Why does underperformance of IPOs in the long-run become

debatable? A theoretical review

Wasantha Perera' and Nada Kulendran'

'Department of Finance, University of Sri Jayewardenepura, Colombo, Sri Lanka

2College of Business, Victoria University, Melbourne, Australia

Abstract
Prior studies have examined initial public offering (IPO) market performance in two
different periods-short run and long run-in terms of two phenomena: the underpricing or
short-run market phenomenon and the underperformance or long-run market phenomenon.
Tofind out the possible theoretical reasons for the underperformance phenomenon, this
study reviews the past literature on the long-run market performance ofIPOs. The evidence
on long-run underperformance of IPOs is not as widespread as that of short-run
underpricing ofIPOs. The previous researchers have explained long-run performance using
behavioural theories, methodological issues and short-run underpricing theories. Some
researchers have found that IPOs underperform marginally or have no abnormal
performance in the long run; thus, they do not reject the market efficiency hypothesis in the
long run. Others have reported that IPOs overperform or do not underperform in the long-

I
run market. Still others have argued that underperformance disappears when different
performance measures or methodologies are used. The rest have found that' IPOs
underperform considerably in the long-run IPO market. However, the long-run
underperformance ofIPOs is a debatable issue amongfinancial researchers because of their
studies conflicting results and controversial findings.
I

Keywords: Behavioural theories, Efficiency Market hypothesis, IPO, Under performance

I. 1ntroduction long run. Long-run market performance is a

debatable issue among financial researchers as
Undcrperformance ofIPOs is generally accepted shown by the conflicting results and
ns typical of long-run market performance, but it controversial findings they have obtained. Some

I
t
I~not as widespread as short-run under-pricing of
IPOs. Long-run underperformance indicates that
tho subsequent share prices are often lower than
researchers have found that IPOs underperform
marginally or have no abnormal performance in
the long run, which implies that the market is
the first trading day prices, which provides efficient because the results do not reject the
f
{
negative abnormal returns for investors in the market efficiency hypothesis in the long run

International Journal of Accounting & Business Finance 01 Issue 1- 2016

(Gompers & Lemer, 2003; Ibbotson, 1975; after going public. Further, Omran (2005) found
Jenkinson & Ljungqvist, 2001). Others have mixed results in the long-run performance of
reported that IPOs overperform or do not Egyptian IPOs between 1994 and 1998. He
underperform in the long-run market (Bird & clearly noted that investors can earn positive
Yeung, 2010; Da Silva Rosa, Velayuthen & aftermarket abnormal returns (average return
W alter, 2003; Thom adakis, N ounis & 41%) over a one-year period and negative
Gounopoulos, 2012). Some have argued that aftermarket abnormal return Over a three- and
underperformance disappears when different five-year horizon. The aftermarket performance
measures of performance or methodology are of internet firms is initially favourable but
used (Abukari & Vijay, 2011; Ahmad-Zaluki, weakens over time, according to . Further, they
Campbell & Goodacre,; Gompers & Lemer, documented that the long-term performance of
2003; Kooli & Suret,(2004). The remaining internet firms in the United States declined over
researchers have found that IPOs underperform time, and the market was underperformed by the
considerably in the long-run IPO market (How, end of one year.
2000; Lee, Taylor & Walter,(1996) Ritter,(1991). Boabang (2005) analysed the opening,
These contradicting outcomes regarding long- short-term, medium-term and long-term
run market performance were the motivations for performance of Canadian unit trust IPOs using a
the current study. sample of 83 IPOs listed on the Toronto Stock
This research paper seeks to review the Exchange over the period 1990-2000. The study
empirical evidence and theoretical explanation concluded that, in the long run, Canadian IPOs
fo r the lo n g -ru n u n d er p erfo rm an ce were fairly priced but underperformed the
phenomenon. The remainder of this article is Canadian market. Further, he indicated that the
organized as follows. Section 2 reviews the Canadian unit trust IPO market appeared to be
empirical evidence on the long-run under inefficient in the short and long term, but over the
performance phenomenon. Section 3 covers medium term, the market appeared to be
th eo retical explanation for the under efficient.
performance phenomenon, and Section 4 Cai, Liu and Mase (2008) examined the
concludes the major findings. three-year post-IPO performance of firms
listedon the Shanghai A-share stock market
2. Evidence on long-run underperformance between 1997 and 2001. According to this study,
phenomenon the IPO market underperformed by 30% over the
long run. Ajlouni and Abu-Ein (2009) reported
This section reviews the empirical evidence on t h a t J o r d a n ia n IP O s s i g n i f i c a n t l y
the long-run under performance phenomenon. underperformed in the long run similarly to
Ritter (1991) documented the long-run advanced economies. In addition, they
performance of US IPOs appearing to be concluded that IPOs of service companies
overpriced (underperformed) as the third performed better than industrial companies.
anomaly in the pricing of IPOs of common stock. However, both companies underperformed in the
He summarised the average holding period market. In the long run, Chinese A-share IPOs
return for a sample of 1,526 IPOs of common slightly underperformed the matched portfolios
stock in 1975-1984 as 34.47% in the three years and B-shares outperformed the benchmark

