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- 17. Private Equity, IPO, Public Equity
- The Long‐Run Performance of initial Public Offerings
- I. Data and Methodology
- I. Data and Methodology
- Long‐Run Performance following Private Placements of Equity
- Long run performance of private equity ipo
- II. Aftermarket Performance
- The long-run performance of PE and VC backed IPOs - Evidence from the Nordic and German markets
Numerous studies have documented two anomalies in the pricing of initial public offerings (IPOs) of common stock: (1) the (short‐run) underpricing phenomenon, and (2) the “hot issue” market phenomenon. Measured from the offering price to the market price at the end of the first day of trading, IPOs produce an average initial return that has been estimated at 16.4%.1 Furthermore, the extent of this underpricing is highly cyclical, with some periods, lasting many months at a time, in which the average initial return is much higher.2 In this paper, I document a third anomaly: in the long‐run, initial public offerings appear to be overpriced.
Using a sample of 1,526 IPOs that went public in the U.S. in the 1975–84 period, I find that in the 3 years after going public these firms significantly underperformed a set of comparable firms matched by size and industry.
There are several reasons why the long‐run performance of initial public offerings is of interest. First, from an investor's viewpoint, the existence of price patterns may present opportunities for active trading strategies to produce superior returns.
Second, a finding of nonzero aftermarket performance calls into question the informational efficiency of the IPO market. It provides evidence concerning Shiller's (1990) hypothesis that equity markets in general and the IPO market in particular are subject to fads that affect market prices. Third, the volume of IPOs displays large variations over time.
If the high volume periods are associated with poor long‐run performance, this would indicate that issuers are successfully timing new issues to take advantage of “windows of opportunity.” Fourth, the cost of external equity capital for companies going public depends not only upon the transaction costs incurred in going public but also upon the returns that investors receive in the aftermarket.
To the degree that low returns are earned in the aftermarket, the cost of external equity capital is lowered for these firms.
To summarize the empirical findings of this paper, the average holding period return for a sample of 1,526 IPOs of common stock in 1975–84 is 34.47% in the 3 years after going public, where this holding period return is measured from the closing market price on the first day of public trading to the market price on the 3 year anniversary.
However, a control sample of 1,526 listed stocks, matched by industry and market value, produces an average total return of 61.86% over this same 3 year holding period. In other words, every dollar invested in a portfolio of IPOs purchased at the closing market price on the first day of trading results in a terminal wealth of $1.3447, while every dollar in the matching firms results in $1.6186, a ratio of only 0.831.
In the long run, IPOs underperformed.
Possible explanations for this underperformance include (1) risk mismeasurement, (2) bad luck, or (3) fads and overoptimism.
To ascertain whether risk mismeasurement could account for the poor long‐run performance, alternative benchmark portfolios are used. To distinguish between the bad luck explanation and the fads and over optimism explanation, various cross‐sectional and time‐series patterns are documented. The pattern that emerges is that the underperformance is concentrated among relatively young growth companies, especially those going public in the high‐volume years of the 1980s.
While this pattern does not rule out bad luck being the cause of the underperformance, it is consistent with a scenario of firms going public when investors are irrationally over optimistic about the future potential of certain industries which, following Shiller (1990), I will refer to as the “fads” explanation.3 Further support for this interpretation is contained in Lee, Shleifer, and Thaler (1991) who find that the annual number of operating companies going public in the 1966–85 period is strongly negatively related to the discount on closed‐end mutual funds, which they interpret as a measure of individual investor sentiment.
At least three published academic studies, plus a series of articles in Forbes magazine, have examined the long‐run performance of IPOs.Stoll and Curley (1970), focusing on 205 small offers, found that, “in the short run, the stocks in the sample showed remarkable price appreciation.… In the long run, investors in small firms did not fare so well.…” (pp. 314–315.)
Ibbotson (1975), using one offering per month for the 10–year period 1960–69, computed excess returns on IPOs with an offer price of at least $3.00 per share.
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He concludes that the “results generally confirm that there are no departures from market efficiency in the aftermarket.” (p. 265.) However, he does find evidence that there is “generally positive performance the first year, negative performance the next 3 years, and generally positive performance the last [fifth] year,” (p. 252), although the standard errors of his estimates are high enough to make it difficult to reject market efficiency.
