The Influence of Share Retention on the
Short-Term and Long-Short-Term Performance of Dutch IPOs
RODERICK KASTEELa Master Thesis MSc BA Finance
Faculty of Economics and Business, Rijksuniversiteit Groningen The Netherlands
ABSTRACT
This thesis analyzes the influence of share retention on both the short- and long-term performance of 64 Dutch IPOs between 1994-2005. There is evidence of IPO underpricing and IPO long-term underperformance in the Netherlands. The average underpricing level is 16.53%. After three years of trading, IPO firms underperformed non IPO firms by -20.70%. In the short term, retention rates above 80% have a significant positive influence on underpricing; in the long-term, retention rates below 70% have a significant negative influence on the post IPO performance.
Keywords: IPO, Underpricing, Long-term Performance, Share Retention JEL Classification: G14, G24, G32
Supervisor: dr. ing. N. Brunia
aE-mail address: rkasteel@gmail.com
I. Introduction
Numerous studies have shown that pre-IPO factors such as firm age, firm size and the underwriter or the auditor of the IPO firm have a significant influence on an IPO’s performance (Ritter (1991); Gompers and Lerner (2001); Loughran and Ritter (2004)). This thesis explores the relationship between share retention and IPO short- and long-term performance.
Academic research on IPO performance measures the short-term performance of an IPO by the share price after the first day of trading, and the long-term performance after three years of trading. Two anomalies have been found related to these moments. Firstly, firms that go public tend to experience a steep price increase of their shares on the first day: underpricing. Secondly, after three years of trading, IPO firms tend to underperform non IPO firms: underperformance. The existence of IPO underpricing and IPO underperformance is widely documented and studied in the literature and yet it remains a challenge why these phenomenons exist.
Underpricing theories have been grouped into four broad headings (Ljungqvist (2004)): asymmetric information theories, control considerations theories, behavioral theories and institutional reasons. The best established of these theories are asymmetric information models. These models argue that one of the parties participating in the IPO knows more than the others, eventually leading to underpricing (Rock (1986); Baron (1982); Benveniste and Spindt (1989)).
Contrary to underpricing theories, theoretical explanations for the long-run underperformance of IPOs are less than abundant. Most explanations can be placed into two groups: behavioral explanations and mis-measurement explanations. Behavior explanations argue that investors give too much weight to recent results and trends resulting, in an over-optimistic perception of the IPO firm. Eventually, this over-optimism will disappear leading to a downward price adjustment and revert of the share price to its fair value (Ritter (1991); Loughran and Ritter (1995); Purnanandam and Swaminathan (2001)). Mis-measurement explanations argue that problems related to measurements of the long-term returns explain the “perceived” underperformance (Barber and Lyon (1997); Brav (2000); Loughran and Ritter (2000); Fama and French (1998)).
indicates a higher firm quality, as the current owners are reluctant to release a high proportion of the future cash flows to outside investors. Recently, Robinson et al. (2004) developed a model in which the signal of share retention has a U-shaped form. They argue that the signal depends on two factors: expected future firm revenues and owner entrenchment benefits1. Higher level of retention signals that the current owners expect higher future revenues; it also indicates higher threats of owner entrenchment benefits. At very high levels of retention, the threat of the costs of owner entrenchment benefits outweighs the expected future revenues causing the U-shaped relation. Investors, therefore, perceive a higher rate of retention as a “positive” signal up to a certain retention level, and as a negative “signal” afterwards. Robinson et al. (2004), empirically support their model for a sample of 3075 IPOs in the United States between 1988 and 1999. Other studies show mixed results. Though Morck et al. (1988), Mc Connel and Servaes (1990), and Keasey and Short (1997) also find a U-shaped relation, Keasey and McGuiness (1992), Karlis (2000) find a positive relation and Mikkelson and Shah (1994), Krinsky and Rotenberg (1989), Yu and Tse (2003) and Neupane and Venkatesh (2004) find a negative relation.
Concerning the relation of share retention and IPO long-term performance, Khurshed et al. (2007) and Alvarez and Gonzales (2005) find that retention rate has a positive influence on an IPO’s long-term performance. Assuming that markets are efficient, the first day after market price is an outcome of the valuation of all pre-IPO factors; and an initial over or under valuation of one of these factors will disappear through a post IPO performance correction. The findings of Khurshed et al. (2007) and Alvarez and Gonzales (2005) therefore mean that initially investors undervalued the factor retention rate, leading to an upward post IPO performance correction.
There are several reasons why this study is of interest. First, to the best of my knowledge, no study investigating the influence of share retention on the short and long-term performance of IPOs has been conducted in the Netherlands. This thesis, therefore, explores the relationship between share retention and IPO short- and long-term performance in the Dutch IPO market. Second, from an investor’s viewpoint, understanding the influence of share retention on the first day after market price, and or IPO’s long-term performance, may present opportunities for better IPO investments. From an issuing firm’s viewpoint understanding the influence of share retention on the first day after market price or an IPO’s long-term performance may help them in the price setting of their IPO.
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The remainder of the paper is organized as follows: Section II gives an overview of previous literature, Section III describes the data and methodology, Section IV presents the results and Section IV presents a conclusion and recommendations for future research.
II. Literature Review
II.1. Underpricing and Share Retention
A continuing question in financial economics is why most IPOs are underpriced. Underpricing is estimated as the percentage difference between the price at which the IPO shares were sold to investors, the offer price, and the price at which the shares subsequently trade in the market (Ljungqvist (2004)). It refers to the phenomenon that, on average, the share price jumps substantially on the first day of trading. Logue (1973) and Ibbotson (1975) were the first who noticed that when companies go public, their shares tend to be underpriced. A large amount of research has followed and evidence of underpricing is worldwide (Appendix A). For the Netherlands, Van Frederikslust and Van der Geest (2000) and Doeswijk et al. (2005) find an average level of underpricing of 16% and 17.6% for the period 1985-1998 and 1977-2001 respectively. Clearly, underpricing is costly to the firm going public: shares are sold at a too low price. Each year, IPO firms leave billions “on the table” and interestingly no consensus has been reached on the explanation of this phenomenon.