International Journal o f Accounting & Business Finance 02 Issue 1 - 2016

 portfolios (Chan,Wang & Wei 2004). Alvarez depends on the methodology and benchmarks
und Gonz&lcz (2005) revealed negative long-run used for assessment.
abnormal stock returns in relation to Spanish In the Australian literature, Finn and
IPOs. Kooli and Suret (2004) examined the Higham(1988) and Lee, Taylor and Walter
ullermarket performance of Canadian IPOs with (1996) found that industrial IPOs under
o sample of 445 IPOs from 1991 to 1998. Their performed by 6.52% and 51.58% based on long-
sample indicated that Canadian IPOs were also run returns. How (2000) found that mining IPOs
underperforming in the long run. These underperformed by 7.6%, whereas Dimovski and
performance results depend on the methodology Brooks (2004) reported that industrial and
used and on the weighting schemes. Moshirian, resource IPOs underperformed by 4.6%.
Ng and Wu (2010) provided further evidence to However, Da Silva Rosa, Velayuthen and Walter
support this argument, revealing that the (2003) found that Australian IPOs did n o t;
existence of long-run underperformance for underperform in the post-market. Bird and Yeung
Asian IPOs depends resoundingly on the (2010) found that Australian IPOs over
methodology used for assessment. In contrast to performed by 12%.
the under performance argument, Ahmad- The review of the above studies attempts to
Znluki, Campbell and Goodacre (2007) shed some light on the IPO market performance
documented significant over performance in the in the long run. Table 1 also presents some
long run in equally weighted (EW) event-time Australian and international evidence on long-
oumulative abnormal returns (CARs) and buy run IPO performance. The table clearly indicates
and hold abnormal retums(BHARs). They that long-run market performance has been
Investigated the long-run share price reported as under performance or over
performance of 454 Malaysian IPOs during the performance in Australia as well as in other
period 1999-2000. Further, they explained that countries. In particular, long-run over
the long-run performance of the Malaysia (n performance can be observed in Korea (+2%),
IPOs was in line with the under performance Malaysia (+17.9%), Sweden (+1.2%), China
phenomenon when return was calculated on (+16.6%) and the United States (+11.7%) based
value weighted (VW) or a matched company on average long-run returns. However, long-run
benchmark. However, this study is consistent underperformance has been reported in more
with the argument that long-run performance parts of the world when compared with

Table 1: Evidence on long-run m arket perform ance phenomenon

.1
Average long-
Sample Sample
Country run return (K Authnrfs) j
size period
)
Australian
Australia -6 J 2 93 1966-1978 Firm Affigham
Australia -2538 120 1974-1984 Alim & Patrick:
Australia -51J8 266 1976-1989 Lee, Taylor & Walter
Australia -7.6 130 1979-1990 How
Austsalia +13.12 333 1991-1999 Da Silva Rosa, Vdsyn&m & Waiter
Australia -4.6 251 1994-1999 Dimovski & rooks
Australia -2521 419 1995-2000 Bayley, Lee & Walter

International Journal of Accounting & Business Finance 03 Issue 1 - 2016

 Australia +12 68 1995-2004 Bird & Yeung
Non-Australian
Austria -2 1 3 57 1965-1993 Ausseaegg
Brazil -47.0 62 1980-1990 AggarwaL, Leal & Hernandez
Canada -17.9 216 1972-1993 Jog &Srivi$tava
(M e -23.7 28 1982-1990 Aggarwal, Leal & Hernandez
China ^0 335 1997-2001 CaiTjn&Mase
China +16.6 897 1996-2002 Chi, Wang & Young
Egypt -27.0 53 1994-1998 Oinian
Finland -21.1 79 1984-1989 Kdobarju
Germany -12.1 145 1970-1990 Ljungqvist
Greece -31.43 254 1994-2002 Thomadakis, Nounrs&Gounopoulos
Japan -27.0 172 1971-1990 Cai&Wei
Jordan -1.5 24 1990-2006 Ajlouni
Korea + 20 99 1985-1988 Kim, Krinsky& Lee
Malaysia +17.9 454 1990-2000 Ahmad-Zalufd, Campbell &Goodacre
Singapore -9 2 45 1976-1984 Hin&Mahmood
Spanish -28.0 52 1987-1997 Alvarez& Gonzalez
Sweden +12 162 1980-1990 Loughran, Ritter &Rydqvist
UK -8.1 712 1980-1988 Levis
US -20.0 4753 1970-1990 Loughran& Ritter
US +11.7 2829 1988-2005 Abukari&Vijay
Source: The figures were taken from the article 'Initial Public Offerings' (Ritter 1998) and the rest of
the figures were based on papers published by the authors listed in the table.
Note: A negative (-) sign indicates underperformance and a positive (+) sign indicates oveiperformance
in the long run.

overperformance. The following section have reported controversial and conflicting

discusses the main reasons for the long-run findings (Thomadakis, Nounis & Gounopoulos
underperformance phenomenon. 2012). Therefore, much attention has been paid
to theoretical explanations for long-run
3. Theoretical explanation for long-run performance of IPOs in the recent IPO literature.
underperformance The following behavioural theories have been
proposed to explain the phenomenon of long-run
This section explains the theoretical background under performance of IPOs (Ritter 1998):
pertaining to long-run under performance and * the divergence of opinion hypothesis
provides a number of reasons why IPOs * the impresario hypothesis (fads
underperform in the long run. hypothesis)
Theoretical explanations for the long-run * the window of opportunity hypothesis.
under performance of IPOs are less abundant In addition to these behavioural theories of
than those for the underpricing phenomenon long-run market performance, some theories on
(Kooli and Sutet (2004). Jakobsen and Sorensen short-run underpricing (e.g. signalling theory,
(2001) also noted that no convincing theory agency cost theory, prospect theory and
exists that explains IPO long-run market uncertainty theory), and methodological issues
performance. Studies on long-run performance including measurement problems can be used to

In te rn a tio n a l Jo u rn a l o f A ccounting & B u siness F inance 04 Issue 1 - 2016

e x p la in lo n g -ru n under p e rfo rm a n c e . inform ation becom es available in the m arket.
Accordingly, the theories on long-run under T he divergence o f opinion betw een optim istic
perform ance are categorised as ( 1) behavioural and pessim istic investors w ill narrow because o f
theories o f long-run underperform ance, (2) the availability o f inform ation. T herefore, this
m ethodological problem s and (3) theories o f w ill lead to a reduction o f the m arket price,

F igure 1 L ong-R un U nder perform ance Theories

(jlmiLmn underpricing. Figure 1 show s the long- resulting in long-run underperform ance.
mi! utulcrpcrform ance theories that are discussed
in (he following section. The im presario hypothesis (fads hypothesis)

