TheIPOMarket

JayR.RitterUniversityofFlorida

March2006

Terminology:

First-dayreturn=100%x(Closingprice–offerprice)/offerprice

First-dayreturna.k.a.“underpricing〞

Moneyonthetable= numberofsharessoldx(closingprice–offerprice)

Table1

SummaryStatisticsfor6,816IPOswithOfferPrice3$5.00

Average,2001Dollars

Period

Mean

First-day

Return

MoneyLeft

ontheTable

GrossProceeds

1980-1989

7%

$2.7million

$42million

1990-1998

15%

$10million

$72million

1999-2000

65%

$82million

$161million

2001-200511%

$20million

$223million

1980-2005

18%

$17million

$86million

Academicexplanationsforunderpricing

The“winner’scurse〞or“GrouchoMarxtheorem〞(Rock)

Ifyouareunsureofthefairvalueofsharesbeingsold, andthereisexcessdemand,themostoptimisticinvestors arelikelytogettheshares

Thus,conditionalongettingtheshares,youfindout thatyouareprobablyoveroptimisitic

Theneedtogiveinstitutionsanincentivetoinvestigatea companyandbuyitsshares(BenvenisteandSpindt)Thesearegoodexplanationsifwewereseekingtoexplainwhy,onaverage,underpricingis5-10%

Thesearenotgoodexplanationswhenwearetryingtoexplainwhyunderpricingis15%ormore

Table2

TheEffectofUnderpricingontheWealthandOwnershipofPre-issueShareholders

Assumptions:

Pre-issuesharesoutstanding: 15.6millionshares

GrossproceedsofIPO: $78million

Post-issuemarketcap: $280.8million

#ofsharessoldbypre-issueshareholders: zero

Strategy1

Strategy2

Offerpriceandnumberofsharesoffered: 7.8mat$10.00 6.0mat$13.00

Post-issuesharesoutstanding: 23.4million 21.6million

Marketpricepershare: $12.00 $13.00

Moneyleftonthetable: $15.6million zero

Post-issuewealthofpre-issueshareholders: $187.2million $202.8million

Post-issue%offirmownedby

pre-issueshareholders: 66.7% 72.2%

UnderpricingandallocationsarerelatedTherearethreeframeworksforviewingdiscretioninallocationsTheinformationacquisitionview(BenvenisteandSpindt) Underwritersfavorregularinvestorswhoprovideinformation aboutdemand,resultinginmoreaccuratepricingThe“pitchbook〞view,inwhichunderwritersseekoutbuy-and-holdinvestorsTherent-seekingview,whereunderwriterstrademoneyleftonthetableforquidproquos(commissionbusiness) Biasedanalystrecommendationsappealtoissuingfirmsand makethemwillingtoleavemoneyonthetableWhydoissuersputupwithsevereunderpricing?

OninternetIPOs,underwritersknewtheywereoverpriced Butwhydidtheiranalystsputout“buy〞r(shí)ecommendations?

Issuerstupidity Thepublicityisworthit Capitalcanberaisedinafollow-onoffering

Prospecttheory Whenpeoplegetgoodnewsabouttheirwealthincreasing, theydon’tbargainashardatthepricingmeeting

Analystlustandspinning Issuersseekoutunderwriterswhereinfluentialanalysts willbebullish SpinningofhotIPOstoexecutivesScandals:

Spinning:AllocatinghotIPOstothepersonalbrokerageaccounts oftopexecutivesinreturnforcompanybusiness Globalsettlementbansspinningbymajorunderwriters

Laddering:Requiringthepurchaseofadditionalsharesinthe aftermarketinreturnforIPOs

Analystconflictsofinterest:Giving“buy〞r(shí)ecommendationsin returnforunderwritingandM&Abusiness

CommissionbusinessinreturnforIPOs:Underwritersallocated IPOsprimarilytoinvestorsthatgeneratedalotofcommissions onothertradesExampleofkickbackswithcommissionbusiness:CreditSuisseFirstBoston(CSFB)receivedcommissionbusinessequaltoasmuchas65%oftheprofitsthatsomeinvestorsreceivedfromcertainhotIPOs,suchastheDecember9,1999IPOofVALinux

TheVALinuxIPOinvolved5.06millionshares

Offerprice: $30.00 Closingmarketprice: $239.25 Capitalgain: $209.25

Grossspread: $2.10

Iftheinvestorthentradedsharestogeneratecommissionsofone-halfofthisprofitthetotalunderwritercompensationpersharewas$2.10plus$104.625,or$106.725

Accordingtoparagraph58oftheSEC’sJanuary22,2002settlementwithCSFB,aninstitutionalcustomerthathadreceiveda12,500shareallocationofVALinuxfromCSFBpaidCSFBatleast$565,000byengaginginthefollowingtransactions:CommissionBusinessinReturnforIPOs: Whatifamutualfundpays5￠persharefortradeswith GoldmanSachsratherthan2￠persharewithanECN?Exampleofspinning:SalomonSmithBarney'sallocationsofIPOstoBernieEbbers,otherWorldComexecs,andothertelecomexecs

Ebber's Offer Market First-dayIPO Date Shares Price Price ProfitMcLeod 6/96 200,000 $20.00 $25.13 $1,026,000TagHeuer 9/96 5,000 $19.55 $20.00 $2,250QwestCommunications 6/97 205,000 $22.00 $28.00 $1,230,000TVAzteca 8/97 1,000 $18.25 $19.19 $900BoxHillSystems 9/97 5,000 $15.00 $20.62 $28,100NextlinkCommunications 9/97 200,000 $17.00 $23.25 $1,250,000ChinaMobileHK 10/97 2,000 $30.50 $28.00 -$5,000MetromediaFiber 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 $32,000RhythmsNetconnection 4/99 10,000 $21.00 $69.13 $481,300JunoOnline 5/99 10,000 $13.00 $11.63 -$13,700JuniperNetworks 6/99 5,000 $34.00 $98.88 $324,400FocalCommunications 7/99 5,000 $13.00 $19.50 $32,500WilliamsCommunications 10/99 35,000 $23.00 $28.06 $177,100RadioUnica 10/99 4,000 $16.00 $27.44 $45,800CharteredSemiconductor 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 $180,000TycomLtd 7/00 7,500 $32.00 $37.00 $37,500Signalsoft 8/00 5,000 $17.00 $21.88 $24,400

WherehavetheNASDandSECbeen?

WhileIPOstendtogouponthefirstdayoftrading,inthelongrun,onaveragetheyhavetendedtounderperform.

Butthereisastrongcross-sectionalpattern:IPOsthathadannualsalesoflessthan$50millionseverelyunderperform,whereasthosethathadachievedannualsalesof$50milliondon’tunderperform.Buy-and-holdstockreturnsareskewed:therearesomebigwinners,butmoststocksunderperform.Thisisespeciallytruewithyoungcompanies,wherethereisevengreaterrightskewness.Annualreturnsinthefiveyearsaftergoingpublicfor6,858IPOsfrom1970-2002,withreturnsthroughDecember