Table I: Overview of Uncertainty Proxies and Their Influence on Underpricing
Uncertainty Proxy Study Sign
Firm Age Carter and Manaster (1990)
-Habib and Ljungqvist (2001) Loughran and Ritter (2004)
Firm Size Habib and Ljungqvist (2001)
-Ritter (1984)
Loughran and Ritter (2004)
Offer Price Booth and Chua (1996)
-Mohan and Chen (2001)
Gross Proceeds Beatty and Ritter (1986)
-Habib and Ljungqvist (2001)
Aggarwal, Prabhala and Puri (2002)
Auditor Reputation Titman and Trueman (1986)
-Balvers, Mc Donald and Miller (1998) Booth and Smith (1986)
Underwriter Reputation Titman and Trueman (1986)
-Carter and Manaster (1990) Megginson and Weis (1991)
Industry Overview Benveniste, Ljunqvist, Wilhelm and Yu (2003)
Technology Loughran and Ritter (2004) +
Hot Market Period Ritter (1991) +
Doeswijk et al. (2005)
Share Retention Karlis (2000) +
Keasey and McGuiness (1992)
Neupane and Venkatesh (2004)
-Yu and Tse (2003)
Mikkelson and Shah (1994)
Robinson et al. (2004) Inverse U-shaped
A subgroup within asymmetric information models are signaling theories. Signaling theories argue that underpricing can be seen as a signal of a firm’s quality. Ibbotson (1975) is the first to stress that issuers underprice to “leave a good taste” to investors. Allen and Faulhaber (1989), Grinblatt and Hwang (1989) and Welch (1989) propose a model in which issuers maximize their expected proceeds of a two stage sale: an initial public offering and second seasoned offerings. They argue that high quality firms want to signal their quality in order to raise capital on better terms in the future and low quality firms have an incentive to imitate whatever high quality firms do. The signal is the offer price: high quality firms offer their shares at a lower price than their true value. The “underpricing cost” is recouped when the firm returns to the market for second seasoned offerings. An important assumption for this signal to be credible is that there is a positive probability that a firm’s true quality is revealed before it returns to the market for a second season offers. This exposes low quality firms to the risk that any cheating on their part will be detected by the market before they can recoup the underpricing cost and profit from imitating high quality firms’ signal. Provided that the risk of detection and the underpricing cost are sufficiently high, low quality firms will refrain from mimicking high quality firms. High quality firms can therefore signal their quality by intentionally leaving money on the table at the IPO and “recouping” it at a future stage.
Several studies argue that, next to underpricing, IPO firms also choose particularly reputable auditors, underwriters or venture capitalists (Booth and Smith (1986); Titman and Trueman (1986)) also as a signal of firm quality. Following this signaling idea, Leland and Pyle (1977) propose a model in which the fraction of equity retained by the current owner at IPO is a signal of a firm’s quality. They argue that higher levels of retention indicate higher firm quality, as the current owners are reluctant to release a high proportion of the future cash flows to outside investors. The results of Trueman (1986), Keasey and McGuinness (1992), and How and Low (1993) empirically support Leland and Pyle’s (1997) model and the ability of share retention to signal firm quality. Ritter (1987) extends the signaling argument and proposes a model taking agency problems in account such as management shirking related to high levels of retention.
two factors: expected future firm revenues and owner entrenchment benefits. Higher level of retention signals that the current owners expect higher future revenues; it also indicates higher threats of owner entrenchment benefits. At very high levels of retention the threat of the costs of owner entrenchment benefits outweighs the expected future revenues causing the U-shaped relation. Investors therefore perceive a higher rate of retention as a “positive” signal up to a certain retention level, and as a negative “signal” afterwards. Provided that investors set the initial market price in reaction to this signal, underpricing is directly related to the signal and has an inverse U-shaped relation with the level of retention. Robinson et al. (2004) empirically supported their model for a sample of 3075 IPOs in the United States between 1988 and 1999. Previous studies give mixed results. Though Morck et al. (1988), Mc Connel and Servaes (1990), and Keasey and Short (1997) find a U-shaped relation given support for the model of Robinson et al. (2004), Keasey and McGuiness (1992) find a positive relation and Mikkelson and Shah (1994) and Krinsky and Rotenberg (1989) find a negative relation. More recently, Karlis (2000) finds a positive relation in the United States and Yu and Tse (2003) in China and Neupane and Venkatesh (2004) in Thailand find a negative relation. Robinson et al. (2004) argue that their model can account for these empirical discrepancies. In fact, most studies find a positive or negative linear relation. Conceivably, due to erroneous or missing data, these results could refer to one side of the inverted U of the model of Robinson et al. (2004).
