better in the long-run. Since underpricing is defined by short-term performance, this finding is not of much use in this research. Ibbotson et al. (1988) suggest in their theory that low offer prices are paired with a higher degree of underpricing. Due to the fact that offer prices are valued low, because of uncertainty. Fernando et al. (2002) found evidence stating that underpricing is higher for low offer prices and for high offer prices as well. He reports the relationship between IPO underpricing and IPO offer price to be U-shaped. Resulting expectations are formalized in the following hypothesis: H3: Offer price has an additional negative influence on IPO underpricing, during the financial crisis. Number of shares offered Rock (1986) incorporated the number of shares offered to the public as a determinant of asymmetric information in his model to explain IPO underpricing. Bansal and Khanna (2013) empirically tested the relationship between the number of shares offered and the degree of underpricing, and found this to be positive. Van Heerden and Alagidede (2012) found results consistent with this. They observed that initial share issues of larger than 200 million shares showed an average first day return of 172.067%, while share issues smaller than 200 million shares experienced an average initial return of 48.919%. Surprisingly, they found that during the financial crash of 2008 the inverse was true. Which as they explained, might be due to the fact that investors seek companies of high quality during financial crisis’s.
H4: The number of shares offered has a negative influence on IPO underpricing, during the financial crisis.
2 Methodology
2.1 Data
The sample used in this research is composed by companies listed in United States’ stock markets, initiating their IPO between the year 2004 and 2012. These companies are obtained by Thomson One database. IPO dates, IPO offer prices, offered IPO shares, first day closing prices, market capitalization at IPO-date, and industry type are also provided by Thomson One database. The original sample consisted of 926 companies, going public in the United States between 2004 and 2012. Of which 670 companies where underpriced. Companies which contained missing data where omitted from the sample selection, resulting in a sample of 522 companies. Outliers where omitted from the sample to prevent problems in the statistical analysis. An outlier is an observation with a value substantially greater than the majority of the data set, and should be excluded from the sample. An outlier is defined to be greater than 3 times the interquartile range (IQR) added by the 3th quartile, or lesser than 3 times the IQR subtracted from the 1th quartile. 2 observations have been omitted due to this criterion. Resulting in a final sample of 520 companies. figure 1 gives an overview of the original sample distribution. The sample is divided by year, and a distinction is made between overpriced and underpriced IPO’s. By observing the table, the relevance of underpricing and the impact of the financial crisis on the IPO market becomes clear. A substantial amount of IPO’s is underpriced. Most noticeable, is the enormous reduction of IPO’s in 2008 and 2009, the crisis years. Which might be explained by Ibbotson’s and Jaffe’s (1975) hot and cold market theory. Stating that during scepticism less firms will go public.Figure 1 - number of IPO's during 2004-2012 The original sample distributed by year. A distinction is made between underpriced and overpriced IPO’s. Underpriced IPO’s are classified as IPO’s with an initial return greater than 0. Overpriced IPO’s are classified as IPO’s with an initial return less than 0.