,f«/ llehavlonral theories The im presario hypothesis w as introduced by

Tile divergence o f opinions hypothesis A ggarw al and R ivoli (1990) follow ing M iller's
(1977) divergence o f opinions explanation. This
The divergence o f opinions hypothesis on long- hypothesis indicates that com panies w ith high
run mock m arket perform ance w as presented by initial returns should have low afterm arket
Miller (1977). This hypothesis explains that returns. T he theory argues that the m arket for
liivcmoro who are m ost optim istic regarding the IPOs is subject to fads and that IPO s are
llitiue cash flows and grow th potential o f IPO s underpriced by investm ent bankers to create the
will be the buyers. T heir valuation determ ines the appearance o f excess dem and (R itter 1998).
initial trading day's price. The valuations o f an Conversely, m any firms g o public near industry-
optimintic investor w ill be higher than those o f specific 'fad' or 'hot' p erio d s (A lvarez &
the pessimistic investor w hen there is uncertainty G onzalez, 2005). Consequently, a negative
about the value o f an IPO . A s tim e goes on, m ore relationship betw een long-run perform ance and

lMtorn:itl<>n:il Journal of Accounting & Business Finance 0 5 Issue 1 - 2016

initial returns can be expected. This hypothesis is this 'window-dressing' technique is not useful in
also similar to the investor overoptimism or the long run because, once investors know the
overreaction hypothesis (De Bondt 1985; Thaler true value of the firm, prices fall (Teoh, Welch &
1987) because investors become overly Wong 1998).
optimistic about a firm's value during fad or hot
periods. Empirical evidence on behavioural theoriesfo r
long-run underperformance
The window o f opportunity hypothesis
The above theories have been examined in the
The window of opportunity hypothesis was IPO literature by many academic researchers.
introduced by Ritter (1991) and considered a Among them, Ritter (1991) has made a
further extension of the fads hypothesis significant contribution to the debate about long-
introduced by Aggarwal and Rivoli (1990). This run performance of IPOs. The long-run
hypothesis suggests that, once investors become underperformance phenomenon was first
overoptimistic about a firm's value, the firm's documented by Ritter (1991). He used a large
share price rises higher than a fair price. Issuers sample of 1,526 US IPOs from 1975 to 1984 and
can take this as an opportunity to sell shares at a documented that the IPOs appeared to be
higher price, thus seizing the 'window of overpriced in the long run. This is considered a
opportunity'. The window of opportunity third anomaly in the IPO literature. This study
hypothesis forecasts that firms going public in found that, in the three years after going public,
high-volume periods Chot' periods) are more the sample firms significantly underperformed in
likely to be overvalued than other IPOs. comparison with a set of comparable firms
matched by size and industry. Further, this study
Earnings management hypothesis explained that there was substantial variation in
the underperformance from year to year and
The earnings management hypothesis is also across industries, and younger companies going
considered a behavioural theory of long-run public in heavy volume years performed even
performance. Normally, companies manage worse than average.
earnings for the following purpose: to window- Ritter's (1991) study made an attempt to
dress financial statements prior to IPO, to shed some light on the reasons for this
increase managers' compensation and job underperformance phenomenon. The possible
security, to avoid violating lending contracts, to reasons included (1) risk mismeasurement, (2)
reduce regulatory costs or to increase regulatory bad luck and (3) fads or overoptimism. In
benefits. Beneish (2001) has argued that much of particular, this study investigated whether the
the evidence of earnings management depends sample companies underperformed merely due
on the company's performance, which suggests to bad luck or whether the market systematically
that earnings management is likely to be present overestimated the growth opportunities of the
when a company's performance is either IPOs. The evidence is consistent with the notion
unusually good or unusually bad. However, some that many firms go public near the peak of
IPO companies manipulate their financial industry-specific fads. The investors in this
statements with a view to attracting investors and sample were overoptimistic about the firms'

In te rn a tio n a l Jo u rn al o f A ccounting & B u siness F inance 0 6 Issue 1 - 2016

