how large is the premium on expected rate of return for...
TRANSCRIPT
How large is the premium on expected rate of return
for Initial Public Offer firms? †
Asher Curtis
School of Accounting
University of New South Wales
Sydney, NSW, Australia 2052
Email: [email protected]
Julian Yeo
Columbia Business School
Uris Hall, 3022 Broadway, Room 607
New York, NY 10027
Email: [email protected]
This Draft: April 2006, Preliminary
Comments welcome
† This paper was undertaken while Asher Curtis was a PhD student at the University of New South Wales. Asher gratefully acknowledges the financial support received from the CPA/ICAA/AFAANZ Doctoral Fellowship and the Faculty of Commerce and Economics Doctoral Fellowship.
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How large is the premium on expected rate of return
for Initial Public Offer firms?
ABSTRACT
We examine the expected rate of return and expected growth premia implied by price,
book value, and forecast earnings for firms that recently engaged in an Initial Public
Offering (IPO) relative to more seasoned firms. We document that on average the
expected rate of return and expected growth IPO premia are 3.51% and 4.74%
respectively. We then examine how quickly IPO firms converge to more seasoned firms
in terms of the average expected rate of return and expected growth. We document a
monotonic decline in the premia over the first five years following the IPOs listing, with
both premia falling below 1% by the fifth year after listing. Finally, we examine the
cross-sectional variation in the IPO premia, we find limited variation with the relative age
of the IPO firm and the relative level of analyst coverage, instead, we find that IPO
premia vary significantly with prior profitability.
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1. Introduction
Many firms that undertake an Initial Public Offering (IPO) list at prices that seem
unjustified by accounting fundamentals. Within a valuation model, it is expected that
firms with high market values relative to their underlying fundamentals will be highly
profitable in the future. In other words, the growth rate that is applied to truncated
payoffs must be high when the difference between price and payoff is large. So, at what
rate is an IPO firm expected to grow? Even with a high degree of uncertainty regarding
future earnings and earnings growth, investors are expected to quickly learn about the
valuation of the IPO firm subsequent to its initial listing. In this study, we first document
the level of the expected rate of return and expected growth premia implied by price,
book value, and forecast earnings for firms that recently engaged in an Initial Public
Offering (IPO) relative to more seasoned firms. We then track these premia for a set of
IPO firms over their first five years post-listing. Contrary to expectations, our results
show that IPO firms do not quickly converge towards the expected rates of returns and
expected growth rates of more established firms. Instead, we show that IPO premia
remain for up to four years post-listing, suggesting that the premia are long-lived.
The premium attached to the pricing of an IPO firm’s fundamentals, through higher
expected rates of return and expected growth, relative to more mature firms raises
interesting implications. It is well known in psychology that individuals often place a
higher probability judgment on the persistence of unlikely events (from any given
distribution) as individuals hold a tendency to anchor to prior events even though these
prior events may be ‘outliers’ (Kahneman and Tversky, 1982). Given that many IPO
firms experience high profitability prior to listings (e.g. Jain and Kini, 1994; Teoh, Welch
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and Wong, 1998), our results are consistent with such psychological biases, as we find
that the market prices recent IPOs in a manner that is consistent with the IPO growing at
rates that are inflated for a significant period of time after listing. In turn this allows for
inflated price relative to fundamentals to persist for an extended period (e.g. Jain and
Kini, 1994).
In our estimation procedure, we relate prices to the combination of book value,
future earnings, expected growth, and expected rates of return. We regress price to book
ratios with forecasted ROE to derive our implied estimates of the expected rate of return
and growth for a portfolio of firms. Our estimation procedure is analogous to studies that
invert the residual income model to infer the implied expected rate of return from prices,
book values, and forecasts of earnings (Easton, Taylor, Shroff, and Sougiannis, 2002).
We begin by estimating the implied expected rate of return and growth premium
simultaneously for a sample of both recent initial public offer (IPO) firms and relatively
more seasoned firms. We expect that as IPO firms are often young, with limited
accounting information, the market will attach a high growth expectation to these firms
relative to their short-term earnings forecasts. Consistent with this prediction, we find
that recent IPO firms have on average a premium of 4.45% in expected growth and an
implied return premium of 3.35%. This premium is not based on the listing price, but the
price at the end of the first complete fiscal year following listing. This distinction is
important for two reasons. First it implies that IPO premia are not removed immediately
following the IPO firm listing on the market, but rather are still present at their first fiscal
year-end after listing. Second it allows us to use book-values that incorporate the
proceeds of the issue. We find that the expected rate of return premium is significant for
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all years from 1983 through to 1998; however, we do not find evidence of an IPO
expected rate of return premium from 1999 onwards. This is an interesting result as it
suggests that there was a major market shift in the pricing of IPOs just before the burst of
the ‘bubble’ and following the recent financial market ‘bubble’ period.