II.2. Long-Term IPO Underperformance and Share Retention
Similar to underpricing, there is a large amount of literature documenting the long-term underperformance of IPOs worldwide (Appendix B). One can refer to the extensive studies of Loughran and Ritter (1995), Ritter (1991), or Gompers and Lerner (2001) for further evidence. Long-term underperformance is also confirmed in the Netherlands: Van Frederikslust and Van der Geest (2000) for the period 1985-1998 and Doeswijk et al. (2005) for the period 1977-2001 find that Dutch IPOs performed significantly worse than their benchmark. The period of bad performance typically lasts from three to five years. Though empirical evidence is widely available, theoretical explanations are less than abundant. Most explanations can be placed into two groups: behavioral explanations and mis-measurement explanations.
have discovered long-run pricing anomalies that have been attributed to investor behavior biases. Miller (1977) proposes a divergence of opinions model. He argues that optimistic investors are the ones who set the first day after market price, as they are the only investors who subscribe to the IPO. Their optimistic perception about the IPO firm results in an inflated first day after market price. With time, however, the level of information about the firm increases and the divergence of opinion between optimistic and pessimistic investors decreases, resulting in a downward price adjustment. Firms with a low level of information availability, such as younger or smaller firms, will therefore suffer from larger downward adjustment. Closely related is Aggarwal and Rivoli (1990), Shiller (1990) and Loughran and Ritter (1995) “fads theory”. They argue that firms go public at the peak of industry-specific fads2resulting in an overly optimistic perception about the firm’s value and pushing the initial market price higher than the fair value. Another explanation is “window dressing”. Window dressing refers to the fact that sometimes IPO firms take various actions such as manipulating accounting numbers (Teoh, Welch, and Wong (1998)) or over or under-investing in R&D (Darrough and Rangan (2004)) to make their firm look better to investors before the IPO; investors will subsequently pay a higher price than the fair one. The general idea of these behavioral models is that investors give too much weight to recent results and trends resulting in an over optimistic perception about the value of the issuing firm. Eventually, this over-optimism will disappear through a downward price adjustment: underperformance.
Concerning the relation with share retention and IPO long-term performance, Khurshed et al. (2007) and Alvarez and Gonzales (2005) find that retention rate has a positive influence on an IPO’s long-term performance. Assuming that markets are efficient, the first day after market price is an outcome of the valuation of all pre-IPO factors; and an initial over or under valuation of one of these factors will disappear through a post IPO performance correction. The findings of Khurshed et al. (2007) and Alvarez and Gonzales (2005) therefore mean that initially investors undervalued the factor retention rate, leading to an upward post IPO performance correction. Table II presents an overview of the influence of the most studied pre-IPO factors on an IPO’s long-term performance.
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Table II: Overview of Pre-IPO Factors and Their Influence on Post IPO Performance
Pre-IPO factor Study Sign
Firm Age Khurshed et al. (2007) +
Ljungqvist and Wilhelm (2003) Ritter(1991)
Firm Size Khurshed et al. (2007) +
Brav and Gompers (1997) Ritter (1991)
Levis (1993)
Offer Price Seguin and Smoller (1997) +
Auditor Reputation Khurshed et al. (2007) +
Michaely and Shaw (1995)
Underwriter Reputation
Khurshed et al. (2007) +
Van Frederikslust and Van der Geest (2000) Carter et al (1998)
Brav and Gompers (2003)
Technology Industry Ritter (1991)
-Van Frederikslust and -Van der Geest (2000) Loughran and Ritter (2004)
Hot Market Period Doeswijk et al. (2005)
-Ritter (1991)
Earnings Growth Van Frederikslust and Van der Geest (2000) -Teoh, Welch, and Wong (1998)
Share Retention Khurshed et al.(2007) +
Alvarez and Gonzales (2005)
Concerning the methods for measuring abnormal returns, most studies use Fama and French’s (1998) cumulative abnormal returns or Barber and Lyon’s (1997) buy-and-hold abnormal returns. Though Barber and Lyon (1997) and Kothari and Warner (1996) find that these different methods yield considerably different and, in some cases conflicting, results, Brav, Geczy and Gompers (1999) and Bessler and Kurth (2005) find no differing results. Overall, no consensus has been reached and there is still an ongoing debate on what is the best benchmark and method for measuring abnormal returns.
III. Data and Methodology
III.1. The Sample
The database of Klaassen (2005) is extended to the year 2008. The original database consists of all IPOs from the 1st of January 1994 until the 30th of June 2005 on the Amsterdam Stock Exchange (AEX). Before 1994 good prospectus collection is difficult. For the IPOs after 2005, the prospectus service offered by the AEX is used3. Information concerning the offer price, cross-sectional characteristics, and share retention was found in the issuing prospectus. In several cases only a price range was specified. In those cases the Financiële Dagblad was used to check the offer price. The first day closing price, yearly stock total returns, and the price to book ratio were collected from DataStream. Missing stock prices and price to book ratios were found in AMADEUS. All currencies other than Euros were converted to Euros with the exchange rate mentioned in the prospectus4. Financial institutions were excluded due to their characteristic nature. The final sample for the underpricing study consists of 63 IPOs (Appendix C): one IPO was excluded because of non-availability of the prospectus. The final sample for the long-term performance study consists of 58 firms. Five firms were excluded because of missing post IPO stock returns data.
III.2. Sample Characteristics
Figure I shows that there is an unequal distribution of IPOs during the last 13 years. Half of the firms that went public during 1994-2008 went public in the period 1997-1999. Similar to Van Frederikslust and Van der Geest (2000) and Doeswijk et al. (2005), the period 1997-1999 is
3
www.euronext.com
4
defined as a “hot market period” in the Netherlands. The burst of the internet bubble is clearly visible; since 2000 IPOs are much less frequent. The worldwide economic slowdown and credit crisis are also evident in the Netherlands: in 2008 no IPO took place. Concerning the months of issue, most of the offerings occurred in the period March to July with, a peak in June.
Figure I: Annual Number of IPOs in the Netherlands between 1994-2008
0 2 4 6 8 10 12 14 16 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Table III shows that most of the companies going public were active in the technology industry. This result is consistent with the fact the technology industry is one of the largest sectors in the Netherlands. Telecom, pharmaceutical and service firms also represent a large amount of the IPO firms.
Table III: Distribution of IPO Firms over the Different Industries
Industry Firms
Technology 22
Telecom 7
Pharmaceuticals & Biotechnology 5
Services 5
Electronics 4
Metal 4
Wholesale trade and retail 4
Media & Entertainment 3
Paper and packaging 3
Automobiles & Parts 1
Chemicals 1
Construction and building materials 1
Diversified Industries 1
Food and beverages 1
Oil and Gas 1
Table IV shows that the ABN AMRO, the largest bank in the Netherlands, is clearly the lead underwriter with more than twice as much IPOs than number two, MeesPierson and Rabo Securities.