prospects und issuers took advantage o f the cold period. A t 60 m onths, the afterm arket
'window o f opportunity'. T hese patterns are returns for h ot and cold issues w ere -3 9 .0 8 % and
condiment with an IPO m arket in w hich ( 1) -4 .6 % respectively. T he difference in these
Investors arc periodically overoptim istic about returns is statistically significant at the 1% level.
the earnings potential o f young com panies, and T his study's findings are also consistent w ith the
(2) firms take advantage o f these w indow s o f evidence th at firm s choose to go public w hen
opportunity. This indicates that the study's investors are w illing to pay a h igh price-earnings
findings arc in line w ith the im presario or fads ratio (P/E ) or m arket-to-book, reflecting the
h y p o th e s is and w in d o w o f o p p o r tu n ity optim istic assessm ents o f the net present value o f
hypothesis. In addition, the study analysed cross- grow th opportunities. T hey m entioned that,
SCCtlonul and tim e-series patterns in the post- according to Ritter's interpretation, this m ay be
tnnrkct perform ance o f IPO s w ith a view to consistent w ith the w indow o f opportunity
identifying possible explanations for the long- hypothesis. T hey concluded that th eir findings on
run undcrpcrform ance o f IPOs. A fterm arket the long-run perform ance o f large Canadian
perform ance w as categ o rised u sin g initial IP O s e x p la in th e in v e s to rs ' o v e rre a c tio n
t'ctlirnH, issue size, industry, age o f the issuing hypothesis, not the divergence o f opinions
firm and year o f issuance. hypothesis.
Finally, R itter (1991) argued that there D im ovski and B rooks (2004) analysed the
were three unresolved issues in relation to long- financial and non-financial characteristics o f
run undcrpcrform ance: ( 1) the generality o f the A ustralian IPO s to explain their long-term
findings. (2) the relationship o f the long-run underperform ance. T he overall results o f their
llllderpoi form ance to the short-run underpricing study support the long-run underperform ance
phenom enon and (3 ) th e te n d e n c y fo r hypothesis on IPOs. D uring the period o f
tm derperfonnance in the long run. 1994-1998, A ustralian IPO s w ere overpriced in
Kooli and S uret(2004) exam ined the the long ru n by 4% an d the m edian m arket-
nfiem iltrkcl perform ance o f IPO s in C anada for adjusted return for the long run w as -2 5 % .
tip to five years using a sam ple o f 445 IPO s E xcess M R w as the m ain explanatory variable o f
during the period 1991-1998. T he cross- the long-run m arket perform ance in A ustralia.
ftCUlloiml patterns w ere also analysed to identify This study indicated a negative coefficient
plflUttlhlc reasons for the undeiperform ance o f (-0 .0 5 1 ) for the one-year excess return variable.
IPO* In Canada. T hey found that overpriced T his supports the overoptim ism hypothesis,
Slocks perform ed b etter than u nderpriced stocks. w hich explains the long-run undeiperform ance.
T his study confirm s the international evidence H ow ever, th e authors argued that their study
till long-term perform ance and it indicates that supports the overoptim ism hypothesis based on
underpriced stocks show a m ore negative long­ the positive coefficient (1.069) on one-m onth
term perform ance. T he study's findings m ildly excess returns. Further, sim ilar interpretations
support the overreaction or fads hypothesis. In can be m ade about the coefficient w ith the
addition, the study segm ented th e sam ple period partitioned data. H ow ever, the M S variable
Into two sections: the hot period and the cold indicates an unexpected positive coefficient.
period. At 36 m onths, the afterm arket return was This finding is not in line w ith the overoptim ism
18.06% for the hot period and -1 0 .4 1 % for the h y p o th e s is and w in d o w o f o p p o r tu n ity

In tern atio n al Journal of Accounting & Business Finance 0 7 Issue 1 - 2016

 i

h y p o th e s is e x p la n a tio n s fo r lo n g -ru n under th e in itia l u n d e rp ric in g and lo n g -ru n

p e rfo rm a n c e. u n d e rp e rfo rm a n c e o f IP O s in th e S p a n ish c a p ita l
In a d d itio n , O m ra n (2 0 0 5 ) d o c u m e n te d m a rk e t.
m ix e d fin d in g s o n th e lo n g -ru n p e rfo rm a n c e o f K o o li a n d S u re t (2 0 0 4 ) h a v e a rg u e d th a t
53 s h a re issu e p riv a tis a tio n s (S IP s) in th e in v e s to r s e n tim e n t to w a rd s an IP O is an
E g y p tia n sto c k m a rk e t b e tw e e n 1994 a n d 1998. im p o rta n t f a c to r in th e lo n g -ru n u n d e rp e r
