EL MUNDO ROMANO

Much of the literature on long-run performance of IPOs has attempted to find firm and issue characteristics (variables) that predict long-run performance. In doing so, researchers have also focused on signalling in IPOs and the role of third party certifiers like underwriters, VCs etc. in the going public process. These factors are briefly reviewed in the discussion below.

Ritter (1991) reports that young growth companies are worst performers in the long-run after the IPO. Since then, researchers have consistently reported similar results of poor long-run returns for small and younger firms (Brav and Gompers, 1997, Brav et al., 2000). Brav and Gompers (1997) point to a number of possible reasons for the poor performance on part of small, low book-to-market firms. First, among them, is the possibility of negative impact of unexpected shock to small growth firms in early 1980s. This is consistent with Fama and French (1995), who find that earnings of small firms declined in 1980s but could not recover when those of large firms did. The other reasons include lack of institutional holdings in small firms and higher information asymmetry attached to smaller firms.

Jain and Kini (1994) provide an explanation of the long-run performance using the agency problem. They relate long-run post IPO performance to the ownership retained by the insiders at the time of IPO. They argue that higher ownership retention would predict a better long-run performance of IPOs consistent with the signalling and agency cost hypothesis (Leland and Pyle, 1977, Jensen and Meckling, 1976). They find that post-issue operating performance is positively related to level of equity retention by inside managers. However, Mikkelson et al. (1997) fail to find significant relation between long-run operating

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performance and the ownership structure. Similarly, Goergen and Renneboog (2007) also find that long-run IPO performance is not related to the control and ownership retention.

Another factor that seems to explain the poor long-run performance in IPOs is the earnings management at the time of offering (Teoh et al., 1998a). Teoh et al. find that firms with aggressive accruals in IPO year experience poor performance in three years after the IPO. They conclude that investors do not fully incorporate the effect of large accruals in pricing of IPOs and could pay a high price for the shares. Discovery of the real value and earnings of the issuers in the post-IPO period leads to loss of optimism and prices are revised downwards leading to poor long-run returns in the aftermarket. Teoh et al. (1998c) also find that opportunistic earnings management in IPOs partially explains the long-run underperformance after the IPO. They find that IPO year abnormal accruals, a proxy of earnings management, explain the performance variation in earnings and stock reruns after the issuance. Rangan (1998) provides similar evidence for SEOs and reports that a one standard deviation increase in the earnings management during offer year leads to a decline of about 10% in the market- adjusted returns in the following year. He concludes that investors overvalue the offerings by extrapolating the earnings growth related with higher earnings management. Subsequent reversal of earnings and poor earnings performance leads to correction of valuation and decline in prices and returns. In a related vein, Purnanandam and Swaminathan (2004) find that IPOs are overpriced compared to the industry peer price multiples for a sample of 2000 IPOs from 1980 to 1997. They further report poor long-run performance for these overpriced IPOs and conclude that investors become optimistic by growth forecasts and pay less attention to profitability in valuation of IPO shares. The earning management and overvaluation are both related to the overconfidence on part of investors and entrepreneurs alike (Ritter and Welch, 2002, Heaton, 2002).