Second, we examine the duration of the expected rate of return premium. We expect
that following the listing of the firm on the market, the IPO premium will decline as the
recent IPO firm becomes a relatively more seasoned firm.1 Consistent with this view, we
show that the IPO premium monotonically declines in the years following the listing of
the IPO firm. Specifically, by the fifth year after listing, we find that the implied rate of
return and expected growth of a surviving IPO firm is similar to that of a relatively more
seasoned firm. This result is interesting, as it documents a relatively slow convergence in
the pricing of IPO firms and their seasoned counterparts.
Third, we examine whether the IPO premia vary in the cross-section due to variation
in the age of the IPO firm since its incorporation. It is often assumed that as a firm
matures, that firm will be priced increasingly using its assets in place relative to expected
growth available from future investment decisions. By comparing the relatively younger
and relatively older IPO firms, we find that the difference in the implied rate of return is
only 0.22%. This result is consistent with the listing of the firm being the driver of the
IPO premia rather than the age of the firm.
Finally, we examine two other potential confounding factors, the relative analyst
coverage of IPO firms following their listing and the prior year’s actual return on equity.
We find only marginal differences in terms of relative analyst coverage. For prior period
1 Such a result could be seen as consistent with the increasing importance firm valuation based on assets in place relative to future investment options as the firm matures (e.g. Hand, 2005).
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profitability however, we find a substantial difference in the level of the IPO premia. but
a substantial increase in the IPO premia for relatively more profitable IPO firms. This
result is consistent with the investors attaching significantly inflated premia to potentially
unstable earnings. Overall, our results suggest that IPO firms list with, and for an
extended period post-listing maintain, a significant premium in the pricing of their
fundamentals.
The reminder of this paper is set out as follows. In section 2, we describe our
estimation procedure and our predictions. In section 3, we describe the data. In section
4, we discuss our empirical findings. We discuss further analyses performed in section 5
and we provide a conclusion in section 6.
2. Estimation procedure and predictions
In this section we discuss our valuation framework, from which we estimate expected
growth, expected rates of return, given consensus forecasts of earnings, market prices and
book-values. Market prices can be linked to accounting book values and earnings under
the no arbitrage assumption and clean surplus accounting as:
( ) [ ]tttt
ttt rBXErBP −++= +
∞
=
+−∑ 10
11 (1)
where, P0, is the market price per share at time 0, B0, is the book value per share at time 0,
E0, is the expectation operator with expectations conditional on the information available
at time 0, r, is the expected rate of return on equity, Xt+1, is the comprehensive earnings
per share for fiscal period t to t+1, and [Xt+1 – rBt] is the residual earnings per share for
period t-1 to t.
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To simultaneously estimate r and the growth rate g that are implied by market prices,
Easton, Taylor, Sougiannis and Schroff (2002) assume that a perpetuity of future residual
earnings discounted at a rate of return r, less expected growth, g, can be combined with
book-value to equal price. Using one-period ahead earnings, we modify the Easton et al.
(2002) approach to consider the following relation between price and residual income:
[ ] ( )grrBXBP tttt −−+= + /1 (2)
Rearranging equation (2) and deflating by book value per share yields:
001001 BPBX γγ += (3)
where, g=0γ and gr −=1γ . The linear relation in equation (3) suggests that the
(average) expected rate of return and growth rate may be estimated from the intercept and
the slope coefficient. Following Easton et al. (2002), an error term is added in equation
(4) to account for (i) the measurement error in our dependent variable (our use I/B/E/S
forecast of earnings to proxy for one-period ahead earnings) and (ii) firm-specific random
components of r and g estimates. The linear regression in equation (4) can be performed
for a portfolio of J firms such that the constant terms and coefficients may be regarded as
the mean of the firm-specific r and g for the portfolio of J firms.
jtjtjtjtjt eBPBX ++=+ 101 γγ (4)
where the average implied expected rate of return, r, is calculated as (γ0 + γ1) and the
average expected growth rate, g, is equal to γ0.
2.1 Estimating the IPO premia
The parameters of equation (4) allow us to identify the means of the implied expected
rate of return and the expected growth for the portfolio of firms selected. By adding
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indicator variables to equation (4) we can estimate differences in r and g for a subset of
firms within the sample. We use this technique to identify the implied rate of return and
expected growth premia for IPO firms, relative to more seasoned firms. We use the
following specification, which includes an indicator variable δ to identify recent IPO
firms and to estimate the premia for both r and g implied by the market prices of recent
IPO firms. To estimate the premium for an IPO firm we consider the following method:
{ } jtjtjtjtjtjtjtjtjt eBPBPBX ++++=− δγδγγγ 32101 (5)
where in this case, the δ is an indicator variable taking the value of unity when the IPO of
firm j occurred during the fiscal year t-1 to t. In equation (5), the implied rate of return for
the average IPO firm is (γ0 + γ1 + γ2 + γ3) with the IPO firm premium calculated as (γ2 +
γ3). Similarly, the implied level of expected growth for IPO firms is calculated as (γ0 + γ2)
with the IPO firm premium calculated as γ2.
