A Comparative Analysis of the Performance of Emerging V. Nonemerging Industry Initial Public Offerings
Finkle, Todd A., Lamb, Reinhold P., New England Journal of Entrepreneurship
This study fills a gap in previous research by investigating differences between the short- and long-run aftermarket performances in a sample of emerging v. nonemerging industries. Utilizing the entire population of biotechnology, semiconductor, and Internet IPOs from 1993-1996 as a representative sample of emerging industries, this study found that emerging firms were significantly underpriced compared to a set of nonemerging IPOs.
Small businesses receive their initial seed and startup capital from a variety of sources that include personal assets, venture capitalists, and lending institutions (Van Auken and Carter 1988; Van Auken and Doran 1990). Despite attracting outside money, these firms frequently fail because of a lack of sustained financial resources (Bruno, Leidecker, and Harder 1986; Peterson, Kozmetsky, and Ridgeway 1983). One way small firms can reduce their exposure to failure due to limited funding is through an initial public offering (IPO). Funds raised from an IPO provide a foundation of capital enabling the firm to finance research projects or rapid growth without regularly seeking additional funds for projects. The importance of this source of funds can be seen by the amount of IPO money raised from August 2000 to February 2001$21.438 billion. Almost 44 percent ($9.4 billion) went to technology companies (IPOMonitor.com 2001).
The purpose of this study is to examine the IPO period for emerging firms and their subsequent performance over a one-year period (Kazanjian and Drazin, 1990 classified an emerging industry as one in which the majority of firms are less than 15 years old). The results of the study will benefit future entrepreneurs of these companies who are considering taking their firms public by understanding the performance of emerging industry IPOs.
Much of the finance literature reports that many IPOs are underpriced. For example, one study finds the average abnormal return from the offering to the end of the first trading day is 14.1 percent (Ritter 1991). After the first month, abnormal returns remain significant at 11.4 percent (Ibbotson 1975). After three years, however, returns turn negative (-37.496). Offerings of smaller firms have lower abnormal returns after the first years than larger firms. Furthermore, younger firms, exhibit both higher initial abnormal returns and lower three-year abnormal returns than older firms going public. It, thus, appears that IPO% are first underpriced and then overpriced.
The phenomenon of underpricing occurs when the initial offering price for a stock is below the closing price for stock at the end of the first day of trading. In addition to the finance literature, entrepreneurship research also recognizes the linkage between equity financing and financial performance (see Prasad, Vozikis, Bruton, and Merikas 1995; Bruton and Prasad 1997).
This study fills a gap in previous research by focusing on the biotechnology, semiconductor, and Internet industries as a representative sample of emerging industries. The importance of emerging industries has received widespread attention. Kazanjian and Drazin (1990); Barley, Freeman, and Hybels (1992); Powell, Koput, and SmithDoerr (1996); Deeds, DeCarolis, and Coombs (1997); Finkle, (1998); Stuart, Hoang, and Hybels (1999) and Zahra and Bogner (2000) report on various aspects of emerging industries. Little attention, however, has been focused on the underpricing and after-market performance of IPOs within emerging industries.
Utilizing a set of 169 emerging industry IPOs (the entire population of biotechnology, semiconductor, and Internet IPOs from 1993-1996) and a comparison set of 100 nonemerging IPOs that went public during the same time period, the following questions are addressed:
To what degree does underpricing exist within emerging industry IPOs?
Do emerging industry and nonemerging IPOs behave differently during the first trading day?
Do emerging industry and nonemerging IPOs behave differently during the first trading year? …