Table IV: Lead Underwriters
Lead Underwriter Firms
ABN AMRO 18
MeesPierson 8
Rabo Securities 8
Goldman Sachs 6
ING Barings 4
Credit Suisse First Boston 4
Morgan Stanley 3
Nationale Investeringsbank 2 Generale Bank Nederland N.V. 2
Kempen & Co 1
Ten Cate & Cie 1
Van der Hoop Effektenbank N.V. 1
KBC Securties 1 NIB Securities N.V. 1 Merryl Linch 1 Cowen International 1 Fortis 1 Total 63
Table V shows that the big 4 (Pricewaterhouse Coopers, Ernst &Young, KPMG and Deloitte & Touche) are also clear leaders in the auditor market.
Table V: Lead Auditors
Auditor Firms
Deloitte & Touche 14
KPMG 16
(Moret) Ernst &Young 15
Pricewaterhouse Coopers 6
Arthur Anderson 3
Coopers & Lybrand 2
BDO CampsOber 3
Van Daal & Partners 1
Binder Hymlan 1
De Keijzer, Nipius & Co. 1 Jonker Joell Registeraccountants 1
Table VI presents the firm specific descriptive statistics.
Table VI: Descriptive Statistics of IPO Firms
Mean Median Max Min Std.
Dev. Jarque-Bera Underpricing 16.53% 7.03% 97.73% -14.17% 26.0% 72.08 Retention Rate 74.25% 73.91% 90.47% 60.85% 8.0% 1.10 Offer Price 12.84 12.26 28 1.91 5.63 1.50 Price to Book 7.42 4.84 67.83 0 9.66 1521.40 Age 21.26 10 115 0.5 28.47 69.80 Gross Proceeds (mln) 167.03 49.01 3119.80 3.01 430.7 3434.00 Total Assets (mln) 524.04 39.58 11595.9 0.65 1722.0 2381.70
Earnings IPO Year (mln) 46.09 4.22 1800 -67.14 231 151.07
Earnings 2 yrs before IPO 12.08 1.36 1610 -1210 256 185.20
Employees 4735.6 239.10 78500 18 15266 761.10
III.3. Methodology
To study the influence of share retention on underpricing and long-term performance OLS regressions are performed. For the short-term, underpricing is the dependent variable while for the long-term, the cumulative abnormal return after three years is the dependent variable.
III.3.1 Dependent Variable Underpricing
Underpricing is estimated as the percentage difference between the price at which the IPO shares were sold to investors, the offer price, and the price at which the shares subsequently trade in the market (Ljungqvist 2004). It is computed as follows:
0 0 1 p P P -P U
where P0the offer price and P1 represents the first day closing price.
Due to non normality of the underpricing variable (Table VI: Jarque Bera higher than 5.99), the Wilcoxon–Mann–Whitney test will be used to test for differences between sub-groups.
III.3.2. Dependent Variable Long-term Performance: BHARs or CARs?
As mentioned previously, the two most important aspects in determining the long-run performance of an IPO are to select an appropriate benchmark and methodology to calculate abnormal returns. Total stock returns are calculated. The Amsterdam all Shares Index5 is therefore chosen as the benchmark (Van Frederikslust and Van der Geest (2000); Van der Groot (1997)). With respect to the methodology for calculating abnormal returns, most studies use the traditional method of cumulative abnormal returns (CAR) and Barber and Lyon’s (1997) buy-and-hold abnormal returns (BHAR). Interestingly, Brav, Geczy and Gompers (1999) and Bessler and Kurth (2005) find no differing results for BHARs or CARs. BHAR and CARs are, in fact, closely related and the method used to calculate daily returns is of crucial importance to differentiate them. Barber and Lyon (1997) use simple returns to calculate abnormal returns ARs and compound them:
1 ) r 1 ( BHAR i,t s 1 t s , i
(1)One could also use continuously compounded returns to calculate ARs. Then the cumulative abnormal returns (CARs) take the “interest over interest” into account and BHARs and CARs are equal. The CAR is derived as follows:
The daily stock and Amsterdam All Shares Index return are calculated using continuously compounded returns: 1 -t i, t , i P P ln it R (2)
The abnormal returns for day t are calculated as follows:
ARit Rit t (3) with
t
representing the daily total return of the benchmark: the Amsterdam all Shares Index. The cumulative abnormal returns are then calculated as the sum of the abnormal returns:
it s 1 t s , i AR CAR
(4) 5To ignore the effect of underpricing, the first day of trading is excluded. For comparison reasons, the CAR after three years is computed (Ritter (1991); Gomper and Leener (2001); Khurshed et al. (2007)).
Due to normality of the CARs (Table X), the conventional t-test is used to test for differences between sub-groups:
n / s X CAR t s
where CARs is the average of CARi,s, s is the standard deviation of the sample, n is the sample
size and X the hypothesized value.
