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...'window opportunity' provided excessive demand to offer and list their shares. In IPOs prior to the 1987 crash, underpricing is very high while there is a strong reversion to fundamentals in the long run. In the period 1988-2004, we find lower IPO underpricing and overall no evidence of long-run underperformance of IPO firms. Bookbuilding IPOs are more underpriced than other price setting systems IPOs, and firms with seasoned public offerings show abnormal returns in the long run.
Keywords hot-issue markets * IPO * investor sentiment * underpricing
JEL G10 * G12 * G14
Introduction
The issue of underpricing in Initial Public Offerings (IPO) has been a rich field for investigation in the financial community, especially during the last decade. However, the debate is now 30 years old dating to Ibbotson (1975) documenting how when companies go public their shares tend to be sold underpriced in that prices tend to rise during the first day of trading. A related line of investigation, which started with Ibbotson and Jaffe (1975) and Ritter (1984), has been the study of IPO timing, with the purpose of identifying the reasons behind large concentrations of IPOs in certain periods (hot markets) while in other periods IPO activity falls sharply (cold markets). The contribution of this paper is to present the case of the Portuguese market in recent years, adding to international evidence of IPO underpricing in emerging markets, before further adding to the hot/cold market and investor sentiment debate, by analyzing the 'hot issue' market of 1986-1987, with its unprecedented volume of IPO activity within the context of a speculative stock market bubble.
The paper is organized as follows. In the next section, we present a review of the literature with a focus on the IPO underpricing phenomena and on the 'hot issue' market and investor sentiment approach. In the third section, we document the Portuguese market and IPO activity in the last 20 years. The fourth section presents the data, results and discussion of the Portuguese 'hot issue' market of 1987 and of IPO activity between 1998 and 2003, dealing particularly with the issues of underpricing and long-run performance. The final section provides conclusions.
A Review of the Literature
The Regularity of IPO Underpricing
In the United States, several studies, including Ritter (1984, 1991), have confirmed the phenomenon of IPO underpricing. Since the 1960s, the price discount has averaged around 19%, but with considerable fluctuations, averaging 21% in the 1960s, 12% in the 1970s, 16% in the 1980s, 21% in the 1990s and 40% in the 4 years since 2000 (Ljungqvist, 2005) The level of underpricing was even stronger in the late 1990s and in the first years since 2000, coinciding with the Internet IPO boom. This is puzzling when we consider the fact that underpricing has been very costly to company owners, in that the 'money left on the table' amounts to billions of dollars. As an extreme example, in 1995, the Netscape IPO was underpriced by 108% and left 174 million dollars 'on the table'. Ritter (1998) argues that issuers fail to 'get upset' about leaving millions of dollars 'on the table' because they simultaneously receive the good news of a perceived increase in wealth, resulting from the jump in price of the retained shares in the aftermarket relative to the offer price.
IPO underpricing is also a widespread regularity as the vast majority of international studies have confirmed. Loughran, Ritter and Rydqvist (1994) confirm this underpricing phenomenon by reviewing more than 30 studies in 25 countries, with higher underpricing in developing than in developed markets. Another study by Huang and Levich (2003) finds that the initial returns for non-OECD countries average 65.9% while for OECD countries initial returns average 11.1%. Chinese IPOs of A-shares exhibit an underpricing of 948.6% (Su & Fleisher, 1999.)
In the United States, fixed price offerings tend to be more underpriced than book-building offers (Ljungqvist Jenkinson & Wilhelm 2003; Ritter, 2003). Some international evidence contrasts, with auction IPOs less underpriced than bookbuilding IPOs in France (Derrien & Womack, 2003) and in Japan (Kutsuna & Smith, 2000).
The evidence on IPOs for state-owned firms is consistent with that on privately-owned firms, also revealing underpricing (Jenkinson & Mayer, 1988; Perotti & Guney, 1993; Vickers & Yarrow, 1988). Dewenter and Malatesta (1997) explicitly compare state-owned IPOs with privately-owned IPOs in eight countries including both well-developed capital markets (Canada, France, Japan, and the UK) and less-developed capital markets (Hungary, Malaysia, Poland, and Thailand) and do not find significant differences in the degree of underpricing between the two types of firms, except in the UK, where privatizations were more underpriced. They also find that underpricing tends to be higher in regulated industries, when compared with unregulated industries, before again confirming that underpricing is more severe in less developed capital markets.
The 'Hot Issue' Market and Investor Sentiment
Another field of investigation is related to the timing of such flotations. These tend to be concentrated in some periods (hot market) while in other periods there are few firms going public (cold market). Hot markets are further identified by severe underpricing, large oversubscription of offerings and, occasionally, large concentrations in particular industries. Contrastingly, cold markets also demonstrate less underpricing and fewer instances of oversubscription. Lowry and Schwert (2002) show that IPO volume tends to be higher following periods of high initial returns and suggest that this link is driven by information learned during the registration process, as more positive information leads to higher initial returns for those offerings and more companies deciding to go public. Loughran et al. (1994) point to a clear tendency for high volume to be associated with market peaks.
Early explanations for hot and cold markets were that firms were drawn into hot markets because offering prices are closer to true valuations, thus avoiding the undervaluation of cold markets (Grinblatt & Hwang, 1989; Welch, 1989). More recently, some theories support the idea that hot markets are characterized by clusters of firms from specific industries for which a technological innovation or positive productivity shock has occurred. When the first offerings are successful, other firms in the same industry tend to follow (Benveniste, Busaba, & Wilhelm 2002; Stoughton, Wong, & Zechner 2001).
In another direction, Helwege and Liang (2004) suggest that technological innovations are not the primary determinant of hot markets, because IPO cycles are more volatile than the lifecycles of nascent industries, and favor the view that hot...
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