Academic journal article Academy of Accounting and Financial Studies Journal

Performance of Emerging and Non-Emerging Industry Initial Public Offerings

Academic journal article Academy of Accounting and Financial Studies Journal

Performance of Emerging and Non-Emerging Industry Initial Public Offerings

Article excerpt

INTRODUCTION

The two ways firms can raise capital include debt and equity financing. One form of equity financing involves offering the firm's stock for sale to the public for the first time. This is commonly referred to as going public or an initial public offering (IPO). IPOs can be an important and fresh source of funds for firms. The initial performance of IPOs up to one year has been the focus of most IPO studies. The high initial returns of IPOs have puzzled finance researchers for decades.

Studies on IPOs have shown that IPOs perform well during the initial day or days of trading. However, IPOs underperform in the long run or 3 to 5 years. This idea of IPO underpricing is a phenomenon that researchers have tried to explain. Underpricing occurs when the initial offering price for a stock is below the closing price for the stock at the end of the first day of trading (Finkle and Lamb, 2002). Most finance literature on IPOs shows that on average most IPOs are underpriced. In fact, US IPOs have enjoyed an 18% first day return over the last several decades causing firms to "leave a considerable amount of money on the table". There have been several explanations cited as to why IPOs are underpriced. Uncertainty surrounding the IPOs is one reason frequently cited as an explanation for the underpricing phenomenon (Johnston, 2000), which leads to high abnormal returns on the first day due to the risk. An agency problem and the existence of investment banker asymmetric information are also possible explanations for the underpricing phenomenon.

The purpose of this study was to extend previous research by investigating the aftermarket performance up to one year for IPOs in emerging and non-emerging industries while controlling for the effect of hot vs. cold markets. Finkle and Lamb (2002) defined an emerging industry as one in which the majority of firms are less than 15 years old. This study utilizes a sample of 40 firms (20 from an emerging industry and 20 from a non-emerging industry) that went public 1996-2012 to address the phenomenon of underpricing for emerging and non-emerging industry IPOs. Similar to the study conducted by Finkle and Lamb (2002), this study will address the following questions:

   Does underpricing exist within emerging and non-emerging industry
   IPOs and to what degree? Do emerging and non-emerging IPOs exhibit
   different aftermarket performance behavior up to one year following
   going public?

If the results show that the emerging industry IPOs are significantly more underpriced compared to the non-emerging industry sample while controlling for hot vs. cold markets, then emerging industry IPOs could be relatively more risky than non-emerging IPOs and thus would support a higher premium for investors.

LITERATURE REVIEW

Emerging Vs. Non-Emerging IPO Performance

This study expands the IPO literature by analyzing and comparing emerging vs. non-emerging short-run return performance up to 1 year after the IPO and in a more controlled setting than in previous research. Specifically, unlike previous studies, this study controls for the extraneous effect of hot vs. cold markets on the observed IPO return performance of emerging vs. non-emerging IPOs.

Lamb and Finkle (2002) found evidence of under-pricing in their study of emerging and non-emerging industry IPOs during hot markets and the results showed that the average return at the end of the first day of trading was higher for emerging firms than for non-emerging firms. Stated differently, investors perceived emerging industries as having more risk than non-emerging industries. This study extends the work of Finkle and Lamb (2002) by focusing on the short-term post IPO performance and by controlling for the effect of hot vs. cold markets. High investor optimism during hot markets may explain significant under-pricing of IPOs observed in previous studies (Helwege and Liang, 2004). …

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