The Aftermarket Performance of Initial Public Offerings in Pakistan

(ProQuest: ... denotes formulae omitted.)1. IntroductionQuestions pertaining to how initial public offerings (IPOs) behave over short and longer time horizons have generated considerable debate. The literature indicates that underwriters seem to underprice IPOs in the short run and that they underperform over longer time horizons. Researchers have constructed empirical as well as theoretical explanations to account for these anomalies. The consensus is that companies initially underprice their shares to promote goodwill for seasoned equity offers.Ritter and Welch (2002) find that the results of empirical studies are extremely sensitive to the methodology used to identify abnormal performance and the time horizon examined. Therefore, a broadly accepted theory of longer-term underperformance remains elusive. Generally, investors experience short-term abnormally positive performance when participating in unseasoned equity issuance and are exposed to longer-term underperformance (Jenkinson & Ljungqvist, 2001). However, IPOs' short-and long-run performance can vary from country to country.The underpricing of IPOs has been a pervasive phenomenon for decades. Banerjee, Dai and Shrestha (2011) find evidence of IPO underpricing in 36 countries; they report that underpricing is universal, but that the level of underpricing varies from country to country. Loughran, Ritter and Rydqvist (1994) give evidence of underpricing in 25 countries and argue that initial underpricing is lower in developed countries than in developing countries. This is particularly true for Asian markets (Moshirian, Ng & Wu, 2010).Examining longer-term underperformance, Ritter (1991) argues that, on average, IPOs underperform over a three-year period following issuance. Some studies have questioned the methodological and conceptual frameworks used to identify abnormal performance. Ritter (1991) applies and consequently devises different methodological approaches to overcome these shortcomings.1 Unfortunately, there is no consensus on which methodology provides the best estimate of longer-term underperformance (see Fama, 1998; Loughran & Ritter, 2000).In terms of IPOs' longer-term performance in developing markets, Sohail and Nasr (2007) report significantly negative market-adjusted abnormal returns (MAAR) over the one-year period following the initial offering in the Pakistani market. Sahoo and Rajib (2010) find that Indian IPOs underperform over the one-year period following the issuance of unseasoned equity shares, although investors who purchase the shares on the offering date benefit from abnormally positive performance.The performance of Pakistani IPOs over a longer time horizon is relatively unexplored. Accordingly, we examine the three-year performance-adjusted, size-based, matched-firm benchmark after listing, using a sample of 57 firms during the period 2000-10 to investigate whether IPOs generate abnormal performance over the short and long run.To test the sensitivity and robustness of the explanatory variables used to determine IPOs' longer-term performance, we conduct an extreme bounds analysis (EBA). We find that the average initial underpricing of IPOs was 32 percent over this time horizon, which implies that investors earned abnormal excess returns by participating in the new issues at the offering price and selling them at the listing price. Explanations for underpricing include information asymmetry, ex-ante uncertainty, underwriters' prestige, and signaling, but there is little agreement on whether a single hypothesis properly explains this phenomenon (Ritter & Welch, 2002).The study uses four different methods to test the robustness of IPOs' longer-term performance: (i) buy-and-hold abnormal returns (BHAR), (ii) cumulative abnormal returns (CAR), (iii) the Fama and French (1993) model, and (iv) the Carhart (1997) model using a size-based, matched-firm benchmark index. …