P o s itiv e a b n o rm a l re tu rn s w e re re p o rte d f o r a fo rm a n c e o f IP O s. G a o (2 0 1 0 ) s tu d ie d th e 'IP O
o n e -y e a r p e rio d a n d n e g a tiv e a b n o rm a l re tu rn s p ric e a n d lo n g -te rm p e rfo rm a n c e in C h in a a fte r
w e re re p o rte d fo r th re e - a n d fiv e -y e a r h o riz o n s. th e a d a p ta tio n o f th e b o o k b u ild in g p ric in g
H o w e v e r, o v e r th re e - a n d fiv e -y e a r p e rio d s, m e c h a n ism . T h e stu d y fo u n d th a t p o s itiv e p r e ­
a b n o rm a l re tu rn s w e re sig n ific a n tly a ffe c te d b y m a rk e t re tu rn s d id n o t a ffe c t h ig h e r u n d e rp ric in g
in itia l e x c e ss re tu rn s a n d th e P /E . T h e ir e m p iric a l a n d it re d u c e d u n d e rp ric in g . T h is in d ic a te s th a t
fin d in g s a re c o n s is te n t w ith th e o v e ro p tim ism th e is s u e r a n d u n d e rw rite r se iz e th e w in d o w o f
h y p o th e sis. o p p o rtu n ity o p e n e d b y IP O issu a n c e to m a x im ise
C a i, L iu a n d M a se (2 0 0 8 ) re p o rte d a th e o ffe r p ric e w h e n in v e s to r s e n tim e n t is h ig h .
c o m p a ra b le le v e l o f u n d e r p e rfo rm a n c e o n th e H o w e v e r, p o s itiv e MS s tr o n g ly in c r e a s e s
lo n g -ru n p e rfo rm a n c e o f IP O s in C h in a . T h e y o v e rp ric in g in th e lo n g ru n . O th e r v a ria b le s
i
fo u n d th a t in itia l o v e ro p tim ism a n d th e siz e o f th e re la te d to in v e s to r se n tim e n t, in d iv id u a l-in v e sto r
o ffe r w e re im p o rta n t e x p la n a to ry v a ria b le s fo r d e m a n d a n d tra d in g v o lu m e , a ls o h a v e a p o sitiv e
th is u n d e r p e rfo rm a n c e . T h is in d ic a te s th a t th e e ffe c t o n IP O o v e rp ric in g . In a d d itio n , IP O in itia l
fin d in g s a re in lin e w ith th e o v e ro p tim ism re tu rn s c a n b e u s e d to p re d ic t IP O lo n g -te rm
h y p o th e s is and d iv e rg e n c e of o p in io n s p e rfo rm a n c e . F in ally , th e stu d y a rg u e s th a t
h y p o th e s is . In a d d itio n , C h in e s e e c o n o m ic ra tio n a l th e o rie s h a v e little p o w e r in e x p la in in g
re fo rm s a ffe c te d g o v e rn m e n t sh a re h o ld in g , a n d th e IP O re tu rn in th e C h in e se m a rk e t. 1
th is su p p o rts a s ig n a l a rg u m e n t in re la tio n to IP O in v e s to rs a re v e ry c o n c e rn e d a b o u t
c o n tin u in g g o v e rn m e n t su p p o rt. T h e re fo re , th is o b ta in in g p ro s p e c tu s in fo rm a tio n b e fo re b u y in g
stu d y p ro v id e s a n in te re s tin g o u tc o m e o n h o w sh a re s, a n d m a n a g e rs h a v e a stro n g m o tiv a tio n to
th e re g u la to r y e n v iro n m e n t a n d e c o n o m ic re p o rt th e ir m a n a g e d e a rn in g s to in c re a s e th e
tra n s itio n have in flu e n c e d th e lo n g -ru n o ffe r p ro c e e d s (B h a b ra & P e ttw a y 2 0 0 3 ; C h a n e y
p e rfo rm a n c e o f IP O s in C h in a . & L e w is 1 9 9 5 ; R a n g a n 1 9 9 8 ; T e o h , W e lc h &i
A lv a re z a n d G onz& lez (2 0 0 5 ) a n a ly se d th e W o n g 1998). L o u g h ra n a n d R itte r (1 9 9 7 ) h a v e '
lo n g -ru n p e rfo rm a n c e o f S p a n ish IP O s d u rin g a rg u e d th a t, i f a n IP O c o m p a n y b o o s ts its c u r r e n t!
th e p e rio d 1 9 8 7 -1 9 9 7 , e x a m in in g th e in flu e n c e e a rn in g s b e fo re issu in g sh a re s, th is m a y le a d to a 1
o f u n d e rp ric in g a s a sig n a llin g m e c h a n ism in th e d e c lin e in sto c k re tu rn s in th e p o s t issu e s b e c a u se
a fte rm a rk e t p e rfo rm a n c e o f S p a n ish IP O s. T h e ir in v e sto rs m a y o v e rv a lu e n e w is s u e s d u e to ,
fin d in g s a re c o n s is te n t w ith th e in te rn a tio n a l m is in te rp re ta tio n o f th e re p o rte d h ig h e a rn in g s. ,
e v id e n c e o n lo n g -ru n u n d e rp e rfo rm a n c e o f IP O s. H o w e v e r, in v e s to rs m a y b e d is a p p o in te d b e c a u s e
T h e y c o n firm e d th a t th e re w a s a p o s itiv e re la tio n o f th e d e c lin e in p o st-o p e ra tin g p e rfo rm a n c e
b e tw e e n th e le v e l o f u n d e rp ric in g o f IP O s a n d th e (e a rn in g s) a n d th is m a y n e g a tiv e ly a ffe c t th e
lo n g -ru n p e rfo rm a n c e o f IP O s. T h is re s u lt lo n g -ru n IP O p e rfo rm a n c e .
c o n firm s th e sig n a llin g h y p o th e s is fo r e x p la in in g

