The IPO Market  

Jay R. RitterUniversity of Florida

 March 2006

Terminology: 

First-day return = 100% x (Closing price – offer price)/offer price 

First-day return a.k.a. “underpricing”  

Money on the table = number of shares sold x (closing price – offer price)

Number of Offerings and Average First-Day Return, 1980-2005

0

100

200

300

400

500

600

700

800

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Nu

mb

er o

f O

ffer

ing

s

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

Number of Offerings Average First-Day Return

Mean First-day Returns and Money Left on the Table, 1990-2005

Mean First-day Return

Year

Number of IPOs

Equal-weighted

Proceeds-weighted

Aggregate

Amount Left on the Table

Aggregate Proceeds

1990 104 10.8% 8.1% $0.33 billion $4.08 billion 1991 273 12.1% 11.2% $1.38 billion $12.28 billion 1992 385 10.2% 8.1% $1.71 billion $20.97 billion 1993 483 12.8% 11.4% $3.20 billion $28.16 billion 1994 387 9.8% 8.5% $1.39 billion $16.24 billion 1995 432 21.5% 17.8% $4.34 billion $24.46 billion 1996 621 16.7% 16.1% $6.53 billion $40.65 billion 1997 432 13.9% 14.7% $4.27 billion $28.97 billion 1998 267 22.3% 15.5% $4.98 billion $32.20 billion 1999 457 71.7% 56.8% $35.63 billion $62.69 billion 2000 346 56.1% 44.2% $26.77 billion $60.54 billion 2001 76 14.4% 8.9% $2.97 billion $33.97 billion 2002 67 8.9% 5.1% $1.13 billion $22.11 billion 2003 62 12.1% 10.5% $1.01 billion $9.58 billion 2004 179 12.1% 12.1% $3.88 billion $32.04 billion 2005 162 10.0% 9.3% $2.65 billion $28.37 billion

1990-2005 4,733 22.9% 22.4% 102.17 billion $457.3 billion

NUMBER OF OFFERINGS, AVERAGE FIRST-DAY RETURNS, AND GROSS PROCEEDS OF INITIAL PUBLIC OFFERINGS IN 1975-2005 Number of Average Gross Proceeds, Year Offerings1 First-day Return,%2 $ Millions3

1975 12 -1.5 262 1976 26 1.9 214 1977 15 3.6 127 1978 20 11.2 209 1979 39 8.5 312 1980 75 13.9 934 1981 197 6.2 2,367 1982 81 10.7 1,016 1983 521 9.0 11,225 1984 222 2.5 2,841 1985 216 6.2 5,492 1986 480 5.9 15,816 1987 341 5.6 12,911 1988 128 5.4 4,125 1989 119 7.9 5,155 1990 112 10.5 4,225 1991 287 11.7 15,398 1992 395 10.1 21,777 1993 505 12.7 28,899 1994 412 9.8 17,784 1995 461 21.1 28,745 1996 687 17.0 42,572 1997 483 13.9 32,478 1998 317 20.1 34,585 1999 487 69.6 65,069 2000 385 55.4 65,627 2001 81 13.7 34,368 2002 70 8.6 22,136 2003 68 12.4 10,122 2004 186 12.2 32,380 2005 169 9.8 28,677 1975-2005 7,597 17.3 547,845

Table 1

Summary Statistics for 6,816 IPOs with Offer Price $5.00

Average, 2001 Dollars

Period

Mean

First-day Return

Money Left on the Table

Gross Proceeds

1980-1989

7%

$2.7 million

$42 million

1990-1998 15% $10 million $72 million

1999-2000 65% $82 million $161 million

2001-2005 11% $20 million $223 million

1980-2005

18%

$17 million

$86 million

Non-tech IPOs, 1980-2005

0

50

100

150

200

250

300

350

400

450

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Calendar Year

Num

ber o

f IPO

s

0

10

20

30

40

50

60

70

80

90

Ave

rage

Fir

st-D

ay R

etur

ns, %

Tech IPOs, 1980-2005

0

50

100

150

200

250

300

350

400

450

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Calendar Year

Num

ber o

f IPO

s

0

10

20

30

40

50

60

70

80

90

Ave

rage

Fir

st-D

ay R

etur

ns, %

Fraction of IPOs with Negative Earnings and Fraction of Tech Stocks, 1980-2005

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%Percentage of Tech StocksPercentage of IPOs with EPS < 0

