Is Long-Term IPO Performance determined by Underpricing? : Analysis of the international IPO markets between 2009-2019

University essay from Umeå universitet/Företagsekonomi

Author: Arjan Kevin Ramak; Felix Fager Burman; [2022]

Keywords: ;

Abstract: Chinese legislative boards are heightening regulations to reduce the presence of ‘junk stocks’, as many new offerings sport remarkably high first day returns, but at the same time mediocre long-term performance. The phenomenon where an IPO (Initial Public Offering) is offered at a lower price than its intrinsic value is prominent in finance and business literature. The phenomenon was coined as “Underpricing” and has been widely theorized by authors such as Ibbotson (1975), Rock (1984) and Ritter (1998). This has prompted an interesting discussion regarding the incentives to underprice in IPO literature. With the motivations of underpricing in mind, the long-term consequences of the phenomenon remain unclear. For this reason, the authors have formulated the research question ‘Are initial IPO returns a predictor for their long-term stock performance?’ in order to characterize the underpricing phenomenon and assess the long-term viability of IPOs from an investing standpoint. The research question has been theorized by exploring past literature and theories such as the Efficient market hypothesis, Rational behavior theory, Asymmetric information theory, Agent-Principal theory and Hofstede’s cultural dimensions. Understanding how the phenomenon affects the performance of IPOs increases the awareness of the long-term validity of the offerings. These factors are important to reduce the intricacies of IPOs and assist investors in building better portfolios that include public offerings. The sample of this study consisted of 1514 IPOs from China, United States, United Kingdom, Japan, and Australia which are five countries that were deemed as highly innovative and entrepreneurial. The intent being to generalize results towards nations of similar essence. The study was conducted under a positivistic research philosophy with deductive reasoning. To assess the research question, the study adopted a quantitative approach and statistically tested the sample’s returns using Ordinary Least Squares (OLS) regression to determine whether there is a correlation between underpricing and IPO long-term developments. By analyzing the returns, the authors found evidence that there is a negative correlation between underpricing and three-year performance, indicating that higher underpricing statistically leads to lowered performance long-term. The findings are in support of Efficient market theory, where the effects of underpricing are reduced over time. On the other hand, the cultural dimensions were found to be insignificant in the long-term; the authors determine these conclusions to be in support of financial globalization. Similar to previous studies, the findings underline the complexity of investing in IPOs and give further insight into the difficulties an IPO investor faces.

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