Firm and industry characteristics, long-term returns and survival of Initial Public Offerings (IPOs) : a critical re-evaluation

This study tracks IPOs from the time of their entry into the public domain up to at least six years post-listing. In the first part of this study, the post-listing performance of these firms relative to that of a set of control firms in event and calendar time is evaluated, using a fresh sample of 746 IPOs in the UK market over the period 1999-2006 and stepwise matching algorithms that select the matching firms from the general population on the basis of key firm risk factors that includes three new factors – pre-IPO performance, turnover growth and earnings yield – employing a refined matching technique and a battery of methods. Given that the majority of the studies in the literature find that IPOs are poor investments in the long-term, the findings in the first part suggest firstly, that investing in IPOs beyond the immediate after-market may not be a bad trading strategy since the relative after-market performance is dependent on the proportions in which the stocks are stacked in the investor’s portfolio; secondly, value-weighted performance does not provide strong evidence against market efficiency when compared to an equally-weighted measure of abnormal performance [which tends to suggest that the former may provide a more useful benchmark in assessing the post-event risk-adjusted performance of IPO firms since it more accurately captures the investors’ wealth effects] and; thirdly, the under-performance of new issues of common stock remains an anomaly that really challenges the efficient market hypothesis only when performance is equally-weighted. In the course of analysing the performance of the firms in the first part, this work finds that the under-performance is more prevalent in some groups of IPOs than others. Hence, in the second part of the work, the economic importance and significance of key firm and industry risk factors prior to or at the IPO that may predict or explain this under-performance is tested. The author’s findings reveal that industry risk factors of IPO surplus value, profitability, market-to-book and equity volatility in addition to firm risk factors of size, market-to-book, past performance, underwriter reputation and the ‘hot’ IPO market can help distinguish the best performing from the worst performing firms. More importantly, the industry effects here are economically large and are first documented in this study. In the third and final part of the work, the firms are tracked in event and calendar time, equally using only that information that is available prior to or at the IPO. The author’s findings reveal that industry risk factors of IPO surplus value and profitability in addition to firm risk factors of size, past performance, initial market return volatility [IPO risk], underwriter prestige and the ‘hot’ IPO market can foreshadow an IPO’s survival. More importantly, the industry effects here are also first documented in this study. More particularly, the evidence here on past performance and underwriter prestige is strong and overwhelming with the results suggesting that firms desirous of going public should first build a track record of profitable performance, while the latter lays credence to the fact that firms underwritten by prestigious underwriters are less likely to fail. The results also suggest that potential IPO investors, IPO firms and their investment bankers should consider industry risk factors prevailing at the time of the IPO to provide them with additional information on whether or not to invest in the IPO [in the case of the investor] or go ahead with the IPO, or alternatively, withdraw and re-launch at a more auspicious date [in the case of the issuing firm and its investment banker].