2.2 Tracking the IPO premia over time
We are also interested in estimating whether the premium persists after the firm has
been listed for a number of years. We adapt equation (5) to include multiple indicator
variables that identify firms who have undertaken an IPO within the last 5 years. Our
adapted specification includes indicator variables δjt-i to identify recent IPO firms that
have occurred within each of the last t-i years. This allows us to estimate the premia for
both r and g implied by the market prices of recent IPO firms up to five years after the
firms’ IPOs. Specifically, we estimate the following model:
{ } jti
jtjtijtiijtijtjtjtjt eBPBPBX ++++= ∑=
−−−
5
1101 δφδλγγ (6)
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where, the δ is an indicator variable taking the value of unity when the IPO of firm j
occurred during the fiscal year t-i to t-i+1. The IPO premia are then calculated from
equation (6) as follows. The estimate implied rate of return premium, for each year after
the year of the IPO, is calculated as (λ + φ) and the expected growth premium is equal to
λ. Similar to the model in equation (5), we estimate the IPO premia relative to more
mature firms. In this case however, we estimate the IPO premia for each year up to five
years out from the IPO, such that the definition of relatively more mature firms changes
to firms who have been listed for more than 5 years. The benefit of this method is that it
allows us to calculate premia for recent IPO firms based on the current relation between
price and fundamentals.
2.2 Cross-sectional variation in the IPO premia
We are also interested in examining whether the IPO premia vary in the cross-
section based on the age of the firm, the level of analyst coverage or prior profitability.
For each of these cases we can estimate the IPO premia by splitting the IPO firms into
two groups that are based on the yearly medians of the variables of interest. This provides
us with two groups of IPO firms per year.2 We then estimate the two sub samples of the
IPO firm premia using the following adapted version of equation (5):
{ } { } jtjtjtjtjtjtjtjtjtjtjtjtjt eBPBPBPBX ++++++=− 2,32,32,22,21,31,31,21,2101 δγδγδγδγγγ (7)
Where δ is an indicator variable taking the value of unity when the IPO of firm j occurred
during the fiscal year t-1 to t and is either in the group of recent IPO firms that listed
below the yearly median (denoted with a subscripts 2,1 and 3,1) or the group of recent 2 We only sort into two groups as in some years that number of IPOs with available data may make the groups exceedingly small.
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IPO firms that listed above the yearly median (denoted with a subscripts 2,2 and 3,2). The
implied rate of return for the average IPO firm that lists above the median, for example, is
( 2,32,210 γγγγ +++ ) with the IPO premium portion calculated as ( 2,32,2 γγ + ). Similarly,
the average level of expected growth for IPO firms is calculated as ( 2,20 γγ + ) with the
premium calculated as 2,2γ . For the group below the median, we calculate these measures
in the same manner but we use the coefficients with the subscript 1. It is important to note
that these models identify the IPO premia for the two groups relative to the more mature
firms, not relative to each other. In the following section, we describe the data and sample
that we use to test our models.
3. Data and sample
3.1 Sample selection
To calculate the implied IPO rate of return premium we require firms to have a
positive book-value and a positive one-year ahead forecast of earnings. This is because
growth from negative payoffs is economically meaningless. We use analysts’ consensus
forecasts of earnings per share collected from I/B/E/S files for the period between 1982
and 2003. We obtain book value of equity (Compustat data item 6), price at fiscal year-
end (Compustat data item 199), and number of shares outstanding (Compustat data item
25) from Compustat Annual primary, secondary, tertiary and full coverage research files.
The relevant forecasts are the consensus I/B/E/S forecasts released prior to the fiscal year
end. Using December year-end as an example, these forecasts are made on the 3rd
Thursday of December. We delete firms with non-December fiscal year-ends so that the
implied expected rate of return and growth rate are estimated at the same point in time for
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each firm-year observation. For each set of tests, firms with any of the dependent or
independent variables for that year in the top or bottom one percent of observations are
winzorised to reduce the effects of outliers.
We gain our listing dates and the age of the IPO firm from the data provided by Jay
Ritter at his website (http://bear.cba.ufl.edu/ritter/). We start tracking the premium from
the first-year after the listing date through to five years following the listing. We do not
however, require that the IPO remains listed for the duration of our tests.3 By
construction we exclude many of the smaller IPO firms from our tests as our sample is
limited to those firms covered by I/B/E/S.