International Journal of Accounting & Business Finance 0 8 Issue 1 - 2016

3.2 Methodological problem s a m o u n t o f a b n o rm a l re tu rn s d e p e n d e d o n th e
I
m e th o d o lo g y u se d a n d o n th e b e n c h m a rk u se d
T h e Innuc o f m e th o d o lo g y is a n o th e r im p o rta n t fo r th e re tu rn a d ju s tm e n t on IP O s. T hey
fhtitor that re se a rc h ers h a v e e m p h a sise d in th e c o n c lu d e d th a t th e lo n g -ru n p e rfo rm a n c e o f IP O s
cu rren t lite ra tu re as fa r a s th e lo n g -ru n u n d e r is a m e th o d o lo g ic a l issu e a n d d e p e n d s o n th e
p e rfo rm an c e p h e n o m e n o n is c o n c e rn e d . A h m a d - a p p ro a c h u sed in e stim a tin g th e lo n g -ru n
X ttlu k i, C a m p b e ll and G o o d a c re (2 0 0 7 ) a b n o rm a l re tu rn s.
d o cu m en te d m ix e d fin d in g s o n th e lo n g -ru n
p ric e p e rfo rm a n c e o f M a la y s ia n IP O s. A 3.5 S h ort-ru n u n d erp ricin g th eo ries
sig n ifican t o v e rp e rfo rm a n c e w a s re p o rte d in E W
event CARs and BHARs u s in g m a rk e t T h e m a in th e o rie s o f sh o rt-ru n u n d e rp ric in g th a t
b en ch m ark s. H o w e v e r, th is fin d in g d isa p p e a re d m a y e x p la in th e lo n g -ru n p e rfo rm a n c e are
w hen the V W m e th o d w a s u se d to m e a su re b o th sig n a llin g th eo ry , a g e n c y c o st th eo ry , p ro sp e c t
retu rn s an d m a tc h e d c o m p a n ie s w e re e m p lo y e d th e o ry a n d u n c e rta in ty theory.
US ft b en ch m ark . In a d d itio n , th e sig n ific a n t o v e r
p erfo rm an c e d isa p p e a re d w h e n th e F a m a - S ig n a llin g th eo ry
F rench Ih rcc-facto r m o d e l w a s u se d to m e a su re
lltC lo n g 'ru n p e rfo rm a n c e. T h is in d ic a te s th a t th e As d isc u sse d in S e c tio n 2 .4 .1 .6 , sh o rt-ru n
ev en -tim e a p p ro a c h p ro v id e s a m o re p o sitiv e u n d e rp ric in g c a n b e u se d as to o l to sig n a l th e
return In the lo n g ru n re la tiv e to th e c a le n d a r-tim e q u a lity o f issu e rs to th e m a rk e t. A lle n a n d
(tpprouch. T h e re fo re, th e fin d in g s v a ry a c c o rd in g F a u lh a b e r (1 9 8 9 ), W elch (1 9 8 9 ) a n d G rin b la tt
(
lO tile m e th o d o lo g y u se d fo r a n a ly sis. G o m p e rs and H w ang (1 9 8 9 ) e x p la in e d s h o rt-ru n
lltlll I,e n te r (2 0 0 3 ) a n d A b u k a ri a n d V ijay (2 0 1 1 ) u n d e rp ric in g a s a sig n a l o f h ig h -q u a lity issu ers.
Also found that w h e th e r IP O s u n d e rp e rfo rm o r N o rm a lly , to re c o v e r any o p p o rtu n ity
o v e r p c rlb n n in th e lo n g ru n is d e te rm in e d b y th e lo sse s a t th e tim e o f th e IP O , h ig h -q u a lity issu ers
m e th o d Of p e rfo rm a n c e m e a s u re m e n t. c o n d u c t se c o n d a ry e q u ity o ffe rin g s w h e n th e
M oreover, A jlo u n i a n d A b u -E in (2 0 0 9 ) h a v e m a rk e t p ric e is e sta b lish e d a fte r q u a lity is
Argued th a t, o v e ra ll, th e su g g e s te d m e th o d isc o v e re d b y in v e sto rs. G rin b la tt a n d H w a n g
d o lo g lcs m ay cre a te a p o sitiv e re tu rn in th e sh o rt (1 9 8 9 ) fo u n d th a t h ig h -q u a lity issu e rs in itia lly
I tlll, but In th e long ru n , th e y a re d a n g e ro u s to th e issu e a lo w p ro p o rtio n o f th e ir e q u ity c a p ita l at
Ifiveslttrs' w ealth . T h e re fo re , th e y re c o m m e n d th e tim e o f th e IP O at a lo w P R IC E a n d th e n sell
i
th e use of d if f e r e n t m e th o d o lo g ie s and th e ir re m a in in g e q u ity c a p ita l a t aj h ig h p ric e in
b e n c h m a rk s in fu tu re a n a ly sis. K o o li and th e seco n d a ry m a r k e t. T h is s i g n a l s th a t
N urel(2004) d o c u m e n te d th a t th e lo n g -ru n u n d e r c o m p a n ie s e a rn in g h ig h sh o rt-ru n re tu rn s w ith a
p erfo rm an c e o f C a n a d ia n IP O s d e p e n d e d o n th e lo w fra c tio n o f th e ir e q u ity c a p ita l te n d to h a v e
m e th o d o lo g y u se d and on th e w e ig h tin g b e tte r lo n g -ru n p e rfo rm a n c e.
sch em es. F inally, M o sh iria n , N g a n d W u (2 0 1 0 ) A lv a re z a n d G o n z a le z (2 0 0 5 ) a n a ly se d th e
used altern a tiv e m e th o d o lo g ie s to e x a m in e th e lo n g -ru n p e rfo rm a n c e o f S p a n ish IP O s d u rin g
ro b u stn ess o f IP O p e rfo rm a n c e in th e A sia n th e p e rio d 1 9 8 7 -1 9 9 7 and e x a m in e d th e
reg io n . T h e ir re su lts c le a rly re v e a le d th a t in flu e n c e o f u n d e rp ric in g as i a s ig n a llin g
c o n f lic tin g fin d in g s w e re o b ta in e d w hen m e c h a n ism in th e a fte rm a rk e t p e rfo rm a n c e o f
dld'orcnt b e n c h m a rk s w e re ad o p ted . F u rth e r, th e S p a n ish IP O s. T h e y fo u n d a p o sitiv e re la tio n

llltm’iititlonal journal of Accounting & Business Finance 09 Issue 1 - 2016

b e tw e e n th e le v e l o f u n d e rp ric in g o f IP O s a n d th e fu n c tio n s th a t o v e rw e ig h lo w p ro b a b ility e v e n ts
lo n g -ru n p e rfo rm a n c e o f IP O s . T h is re s u lt a n d u n d e rw e ig h t m e d iu m a n d h ig h p ro b a b ility
c o n f ir m s th e s ig n a llin g h y p o th e s is as an e v e n ts. IP O s h a v e m o re e x tre m e re tu rn s u n d e r
e x p la n a tio n f o r th e lo n g -ru n u n d e r p e rfo rm a n c e th e p ro s p e c t th e o ry th a n th e e x p e c te d u tility
o f IP O s in th e S p a n ish c a p ita l m a rk e t. th e o ry . T h e re fo re , i f th e a v e ra g e re tu rn s in th e
U s in g A u s tra lia n a n d U K IP O s, L e e , T a y lo r lo n g ru n a re lo w e r, th e in v e s to rs w ill s till in v e s t
a n d W a lte r (1 9 9 6 ) a n d B e lg h ita r a n d D ix o n in IP O s b e c a u s e o f th e s e e x tre m e re tu rn s u n d e r
(2 0 1 2 ) fo u n d a p o s itiv e re la tio n s h ip b e tw e e n th e p r o s p e c t th e o ry .
lo n g -ru n m a rk e t p e rfo rm a n c e a n d th e first-d a y
re tu rn . T h e y c o n firm e d th e sig n a llin g th e o ry a s Uncertainty theory '