2.2 Variables
In order to empirically test the hypotheses, variables must be allocated to causes of underpricing derived from existing literature. these variables will be explained. First a description and formula for underpricing will be stated, secondly the independent and dummy variables explaining underpricing will be elaborated. INITIALRETURN IPO underpricing is calculated by the initial return of a stock. The initial return, the dependent variable in this research, is the percentage difference of the offer price and the first day closing price. The initial return for each firm is calculated the following: 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝐼𝑅 =-./01 234 5670.89 :/.5;7--;/ :/.5; − 1 (1) PRICE PRICE is an independent variable irepresenting offer price. The offer price is the dollar price at which a publicly traded stock will be available for purchase at the moment of IPO. IPO’s with high uncertainty are regularly valued low. Offer price is expected to be negatively related to underpricing. This thesis will use the natural logarithm of the offer price in the regression. 𝑂𝐹𝐹𝐸𝑅 = 𝐿𝑛(𝑜𝑓𝑓𝑒𝑟 𝑝𝑟𝑖𝑐𝑒) (2) 0 20 40 60 80 100 120 140 160 180 200 2004 2005 2006 2007 2008 2009 2010 2011 2012 Underpriced OverpricedOFFERED OFFERED is an independent variable representing the number of offered shares. These are the number of shares offered at IPO. The natural logarithm is used in the regression. 𝑂𝐹𝐹𝐸𝑅𝐸𝐷 = 𝐿𝑛(𝑜𝑓𝑓𝑒𝑟𝑒𝑑 𝑠ℎ𝑎𝑟𝑒𝑠) (3) MC MC is an independent variable representing market capitalization as proxy for firm size. The market capitalization of a firms is the total dollar value of its outstanding shares. Large firms are expected to established and are able to offer greater performance records, and thus lower asymmetric information. Expected is that firm size negatively influences underpricing. The natural logarithm of the firm’s market capitalization at IPO-date is used in this regression. 𝑀𝐶 = 𝐿𝑛(𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔1∗ 𝑠ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒1) (4) Firms age (AGE) The firm’s age is given by the firm’s age at IPO-date. This is defined by the difference in establishment date with the IPO date. Future performance can be derived from past performance. Younger firms are associated with a higher degree of uncertainty due to their lack of historical data. Age of the firm is therefore expected to have a negative influence on underpricing. The natural logarithm of firm age is used in this regression. 𝐴𝐺𝐸 = 𝐿𝑛(𝐼𝑃𝑂 𝑑𝑎𝑡𝑒 − 𝐸𝑠𝑡𝑎𝑏𝑙𝑖𝑠ℎ𝑒𝑚𝑒𝑛𝑡 𝑑𝑎𝑡𝑒) (5) CRISIS CRISIS is a dummy variable representing the financial crisis. The volume and quality of information offered during a crisis is low. Increasing asymmetric information as a result. The crisis is expected to be positively related to underpricing. A value of one is assigned to firms initiating their IPO from 1 December 2007 till 31 December 2009. In all other cases, a value of zero is assigned. POSTCRISIS POSTCRISIS is a dummy variable representing the period after the financial crisis, in which the financial crisis still had influence. Assuming that the financial crisis’s aftershock lasted until 2012, some of the financial crisis’s features on the economy where still around then, in a mildly manner. The POSTCRISIS variable is expected to be positively related to underpricing, but in a smaller degree
than the CRISIS variable itself. A value of one is assigned to firms initiating their IPO after 2009. In all other cases, a value of zero is assigned. HT HT is a dummy variable representing the high technology sector. A value of one is assigned to firms located in the in the high technology sector. Firms allocated in the high technology sector are identified by their 3-digit Standard Industrial Classification (SIC) code provided by Kile and Phillips (2009), shown in appendix A. A value of zero is assigned to firms located in any other sector.