3.2 Sample description
In Panel A of Table 1 we report descriptive statistics for our sample IPO firms and
control firms. We identify a sample of 4,632 recent IPO firms (based on the year of the
IPO being one-year prior to the fiscal year end) during the period 1982-2003 and we have
a sample of 52,363 firm year observations for our relatively more mature firms. Our
sample IPO firms have a higher one-year ahead forecast earnings to book ratio (mean =
20.4%, median = 17.5%) relative to the more mature sample (mean = 17.2%, median =
14.8%). The recent IPO firms also have a much higher price to book ratio (mean = 4.21,
median = 2.47) relative to the more mature sample (mean = 2.87, median = 1.89). The
average IPO firm in our sample listed approximately 17 years after their incorporation
date (median = 9).
3 Neither do we require that each IPO firm remains listed within the 5 years post-listing period over which we document the decline of the premia.
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We also report the descriptive statistics by year. The market-wide trend in the late
1990’s of increasing divergence of price from fundamentals is evident both for our
sample of recent IPO firms and also for our control firms. The price-to-book ratio is
higher for IPO firms in all years relative to more mature firms. The forecast ROE
however, is also higher for our recent IPO firms in comparison to the control firms. This
descriptive analysis suggests that IPO firms may be priced at a premium to their more
mature counterparts. As the earnings to book ratios are however, generally higher for
recent IPO firms, and it is also possible that IPO firms book-values are systematically
lower, we require our regression models which control for expected growth, to identify
whether the higher price to book ratios are due to an increase in the implied rate of return.
4. Empirical analyses
4.1 Estimating the implied IPO required rate premium
We estimate the IPO premia by comparing firms that have recently undertaken an
IPO with all other firms with available data. We define recent IPOs as those firms in our
sample who listed one year prior to the current fiscal year.4 We start at the end of the first
year following listing to ensure that the IPO proceeds in the book-value are correctly
measured in book-value (rather than using pro-forma measures) and that the IPO firm has
sufficient analyst coverage to be included on I/B/E/S. This reduces the potential for
measurement error in both expected earnings and book values to drive our results. To the
extent that the pricing of an IPO firm would revert quickly to the pricing of more mature
firms, this selection process biases against finding a result.
4 For example, if the fiscal year end was 1999, we would include firms listing in 1998 as recent IPOs.
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In Table 2 we report the sample expected rate of return, and growth in residual
income, using the parameters of equation (5) estimated yearly. For our sample of IPO
firms we find an average premium of 4.74% in expected growth and an expected rate of
return premium of 3.51%. These average IPO premia are significantly different to zero
based on the standard errors of the yearly coefficients, and in the early years, each
individual premium is also statistically significant. That is, the premium is consistent and
positive for all years during the period 1982 – 1998. The IPO premia are particularly
pronounced around in the early 1980’s just following the ‘hot market’ of 1980 (Ritter,
1984). Interestingly, from 1999 onwards, we find that the IPO premium tends to be
negative, consistent with the quiet period for the IPO market after the late 1990’s boom.
Our results can be reconciled to prior research documenting the implied rate of
return for the market sample. Our estimate of the average implied rate of return of
12.28% is comparable to the results reported in Easton et al. (2002). In addition,
documented trends in the overall data, such as the pronounced market decline in 2001,
and the extended bull market of the late 1990’s are evident in the time trends present in
our market average price to book ratios.
Our results can also be reconciled to the results of Kim and Ritter (1999) and
Purnandanam and Swaminathan (2004) who suggest that IPO firms are on average priced
at a premium to more mature firms. Our results support these findings in the prior
literature and show that part of the premium is due to the pricing of inflated expectations
about the rate of return and growth. To summarize the results in this section, we
document a significant premium in the expected rate of return and a significant premium
in the expected growth implied by the market’s pricing of recent IPOs. In the following
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section, we track the IPO premia to examine whether they are relatively temporary, or
whether they exist for an extended period of time post-listing.
4.2 Tracking the duration of the IPO premium
We expect that, as a firm lists on the market, the size of the IPO premium will
diminish as the pricing of the firm reverts towards the pricing of a relatively more
seasoned firm. Such a result would be consistent with the increasing importance of firm
valuation based on assets in place relative to growth options embedded in future
investment opportunities (e.g. Hand, 2005). We estimate the recent IPO firm premia
starting for only those firms with an IPO one year ago, through to IPOs up to five years
earlier.
