The effects of firm maturity: IPO and post -IPO performance, growth, efficiency, profitability and returns; & the rational part of momentum

The Effects of Firm Maturity: IPO and Post-IPO Performance, Growth, Efficiency, Profitability and Returns; & The Rational Part of Momentum Jorge Alberto Murillo Garza This thesis analyses the relation of firm maturity (age) and firm's performance at their IPO and Post DPO returns and fundamentals. The first chapter analyses post-issuance performance utilizing a sample of 9,400 IPOs spread from 1935 to 2002 and shows that young firms (under 9 years old) are the most likely to underperform and be delisted; three and five year cumulative abnormal returns range between -20% and -75% for this age group. Between 8% and 18% of young firms delist before reaching their third IPO anniversary, in contrast only 2% of old and mature firms delist. The increasing number of young firms listed during the 80's and 90's, both on the Nasdaq and NYSE, accounts for the strong underperformance during that period. Given the small supply of young-small IPOs it is very plausible that investors seeking "the next Big Thing" overprice these "lottery like" securities and underestimate their failure probabilities, resulting in overall underperformance from this group. The second chapter establishes an important link between industrial economics and finance by exploring the effects of a firm's age on realized returns and firm fundamentals. Over four decades, Mature firms generated an excess return of 20 to 30 basis points after controlling for industry, size and book-to-market characteristics. A simple zero cost strategy that takes long positions in mature firms and short positions in young and old firms yields annualized returns of 5.38% and 5.60% or between 7.33% and 3.71% in excess to size and value portfolios. We decompose age, listing cohort, and year effects to analyze key firm fundamental characteristics related to growth, innovation, efficiency, liquidity, default risk, and profitability. Maturity decreases firms' default probability, earnings uncertainty, market illiquidity, and shortens the investment horizon. While innovation and growth opportunities decrease with time, profitability, dividend yield, and process efficiency increase with firm age. Firms in their mature stage enjoy growth, profitability, lower risk and offer higher returns. Finally, the third chapter presents arguments supporting rationality in the well known momentum effect. We find that the returns of different momentum deciles closely track a measure the rate of change in fundamental value calculated from analysts' earnings estimates. We also find that while past changes in fundamental value predict future stock returns, stock rates of return appear to predict subsequent changes in fundamental value, up to a year in the future. The ability of past returns to predict both future returns and future changes in fundamental value is consistent with heterogeneous expectations models of capital market equilibrium, where the expectations of informed investors create the apparent predictive ability of past returns. Since heterogeneous expectations models are consistent with rational behavior, if there is a significant irrational component to momentum, it is likely to deal with biases in the way analysts and investors form estimates of earnings and fundamental value.