2.3 Multicollinearity
Multicollinearity arises in the regression when two independent variables predict each others value. For regression purposes, one of the variables causing multicollinearity will be omitted from the regression. An indicator of multicollinearity is high inter-correlations between two variables. This can be discovered by a correlation matrix. Table 1 shows high correlation between the variables PROCEEDS and MC. Which is not a surprise at all, since proceeds are a fraction of the firm’s market capitalization. Correlation was expected, but not to this degree. The variable PROCEEDS has been omitted from the regression to guarantee statistical reliability. Table 1 - correlation matrix of dependent and independent variables Values highlighted by a *, indicate significance at the 5% level. Values shown in bold, indicate high mutual correlation.2.4 Methodology
To statistically test the hypotheses, the dependent variable will be regressed against its explanatory variables, derived from the literature. This will be done by three ordinary least squares (OLS) regressions. At first, to test whether the financial crisis is significantly related to underpricing, initial return will be regressed against the variables serving as asymmetric information proxies. These are firm size, offer price, number of shares offered, and the firm’s age. This regression model isINITIAL
RETURN
AGE
MC
PRICE
OFFERED PROCEED
INITIAL
RETURN
1
AGE
0.0995*
1
MC
0.1433*
0.1352*
1
PRICE
0.0875*
0.0806
0.6827*
1
OFFERED
-0.0168
0.0199
0.7383*
0.2808*
1
PROCEEDS 0.0238
0.0554
0.8697*
0.6419*
0.5706
1
stated in formula 6. In formula 7, dummy variables will be added to formula 6 to control the regression equation. Finally, to test whether the crisis has a separate effect on each of the explanatory variables, interaction variables will be included to the regression model. This results in formula 8. 𝐼𝑁𝐼𝑇𝐼𝐴𝐿𝑅𝐸𝑇𝑈𝑅𝑁. = 𝛼 + 𝛽[𝐶𝑅𝐼𝑆𝐼𝑆 + 𝛽]𝑃𝑅𝐼𝐶𝐸 + 𝛽^𝑂𝐹𝐹𝐸𝑅𝐸𝐷 + 𝛽_𝑀𝐶 + 𝛽`𝐴𝐺𝐸 + 𝜀. (6) 𝐼𝑁𝐼𝑇𝐼𝐴𝐿𝑅𝐸𝑇𝑈𝑅𝑁. = 𝛼 + 𝛽[𝐶𝑅𝐼𝑆𝐼𝑆 + 𝛽]𝑃𝑅𝐼𝐶𝐸 + 𝛽^𝑂𝐹𝐹𝐸𝑅𝐸𝐷 + 𝛽_𝑀𝐶 + 𝛽`𝐴𝐺𝐸 + 𝛽b𝐻𝑇 + 𝜀.(7) 𝐼𝑁𝐼𝑇𝐼𝐴𝐿𝑅𝐸𝑇𝑈𝑅𝑁. = 𝛼 + 𝛽[𝐶𝑅𝐼𝑆𝐼𝑆 + 𝛽]𝑃𝑅𝐼𝐶𝐸 + 𝛽^𝑂𝐹𝐹𝐸𝑅𝐸𝐷 + 𝛽_𝑀𝐶 + 𝛽`𝐴𝐺𝐸 + 𝛽b𝑃𝑅𝐼𝐶𝐸 ∗ 𝐶𝑅𝐼𝑆𝐼𝑆 + 𝛽d𝑂𝐹𝐹𝐸𝑅𝐸𝐷 ∗ 𝐶𝑅𝐼𝑆𝐼𝑆 + 𝛽e𝑀𝐶 ∗ 𝐶𝑅𝐼𝑆𝐼𝑆 + 𝛽f𝐴𝐺𝐸 ∗ 𝐶𝑅𝐼𝑆𝐼𝑆 + 𝛽[g𝐻𝑇 + 𝜀. (8)
3. Empirical research
3.1 Descriptive statistics
The descriptive statistics of the variables used will be presented and explained in this paragraph. In table 2, the descriptive statistics of the dependent variable INITIALRETURN are shown. Descriptive statistics are derived from the original sample consisting of 986 firms, the sample limited to underpriced stocks, and the sample consisting of only undepriced stocks during the financial crisis. Table 2 – descriptive statistics of the initial return The descriptive statistics of the dependent variable, the initial return, across three different samples. Column 1 shows the descriptive statistic of the initial return on the complete sample of IPO’s initiated during 2004-2012, in the Unites States. Column two shows the descriptive statistics of the sample limited to underpriced IPO’s. Column three shows the descriptive statistics of the initial return of IPO’s underpriced during the financial crisis. The average initial return of the complete sample is 0.106. Stating that the average IPO during 2004-2012 is 10.6% underpriced. This value is expected, since underpricing can take on higher values than overpricing. Underpricing can reach values of above 100%, of which some are included in the sample, shown by the maximum value of 3.5. While overpricing can not reach values lower than -100%. So it is logically to assume that the average initial return is greater than 0. However, by reviewing figure 1 again, it can be concluded that the average IPO is underpriced. These findings are consistent with Ibbotson and Jaffe (1975). The sample consisting of only underpriced IPO’s, shows an average underpricing of 18.9%. By comparing this to the average underpricing of 25.8% during themean
sd
min
max
#
INITIAL RETURN
0.106
0.252
-0.799
3.5
986
INITIAL RETURN
0.189
0.223
0.0004
2.467
520