Median Age and Fraction of IPOs with Negative Earnings, 1980-2005 Mean First-day Returns

Year Number of IPOs

Median Age

Percentage Tech Stocks

Percentage of IPOs with EPS<0 EPS<0 EPS0

1980 70 6 31% 25% 7.1% 16.9% 1981 191 8 37% 17% 8.4% 5.4% 1982 77 5 52% 20% 8.1% 11.0% 1983 442 7 39% 21% 14.8% 9.0% 1984 172 7 28% 16% 9.2% 2.3% 1985 179 8 19% 15% 5.2% 6.4% 1986 378 8 20% 21% 7.6% 6.0% 1987 271 7 21% 18% 5.0% 6.2% 1988 97 8 27% 18% 7.0% 5.1% 1989 105 7 30% 22% 9.2% 7.8% 1990 104 9 26% 13% 10.4% 10.9% 1991 273 9 24% 24% 10.0% 12.7% 1992 385 10 25% 30% 10.8% 10.0% 1993 483 8 23% 28% 12.9% 12.7% 1994 387 7 27% 24% 8.2% 10.3% 1995 432 7 43% 29% 21.7% 21.4% 1996 621 7 38% 40% 15.4% 17.6% 1997 432 8 34% 34% 12.2% 14.7% 1998 267 7 39% 50% 30.1% 14.0% 1999 457 4 77% 77% 80.1% 41.3% 2000 346 6 67% 80% 58.8% 42.7% 2001 76 12 29% 50% 14.6% 12.4% 2002 67 15 30% 46% 5.1% 12.2% 2003 63 11 27% 45% 11.1% 13.1% 2004 178 8 33% 49% 11.6% 13.1% 2005 162 11 28% 44% 6.9% 12.5%

1980-2005 6,715 7 36% 34% 30.5% 12.6%

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

Tech

Non-Tech

0

5

10

15

20

Calendar Year

Median Age, 1980-2005

Median Age and Fraction of IPOs with VC backing, 1980-2005 Technology IPOs

Year Number of IPOs

Median Age

Percentage VC-backed

Number of VC-backed IPOs Number % VC-backed

1980 70 6 33% 23 18 67% 1981 191 8 29% 56 63 41% 1982 77 5 27% 21 36 36% 1983 442 7 26% 117 155 39% 1984 172 7 27% 47 38 55% 1985 179 8 25% 44 28 54% 1986 378 8 23% 88 71 44% 1987 271 7 28% 75 57 65% 1988 97 8 34% 33 26 65% 1989 105 7 39% 41 29 62% 1990 104 9 46% 48 26 81% 1991 273 9 51% 138 60 72% 1992 385 10 47% 182 94 76% 1993 483 8 46% 223 106 79% 1994 387 7 35% 137 94 59% 1995 432 7 44% 191 176 64% 1996 621 7 43% 265 229 63% 1997 432 8 30% 130 144 49% 1998 267 7 29% 77 102 50% 1999 457 4 59% 271 351 69% 2000 346 6 62% 216 225 68% 2001 76 12 53% 40 23 74% 2002 66 15 29% 19 20 55% 2003 63 11 37% 23 17 53% 2004 179 8 48% 83 58 69% 2005 162 11 33% 53 45 56%

1980-2005 6,749 7 39% 2,641 2,291 61%

Average first-day returns on IPOs

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

Country

Ave

rag

e fi

rst-

day

ret

urn

s

Academic explanations for underpricing 

The “winner’s curse” or “Groucho Marx theorem” (Rock)

If you are unsure of the fair value of shares being sold, and there is excess demand, the most optimistic investors are likely to get the shares

  Thus, conditional on getting the shares, you find out that you are probably overoptimisitic

 The need to give institutions an incentive to investigate a company and buy its shares (Benveniste and Spindt)

These are good explanations if we were seeking to explain why, on average, underpricing is 5-10% These are not good explanations when we are trying to explain why underpricing is 15% or more

