We review the theory and evidence on IPO activity: why firms go public, why they reward first-day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective is threefold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phenomena.

This paper addresses the agency problem between controlling shareholders and minority shareholders. This problem is common among public firms in many countries where the legal system does not effectively protect minority shareholders against oppression by controlling shareholders. We show that even without any explicit corporate governance mechanisms protecting minority shareholders, controlling shareholders can implicitly commit not to expropriate them. Stock prices of such companies are significantly higher and firms are more likely go public because of this reputation effect. Moreover, insiders divest shares gradually over time, at a rate that is negatively related to the degree of moral hazard. RECENT EMPIRICAL RESEARCH INDICATES THAT in many countries the relevant corporate finance issue is not the traditional agency problem between management and shareholders, but rather the agency problem between the controlling shareholders and the minority shareholders. This problem may arise in some countries for two reasons: ~1! the corporate governance structure of public

IPO initial returns reached astronomical levels during 1999-2000. We show that the regime shift in initial returns and other elements of pricing behavior can be at least partially accounted for by a variety of marked changes in pre-IPO ownership structure and insider selling behavior over the period, which reduced key decision-makers ’ incentives to control underpricing. After controlling for these changes, the difference in underpricing between 1999-2000 and the preceding three years is much reduced. Our results suggest that it was firm characteristics that were unique during the “dot-com bubble ” and that pricing behavior followed from incentives created by these characteristics.

This paper explores the role of investment bankers and lock-up provisions in the market for new equity issues. In a sample of 1,948 IPOs, we find support for the notion that lock-ups serve as commitment mechanisms at the time of the IPO. Insiders of firms that are associated with greater informational asymmetries lockup their shares for a longer period of time. We also find that underpricing is higher for firms that lock-up their shares for a longer period of time or lock-up a larger fraction of their shares. The average abnormal return at lock-up expiration is-1.2 % on average and is larger for firms that lock-up a greater fraction of their shares and firms that are backed by venture capitalists. This price drop is inconsistent with rational expectations on the part of investors. Finally, we find that earnings forecasts made by both affiliated and unaffiliated analysts are more optimistic around lock-up expiration and their recommendations are temporarily more favorable. Moreover, affiliated analysts are more likely to issue “strong buy ” recommendations than are unaffiliated analysts at these lock-up expirations.

We are grateful for helpful discussions with David

Our model of the initial public offering process links the three main empirical IPO ‘anomalies’ – underpricing, hot issue markets, and long-run underperformance – and traces them to a common source of inefficiency. We relate hot IPO markets (such as the 1999/2000 market for Internet IPOs) to the presence of a class of investors who are ‘irrational’ in the sense of having exuberant expectations regarding future performance. Underpricing and long-run underperformance emerge as underwriters attempt to maximize profits from the sale of equity, at the expense of these exuberant investors. Underpricing serves to compensate regular IPO investors for their role in restricting the supply of available shares and maintaining prices. The model is shown to be consistent with many aspects of the IPO process. It also generates a number of new empirical predictions.

We find that dual-class firms experience less underpricing than single-class firms, and we explore several hypotheses which might explain this phenomenon. Compared to single-class firms, dual-class companies have slightly higher post-IPO institutional ownership and experience fewer control events. Although dual-class firms achieve a lower underpricing cost, they trade at lower prices relative to earnings and sales than do single-class IPOs. This pricing differential, combined with evidence that dual-class managers earn higher compensation and that dual-class shares are common among media and entertainment industry IPOs, suggests that dual-class ownership structures protect private control benefits.

A simple model is developed in the paper in which two market conditions change over time: (i) investor sentiment or price-insensitive demand; and (ii) feedback trader risk or the propensity of investors to chase trends. The model shows that these conditions partially explain the three anomalies associated with the IPO market: (i) underpricing; (ii) windows of opportunity for new issues and (iii) long-term underperformance. The model is tested using a sample of firm commitment IPOs over the 1975-1987 period. The paper finds that the predictions of the model are largely borne out in the data. 1 We thank Jay Ritter and Mike Vetsuypens, and I.B.E.S. for allowing us to use their database.

The literature on IPOs offers a wide variety of explanations to justify the dramatic swings in the volume of IPOs observed in the market. Many theories predict that hot IPO markets are characterized by clusters of firms in particular industries for which a technological innovation has occurred, suggesting that hot and cold market IPO firms will differ in quality, prospects, or types of business. We compare firms that go public in the two types of markets from 1982-93, examining them at the time of the IPO and in the following five years. We find that both hot and cold market IPOs are largely concentrated in the same narrow set of high-tech industries. We also find few distinctions in quality or long-term earnings potential. Our results are not consistent with the going public models that imply cold market IPOs are firms with few product innovations and lower growth prospects. Jean Helwege Department of Finance Ohio State University 812 Fisher Hall 2100 Neil Avenue Columbus, OH 43210 (614) 292-3217 (614) 292-2418 FAX helwege_1@cob.osu.edu Nellie Liang Board of Governors of the Federal Reserve System Division of Research and Statistics Capital Markets Section Mail Stop 89 Washington, DC 20551 (202) 452-2918 (202) 452-3819 FAX nliang@frb.gov For example, Ritter (1984) shows that most of the underpricing in the hot issue market of 1980-1981 is attributable to underpricing among IPOs in the natural resources sector. Also, see Lowry and Schwert (2000) on the relationship between underpricing and volume in hot and cold markets, as well as James and Krieshnick (1997).

This paper examines the potential for external conflicts in large, diversified business groups. On one hand, these groups are highly visible, facilitating the detection of opportunistic actions. Accordingly, reputation concerns should effectively constrain group behavior. On the other hand, these groups are highly complex, making it difficult for outsiders to unveil group strategies from among a myriad of transactions. This complexity should limit the power of reputation concerns to constrain actions. We use data on IPO initial returns to evaluate the trade-off between visibility and complexity. The evidence suggests that complexity dominates visibility, providing scope for opportunistic behavior against outside investors.