IPO first-day returns, offer price revision, volatility, and form S

IPO first-day returns, offer price revision,
volatility, and form S-1 language
by Tim Loughran and Bill McDonald
April 24, 2015 - Corporate Finance: Theory and Empirical Foundations
Giuseppe Corbisiero
Motivation and research question
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IPOs offer few tangible information
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S-1 filing offers ample amount of intangible information
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important impact on investors’ assessment
Research question:
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Can S-1 language, by measuring uncertainty, explain first-day
returns and subsequent volatility?
Contribution and related literature
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Beatty and Ritter (1986)
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reputation problem of underwriter: underpricing equilibrium
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too low initial return, investor cease doing business with her
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higher ex ante uncertainty → higher underpricing (1st-day return)
How to measure ex-ante uncertainty?
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Previous literature offer few ex-ante proxies for uncertainty
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Papers with focus on final IPO prospectus
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This paper: exploit use in S-1 filings of uncertain/weak modal
words or negative words
Related papers
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Loughran and McDonald (2011): 10-K and subsequent volatility
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Hanley and Hoberg (2010): standard vs. informative language
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Hanley and Hoberg (2012): litigation and information disclosure
Data and sample statistics
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Sample of 1,887 completed US IPOs during 1997-2010
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How uncertain text is measured? 6 word lists
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uncertain (e.g. assume, approximately, risk); weak modal (e.g. may,
could, possible); negative (e.g. loss, failure, decline); positive (e.g.
beneficial, successful, strong); legal (e.g. contract, lawsuits, plaintiff );
strong modal (e.g. always, must, will)
Mean
Std. dev.
5th
Median
95th
First-day returns
34.8%
65.2%
-8.2%
13.3%
173.9%
Up revision
11.7%
21.7%
0%
0%
50%
3.21
3.67
0.34
1.79
10.12
% uncertain
1.31
0.19
0.99
1.32
1.61
% weak modal
0.64
0.17
0.35
0.64
0.92
% negative
1.41
0.30
0.89
1.42
1.88
% positive
0.97
0.17
0.71
0.97
1.26
% legal
0.75
0.20
0.49
0.71
1.13
% strong modal
0.53
0.11
0.36
0.52
0.72
Return volatility
Form S-1
Results: First-day returns
(1)
(2)
(3)
(4)
(5)
(6)
days S-1 to 424
-4.93**
-4.92**
-4.95**
-5.15**
-5.18**
-5.05**
% uncertain
17.18***
% weak modal
23.23***
% negative
14.27***
% positive
2.40
% legal
-3.59
% strong modal
-12.90*
control variables
up revision
R2
value
1.69***
1.69***
1.68***
1.69***
1.69***
1.69***
56.2%
56.2%
56.3%
56.1%
56.1%
56.1%
full table
Revision in the offer price
(1)
(2)
(3)
(4)
(5)
(6)
days S-1 to 424
-0.28
-0.22
-0.16
-0.21
-0.29
-0.31
% uncertain
1.59
% weak modal
6.66**
% negative
7.65***
% positive
3.92**
% legal
-2.63*
% strong modal
0.46
control variables
R 2 value
19.5%
19.6%
20.1%
19.5%
19.5%
19.5%
Upward revision in the offer price
days S-1 to 424
% uncertain
(1)
(2)
(3)
(4)
(5)
(6)
-3.11***
-3.08***
-3.01***
-3.09***
-3.11***
-3.10***
0.89
% weak modal
3.47**
% negative
5.91**
% positive
1.84**
% legal
-2.72***
% strong modal
-1.94
control variables
R 2 value
28.2%
28.2%
28.5%
28.2%
28.3%
28.2%
Other theories of IPO pricing
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Underwriter take advantage of issuers in weak informational position
(Loughran and Ritter, 2002)
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lowball initial offer price
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only partly increase final offer price
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indirect benefit of allocating underpriced shares
Absolute revision in offer price: bookbuilding (Sherman and Titman,
2002)
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issuers using language to attract information production
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underpricing compensation for revealing info to underwriter
Post-IPO return volatility
days S-1 to 424
% uncertain
(1)
(2)
(3)
(4)
(5)
(6)
-0.21
-0.19
-0.21
-0.23*
-0.23*
-0.22*
0.92***
% weak modal
3.07***
% negative
1.03***
% positive
0.14
% legal
0.33
% strong modal
-0.34
control variables
R 2 value
46.7%
47.3%
46.9%
46.6%
46.6%
46.6%
Further results
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Change in % use of words from S-1 to 424
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no significant effect on Up revisions
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Uncertain language correlated with VC and lower sales
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793 withdrawn IPOs
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uncertain language marginally raise probability of withdraw
Conclusion
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Evidence supporting link between ex-ante uncertainty and
underpricing
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Word lists on S-1 provide measure of uncertainty that are
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direct, ex-ante, firm-specific, measured well before the IPO
Criticisms
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some results sensitive to word counting (Ferris, Hao, and Liao,
forthcoming)
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macroeconomic conditions → price volatility and uncertain text
Backup slides
Table 3: First day returns
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