Table 2 The Effect of Underpricing on the Wealth and Ownership of Pre-issue Shareholders

Assumptions:Pre-issue shares outstanding: 15.6 million sharesGross proceeds of IPO: $78 millionPost-issue market cap: $280.8 million# of shares sold by pre-issue shareholders:zero

Strategy 1 Strategy 2Offer price and number of shares offered: 7.8 m at $10.00 6.0 m at $13.00Post-issue shares outstanding: 23.4 million 21.6 millionMarket price per share: $12.00 $13.00Money left on the table: $15.6 million zeroPost-issue wealth of pre-issue shareholders: $187.2 million $202.8 millionPost-issue % of firm owned by

pre-issue shareholders: 66.7% 72.2%

Underpricing and allocations are related

There are three frameworks for viewing discretion in allocations The information acquisition view (Benveniste and Spindt)

Underwriters favor regular investors who provide informationabout demand, resulting in more accurate pricing

The “pitchbook” view, in which underwriters seek out buy-and-hold investors

The rent-seeking view, where underwriters trade money left on the table for quid pro quos (commission business)

Biased analyst recommendations appeal to issuing firms and make them willing to leave money on the table

Why do issuers put up with severe underpricing? 

On internet IPOs, underwriters knew they were overpriced But why did their analysts put out “buy” recommendations?

 Issuer stupidity The publicity is worth it Capital can be raised in a follow-on offering

 Prospect theory When people get good news about their wealth increasing, they don’t bargain as hard at the pricing meeting

 Analyst lust and spinning Issuers seek out underwriters where influential analysts will be bullish Spinning of hot IPOs to executives

Scandals: 

Spinning: Allocating hot IPOs to the personal brokerage accounts of top executives in return for company business

Global settlement bans spinning by major underwriters 

Laddering: Requiring the purchase of additional shares in the aftermarket in return for IPOs

 Analyst conflicts of interest: Giving “buy” recommendations in return for underwriting and M&A business

 Commission business in return for IPOs: Underwriters allocated IPOs primarily to investors that generated a lot of commissions on other trades

Example of kickbacks with commission business: Credit Suisse FirstBoston (CSFB) received commission business equal to as much as 65% of the profits that some investors received from certain hot IPOs, such as the December 9, 1999 IPO of VA Linux The VA Linux IPO involved 5.06 million shares 

Offer price: $30.00Closing market price: $239.25Capital gain: $209.25

  Gross spread: $2.10 If the investor then traded shares to generate commissions of one-half of this profit the total underwriter compensation per share was $2.10 plus $104.625, or $106.725

According to paragraph 58 of the SEC’s January 22, 2002 settlement with CSFB, an institutional customer that had received a 12,500 share allocation of VA Linux from CSFB paid CSFB at least $565,000 by engaging in the following transactions:

Commission Number Date Per Share Security of Shares

12/9/99 $2.75 AT&T 50,000

12/9/99 $2.70 Citigroup 50,000

12/9/99 $1.25 Compaq 100,000

12/9/99 $0.50 K Mart 50,000

12/9/99 $0.80 Kroger Co. 100,000

12/10/99 $0.50 Kroger Co. 125,000

Commission Business in Return for IPOs:What if a mutual fund pays 5¢ per share for trades with Goldman Sachs rather than 2¢ per share with an ECN?

Example of spinning: Salomon Smith Barney's allocations of IPOs to Bernie Ebbers,other WorldCom execs, and other telecom execs 