We report the estimates of the recent IPO firm premia over the first five years of
listing in Table 3. As expected, the average IPO firm does tend to converge to the average
seasoned firm in both the implied rate of return and the expected growth. Specifically, we
document that the IPO premia monotonically decline in the years following the listing of
the IPO firm. By the fifth year after listing, we find that the implied rate of return and
expected growth of a surviving IPO firm is similar to that of a relatively more seasoned
firm. While this result is consistent with the reduction in the value placed in future
investment options, this result is interesting, as it documents a relatively slow
convergence in the pricing of IPO firms and their seasoned counterparts.
We also present the trend in the expected rate of return IPO premium graphically in
figure 1. It is clear that the majority of the expected rate of return premium declines in the
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second year. The slow decay from the second year onwards is also a very noticeable
trend.
To summarize the results in this section, we document that the IPO premia decline
monotonically over the first five years that the firm has been listed on the market. In the
following section, we investigate some of the potential cross-sectional variation that
could help explain why the premium exists for IPO firms.
5. Further analysis
5.1 Further analysis of the effect of variation in listing firm age
Some of our IPO firms list after having existed as an incorporated company for a
significant amount of time. As our IPO premia decline over time, we consider the
possibility that similar to the valuation of IPO firms shifting from assets in place relative
to future investment options (e.g. Hand, 2005) that the IPO premium will vary with the
age of the firm. In this section we examine whether this is the case for the IPO premia
that we documented in the early part of this study. An alternative explanation is that the
premia do not vary significantly with the age of the firm, but instead are simply a
function of listing. This is an important test as it helps distinguish between the behavioral
prediction that IPO firms have a “listing premium” such as that predicted by the
“windows of opportunity” conjecture of Loughran and Ritter (1995), versus the
uncertainty argument based on the short history of the firm. For this analysis we include
all IPO’s at the end of their first year of listing, and sort into groups based on the age of
the firm since incorporation.
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We report the results of this analysis in Table 4. Overall, we find that splitting the
firms into yearly groups above and below the median age has little impact on the size of
the implied rate of return for recent IPO firms. Specifically, the estimate of the implied
rate of return for the group of relatively younger IPOs is 15.88% which is only 0.22%
higher than the estimate for the relatively older IPOs of 15.66%. This result is surprising
as it does not support the uncertainty argument, which would predict a much higher
difference between these groups. Instead, it appears that the majority of the 3.51% IPO
implied rate of return premium is due merely to the listing of the firm.
5.2 The potential for analyst forecast bias in the estimates of r and g
Several papers examine the behavior of analysts who cover IPO firms in the short
period following the listing of the firm. In particular, Rajan and Servaes (1997) find that
analysts are overly optimistic regarding the short-term and long-term growth of recent
IPOs. The authors also show that higher underpricing leads to increased analyst
following. These findings potentially lead to a bias in our results, as the implied return on
equity is biased upwards when analyst forecasts are more optimistic (Easton and
Sommers, 2006)5.
We investigate this effect by examining whether there is variation in the IPO premia
based on the relative level of analyst coverage. Similar to the analysis by IPO firm age,
we split the IPO firms into two groups that are based on the yearly median analyst
coverage. We report a summary of the yearly regression parameters in Table 4. Again,
we find very little evidence that analyst coverage alters the IPO implied rate of return in
5 While the level of the analyst forecast optimism was on average higher for IPO firms relative to more seasoned firms, we found that the difference was not significant.
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any systematic manner. Specifically, the estimate of the implied rate of return for the
group of relatively less well covered IPOs is 16.28% which is only 0.51% higher than the
estimate for the relatively better covered IPOs of 15.50%. Again, this is in the predicted
direction, but it does not explain much of the 3.51% premium for IPOs.
5.3 The effect of variation in prior period ROE
Following the “windows of opportunity” conjecture of Loughran and Ritter (1995)
we would expect that investors will provide higher valuations to firms with higher past
profitability. Such a hypothesis would be consistent with investors behaving in a manner
consistent with a well known bias in individuals’ judgments. Specifically, it is well
known that individuals often place a higher probability judgment on the persistence of
unlikely events (from any given distribution) as individuals hold a tendency to anchor to
prior events even though these prior events may be ‘outliers’ (Kahneman and Tversky,
1989). As extreme observations are increasingly unlikely to persist for an extended
duration, investors should modify their growth expectations rather than extrapolate such
expectations.
We present a preliminary investigation into this possibility by splitting the recent
IPO firms into groups based on prior year profitability. Similar to the analysis by IPO
firm age, we split the IPO firms into two groups that are based on the yearly median of
past return on equity. We report the results in Table 4. In this case, we find that there is a
very large difference in the premia for the two groups of IPOs. Specifically, the estimate
of the implied rate of return for the group of relatively less profitable IPO firms is
12.33% which is lower than the average, representing a negative premium. In stark
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contrast, the more profitable group has an implied rate of return of 20.97%. This result is
consistent with IPO premia being driven in part by the extrapolation of past profitability.
