FIMA Research Center, University of Hawai'i

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Lessons from the U.S. IPO and SEO Markets

S. Ghon RheeS. Ghon RheeUniversity of HawaiUniversity of Hawai‘‘ii

FIMA Research Center, University of Hawai'i

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Two Major Anomalies: The New Issues Market

1.1. Short-Term UnderpricingShort-Term UnderpricingInternet Bubble Period (1999-2000)Internet Bubble Period (1999-2000)a.a. 182 out of 803 IPOs: First trading day return 182 out of 803 IPOs: First trading day return

of 100% or higherof 100% or higher b.b. 12 out of 12 out of 323 internet IPOs: Trading above 323 internet IPOs: Trading above

their offer price their offer price

2.2. Long-Term Underperformance Long-Term Underperformance

US IPO firms overvalued by about 50% relative to its US IPO firms overvalued by about 50% relative to its industry peers in 1980-1997.industry peers in 1980-1997.

FIMA Research Center, University of Hawai'i

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U.S. IPO Statistics

Unit: $ Billion Number of Average First Number of IPOs Money Left Gross Year IPOs Day Return with Return >100% on the Table Proceeds 1990 104 10.8% 1 $0.45 $5.61 1991 273 12.1% 0 $1.79 $15.92 1992 385 10.2% 2 $2.15 $26.37 1993 483 12.8% 2 $3.92 $34.42 1994 387 9.8% 1 $1.65 $19.32 1995 432 21.5% 13 $5.03 $28.35 1996 621 16.7% 7 $7.38 $45.94 1997 432 13.8% 2 $4.64 $31.70 1998 267 22.3% 12 $5.35 $34.63 1999 457 71.7% 111 $37.94 $66.77 2000 346 56.1% 71 $27.68 $62.59 2001 80 14.0% 0 $2.97 $34.34 Total 4,267 24.19% 222 $100.99 $405.97

FIMA Research Center, University of Hawai'i

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IPOs with Negative Earnings Prior to Going Public

----------------------------------------------------------------------------------------------------------------- Number of IPOs with 1st Day Returns Period IPOs Negative EPS EPS<0 EPS>0 1980-1989 1,982 19% 9.1% 6.8% 1990-1994 1,632 26% 10.8% 11.4% 1995-1998 1,752 37% 19.2% 17.4% 1999-2000 803 79% 72.0% 43.5% 2001 80 49% 13.3% 11.6% 1980-2001 6,249 34% 31.4% 12.5% --------------------------------------------------------------------------------------------------------

FIMA Research Center, University of Hawai'i

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Long-Term Stock Performance of New Issues (IPOs and SEOs)

------------------------------------------------------------------------------------------------------------ Number of 3-Year Return 5-Year Return Period Type Sample Issuer Nonissuer Issuer Nonissuer A. US Market 1970-1990 IPO 4,753 8.4% 35.3% 15.7% 66.4% 1970-1990 SEO 3,702 15.0% 48.0% 33.4% 92.8% B. Japanese Market 1971-1992 IPO 180 34.2% 82.9% 62.1% 101.4% 1971-1992 SEO 1,389 33.7% 51.5% 74.1% 112.9% C. UK Market 1980-1988 IPO 806 55.7% 97.8% n.a. ------------------------------------------------------------------------------------------------------------

FIMA Research Center, University of Hawai'i

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Long-Term Operating Performance of IPO and SEO Firms Industry-adjusted operating return on Industry-adjusted operating return on

assets usually peak prior to the offering.assets usually peak prior to the offering. But, industry-adjusted ROA and other But, industry-adjusted ROA and other

long-term performance measures long-term performance measures deteriorate over time after the offeringdeteriorate over time after the offering

IPO and SEO firms expand their assets IPO and SEO firms expand their assets faster than their sales overtime…..faster than their sales overtime…..an an indication of investment in negative NPV indication of investment in negative NPV projects?projects?

FIMA Research Center, University of Hawai'i

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Which Anomaly Deserves More Attention from Market Regulators?

Long-term underperformance is a Long-term underperformance is a more serious issuemore serious issuea.a. Due to Welfare Implications for Due to Welfare Implications for InvestorsInvestorsb.b. Short-Term Underpricing is a one-day Short-Term Underpricing is a one-day

phenomenon and can be corrected phenomenon and can be corrected to some degreeto some degree

FIMA Research Center, University of Hawai'i

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IPO Performance: Japan’s Experience

Number 1st Day 3-Day Period* of IPOs Return Return** I 93 70% 0.8% II 17 19% -0.8% III 37 12% 0.2% Notes: * Period I (1/1/1980 - 5/1/1988): Price Limits and Formula-Based Pricing Period II (5/2/1988 - 3/31/1989): No Price Limits but Formula-Based Pricing

Retained Period III (4/1/1989 – 3/31/1993): No Price Limits and Auction-Based Pricing

** Not including 1st day return

FIMA Research Center, University of Hawai'i

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What Explains Long-Term Underperformance? IPO and SEO firms exhibit unusually large and IPO and SEO firms exhibit unusually large and

significant gains in operating performance one significant gains in operating performance one year prior to the offer dateyear prior to the offer date

SEO firms exhibit superb stock performance in SEO firms exhibit superb stock performance in the year prior to the offeringthe year prior to the offering>>>>>> >>>>>> Earnings Management Earnings Management which mislead investors to be over which mislead investors to be over optimistic optimistic about the issuer’s prospectsabout the issuer’s prospects

FIMA Research Center, University of Hawai'i

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Distribution of Scaled Earnings(Whole Sample)

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-0.30 -0.25 -0.2 -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25

Level of Earnings Scaled by the Beginning Total Assets

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y

FIMA Research Center, University of Hawai'i

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Distribution of Scaled Earnings(Large Size Quintile)

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-0.30 -0.25 -0.2 -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25

Level of Earings Scaled by Beginning Total Assets

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FIMA Research Center, University of Hawai'i

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Distribution of Scaled Earnings(Small Size Quintile)

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-0.30 -0.25 -0.2 -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25

Level of Earnings Scaled by Beginning Total Assets

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y

FIMA Research Center, University of Hawai'i

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Country Classification by Earnings Opacity Measure

Rank 5 (Most Opaque): Rank 5 (Most Opaque): India, Indonesia, Japan, Korea, GreeceIndia, Indonesia, Japan, Korea, Greece

Rank 4:Rank 4:Malaysia, Pakistan, Singapore, Taiwan, Turkey, S. AfricaMalaysia, Pakistan, Singapore, Taiwan, Turkey, S. Africa

Rank 3:Rank 3:Hong Kong, Thailand, Austria, Finland, Germany, Hong Kong, Thailand, Austria, Finland, Germany, Ireland, Ireland, NetherlandsNetherlandsRank 2:Rank 2:Australia, Denmark, France, Sweden, Switzerland, Australia, Denmark, France, Sweden, Switzerland, United United KingdomKingdom

Rank 1 (Least Opaque): Rank 1 (Least Opaque): Belgium, Canada, Norway, Portugal, United StatesBelgium, Canada, Norway, Portugal, United States

Source:Source: Bhattacharya, Daouk, and Welker(2002) Bhattacharya, Daouk, and Welker(2002)

Thank You!