Ebber's Offer Market First-dayIPO Date Shares Price Price Profit

McLeod 6/96 200,000 $20.00 $25.13 $1,026,000Tag Heuer 9/96 5,000 $19.55 $20.00 $2,250Qwest Communications 6/97 205,000 $22.00 $28.00 $1,230,000TV Azteca 8/97 1,000 $18.25 $19.19 $900Box Hill Systems 9/97 5,000 $15.00 $20.62 $28,100Nextlink Communications 9/97 200,000 $17.00 $23.25 $1,250,000China Mobile HK 10/97 2,000 $30.50 $28.00 -$5,000Metromedia Fiber 10/97 100,000 $16.00 $21.38 $538,000Teligent 11/97 30,000 $21.50 $25.63 $123,900Earthshell 3/98 12,500 $21.00 $23.56 $32,000Rhythms Netconnection 4/99 10,000 $21.00 $69.13 $481,300Juno Online 5/99 10,000 $13.00 $11.63 -$13,700Juniper Networks 6/99 5,000 $34.00 $98.88 $324,400Focal Communications 7/99 5,000 $13.00 $19.50 $32,500Williams Communications 10/99 35,000 $23.00 $28.06 $177,100Radio Unica 10/99 4,000 $16.00 $27.44 $45,800Chartered Semiconductor 10/99 5,000 $20.00 $33.19 $66,000UPS 11/99 2,000 $50.00 $67.38 $34,800KPNQwest 11/99 20,000 $20.81 $29.81 $180,000Tycom Ltd 7/00 7,500 $32.00 $37.00 $37,500Signalsoft 8/00 5,000 $17.00 $21.88 $24,400 

Where have the NASD and SEC been? 

While IPOs tend to go up on the first day of trading, in the long run, on average they have tended to underperform. But there is a strong cross-sectional pattern: IPOs that had annual sales of less than $50 million severely underperform, whereas those that had achieved annual sales of $50 million don’t underperform.

Buy-and-hold stock returns are skewed: there are some big winners, but most stocks underperform. This is especially true with young companies, where there is even greater right skewness.

Annual returns in the five years after going public for 6,858 IPOs from 1970-2002, with returns through December 2003. Style-matched firms match on market cap and book-to-market.

Long-run Returns on IPOs Categorized by the Pre-issue Sales of the Firm

Average 3-year Buy-and-hold Return

Sales

Number of IPOs

Average First-day Return

IPOs

Market-adjusted

Style-adjusted

0-9.999 mm 1,359 27.2% -15.9% -52.9% -34.9% 10-19.999 mm 737 25.8% 15.1% -28.4% -11.7% 20-49.999 mm 1,394 20.8% 22.9% -23.8% -0.7% 50-99.999 mm 993 15.1% 46.1% -0.7% 12.8%

100-499.999 mm 1,265 10.2% 42.4% -5.8% 14.0% 500 mm and up 473 9.0% 41.0% 0.4% 10.7%

1980-2002

6,221

18.8%

22.5%

-21.5%

-1.6%

August 18, 2004 Jay R. Ritter

Table I of Ritter and Welch 2002 Journal of Finance article, updated on August 18, 2004 Number of IPOs, First-day Returns, and Long Run Performance, 1980 to 2002

Average 3-year Buy-and-hold Return

Year

Number of IPOs

Average First-day Return

IPOs

Market-adjusted

Style-adjusted

1980 70 14.5% 88.2% 35.5% 17.1% 1981 191 5.9% 12.8% -26.2% -7.4% 1982 77 11.4% 32.2% -36.5% -48.7% 1983 442 10.1% 15.4% -38.7% 2.5% 1984 172 3.6% 27.7% -51.3% 3.0% 1985 179 6.3% 7.6% -39.5% 7.3% 1986 378 6.3% 18.6% -20.4% 14.3% 1987 271 6.0% -1.8% -18.9% 4.5% 1988 97 5.4% 55.7% 8.3% 51.3% 1989 105 8.1% 51.1% 16.8% 32.5% 1990 104 10.8% 12.2% -34.1% -32.4% 1991 273 12.1% 31.5% -1.7% 5.8% 1992 385 10.2% 34.8% -2.3% -19.4% 1993 483 12.8% 44.9% -7.8% -23.9% 1994 387 9.8% 74.1% -8.3% 1.0% 1995 432 21.5% 24.8% -62.3% -14.1% 1996 621 16.7% 25.6% -57.0% 8.6% 1997 432 13.8% 67.7% 6.8% 41.0% 1998 267 22.3% 27.1% 9.1% 12.2% 1999 457 71.7% -45.2% -30.2% -52.0% 2000 344 56.2% -59.6% -30.2% -48.5% 2001 80 13.5% 8.9% 9.0% -20.3% 2002 64 8.9% 34.7% 19.7% 0.1%