6. Conclusion
We use a technique that simultaneously estimates the expected rate of return and
growth premia of recent IPO firms relative to more seasoned firms. Our main results are
as follows. First, we find that recent IPO firms have on average an expected return
premium of 3.51% and an expected growth premium of 4.74%. We find substantial time
variation in the estimates of these premia over the sample period. While the premium is
consistently positive during the period 1982-1998, we find that the premium is negative
from the end of 1999 onwards.
Second, we track the size of the premia over the first 5 years following the year of
the IPO. We find that IPO firms expected rates of return converge to those of more
mature firms within 5 years of being listed. The premia decline monotonically in all five
years following the issue, however, the relatively small portion of the premia left after the
second year tends to decay remarkably slowly. Our results are consistent with the IPO
premia being long-lived.
This result is contrary to the view that the pricing of a recent IPO firm’s
fundamentals will be similar to listed firms rapidly upon the listing of the firm, instead
we find results consistent with an inflated implied rate of return and expected growth
which persists for up to four years following the listing of an IPO firm. This could be
considered a relatively slow convergence in the pricing of IPO firms and their seasoned
counterparts. This result is surprising as IPO firms are known to perform relatively poorly
18
over the long-run both in terms of their post-listing share price performance (e.g. Ritter,
1991; Loughran and Ritter, 1995) and their post-listing operating performance (e.g. Jain
and Kini, 1994).
Third, we examine cross-sectional variation in the IPO premia. We do not find
significant variation with the relative age of the IPO or the relative analyst coverage of
the IPO. This is surprising, as it suggests that the IPO premia are not due only to firm age
effects, as would be expected based on the assets in place versus growth options
hypothesis (e.g. Hand, 2005). This result is puzzling as it does not support the
conventional view that the more mature firms would have a lower implied rate of return.
Instead, as we find that the premiums are significant for both groups, it appears that the
act of listing leads to the inflation of implied rates of return and expected growth. Instead,
we document that IPO premiums are associated with prior period profitability. This
finding is consistent with IPO investors attaching large IPO premia to firms with
potentially unsustainable pre-issue performance.
19
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-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
1 2 3 4 5
Figure 1. The expected rate of return premium for IPO firms for the first five years after listing.
This figure shows the decline in the IPO firm expected rate of return premium from the fiscal year end after the IPO i = 1 to five years after the time of the IPO i = 5. The cost of equity (r) and the growth in residual earnings (g) are estimated simultaneously along with the IPO premia from the linear coefficients of the regression:
{ } jti
jtjtijtiijtijtjtjtjt eBPBPBX ++++= ∑=
−−−
5
1101 δφδλγγ
where Pjt is the price per share j at time t, Bjt is the per share book value of equity of firm j at time t, and Xjt is the I/B/E/S consensus one-year forecast of earnings per share for firm j at time t. n refers to the number of observations in the regression, R2 is the adjusted R-square for the regression. r and g are the estimated expected rate of return on equity and long-term growth in residual income derived from the estimates of the coefficients γ0 and γ1 where g = γ0 and r = γ0 + γ1, the IPO premia at the end of the first year are calculated as gipo,1 = g + λ1 and ripo,1 = r + λ1 + φ1. Each of the λi and (λi + φi) terms presents an estimate of the IPO growth and required rate of return premia respectively as implied by current market prices, for each group of IPO firms that listed i years ago. The number of observations used in the regression equals 56,995.
