Fads in the Initial Public Offering Market?

Abstract

m Early research related to initial public offerings (IPOs) documented the tendency of IPOs to provide abnormal returns to investors who purchased them at the initial offering (Reilly and Hatfield [27] and Stoll and Curley [33]). Refinements and extensions followed, including efforts to explain the variation in abnormal returns across firms and underwriters (Johnson and Miller [16] and Miller and Reilly [22]). Information asymmetry, legal liability, and signaling theories have also been incorporated into IPO related research (Allen and Faulhaber [1], Baron [4], Rock [30], and Tinic [35]). In general terms, there are two possible explanations for these abnormal returns. The most widely held view is that IPOs are underpriced at the initial offering. A second possibility, however, is that IPOs are not priced at intrinsic values in early aftermarket trading. Financial researchers have traditionally adhered to the first explanation (underpricing) rather than the second (aftermarket inefficiencies). For example, Tinic [35] considers the possibility that speculative bubbles exist in the IPO market but writes that ... there is no empirical evidence that supports such a pattern ... [p. 792]. However, there has been little comprehensive empirical analysis of the aftermarket price behavior of IPOs. The overwhelming majority of IPO related research has focused on price behavior in the days or weeks following the offering. Aftermarket efficiency has been supported because there are typically no abnormal returns for investors purchasing in the aftermarket. However, the short time periods studied do not allow for more comprehensive examination of price behavior. This research was partially supported by research grants from the U.S. Small Business Administration and Georgetown University. The extensive research assistance of Mr. Kamran Bakr is gratefully acknowledged. Professors Dennis Logue, Lemma Senbet, Richard Sweeney, Donald Tuttle, David Walker, and participants at the SEC workshop provided helpful comments. We have also benefitted from the critiques of four anonymous reviewers and the editor. Finally, we are grateful to the many investment bankers who answered our questions for this and related research.