17. Private Equity, IPO, Public Equity
In his Table 12 he reports initial public offerings underperforming by an average of approximately 1% per month in the second through fourth years of public trading, with positive excess returns in the first and fifth years.4
Buser and Chan (1987) evaluate the two‐year performance of over 1,078 NASDAQ/National Market System (NMS)‐eligible initial public offerings in 1981–1985.5 Their sample has a positive average initial return of 6.2% and a mean 2–year market‐adjusted return of 11.2% (exclusive of the initial return) where they use the NASDAQ Composite Index for their market adjustment.
The cover story of the December 2, 1985 Forbes magazine, entitled “Why New Issues Are Lousy Investments,” reports the results of a study that finds, for the period from January 1975 through June 1985, that initial public offerings have underperformed the market in the long run. Stern and Bornstein (1985) find as reported on p. 152 that “from its date of going public to last month, the average new issue was down 22% relative to the broad Standard & Poor's 500 stock index.” Forbes analyzed 1,922 issues with an offering price of $1.00 or more.
Unlike academic research, which typically uses event time, Forbes used calendar time, so their excess returns are computed over a period of anywhere from 10 years to a few months.
In summary, Stoll and Curley (1970), Ibbotson (1975), and Stern and Bornstein (1985) present evidence which suggests that at some point after going public the abnormal returns on initial public offerings may be negative.
Ibbotson conducts the most satisfactory formal statistical tests, but his small sample size (120 issues) results in such large standard errors that he is unable to reject the hypothesis of market efficiency after a stock goes public. Only the Buser and Chan (1987) study does not find evidence of negative aftermarket performance after the initial return period.
The structure of this paper is as follows. Section I describes the data and methodology. Section II presents evidence regarding the aftermarket performance.
The Long‐Run Performance of initial Public Offerings
Section III presents cross‐sectional and time‐series evidence on the aftermarket performance. Section IV concludes the paper with a summary and interpretation of the findings.
I. Data and Methodology
The sample is comprised of 1,526 initial public offerings in 1975–1984 meeting the following criteria: (1) an offer price of $1.00 per share or more, (2) gross proceeds,6 measured in terms of 1984 purchasing power, of $1,000,000 or more, (3) the offering involved common stock only (unit offers are excluded), (4) the company is listed on the CRSP daily Amex‐NYSE or NASDAQ tapes within 6 months of the offer date,7 and (5) an investment banker took the company public.
These firms represent 85.1% of the aggregate gross proceeds of all firms going public in 1975–84.
Table I presents the distribution of the sample by year, both in terms of the number of offers and the gross proceeds. Inspection of Table I shows that the number and value of IPOs were not evenly distributed over the 1975–84 sample period.
Only 143 of the 1,526 sample offers occurred during the first half of the period. Fifty‐seven percent ($12,060.4 million of the $21,066.9 million total) of the aggregate gross proceeds in the sample was raised in 1983 alone.
I. Data and Methodology
To evaluate the long‐run performance of initial public offerings, two measures are used: (1) cumulative average adjusted returns (CAR) calculated with monthly portfolio rebalancing, where the adjusted returns are computed using several different benchmarks, and (2) 3–year buy and hold returns for both the IPOs and a set of matching firms. The matching firms are represented by American and New York stock exchange‐listed securities that are to some extent matched by industry and market capitalization with each IPO.8
Distribution of Initial Public Offerings by Year, 1975–84
|The number of total offers is based upon Going Public: The IPO Reporter's listings, after excluding closed‐end mutual funds and real estate investment trusts.
Gross proceeds calculations are based upon the amount sold in the United States, including the proceeds from overallotment options, if exercised. No price level adjustments have been made in this table.
|Total of 2,476 offers||1,526 offers in sample||Total included|
|Year||No. of IPOs||Aggregate gross proceeds, $ millions||No. of IPOs||Aggregate gross proceeds, $ millions||No.
of IPOs %
|Aggregate gross proceeds %|
Returns are calculated for two intervals: the initial return period (normally 1 day), defined as the offering date to the first closing price listed on the CRSP daily return tapes (both NASDAQ and Amex‐NYSE), and the aftermarket period, defined as the 3 years after the IPO exclusive of the initial return period.
The initial return period is defined to be month 0, and the aftermarket period includes the following 36 months where months are defined as successive 21–trading‐day periods relative to the IPO date.
Thus, month 1 consists of event days 2–22, month 2 consists of event days 23–43, etc.