22
TABLE 1
Sample means for variables used in the main analysis Panel A: Full sample Recent IPO firms (n=4,632) Control firms (n=52,363)
Age X/B P/B X/B P/B Mean 16.9 0.204 4.21 0.148 2.87
(Median) (9) (0.175) (2.47) (0.127) (1.89) Panel B: Means by financial year Recent IPO firms (n=4,632) Control firms (n=52,363)
N Age X/B P/B N X/B P/B 1982 34 14.9 0.250 4.14 1587 0.159 2.04 1983 68 13.7 0.225 2.93 1705 0.170 1.77 1984 164 15.2 0.238 3.54 1729 0.181 2.10 1985 62 18.1 0.241 3.32 1769 0.166 2.34 1986 89 21.7 0.203 2.35 1697 0.163 2.12 1987 108 18.6 0.247 2.89 1734 0.173 2.08 1988 122 16.7 0.243 3.12 1858 0.181 2.33 1989 88 18.0 0.228 3.11 2014 0.184 2.00 1990 120 15.0 0.217 3.49 2039 0.170 2.49 1991 185 21.0 0.199 3.68 2087 0.160 2.60 1992 311 23.1 0.218 4.16 2181 0.166 2.78 1993 348 19.1 0.203 3.50 2417 0.166 2.50 1994 441 15.5 0.213 3.94 2650 0.179 3.04 1995 408 13.8 0.213 5.02 3058 0.180 3.18 1996 529 13.1 0.195 4.65 3244 0.180 3.59 1997 506 15.1 0.199 4.09 3290 0.186 3.19 1998 353 16.6 0.198 5.51 3290 0.185 4.20 1999 244 16.3 0.181 6.89 3161 0.182 3.67 2000 218 17.9 0.154 3.34 2843 0.182 2.88 2001 108 22.0 0.145 2.61 2539 0.155 2.48 2002 65 23.9 0.186 5.22 2759 0.154 3.27 2003 61 23.7 0.192 4.61 2712 0.152 3.44
Notes: Recent IPO firms are identified as those firms which went public at most one year prior to the fiscal year end for which the book value data is obtained. Control firms are all firms with available data that are not identified as a recent IPO firm. Pjt is the price per share j at time t, Bjt is the per share book value of equity of firm j at time t, and Xjt is the I/B/E/S consensus one-year forecast of earnings per share for firm j at time t. N refers to the number of observations and the age of IPO firms is calculated as the difference between the listing year and the year of incorporation.
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TABLE 2 Annual estimates of the expected rate of return (r) and the expected long-term growth in residual
income (g) based on short-term forecasts of earnings year g r gipo ripo gipo-g ripo-r R2
1982 9.26% 12.49% 18.09% 19.76% 8.83% 7.27% 0.443 1983 8.88% 13.46% 17.76% 19.38% 8.87% 5.92% 0.455 1984 5.87% 11.70% 18.01% 19.64% 12.14% 7.94% 0.514 1985 8.77% 12.12% 13.43% 16.64% 4.66% 4.52% 0.474 1986 9.72% 12.81% 16.12% 17.91% 6.40% 5.10% 0.365 1987 7.63% 12.28% 11.10% 15.79% 3.47% 3.51% 0.544 1988 9.05% 12.92% 17.68% 19.80% 8.64% 6.88% 0.501 1989 10.32% 14.35% 17.88% 19.45% 7.56% 5.10% 0.408 1990 9.87% 12.73% 16.19% 17.78% 6.31% 5.05% 0.447 1991 8.53% 11.42% 14.00% 15.59% 5.47% 4.18% 0.491 1992 8.18% 11.22% 14.70% 16.39% 6.52% 5.17% 0.415 1993 8.01% 11.47% 15.12% 16.61% 7.11% 5.15% 0.448 1994 10.72% 13.10% 17.38% 18.38% 6.66% 5.28% 0.380 1995 11.45% 13.52% 15.80% 16.91% 4.36% 3.39% 0.354 1996 8.91% 11.43% 11.03% 12.85% 2.12% 1.42% 0.497 1997 11.20% 13.53% 16.13% 17.06% 4.93% 3.53% 0.387 1998 13.70% 14.84% 18.40% 18.65% 4.70% 3.82% 0.280 1999 14.22% 15.30% 14.14% 14.71% -0.08% -0.59% 0.201 2000 9.13% 12.29% 8.30% 10.42% -0.83% -1.88% 0.405 2001 5.13% 9.31% 3.74% 7.87% -1.39% -1.44% 0.522 2002 6.43% 9.18% 4.26% 7.01% -2.16% -2.17% 0.479 2003 6.18% 8.80% 6.15% 8.98% -0.04% 0.19% 0.553
Average 9.14% 12.28% 13.88% 15.80% 4.74% 3.51% 0.435 Notes: The cost of equity (r) and the growth in residual earnings (g) are estimated from the linear regression model:
{ } jtjtjtjtjtjtjtjtjt eBPBPBX ++++=− δγδγγγ 32101
where Pjt is the price per share j at time t, Bjt is the per share book value of equity of firm j at time t, and Xjt is the I/B/E/S consensus one-year forecast of earnings per share for firm j at time t. δ is an indicator variable taking the value of unity when the firm undertook their IPO in the prior year. R2 is the adjusted R-square for the regression. r and g are the estimated expected rate of return on equity and long-term growth in residual income derived from the estimates of the coefficients γ0 and γ1 where r = γ0+γ1 and g = γ0, the growth for IPO firms is calculated by gipo = g+γ2 and ripo = r+γ2+γ3. n=56,995.