1980-2002

6,304

18.7%

22.4%

-21.7%

-1.6%

IPO Turnover Categorized by Decade and First-Day Return, 1980-2000

IR < 0%0% < IR <

10% 10% < IR <60% IR > 60%

1980-1989

1990-1998

1999-2000

0%

50%

100%

150%

200%

250%

Average Percentage Turnover

First-Day Return and Revisions from the File Price Range, 1990-2005

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Percentage of IPOs with OP<Lo Percentage of IPOs in the Middle Percentage of IPOs with OP >Hi

Number of Initial Public Offerings, First-Day Return, and Revisions from the File Price Range by Cohort Year, 1990-2005

Cohort Year

Number of IPOs

Percentage First-day Return

Percentage of IPOs with

OP > Hi

Percentage of IPOs in the Middle

Percentage of IPOs with

OP < Lo

1990 89 9.5 23.6 50.6 25.8 1991 256 11.1 24.2 55.9 19.9 1992 343 9.8 21.3 40.5 38.2 1993 441 11.6 24.3 54.2 21.5 1994 335 8.6 13.1 49.3 37.6 1995 387 19.9 36.2 43.4 20.4 1996 600 16.0 25.3 49.5 25.2 1997 419 13.5 24.1 45.6 30.3 1998 283 21.4 22.6 49.1 28.3 1999 466 70.2 47.9 36.9 15.2 2000 374 56.4 38.5 38.5 23.0 2001 79 13.9 16.5 55.7 27.8 2002 67 8.7 13.4 55.2 31.3 2003 66 12.5 30.3 53.0 16.7 2004 171 12.1 21.1 41.5 37.4 2005 162 9.8 22.2 43.8 34.0

1990-2005 4,538 22.9 27.4 46.3 26.3

The Growth of IPO Auctions in the U.S. For IPO auctions where WRHambrecht was the bookrunner, the numbers are as follows: Gross Gross Name of IPO (ticker) Date of IPO Spread Proceeds 1999: (3 out of 477 IPOs) Ravenswood Winery (RVWD) 19990408 4.00% $10.5 million Salon.com (SALN) 19990622 5.00% $26.25 million Andover.net (ANDN) 19991208 6.50% $72.0 million 2000: (1 out of 383 IPOs) Nogatech (NGTC) 20000518 6.50% $42.0 million 2001: (2 out of 81 IPOs) Peet's Coffee (PEET) 20010125 6.50% $26.4 million Briazz (BRZZ) 20010502 6.00% $16.0 million 2002: (1 out of 66 IPOs) Overstock.com (OSTK) 20020529 4.00% $39.0 million 2003: (2 out of 63 IPOs) RedEnvelope (REDE) 20030925 6.00% $30.8 million Genitope (GTOP) 20031029 7.00% $33.3 million In 2003, WRHambrecht was also the joint bookrunner with JP Morgan on the Sunset Financial Resources IPO that did not use an auction. 2004: (1 out of 174 IPOs) New River Pharmaceuticals (NRPH) 20040805 7.00% $33.6 million In 2004, WRHambrecht was a co-manager on the Google auction IPO where CSFB and Morgan Stanley were the bookrunners. 2005: (5 out of 162 IPOs) B of I Holding (BOFI) 20050315 6.00% $35.1 million Morningstar (MORN) 20050502 2.00% $140.83 million CryoCor (CRYO) 20050714 7.00% $40.8 million Avalon Pharmaceuticals (AVRX) 20050928 7.00% $28.88 million Dover Saddlery (DOVR) 20051117 5.00% $27.5 million 2006: Traffic.com (TRFC) 20060125 6.00% $78.6 million FortuNet (FNET) 20060131 4.50% $22.5 million

Summary 

Hot and Cold markets will continue

Long-run underperformance is restricted to companies going public with less than $50 million in annual sales

In the U.S., auctions are becoming more common 

Regulatory reform has changed the game a little Spinning has been nearly eliminated Tying of loans to underwriting is controversial Analyst lust will continue

Issuers still put up with underpricing Commission business in return for IPOs is still allowed

Underwriters still have an incentive to underprice

The academic literature still focuses too much on asymmetric information models rather than agency models