financial crisis, first impression tells us that the financial crisis definitely has an influence on IPO underpricing. However, since this is not empirically proven yet, no statistical guarantee can be granted. Reviewing these result reveals the economic relevance of IPO underpricing and the financial crisis’s influence on this phenomenon, and the potential value created by researching this. Table 3 shows the descriptive statistics of the complete dataset, summarizing the proxies of information asymmetry. The average market cap of the sampled firms is 767 thousand dollars. The high standard deviation of 2.33 million indicates that the market capitalization of the sampled firms is widely spread across the mean. Which can be derived from looking at the the low minimum value and the high maximum value. The offering price averages at 14.58 dollar. The lowest and highest offer price was 5 dollar cent and 65 dollar respectively. The number of IPO shares offered averaged at 13.9 million shares. Likewise, the high standard deviation indicates that the number of shares offered by the sampled firms is widely spread across the mean. The average age-at-IPO of the sampled firms is 17.25 years. The minimum age of a firm going public was 1-year-old, while the maximum age was 134 years old.
mean
sd
min
max
N
Underpricing
0.18
0.26
0.04
3.50
670
Marketcap (x1000)
767.00
2,330.00
0.20
49,500.00
626
Offer price ($)
14.58
6.22
0.05
65.00
670
Shares offered (x1000)
13,969.85
27,119.00
925.00
549,700.00
670
Age
17.25
22.92
1
134.00
520
Table 3 - descriptive statistics of the explanatory variables This table shows the descriptive statistics of initial return and its explanatory variables, market capitalization, offer price, shares offered and age, also known as the proxy variables of information asymmetry. The mean, standard deviation (sd), minimum value (min), maximum value (max) and the number of observations (#) are summarized.3.2 Regression analysis
Table 4 shows the estimated OLS regression results for regression equation 6, 7 and 8. Model (1) in table 4 shows that the coefficient of the financial crisis (CRISIS) is significant at the 10% level. The financial crisis is positively related to IPO underpricing, implying that IPO underpricing increases during the financial crisis. This result is in line with existing literature and derived expectations. at-IPO-age (AGE) of the firm is estimated to be positively related to IPO underpricing, which is contradicting to the expectations. This variable is however shown to be insignificant, which might explain the deviation. firm size (MC) is shown to be positively related to underpricing at a 1% significance level. This result is contradicting the expectations, but can still beexplained by existing literature. The number of shares offered (OFFERED) positively influences IPO underpricing, which is consistent with existing literature. The IPO price is negatively related to IPO underpricing at a 5% significance level. Higher IPO prices tent to outperform low IPO prices in the short-term, which is consistent with the expectations. By adding the control variables POSTCRISIS and HT to the model, shown in model (2) in table 4, no abrupt enhancement occurs, in neither the model nor the explanatory variables. Notable is that by adding the control variables, the negative relationship between the offer price (PRICE) and IPO underpricing becomes insignificant. Non of the coefficients of the explanatory variables change drastically by adding the control variables to the model. The small change can however be explained by the effect the control variables POSTCRISIS and HT have on the explanatory variables, that is taken away by adding them to the equation. The post crisis period (POSTCRISIS) is as expected positively, yet insignificantly, related to IPO underpricing in a smaller degree than the financial crisis (CRISIS) itself. Firms located in the high technology sector (HT) face a higher degree of undepricing, as expected, at a 1% significance level. In model (3) of table 4, the interaction coefficients are added to the model to test the relationship of the financial crisis (CRISIS) with the asymmetric information proxy variables. The age of the firm has an additional positive effect on underpricing during the financial crisis. However, the interaction variable coefficient AGE*CRISIS is stated to be insignificant, just as the AGE variable. The coefficient MC is positively related to INITIALRETURN, however the interaction variable MC*CRISIS is negatively related to INITIALRETURN, significant at the 1% and 5% level, respectively. Implying that market capitalization is positively related to IPO underpricing, but this effect is diminished during the financial crisis. The number