a n e x p la n a tio n o f lo n g - r u n m a rk e t p e rfo rm a n c e .
T h o m a d a k is, N o u n is a n d G o u n o p o u lo s (2 0 1 2 )
Agency cost theory u s e d th e o w n e rsh ip re te n tio n r a tio a s a p ro x y to
m e a s u re th e u n c e rta in ty o f th e q u a lity o f th e firm
W h e n a c o m p a n y is c o n v e rte d to a n IP O , th e a n d a rg u e d th a t a h ig h re te n tio n r a tio w ill in d ic a te
o w n e rsh ip a n d c o n tro l a re c o n d u c te d b y tw o lo w u n c e rta in ty a b o u t th e q u a lity o f th e fir m a n d
d iffe re n t p a rtie s . T h is is k n o w n a s s e p a ra tio n o f e x p e c ta tio n s o f b e tte r lo n g -ru n p e rfo rm a n c e .
o w n e rsh ip a n d c o n tro l. T h is le a d s to a n in c re a se G o e rg e n a n d R e n n e b o o g (2 0 0 7 ) su p p o rte d th is
in a g e n c y c o sts, p a rtic u la rly b e c a u s e th e re is a a rg u m e n t. S o m e re se a rc h e rs h a v e u s e d v a ria b le s
re d u c tio n in o w n e r m a n a g e rs o r m a n a g e m e n t to te s t th e u n c e rta in ty th e o ry to e x p la in lo n g -ru n
o w n e rs. T h is p rin c ip le w a s d is c u s s e d in S e c tio n m a rk e t p e rfo rm a n c e . T h e s e v a ria b le s a re th e a g e
2 .4 .2 .2 . o f th e is s u in g firm , s iz e o f th e is s u e , s iz e o f th e
The agency c o s t th e o ry m ay e x p la in firm , o ffe r p ric e , L IS D a n d M V . H o w (2 0 0 0 ) u s e d
d e c lin e s in lo n g -ru n m a rk e t p e rfo rm a n c e d u e to th e d e la y v a ria b le to e x p la in lo n g -ru n p e r
th e lo w o w n e rsh ip re ta in e d b y o w n e r m a n a g e rs a t fo rm a n c e . O ffe r siz e w a s u s e d to e x p la in lo n g -
tiie tim e o f th e IP O . In o th e r w o rd s, i f th e o w n e r r u n p e rfo rm a n c e b y C a i, L iu a n d M a s e (2 0 0 8 )
m a n a g e rs h a v e h ig h o w n e rsh ip a fte r th e IP O , th e a n d T h o m a d a k is, N o u n is a n d G o u n o p o u lo s
c o m p a n y m a y p e rfo rm b e tte r in th e lo n g ru n . (2 0 1 2 ). O m ra n (2 0 0 5 ) used MV as an
H o w e v e r, J e n k in s o n and L ju n g q v ist (2 0 0 1 ) e x p la n a to ry v a ria b le o f lo n g - r u n p e rfo rm a n c e .
fo u n d th a t lo n g -ru n m a rk e t p e rfo rm a n c e c a n n o t
b e e x p la in e d b y a g e n c y c o s t in a se m i-stro n g 4 . C o n c lu s io n s
e ffic ie n t m a rk e t.
T h is se c tio n su m m a rise s th e a b o v e m e n tio n e d
Prospect theory lite r a tu r e r e la tin g to th e lo n g - r u n m a rk e t
p e rfo rm a n c e o f IP O s.
M a a n d S h e n (2 0 0 3 ) e x p la in e d lo n g -ru n IP O The e v id e n c e on lo n g -ru n under
p e rfo rm a n c e u s in g p r o s p e c t th e o r y as an p e rfo rm a n c e o f IP O s is n o t a s w id e s p re a d a s th a t
a lte rn a tiv e to th e e x is tin g th e o rie s. T h e y a rg u e d o f sh o rt-ru n u n d e rp ric in g o f IP O s. H o w e v e r, th e
th a t IP O u n d e r p e rfo rm a n c e is n o t a p u z z le lo n g - r u n u n d e rp e rfo rm a n c e o f IP O s is a
b e c a u s e o f in v e s to r ra tio n a lity . A c c o rd in g to th is d e b a ta b le phenom enon becau se lo n g -ru n
th e o ry , it is a s s u m e d th a t in v e s to rs h a v e u tility p e rfo rm a n c e is th e m o s t c o n tro v e rs ia l a re a in