B.3.3. Independent Variables Retention Rate
Similar to Keasey and McGuiness (1992) and Robinson et al. (2004), the retention rate is calculated as the ratio between the difference of the total shares outstanding and the total shares sold, and the total shares outstanding:
g Outstandin Shares Total Sold Shares Total -g Outstandin Shares Total Retention Control variables
Table VII: Summary of the Variables and Their Expected Signs
Variable Definition Underpricing Long-term
performance Retention Rate The ratio between the difference of the
total shares outstanding and the total shares sold, and the total shares outstanding
High Retention Dummy
Firms retaining more than 80% of their shares are coded 1 others are coded 0
+
Low Retention Dummy
Firms retaining less than 70% of their shares are coded 1 others are coded 0
-Underpricing The underpricing level
-Firm Age The age of the firm at the initial public offering
- +
Offer Price The initial offer price - +
Auditor Dummy
The Big Four are coded 1 others are coded 0
- +
Technology Dummy
Firms active in technology sector are coded 1 others are coded 0
+
-Hot Market Period
Firms that went public in 1997-1999 are coded 1 others are coded 0
+
-Earnings Growth
Change in ranking based on growth earnings from 1 year before to IPO year
-
-Underwriter Dummy
The lead underwriter ABN AMRO is coded 1 others are coded 0
- +
Price to Book The ratio of the current stock price multiplied by the number of outstanding shares divided by the book value of the outstanding shares
+ +
III.3.4. Assumptions of Ordinary Least Square Regression Analysis
Before running the regression analysis, the variables were examined for possible problems related to their distribution and the assumptions of ordinary least square regression analysis (Tabachnik & Fidell (1996)). Due to the high correlation coefficient between retention rate and the high retention dummy (0.77, Appendix D) and to avoid problems of multicollinearity, two regressions were performed for the underpricing analysis: model A with the retention rate variable and model B with the high retention dummy and without with the retention rate variable. Furthermore residuals were normally distributed and White’s test for homoscedasticity does not reject homoscedasticity (Appendix D).
IV. Results
IV.1. Descriptive Statistics
IV.1.1. Underpricing Characteristics
Several results can be derived from Table VIII. First, the average level of underpricing for the whole period is 16.53%; the result is significant. This result is similar to Van Frederikslust and Van der Geest (2000) and Doeswijk et al. (2005) who find an average level of underpricing of 16% and 17.6% for the period 1985-1998 and 1977-2001 in the Netherlands. Second, during the hot market period of 1997-1999, the underpricing was significantly higher than during the cold market period 1994-1996 and 2000-2008, 20.12% versus 12.31%. Third, the average level of retention during the period is 74.25%. This result is higher than Yu & Tse (2003) in China, Khurshed et al. (2007) in the UK, and Alvarez and Gonzales (2005) in Spain who find that firms retain on average 64.9%, 52% and 65% of their equity, and similar to the results of Goergen (1998) in Germany who finds that firms retain on average 73.6% of their shares. There is no significant difference in retention between hot market and cold market periods.
Table VIII: Underpricing and Retention Rates for Hot and Cold Markets
Period Underpricing Retention rate
Hot market (1997-1999) 20.12%*** 74.92%
Cold market (1994-1996;2000-2005) 12.31% 74.23%
Median 7.03% 73.91%
Mean 16.53%** 74.25%
Interestingly, Table IX shows that the level of underpricing decreases when the retention increases from 60%-70% to 70%-80% and increases when the retention rate increases beyond 80%. The increase in underpricing beyond 80% is significant whereas the decrease in underpricing from 60%-70% to 70%-80% is not significant. A nonlinear relation between retention rate and underpricing cannot be rejected. One should however notice that the sample size is quite small and these results should be interpreted carefully.
Table IX: Retention Rates and Underpricing Levels
Retention Rate 60%-70% 70%-80% 80%-90%
Average Underpricing 13.54% 8.25% 33.00%***
Median Underpricing 8.21% 4.37% 15.22%
Total Observations 19 27 17
A Wilcoxon–Mann–Whitney test was performed with the null hypothesis that the average underpricing is the same between the sub-groups. ***,**,*, significant at respectively the 1%, 5% and 10% level.
IV.1.2. Long-term Performance Characteristics
Table X and Figure II present the abnormal long-term performance of Dutch IPOs between 1994 and 2008. There is evidence of significant underperformance of the IPOs in the first three years post IPO. The IPO portfolio achieved an average CAR of 9.52% after one year, -17.04% after two years and -20.70% after three years. The results are similar to Van Frederikslust and Van der Geest (2000) and Doeswijk et al. (2005). They find that Dutch IPO firms underperform their benchmark with respectively 16 % and 10% the first three years after IPO.
Table X: Descriptive Statistics Cumulative Abnormal Returns
Mean Median Max Min Std. Dev. Skewness Kurtosis N
CAR1 -9.52%** ªª -6.65% 123.65% -91.77% 46.39% 0.31 2.89 56
CAR2 -17.04%**ªª -17.87% 123.65% -190.46% 69.62% -0.10 2.35 56
CAR3 -20.70%**ª -19.38% 145.08% -179.54% 80.47% -0.15 2.50 46
A t-test was performed with the null hypothesis that the average average of CAR, CAR2 and CAR3 is zero. ***,**,*, significant at respectively the 1%, 5% and 10% level.
Figure II: Cumulative Abnormal Returns for the First 3 Years -25.00% -20.00% -15.00% -10.00% -5.00% 0.00% 1 2 3 Years C A R s
Table XI shows that IPO firms which went public during the hot market period 1997-1999 underperform their benchmark significantly more in the first three years than firms which went public in the cold market period.
Table XI: Cumulative Abnormal Returns in Hot and Cold Markets
Year 1 N 2 N 3 N
Hot market (1997-1999) -15.33%** 30 -22.16%* 30 -27.60%** 29 Cold market (1994-1996;2000-2005) -2.82% 26 -11.12% 26 -7.52%** 17
Mean -9.52% 56 -17.04% 56 -20.17% 46
A t-test was performed with the null hypothesis that the CARs are the same for the hot and cold market period. ***,**,*, significant at respectively the 1%, 5% and 10% level
Table XII shows that firms retaining a lower percentage of shares at IPO perform significantly worse in the first three years post IPO than those retaining a higher percentage of shares.