24
TABLE 3
Tracking IPO premiums for implied rates of return and expected growth over the number of years since listing
Estimate
(t-statistic) Estimate
(t-statistic) Estimate
(t-statistic) Estimate
(t-statistic) Estimate
(t-statistic) g 9.41% 9.28% 9.20% 9.15% 9.11% (t statistic γ0) (18.66) (18.60) (18.51) (18.21) (18.00) r 12.45% 12.38% 12.34% 12.31% 12.30% (t statistic γ1) (12.83) (12.91) (12.94) (12.99) (12.98) gipo,1-g 4.45% 4.58% 4.66% 4.70% 4.74% (t statistic λ1) (5.48) (5.54) (5.55) (5.60) (5.63) ripo,1-r 3.35% 3.42% 3.46% 3.48% 3.49% (t statistic φ1) (-4.28) (-4.42) (-4.49) (-4.61) (-4.69) gipo,2-g 2.24% 2.32% 2.36% 2.41% (t statistic λ2) (3.03) (3.08) (3.13) (3.17) ripo,2-r 1.25% 1.29% 1.31% 1.33% (t statistic φ2) (-3.66) (-3.74) (-3.86) (-3.94) gipo,3-g 1.57% 1.61% 1.66% (t statistic λ3) (2.20) (2.26) (2.31) ripo,3-r 0.76% 0.77% 0.79% (t statistic φ3) (-2.93) (-3.03) (-3.12) gipo,4-g 1.50% 1.55% (t statistic λ4) (2.75) (2.83) ripo,4-r 0.75% 0.77% (t statistic φ4) (-4.24) (-4.41) gipo,5-g 0.60% (t statistic λ5) (0.57) ripo,5-r -0.11% (t statistic φ5) (-2.16) Adjusted R-square 0.437 0.431 0.434 0.436 0.437 The cost of equity (r) and the growth in residual earnings (g) are estimated from the linear regression model: { } jt
ijtjtijtiijtijtjtjtjt eBPBPBX ++++= ∑
=−−−
5
1101 δφδλγγ
where Pjt is the price per share j at time t, Bjt is the per share book value of equity of firm j at time t, and Xjt is the I/B/E/S consensus one-year forecast of earnings per share for firm j at time t. δ is an indicator variable taking the value of unity when the firm undertook their IPO in the year t-i. R2 is the adjusted R-square for the regression. r and g are the estimated expected rate of return on equity and long-term growth in residual income derived from the estimates of the coefficients γ0 and γ1 where g = γ0 and r = γ0 + γ1, the IPO premia at the end of the first year are calculated as gipo,1 = g + λ1 and ripo,1 = r + λ1 + φ1. Each of the λi and (λi + φi) terms presents an estimate of the IPO growth and required rate of return premia respectively as implied by current market prices, for each group of IPO firms that listed i years ago. n=56,995.
25
TABLE 4
Variation in the IPO premium based on IPO firm age, analyst following and lagged ROE Younger IPO firms Older IPO firms
Difference
g 9.41% 14.21% 13.38% r 12.45% 15.88% 15.66% gipo-g - 4.80% 3.97% 0.83% ripo-r - 3.43% 3.21% 0.22% Adjusted R2 0.428
Lower analyst
coverage Higher analyst
coverage
g 9.41% 14.18% 13.67% r 12.45% 16.28% 15.50% gipo-g - 4.77% 4.26% 0.51% ripo-r - 3.83% 3.05% 0.78% Adjusted R2 0.429
Lower prior year
actual ROE Higher prior
year actual ROE
g 9.41% 10.46% 19.58% r 12.45% 12.33% 20.97% gipo-g - 1.05% 10.17% -9.12% ripo-r - -0.12% 8.52% -8.64% Adjusted R2 0.432 The cost of equity (r) and the growth in residual earnings (g) are estimated from the linear regression model:
{ } { } jtjtjtjtjtjtjtjtjtjtjtjtjt eBPBPBPBX ++++++=− 2,32,32,22,21,31,31,21,2101 δγδγδγδγγγ where Pjt is the price per share j at time t, Bjt is the per share book value of equity of firm j at time t, and Xjt is the I/B/E/S consensus one-year forecast of earnings per share for firm j at time t. R2 is the adjusted R-square for the regression. r and g are the estimated expected rate of return on equity and growth in residual income derived from the estimates of the coefficients g0 and g1 where g = γ0 and r = γ0+γ1, Where δ is an indicator variable taking the value of unity when the IPO of firm j occurred during the fiscal year t-1 to t and is either in the group of recent IPO firms that listed below the yearly median (denoted with a subscripts 2,1 and 3,1) or the group of recent IPO firms and the refers to the group of firms that listed above the yearly median (denoted with a subscripts 2,2 and 3,2). The implied rate of return for the average IPO firm that lists above the median, for example, is (γ0+γ1+γ2,2+γ3,2) with the IPO premium portion calculated as (γ2,2+γ3,2). Similarly, the average level of expected growth for IPO firms is calculated as (γ0+γ2,2) with the premium calculated as γ2,2.