of shares offered has a positive influence on IPO underpricing, with 1% significance. This effect is reduced during the financial crisis. This result is derived from the negative interaction variable coefficient OFFERED*CRISIS, significant at a 1% level. In general, the offer price (PRICE) is negatively related to IPO underpricing (INITIALRETURN), while during the financial crisis, an additional positive effect is discovered. Both the coefficient of the variable PRICE and the interaction variable PRICE*CRISIS are shown to be insignificant. The R-squared is a goodness of fit measurement of the model. It tests the variability of the dependent variable, explained by the independent variables. The R-squared values of the tested models are 7.6%, 9.9% and 12.4%, respectively. These are low, however this is not bad by definition. These models where not expected to have high R-squares. Some determinants of IPO underpricing are absent in the models, which would improve the goodness of fit, however this does not have any implications on the variables that are used. This research is developed to test the statistical significance of the predictors of IPO underpricing. The R-squared has no explanatory power on the individual coefficient whatsoever.
Table 4 - regression results of equation 6, 7 and 8 This table shows the estimated regression results of IPO’s initial return on its explanatory variables. Column (1) shows the regression estimates of regression equation 6. Column (2) shows the regression estimates of regression equation 7. Column (2) shows the regression estimates of equation regression equation 8. The standard deviation is given below the variable coefficients. *, **, and *** represent significance levels P<0.1, P<0.05, and P<0.01, respectively.
(1)
(2)
(3)
β
β
β
CRISIS
0.0641*
0.0621*
-2.016***
(0.037)
(0.0373)
(0.636)
AGE
0.00859
0.00965
0.00477
(0.0086)
(0.00854)
(0.00889)
MC
0.103***
0.0822***
0.0923***
(0.0191)
(0.0198)
(0.0203)
OFFERED
0.100***
0.0829***
0.101***
(0.0204)
(0.0207)
(0.0211)
PRICE
-0.0729**
-0.0428
-0.0462
(0.0299)
(0.031)
(0.0317)
AGE*CRISIS
0.0315
(0.0312)
MC*CRISIS
-0.165**
(0.072)
OFFERED*CRISIS
-0.288***
(0.0812)
PRICE*CRISIS
0.125
(0.137)
POSTCRISIS
0.0177
0.0186
(0.0223)
(0.0221)
HT
0.0822***
0.0903***
(0.0236)
(0.023)5
Constant
0.660***
0.521***
0.649***
(0.147)
(0.15)
(0.153)
Observations
520
520
520
R-squared
0.076
0.099
0.124
3.3 Discussion results
The financial crisis is observed to be positively related to IPO underpricing. Results are shown in table 4, model (1) and (2), and is in line with expectations and previous literature of Geng Cui and Chan (2016), Ljungqvist and Wilhelm (2003) and Dorsman and Gounopoulos (2013). The theory suggests that the quality and volume of information supplied is lower during a financial crisis, increasing information asymmetry between the firm and its investors. This results in the firms underpricing their IPO to attract investors anyhow, and indirectly compensating them for their lack of information. Firms age is positively related to IPO underpricing. Older firms are expected to experience higher degrees of underpricing. The financial crisis has an additional positive effect of the relationship between firm age and IPO underpricing. These results are contradicting expectations and existing literature. Although the effect of the firm age on IPO underpricing is found to be insignificant, the contradicting effect is still surprising. This contradictory result might be caused by the high degree of missing data of establishing dates in the sample. Resulting in the removal of a great amount of firms in the dataset, which might have biased the age-at-IPO data. Model (3) in table 4 shows a significant positive relationship between firms’ market capitalization and IPO underpricing, which is in line with the signalling hypothesis of Welch (1989), assuming that big firms are of high quality. This effect is diminished during the financial crisis, which might be explained by theory provided by Geng Cui and Chan (2016). This might be explained by the fact that big firms have to signal their quality during a booming economy, by undepricing their IPO. However, during the financial crisis, the information supplied by big firms might be of better quality and greater volume than that of small firms. Reducing the need to signal their quality in the form of underpricing, and thus reducing the