Tim Loughran

Initial public offerings: International insights

Abstract This paper discusses evidence on the short-run and long-run performance of companies going public in many countries. Differences in average initial returns are analyzed in terms of binding regulations, contractual mechanisms, and the characteristics of the firms going public. The evidence suggests that the move in recent years by most East Asian countries to reduce regulatory interference in the setting of offering prices should result in less short-run underpricing in the 1990s than in the 1980s. Evidence is presented that companies successfully time their offerings for periods when valuations are high, with investors receiving low returns in the long-run. Implications for investors, issuers, and regulators are discussed.

Uniformly Least Powerful Tests of Market Efficiency

Defenders of market efficiency argue that anomalies involving long-term abnormal returns are not robust to alternative methodologies. We argue that because various methodologies use different weighting schemes, the magnitude of abnormal returns should differ, and in a predictable manner. Three problems are identified that cause low power in value-weighted three-factor time series regressions when abnormal returns following managerial actions are being estimated. We illustrate the sensitivities in the context of the new issues puzzle as well as with simulations. More generally, multifactor models as currently used do not, and cannot, test market efficiency.

Book-to-Market across Firm Size, Exchange, and Seasonality: Is There an Effect?

Fama and French (1992) report that size and the book-to- market ratio capture the cross-sectional variation of average stock returns for the universe of NYSE, Amex, and Nasdaq securities. This paper, in providing an exhaustive exploration of book-to-market across the dimensions of firm size, exchange listing, and calendar seasonality, reports that Fama and Frenchs empirical findings are driven by two features of the data: a January seasonal in the book-to- market effect, and exceptionally low returns on small, young, growth stocks. In the largest size quintile of all firms (accounting for 73% of the total market value of all publicly traded firms), book-to-market has no significant explanatory power on the cross-section of realized returns during the 1963-1995 period. Thus, book-to-market as such would have less importance to money managers than the literature would have led us to believe.

Discounting and Clustering in Seasoned Equity Offering Prices

An analysis of 4,814 SEOs during 1986–1999 indicates that the average offering ofnew shares is priced at a discount of 3% from the closing price on the day before the issue. Discounts have risen steadily over time, sharply increasing the indirect costs of issuing seasoned equity. There is evidence of increased clustering of offer prices at integers, and of greater importance in the analyst coverage provided by underwriters. Adjusting for other factors, we find that issues with integer offer prices, and underwriters with highly regarded analysts, are increasingly associated with larger discounts. The rise in discounts is consistent with an increased ability of investment bankers to extract rents from issuing firms.

NYSE vs NASDAQ returns: Market microstructure or the poor performance of initial public offerings?

Abstract Reinganum (1990) reports that small NYSE securities have average returns about 6% per year higher than those of similarly-sized NASDAQ securities during the 1973–1988 period. He attributes the return differential to market microstructure differences. In contrast, this paper demonstrates that differences in the characteristics of the companies listed on the two exchanges explain much of the disparity. About 60% of the return differential can be attributed to the poor performance of recent initial public offerings, which comprise a large portion of the firms on NASDAQ. On average, IPOs underperform during the six calendar years after going public.

Three analyses of the firm size premium

Abstract The size premium for smaller companies is one of the best-known academic market anomalies. The relevant issue for investors is whether size premium for small-cap stocks is still positive, and, if so, whether its magnitude is substantial. In our analysis, we use annual compounded returns, monthly cross-sectional regressions, and linear spline regressions to investigate the relation between expected returns and firm size during 1980–1996. All three methodologies report no consistent relationship between size and realized returns. Hence, our results show that the widespread use of size in asset pricing is unwarranted.

Performance following convertible bond issuance

Abstract Using a sample of 986 convertible bond issuers of U.S. operating companies during 1975–1990, we document poor stock and operating performance in the years following the offering. The underperformance of stock returns cannot be explained by new issues activity (recent initial public offerings (IPOs) or seasoned equity offerings (SEOs)) or the level of the proceeds. Concurrent with the low subsequent stock returns, we document a rapid decline in the operating performance of the issuers following the offering. Profit margin and return on assets for the issuers are approximately halved in the four years after the convertible bond issue.

Cash Flow Is King? Cognitive Errors by Investors

When investors fixate on current earnings, they commit a cognitive error and fail to fully value the information contained in accruals and cash flows. Extending the accrual anomaly documented by Sloan [1996], we identify significant excess returns from a cash flow-based trading strategy. The market consistently underestimates the transitory nature of accruals and the long-term persistence of cash flows. We find that the accrual anomaly derives from the poor performance of high accrual firms, which are more likely to manage earnings. Combining the accrual and cash flow information also reveals that investors misvalue the quality of earnings. Contrary to Fama [1998], these anomalies are robust to the three-factor model with equally or value-weighted portfolio returns.

The performance of Japanese seasoned equity offerings, 1971–1992

Abstract Japanese firms conducting 1389 seasoned equity offerings during 1971–1992 significantly underperform various benchmarks over a subsequent 5-year period. This poor stock performance is accompanied by a deterioration of the matching-firm adjusted operating performance. Neither Keiretsu affiliation nor ownership structure can explain the poor performance by issuing firms. In contrast to evidence from the U.S., cross-sectional variation of post-issue performance changes is not related to the level of agency costs prior to the issue. Our results from the Japanese financial markets are inconsistent with an agency explanation for the new issues puzzle.

Commonality in Codes of Ethics

We create a database of company codes of ethics from firms listed on the Standard & Poor’s 500 Index and, separately, a sample of small firms. The SEC believes that “ethics codes do, and should, vary from company to company.” Using textual analysis techniques, we measure the extent of commonality across the documents. We find substantial levels of common sentences used by the firms, including a few cases where the codes of ethics are essentially identical. We consider these results in the context of legal statements versus value statements. While legal writing often mandates duplication, we argue that value-based statements should be held to a higher standard of originality. Our evidence is consistent with isomorphic pressures on smaller firms to conform.