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 examines aftermarket trading of underwriters and unaffiliated market makers in the three month period after an IPO. We find that the lead underwriter is always the dominant market maker, he takes substantial inventory positions in the aftermarket trading, and co-managers play a negligible role in aftermarket trading. The lead underwriter engages in stabilization activity for less successful IPOs, and uses the overallotment option to reduce his inventory risk. Compensation to the underwriter arises primarily from fees, but aftermarket trading does generate positive profits, which are positively related to the degree of underpricing.

Prior research has assumed that underwriters post a stabilizing bid in the aftermarket. We find instead that aftermarket activities are less transparent and include stimulating demand through short covering and restricting supply by penalizing the flipping of shares. In more than half of IPOs, a short position of an average 10.75 percent of shares offered is covered in 22 transactions over 16.6 days in the aftermarket, resulting in a loss of 3.61 percent of underwriting fees. Underwriters manage price support activities by using a combination of aftermarket short covering, penalty bids, and the selective use of the overallotment option. RESEARCHERS ARE STILL TRYING TO UNDERSTAND the price behavior of initial public offerings ~IPOs!. 1 Short-run underpricing and long-run overpricing continue to be a puzzle. Underpricing refers to the initial trading of IPOs above the offer price in the immediate aftermarket, whereas overpricing refers to long-run underperformance. However, finance research has paid little attention to the specific activities of underwriters in the aftermarket that are likely to have an impact on IPO price performance. These interventions by underwriters are not well understood because of both lack of data and lack of transparency in industry practices. The unique data set used in this paper allows for the first time a comprehensive analysis of exactly how these aftermarket activities are conducted, the characteristics of IPOs in which un-

This paper examines the book building mechanism for marketing initial public offerings. We present a model where the underwriter selects a group of investors along with a pricing and allocation mechanism in a way that maximizes the information generated during the process of going public at a minimum cost. Unlike previous models, we take into account the moral hazard problem that is faced by investors when evaluation is costly. Our results suggest that for firms with the most to gain from accurate pricing, the number of investors participating in the offering is larger, and underpricing will be greater. When a firm's demand for accuracy is relatively low, the expected amount of underpricing exactly offsets the investors' costs of acquiring information. However, when the demand for accuracy is high, the expected amount of underpricing can exceed the cost of information and investors can earn economic rents

There is a general perception that the large trading volume in initial public offerings is mostly due to “flippers ” that are allocated shares in the offering and immediately resell them. On average, however, flipping accounts for only 19 % of trading volume and 15 % of shares offered during the first two days of trading. Institutions do more flipping than retail customers and hot IPOs are flipped much more than cold IPOs. Institutions do not quickly flip cold IPOs to take advantage of price support activities by the underwriter. Explicit penalty bids are rarely assessed against flippers.

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.

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).

Individual and institutional investors can trade German initial public equity offerings on an as–if/when–issued basis before the start of secondary trading. Using a novel data set of pre – and post–IPO trades made by a sample of clients at a large German retail broker, the paper documents that retail investors both are willing to overpay and end up overpaying for IPOs, especially following periods of high returns in recent new issues. IPOs that are more aggressively bought by retail investors in the pre–IPO market or on the day of the IPO post higher first-day returns, but also experience lower aftermarket returns, controlling for firm characteristics such as size and book–to–market ratio. In short, sentiment – expectations about asset values unwarranted by fundamentals – drives retail purchases of IPOs and appears to have a transitory effect on prices.

Exchange Commission for their helpful and valuable comments. The Securities and Exchange Commission disclaims responsibility for any private publication or statement by any of its employees. This study expresses the authors ’ views and does not necessarily reflect those of the Commission, the Commissioners or other members of the staff. This study benefited from discussions with Chester Spatt, Stewart Mayhew and Tim McCormick,.

This paper studies the valuation of initial public offerings (IPO) using comparable firm multiples. In a sample of more than 2000 IPOs from 1980 to 1997, we find that the median IPO is overvalued at the offer by about 50 % relative to its industry peers. This overvaluation is robust over time, across technology and non-technology IPOs, to different price multiples, industry classifications, and matching firms. In the cross-section, overvalued IPOs earn 5 % to 7 % higher first day returns than undervalued IPOs but earn 20 % to 50 % lower returns over the next five years. The long-run underperformance of overvalued IPOs is robust to various benchmarks and return measurement methodologies including the Fama-French three-factor model. Overvalued IPOs exhibit higher sales growth rates temporarily but earn persistently lower profit margins and return on assets than undervalued IPOs over the next five years suggesting that any projected growth opportunities implicit in the initial valuation fail to materialize subsequently. Our results are inconsistent with asymmetric information models of IPO pricing and provide support for behavioral theories based on investor overconfidence. 2