Table XII: Retention Rates and Cumulative Abnormal Returns
Retention Rate CAR1 N CAR2 N CAR3 N
60-70% -13.42%* 18 -25.01%** 18 -34.01%** 15
70-80% -7.28% 24 -10.50% 24 -15.57% 20
80-90% -8.37% 14 -17.99% 14 -9.68% 11
Mean -9.52% 56 -17.04% 56 -20.17% 46
IV.2. Regression Results IV.2.1. Underpricing
Table XIII presents the final regression model. Only the variables which were significant at 10% and which had the appropriate sign are included in the final model. The unrestricted regression results can be found in Appendix E.
Two regressions have been performed, model B with the high retention dummy and model A without. In model A retention rate is not significant. In model B, the added dummy variable for high levels of retention is positive and significant, meaning that retention rate has a significant positive influence on underpricing when retention is above 80%. This result is in part similar to Keasey and McGuiness (1992) and Karlis (2000) who find a linear positive relation between all levels of retention rate and underpricing. The U-shaped relation which Robinson et al. (2004) argue for could not be confirmed.
Table XIII: Regression Results Underpricing (Dependent Variable: Underpricing)
Model A Model B
Regressor Coefficient P-value Coefficient P-value
Constant -0.145 0.604 0.208 ** 0.011
(0.279) (0.079)
Retention Rate 0.542 0.132
(0.354)
High Retention Dummy 0.152 ** 0.021
(0.060)
Offer Price -0.012 ** 0.025 -0.010 * 0.053
(0.005) (0.005)
Hot Market Dummy 0.140 ** 0.027 0.111 * 0.077
(0.062) (0.606) Underwriter Dummy -0.127 * 0.057 -0.116 * 0.067 (0.065) (0.062) Price to Book 0.006 * 0.057 0.005 * 0.069 (0.003) (0.003) Firm Size 0.000 0.332 0.000 0.305 (0.000) (0.000) DIAGNOSTICS R² 0.321 0.359 Adjusted R² 0.262 0.303 F-statistic 5.411 6.393 Prob (F-statistic) 0.001 0.001 Observations 63 63
Standard error in parenthesis and ***,**,*, significant at respectively the 1%, 5% and 10% level.
IV.2.2. Long-term Performance
Table XIV presents the final regression model. Only the variables which were significant at 10% and which had the appropriate sign are included in the final model. The unrestricted regression results can be found in Appendix F.
In model B and C underpricing is negative and significant, which means that the higher the underpricing, the lower the post IPO performance. This result is consistent with the behavioral explanations of long-term underperformance (Miller (1977); Aggarwal and Rivoli (1990), Shiller (1990) and Loughran and Ritter (1995)).
In the three models retention rate is not significant. In model C, however, the added dummy variable for low levels of retention is significant, which indicates that retention rate has a significant negative influence on the post IPO performance when retention is below 70%. Investors, therefore, initially overvalue retention rates below 70%, resulting in a downward post IPO performance correction only for levels of retention below 70%. This result is different than Khurshed et al. (2007) in the U.K and Alvarez and Gonzales (2005) in Spain. They find that investors undervalue all level of retentions.
Table XIV: Regression Results Long-term Performance (Dependent Variable: CAR3)
Model A Model B Model C
Regressor Coefficient P-value Coefficient P-value Coefficient P-value
Constant -2.468 * 0.054 -2.437 * 0.044 -2.090 * 0.063 (1.244) (1.167) (1.088) Retention Rate 1.236 0.409 1.506 0.287 1.072 0.415 (1.481) (1.393) (1.300) Firm Age 0.010 ** 0.023 0.010 ** 0.019 0.010 ** 0.013 (0.004) (0.004) (0.004) Auditor 1.312 ** 0.016 1.186 ** 0.020 1.353 *** 0.005 (0.518) (0.489) (0.456)
Hot Market Dummy -0.289 0.248 -0.264 0.261 -0.247 0.257
(0.247) (0.231) (0.215) Price to Book 0.021 0.345 0.033 0.118 0.029 0.138 (0.022) (0.021) (0.019) Firm Size 0.000 0.323 0.001 0.314 0.000 0.531 (0.000) (0.001) (0.001) Underpricing -0.896 ** 0.016 -0.852 ** 0.014 (0.330)
Low Retention Dummy -0.610 ** 0.050
DIAGNOSTICS R² 0.259 0.365 0.400 Adjusted R² 0.145 0.248 0.315 F-statistic 2.274 3.117 4.100 Prob (F-statistic) 0.056 0.011 0.001 Observations 46 46 46
V. Summary Discussion and Conclusions
This thesis analyzes the influence of share retention on both the short- and long-term performance of 64 Dutch IPOs between 1994-2005. First, the short- and long-term performance of the IPOs are computed. The average underpricing level is 16.53%. After three years of trading, IPO firms underperformed non IPO firms by -20.70%.These results are in line with Van Frederikslust and Van der Geest (2000) and Doeswijk et al. (2005).
In the short term, retention rates above 80% have a significant positive influence on underpricing. This result is in part similar to Keasey and McGuiness (1992) and Karlis (2000) who find a linear positive relation between all levels of retention rate and underpricing.
In the long-term, retention rates below 70% have a significant negative influence on the post IPO performance. Dutch investors, thus, initially overvalue retention rates below 70%, resulting in a downward post IPO performance correction on the long-term. This result is different from Khurshed et al. (2007) in the U.K and Alvarez and Gonzales (2005) in Spain. They find that investors initially undervalue retention rates. Future research may want to investigate why Dutch investors differ from English and Spanish investors in their perception of share retention.
Some other interesting results were found. Underpricing has a negative influence on the post IPO performance. Behavioral explanations (Ritter (1991); Loughran and Ritter (1995)) which argue that initially investors are over optimistic about the value of the issuing firm leading to an inflated first day market price and eventually a downward price adjustment are confirmed. Furthermore, consistent with Ritter (1991) and Doeswijk et al. (2005), firms which went public during the 1997-1999 hot market period experienced a higher underpricing than firms which went public in a cold market. Also, similar to Titman and Trueman (1986), Balvers et al (1998) and Booth and Smith (1986), firms audited by high quality auditors experienced a lower level of underpricing. Moreover at IPO, investors undervalue the quality of the auditor resulting in positive post IPO performance adjustment.
performance could help investors identify IPO firms which may experience a larger underperformance.