Long‐Run Performance following Private Placements of Equity
For IPOs in which the initial return period is greater than 1 day, the month 1 period is truncated accordingly, e.g., if the initial return period is 6 days, month 1 consists of event days 7–22. For IPOs that are delisted before their 3–year anniversary, the aftermarket period is truncated, and the 3–year buy and hold return ends with CRSP's last listing. Firms which moved from NASDAQ to the American or New York stock exchanges during the 3 years after their offering date are not removed unless they are subsequently delisted from the Amex‐NYSE tape.
The CRSP NASDAQ daily returns file and the CRSP Amex‐NYSE daily returns file are the source of the returns data.
Monthly benchmark‐adjusted returns are calculated as the monthly raw return on a stock minus the monthly benchmark return for the corresponding 21–trading‐day period. The benchmarks used are (1) the CRSP value‐weighted NASDAQ index, (2) the CRSP value‐weighted Amex‐NYSE index, (3) listed firms matched by industry and size, and (4) an index of the smallest size decile of the New York Stock Exchange.
The benchmark‐adjusted return for stock i in event month t is defined as
The average benchmark‐adjusted return on a portfolio of n stocks for event month t is the equally‐weighted arithmetic average of the benchmark‐adjusted returns:
The cumulative benchmark‐adjusted aftermarket performance from event month q to event month s is the summation of the average benchmark‐adjusted returns:
When a firm in portfolio p is delisted from the CRSP data, the portfolio return for the next month is an equally‐weighted average of the remaining firms in the portfolio.
The cumulative market‐adjusted return for months 1 to 36, , thus involves monthly rebalancing, with the proceeds of a delisted firm equally allocated among the surviving members of the portfolio p in each subsequent month. For the month in which an IPO is delisted, the return for both the IPO and the benchmark includes just the days from the start of the month until the delisting.
Long run performance of private equity ipo
As an alternative to the use of cumulative average benchmark‐adjusted returns, which implicitly assumes monthly portfolio rebalancing, I also compute 3–year holding period returns, defined aswhere is the raw return on firm i in event month t.
This measures the total return from a buy and hold strategy where a stock is purchased at the first closing market price after going public and held until the earlier of (i) its 3–year anniversary, or (ii) its delisting.9 To interpret this 3–year total return, I compute wealth relatives as a performance measure, defined as
A wealth relative of greater than 1.00 can be interpreted as IPOs outperforming a portfolio of matching firms; a wealth relative of less than 1.00 indicates that IPOs underperformed.
In this paper, I have calculated performance measures without explicitly adjusting for betas. While I do not report them here, the betas of the IPO firms display the same time‐series patterns documented in Ibbotson (1975), Chan and Lakonishok (1990), and Clarkson and Thompson (1990), i.e., the average beta is greater than 1.00, and the average betas decline with the length of time since the IPO.
This is true when betas are calculated using either the CRSP value‐weighted NASDAQ or Amex‐NYSE indices.
The matching firms also have betas greater than 1.00. For post‐issue months 1–12, 13–24, and 25–36, respectively, the average betas for IPOs are 1.39, 1.24, and 1.14 and the average betas for matching firms are 1.14, 1.13, and 1.04, using the CRSP value‐weighted Amex‐NYSE index.10 Although the IPO betas are greater than 1.00 on average, the difference in betas between the IPOs and matching firms is too small to have economically significant effects on the conclusions.
To the degree that the IPO betas are higher than the betas of control portfolios, computing adjusted returns without explicitly adjusting for beta differences results in conservative estimates of IPO underperformance when the market risk premium is positive, as it is for this paper's sample.11
Table II reports the average matching firm‐adjusted returns and cumulative average matching firm‐adjusted returns for the 36 months after the offering date for 1,526 IPOs in 1975–84.
Thirty‐one of the 36 monthly average adjusted returns are negative, with 13 of them having t‐statistics lower than −2.00. The negative average adjusted returns are reflected in a steady decline in the cumulative average adjusted returns, which, after a slight increase in the first 2 months of seasoning, falls to −29.13% by the end of month 36, exclusive of the initial return, with an associated t‐statistic of −5.89.
The underperformance of the IPOs is both economically and statistically significant.
The long-run performance of PE and VC backed IPOs - Evidence from the Nordic and German markets
In Figure 1, I have plotted the matching firm‐adjusted CAR, where the initial return is also included. Also plotted are four other cumulative average returns with different adjustments. The five series plotted, in order of their , are, from top to bottom: (1) raw returns, (2) CRSP value‐weighted NASDAQ‐adjusted returns, (3) CRSP value‐weighted Amex‐NYSE‐adjusted returns, (4) matching firm‐adjusted returns, and (5) small firm‐adjusted returns.