degree of underpricing during financial crisis. This is a potential explanation of the phenomenon discovered in model (3). Further theory regarding the firm size must be developed to confirm this. The effect of the number of IPO shares offered on IPO underpricing is observed to be positive. During the financial crisis this effect is vice versa. These findings are both significant at a 1% level. These result are consistent with the findings of van Heerden and Alagidede (2012). They explain the contra dictionary results to be caused by the fact that during crisis times, investors seek high quality firms. The negative influence of offer price on IPO underpricing is in line with the expectation. The positive effect of the IPO price on IPO underpricing observed during the financial crisis is however surprising. Especially by reviewing the theory of Ibbotson et al. (1988), stating that IPO prices are valued low due to uncertainty, which causes underpricing. Geng Cui and Chan (2016) states thatuncertainty rises during a crisis. By combining these studies, it is logical to assume that the offer price has an additional positive effect on underpricing during the crisis. The coefficients of the variable PRICE and the interaction variable PRICE*CRISIS, shown by model (3) in table 4, appear to be insignificant.
4. Conclusion
This thesis researched the effect of the financial crisis on the phenomenon of IPO underpricing in the United States between the years 2004-2012. A sample of 928 IPO’s in the united states during the year 2004-2012 was obtained. Showing that the average initial return was 10.6% underpriced. Limiting the sample to underpriced IPO’s resulted in an average underpricing of 18.9%, with its peak during the financial crisis of an average underpricing of 25.8%. By doing an initial return analysis, I show the relevance of IPO underpricing and the effect of the financial crisis on this phenomenon. By reviewing existing literature, the assumption was made that information asymmetry between interested parties causes IPO underpicing. Empirically proven proxies of information asymmetry where derived from existing literature. I performed multiple OLS regressions using the initial return as dependent variable, and the financial crisis, asymmetric information proxies, and control variables as independent variable. I tested the effect of the financial crisis on the initial return, and separately on the asymmetric information proxies. The dummy variable used to account for the financial crisis (CRISIS) showed to be significantly positively related to the initial return. Implying that during the financial crisis, IPO underpricing increased in the United States. The firm size variable (MC) shows that big firms have greater initial returns, while this effect is vice versa during the financial crisis. Big firms show lower degrees of underpricing during the financial crisis than during periods pre- and post crisis. IPO’s offering a great amount of shares experience higher degrees of underpricing, as shown by the OFFERED variable. This effect is limited by the financial crisis. Offering a great amount of IPO shares during the financial crisis results in a lower degree of underpricing, than would have been experienced in periods pre or post financial crisis. The regression results show no evidence that at-IPO-age of the firm and the offer price are related to underpricing. Constraints to this research was the lack of data available to most of the sampled firms. Resulting in the reduction of the sample size, which might have compromised some of the results. Thomson One database provided not enough data to support for more than 4 explanatory variables, which was a limitation. Empirically proven variables causing IPO underpricing where due to this constraint left out. Prove of the relationship between the left out determinants of IPO underpricing, and the financial crisis are not provided by this research. Further research should incorporate thesevariables and expand the sample size. No theories have been developed explaining the relationship between the financial crisis and the explanatory variables used in this research. Therefor, it is difficult to rationally explain and substantiate the found relationships. Future studies could research this relationship, and develop theories and evidence explaining them.
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