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VI. Appendices
Appendix A.: International Evidence of Underpricing (Updated Version of Loughran, Ritter and Rydqvist 2008)
Appendix B.: International Evidence of IPO Long-term Underperformance (Updated Version of L'Her 2003)
Appendix C.: IPOs in the Sample
Appendix D.: Correlation Matrix and Heteroscedasticity Test
Appendix A.: International Evidence of Underpricing (Updated Version of Loughran, Ritter and Rydqvist 2006)
Country Author(s) Sample Time
Period
First Day Return
Argentina Eijgenhuijsen and Van der Valk (1997)
20 1991-1994 4.40%
Australia Lee, Taylor & Walter (1996);Ritter (1991)
1103 1976-1995 19.80%
Austria Aussenegg (2002) 96 1971-2002 6.50%
Belgium Rogiers, Manigart and Ooghe (1993); Manigart DuMortier (2006)
114 1984-2004 13.50%
Brazil Aggarwal, Leal and Hernandez (1993)
62 1979-1990 78.5%
Canada Jog & Riding (1987); Lazrak and Rakita (2006)
635 1971-2002 7.10%
Chile Aggarwal, Leal & Hernandez (1993) ;Celis and Maturana (1998)
65 1982-1997 8.40%
China Yu & Tse (2003); Chen, Choi, and Jiang (2008)
343 1995-2005 123.59%
Finland Keloharju (1993); Westerholm (2003)
99 1984-1997 10.1%
France Husson and Jacquillat (1990); Leleux & Muzyka (2000)
571 1983-2000 11.6%
Germany Ljungqvist (1997); Rocholl (2007) 545 1978-2001 31.1% India Marisetty and Subrahmanyam
(2008)
2,713 1990-2004 95.4%
Italy Arosio, Giudici & Paleari (2001) 181 1985-2001 21.7%
Japan Fukuda (2001); Dawson & Hiraki (1985) Hebner & Hiraki (1993)
1689 1970-2001 28.4%
Korea Dhatt, Kim & Lim (1993); Ihm; Choi & Heo (1996)
1490 1980-2008 55.2%
Malaysia Isa; Isa & Yong (2003); Yong (1999)
350 1980-2006 69.6%
Mexico Aggarwal, Leal & Hernandez (1993); Eijgenhuijsen & Van der Valk (1997)
88 1987-1994 15.9%
Netherlands Van Frederikslust & Van der Geest (2000); Doeswijk et al. (2005)
181 1982-2006 10.2%
Thailand Neupane & Venkatesh (2004) 74 2000-2004 33.82%
United States
Ibbotson, Sindelar & Ritter (1994); Ritter (1991)
Appendix B.: International Evidence of IPO Long-term Underperformance (Updated Version of L'Her 2003)
Country Authors(s) Sample Time
Period
Performance after 3 years
Australia Lee, Taylor and Walter (1996) 266 1976-1989 -46.5%
Austria Aussenegg (1997) 57 1965-1993 -27.3%
Brazil Aggarwal, Leal & Hernandez (1993)
62 1980-1990 -47.0%
Canada Kooli and Suret (2003) 445 1991-1989 -19.86%
Chile Aggarwal, Leal and Hernandez (1993)
28 1982-1990 -23.7%
China Xiaoqiong Can, Liu and Mase (2008); Chan, Wang and Wei (2004)
335 1997-2001 -30%
Finland Keloharsju (1993) 79 1984-1989 -21.1%
Germany Bessler and Thies (2006); Ljungqvist (1997)
218 1977-1995 -10%
Japan Cai and Wei (1997) 172 1971-1990 -27.0%
Korea Kim, Krinsky and Lee (1993) 99 1985-1988 +2.0%
Netherlands Doewijk et al. (2005), Van Frederikslust and Van der Geest (2000)
183 1977-2001 -38.4%
New Zealand Firth (1997) 143 1979-1987 -10.00%
Sweden Loughran, Ritter and Rydqvist (1994)
162 1980-1990 +1.2%
United Kingdom
Levis (1993); Khurshed et al. (2007) 712 1980-1995 -10.1%
United States Loughran, and Ritter (1995); Brav, Geczy and Gompers (2000)
Appendix C.: IPOs in the Sample Company IPO Year Retention Rate Underpricing Offer price CAR after 3 years KONINKLIJKE KPN 1994 70.61% 0.90% 40.00% VENDEX INTERNATIONAL 1995 61.32% 5.90% 7.00% ASM LITHOGRAPHY HLDG. 1995 63.33% 33.15% CMG PLC 1995 72.12% 17.22% 99.50% BE SEMICONDUCTOR 1995 75.54% 16.99% 97.24% BAAN 1995 84.88% 53.10% 8.58% ENDEMOL ENTERTAINMENT 1996 67.00% 17.68% -67.46%
LEER, KONINKLIJK VAN 1996 74.25% 4.64% 28.32%
TOOLEX ALPHA N.V. 1996 83.11% 21.63% -71.65%
BETER BED HOLDING 1996 83.96% 9.28% 31.13%
BRUNEL 1997 62.47% 8.97% VEDIOR 1997 69.45% 26.70% 73.52% HCI 1997 69.90% -7.59% -28.80% UCC GROEP 1997 70.00% 7.99% -105.83% CSS 1997 70.00% 23.50% 140.04% NYLOPLAST 1997 74.86% 0.00% -152.70% DOCDATA 1997 75.00% 0.16% -83.09% PROLION HOLDING 1997 75.94% 2.50% ICT AUTOMATISERING 1997 77.59% 4.98% 96.08% NUTRECO 1997 78.83% 19.97% -28.62%