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Presence of VCs and PE firms in IPOs has also been examined in the going public process. Prior literature has generally reported positive impact of VC presence on the underpricing and long-run performance of IPOs. For example, VC backed IPOs on average are less underpriced due to the monitoring and certification role of VCs compared to their non-VC counterparts (Barry et al., 1990, Megginson and Weiss, 1991). As VCs maintain their positions in the IPOs long after going public (Barry et al., 1990), their certification and monitoring should result in better performance in the long-run for equity issuers. Consistent with this argument, Brav and Gompers (1997) find that VC backed IPOs outperform non-VC backed IPOs over a five year period after listing on an equal weighted returns basis. Jain and Kini (1995) relate VC backing at the time of IPO with post-issue operating performance and find that VC backed IPOs experience superior operating performance compared to non-VC backed ones. Recently, researchers have focused on the differences between VC and private equity (PE) firms to explain cross sectional performance variations in the VC and PE backed IPOs. For instance, Gompers (1996) develops a ‘grandstanding’ hypothesis which asserts that young VC in order to establish reputation and raise new funds, bring younger companies to the public market which are more underpriced compared to the companies backed by older VCs. Lee and Wahal (2004), on the other hand, find that VC backed IPOs are more underpriced compared to non- VC backed IPOs once the endogeniety issues of VC financing are addressed. They, however, find support for the grandstanding hypothesis by showing that young VC firms and those with fewer IPOs in the past, rush young and smaller companies to the public market. Along the similar lines, another stream of research has examined the reputation of VC and PE firms in relation to the post-IPO performance of companies they bring to the market (Nahata, 2008). Krishnan et al. (2011b), for example, find that VC reputation, measured by previous market share of VC backed IPOs, is significantly positively related to the long-run performance of

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IPOs. They also report that reputed VCs are actively involved in the corporate governance of their companies after the IPO and this involvement positively influences the performance even after controlling the VC selection bias. Much of the evidence discussed above relates to US markets and is conclusive; however, results from other markets are not consistent. For instance, studies on VC backing and performance of IPOs from UK report mixed results regarding the impact of VCs on performance. Jelic et al. (2005) examine private-to-public management buyout IPOs in the UK and fail to find significant differences in performance between VC backed vs non-VC backed IPOs. They, however, find that IPOs backed by reputed VC are better long-term investment compared to those backed by less reputed VCs.

Several studies have examined the reputation of underwriter as a significant predictor of long- run IPO performance. Carter et al. (1998) find that long-run market adjusted returns are less negative for IPOs backed by more reputable underwriters. Moreover, they also report less underpricing for more prestigious underwriters in line with Carter and Manaster (1990). Both of these results are consistent with earlier findings of Michaely and Shaw (1994) who show that IPOs backed by reputable underwriters are less underpriced and perform better in the long-run. Similarly, IPOs backed by highly reputed underwriters also show superior operating performance relative IPOs backed by less reputed underwriters (Jain and Kini, 1999b). Some recent studies report that underwriter reputation continues to be a significant predictor of long-run IPO performance. Dong et al. (2011) examine underwriter reputation and long-run IPO performance in US from 1980 to 2006. They focus on marketing, certification and screening and information production role of underwriters an find that higher underwriter quality predicts superior long-run performance. They further find that marketing and certification and screening are important attributes of underwriter quality in terms of post- issue quality.

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Recent literature has documented some other variables and issue characteristics which are significantly related to the performance of IPOs in the long-run. Wu and Kwok (2007), for example, find that global IPOs on US markets show poor long-run performance compared to market as well as the domestic IPOs over three years after issuance. They suggest that investors are optimistic about the future growth of firms engaged in global offerings and these expectations are corrected over time after IPO causing underperformance, which is consistent with the window of opportunity hypothesis. Gao and Jain (2011) examine the long-run performance differences between founder CEO and non-founder CEO IPOs and find weak evidence of superior performance for founder CEO IPOs relative to non-founder ones in general. However, they show significant higher returns for founder CEO IPOs compared to non-founder CEO IPOs in context of high technology firms. Brau et al. (2012) show the impact of acquisition activity on the long-run stock performance for US IPOs from 1985 to 2003. Their results show that acquisition activity within one year of listing is negatively related to stock performance from one through five year holding period following first year. More specifically, they find that three year style adjusted abnormal returns are -15.6 percent for IPOs that acquire within first year of listing while abnormal returns for non-acquirers are 5.9%. Finally, Mudambi et al. (2012) show that for a sample of UK IPOs, firms with higher levels of multinationality outperform domestic firms in long-run; where multinationality is measured as presence in markets outside UK.