CHICAGO BRIDGE & IRON 1997 83.22% -3.00% 4.19%
LANDIS GROUP 1998 60.85% 6.18% -27.42% HITT 1998 64.52% 27.04% 20.00% AXA STENMAN 1998 66.67% 3.45% -168.12% MAGNUS HOLDING 1998 67.04% 8.21% -114.63% NEDGRAPICS HOLDING 1998 71.57% 20.63% 67.10% COPACO 1998 75.38% 7.03% 111.74% ACCELL GROUP 1998 78.75% 0.00% -23.25% CARDIO CONTROL 1998 79.67% 90.21% UNIT 4 AGRESSO 1998 80.03% 26.25% -76.54%
RING ROSA PRODUCTS NV 1998 80.36% 92.76% -179.54%
PETROPLUS INT. 1998 80.41% 7.70% -30.78% C/TAC 1998 81.00% 90.40% 58.82% INNOCONCEPTS 1998 83.50% 42.76% 40.97% AIRSPRAY 1998 87.81% 97.73% -70.75% AFC AJAX 1998 89.00% 21.17% DPA HOLDING 1999 61.88% -0.78%
VERSATEL TELECOM INT. 1999 65.62% 20.00% 23.52%
MCGREGOR FASHION GRP 1999 66.33% -7.11% -91.74%
PHARMING GROUP 1999 66.56% 6.80% -17.10%
SEAGULL HOLDING 1999 71.31% 14.67% -156.44%
BLUE FOX ENTERPRISES 1999 77.04% 12.50% 85.63% LIBERTEL 1999 77.50% 0.00% 46.85% EXACT HOLDING 1999 85.30% 0.00% KPN QWEST 1999 89.00% 6.67% -7.67% SNT 2000 66.67% 95.00% CRUCELL 2000 70.23% -14.17% -86.52% AINO 2000 73.33% 4.10% -28.12%
NEW SKIES SATELLITES 2000 77.87% -6.31% -44.07%
Appendix D.: Correlation Matrix and Heteroscedasticity Test Correlation Matrix Retention Rate Firm Age Firm Size Price to Book Offer Price Earnings Growth Hot market Dummy Auditor Dummy Underwriter Dummy Technology Dummy Low Retention Dummy High Retention Dummy Underpricing Retention Rate 1.00 0.32 -0.07 -0.13 -0.13 -0.18 0.05 0.00 0.10 0.09 -0.10 0.77 0.05 Firm Age 1.00 -0.07 -0.09 -0.14 0.02 0.07 -0.17 0.09 0.12 -0.04 0.07 0.02 Firm Size 1.00 -0.14 0.11 0.06 -0.19 0.09 0.10 -0.19 -0.11 -0.10 -0.06 Price to Book 1.00 -0.04 -0.10 0.04 -0.25 -0.11 0.11 -0.02 0.03 0.10 Offer Price 1.00 0.07 0.03 0.20 -0.02 -0.26 0.00 -0.18 -0.12 Earnings Growth 1.00 -0.05 0.10 -0.21 0.01 0.19 0.01 0.12
Hot market Dummy 1.00 -0.10 -0.16 0.16 0.12 0.25 0.16
Auditor Dummy 1.00 -0.11 0.05 0.18 -0.11 -0.02
Underwriter Dummy 1.00 0.05 0.02 -0.11 -0.04
Technology Dummy 1.00 0.04 0.13 0.08
Low Retention Dummy 1.00 -0.15 0.08
High Retention Dummy 1.00 0.39
Underpricing 1.00
Heteroscedasticity Test Underpricing Regression Heteroscedasticity Test: White
F-statistic 0.665 Prob. F(16,29) 0.803
Heteroscedasticity Test Long-term Performance Regression Heteroscedasticity Test: White
Appendix E: Unrestricted Regression Results Underpricing (Dependent Variable: Underpricing)
Unrestricted Model
Regressor Coefficient P-value
Constant 0.364 0.449 (0.48) Retention Rate -0.28 0.634 -0.585 Firm Age 0.000 0.986 (0.00) Firm Size 0.002 0.956 (0.04) Price to Book 0.006 * 0.097 (0.00) Offer Price -0.011 * 0.092 (0.01) Earnings Growth -0.001 0.721 (0.00)
Hot market Dummy 0.121 * 0.08
(0.07)
High Retention Dummy 0.194 * 0.08 (0.11) Auditor Dummy 0.042 0.682 (0.10) Underwriter Dummy -0.12 0.118 (0.08) Technology Dummy -0.029 0.672 (0.07) DIAGNOSTICS R² 0.386 Adjusted R² 0.239 F-statistic 2.629 Prob (F-statistic) 0.008 Observations 63
Appendix F.: Unrestricted Regression Results Long-term Performance (Dependent Variable: CAR3)
Unrestricted Model
Regressor Coefficient P-value
Constant -1.656 0.181 (1.217) Retention Rate 0.737 0.596 (1.377) Firm Age 0.011 ** 0.016 (0.004) Firm Size 0.000 0.435 (0.000) Price to Book 0.033 0.129 (0.020) Offer Price 0.001 0.995 (0.020) Earnings Growth -0.006 0.347 (0.007)
Hot market Dummy -0.312 * 0.09
(0.243)
Low Retention Dummy -0.525 ** 0.038
(0.243) Auditor Dummy 1.218 ** 0.018 (0.490) Underwriter Dummy -0.278 0.266 (0.247) Technology Dummy -0.008 0.973 (0.246) Underpricing -0.824 ** 0.027 (0.356) DIAGNOSTICS R² 0.497 Adjusted R² 0.314 F-statistic 2.720 Prob (F-statistic) 0.011 Observations 45