International journal of Accounting & Business Finance 1 0 Issue 1 - 2016

11*0 research . Ja k o b se n a n d S o re n se n (2 0 0 1 ) in itia l p u b lic o ffe rin g market!.Financial
su p p o rte d Ibis arg u m e n t, re p o rtin g th a t th e re is Management, 19 (4 ), 4 5 -5 7 :
n o c o n v in c in g th e o ry th a t ex p la in s IP O lo n g -ru n A h m a d & Z a lu k i, N . A ., C a m p b e ll, K., &
I
m ark et p e rfo rm a n c e . In a d d itio n , T h o m a d a k is, G o o d a c re , A . (2 0 0 7 ). T hej lo n g ru n sh a re
N ounlo an d G o u n o p o u lo s (2 0 1 2 ) m e n tio n e d th a t p ric e p e rfo rm a n c e o f M a la y sia n in itial
lo n g -ru n p e rfo rm a n c e stu d ie s h a v e re p o rte d p u b lic o f f e r in g s (IP O s). Jo u rn a l of
c o n tro v e rsia l a n d c o n flic tin g fin d in g s. Som e B u sin e ss F in a n c e & A c c o u n tin g , 3 4 (1 2 ),
re se a rc h ers h a v e fo u n d th a t IP O s u n d e rp e rfo rm 78-110.
m arg in ally o r h a v e n o a b n o rm a l p e rfo rm a n c e in A jlo u n i, M & A b u -E in , 0 .( 2 0 0 9 ) . L o n g -ru n
(lie lo n g ru n ; th u s, th e y d o n o t re je c t th e m a rk e t p e rfo rm a n c e o f in itia l p u b lic o ffe rin g s in
efficien cy h y p o th e sis in th e lo n g ru n (G o m p e rs & a n e m e rg in g m a rk e t: the, ca se o f A m m a n
I,e n te r 20 0 3 ; Ib b o tso n 1975; J e n k in so n & Journal of International
sto c k e x c h a n g e ',
I Ju n g q v isl, 2 0 0 1 ). O th e rs h a v e re p o rte d th a t Finance andEconomics, 9,(1), 2 5 -4 4 .
IP O s o v e rp e rfo rm o r d o n o t u n d e rp e rfo rm in th e A lle n , D & P a tric k , M (1 9 9 6 ). S o m e fu rth e r
lo n g -ru n m a rk e t (B ird & Y eung 2 0 1 0 ; D a S ilv a A u s tra lia n e v id e n c e on th e lo n g -ru n
Homi. V clayuthen & W alter, 2 0 0 3 ; T h o m a d a k is, p e rfo rm a n c e o f i n i t i a l !p u b lic o ffe rin g s:
N tninls & G o u n o p o u lo s, 2 0 1 2 ). S till o th e rs h a v e 1 9 7 4 -1 9 8 4 , in T B o s i & T F e th e rsto n e
atgtictl that u n d e rp e rfo rm a n c e d isa p p e a rs w h e n (e d s.), Advances in Pacific Basin financial
d iffe re n t p e rfo rm a n c e m e a s u re s or m e th o markets, E m e ra ld G ro u p , 2 A , 1 3 3 -1 5 5 .
d o lo g lc s are u se d (A b u k a ri & V ijay , 2011; A lle n , F & F a u lh a b e r, G .(1 9 8 9 ). S ig n a llin g b y
A lin iad -Z u lu k i, C a m p b e ll & G o o d a c re ,(2 0 0 7 ) u n d e rp ric in g in th e IP O m a rk e t', Journal of
(lu m p e rs & L c m e r, 2 0 0 3 ; K o o li & S u re t,(2 0 0 4 ). Financial Economics, 2 3 (2 ), 303—323.
T h e rest h a v e fo u n d th a t IP O s u n d e rp e rfo rm A lv a re z , S & G o n z a le z , V (2 0 0 5 ). S ig n a llin g a n d
euniildem bly in th e lo n g -ru n IP O m a rk e t (H o w th e lo n g -ru n p e rfo rm a n c e o f S p a n ish in itial
2000; L ee. T a y lo r & W alter,(1 9 9 6 ) R itte r (1 9 9 1 ). p u b lic Journal o f
o f f e r in g s ( I P O s ) ',
H o w ev er, p re v io u s re se a rc h e rs h a v e e x p la in e d Business Finance & Accounting, 3 2 , (1 - 2 ) ,
lo n g -ru n p e rfo rm a n c e u s in g be h a v io u ra l 3 2 5 -3 5 0 .
th eo ries, m e th o d o lo g ic a l issu e s a n d sh o rt-ru n B e lg h ita r, Y & D ix o n , R .(2 0 1 2 ).D o v e n tu re
u n d e rp ric in g th e o rie s. S o m e IP O re se a rc h e rs are c a p ita lis ts j u n d e rp ric in g a n d
re d u c e
III line w ith an e ffic ie n t m a rk e t p o in t o f v ie w an d u n d e rp e rfo rm a n c e o f IP O s ? ', Applied
Others are in lin e w ith a b e h a v io u ra l p o in t o f FinancialEconomics, . 2 2 ,( 1 ) , 33—44.
view, B e n e ish , M D . (2 0 0 1 ). E a rn in g s m a n a g e m e n t: a
p e rsp e c tiv e , Managerial Finance, 2 7 , (1 2 ),
R e fe re n c e s 3 -1 7 .
A huknri. K & V ijay, J.(2 0 1 1 ). Long te rm B h a b ra , H & P ettw ay , R .(2 0 0 3 ). IP O p ro sp e c tu s
p e rfo rm a n c e a n d p re d ic ta b ilty o f in itia l in fo rm a tio n a n d s u b se q u e n t p e rfo rm a n c e ',
p u b lic o ffe rin g s (IP O s), FMA Annual The Financial Review, 3 8 , (3 ),. 3 6 9 -3 9 7 .
Meeting Program, O tta w a , v ie w e d 20 B ird , R & Y e u n g , D 2 0 1 0 , Institutional
A u g u st 2012, < w w w .fin a .o rg / D e n v e r/ ownership and IPO performance:
D c n v e rP ro g ra m .h tm >. Australian evidence, W o rk in g p a p e r se ries
A g g u rw al, R & R iv o li, P .(1990). F a d s in th e 6 , P a u l W o o lley C e n tre fo r C a p ita l M a rk e t

liileniullonnl lournal of Accounting & Business Finance H Issue 1 - 2016

 D y s fu n c tio n a lity , U n iv e rs ity of 3 3 3 -3 5 1 .
T e c h n o lo g y Sydney, N SW , v ie w e d 4 G a o , Y. (2 0 1 0 ) W h a t c o m p rise s IP O in itia l
D ecem ber 2 0 1 2 ,< h ttp ://b u s in e s s . r e tu r n s : e v id e n c e fro m th e C h in e s e
u ts .e d u .a u /q frc /p w c /re s e a rc h /w o rk in g p a p m a rk e t’, Pacific-Basin Finance Journal,
e r s /2 0 10 /w p 6 .p d f>. 1 8 ,7 7 - 8 9 .
B o a b a n g , F .(2 0 0 5 ). T h e o p e n in g , sh o rt, m e d iu m G o e rg e n , M & R e n n e b o o g , L . (2 0 0 7 ). D o e s
a n d lo n g te rm p e rfo rm a n c e o f C a n a d ia n o w n e rsh ip m a tte r? A stu d y o f G e rm a n a n d
u n it tru s t in itia l p u b lic o ffe rin g s U K IP O s’, M anagerial Finance, 3 3 (6 ),
{\P O s)Joum al o f Business Finance & 3 6 8 -3 8 7 .
Accounting, 3 2 , (7 - 8 ) , 1519—1536. G o m p e rs, PA & L e m e r, J. (2 0 0 3 ). T h e re a lly
C a i, X , L iu , G & M a se , B .(2 0 0 8 ). T h e lo n g -ru n lo n g -ru n p e rfo rm a n c e o f in itia l p u b lic
p e rfo rm a n c e o f in itia l p u b lic o ffe rin g s a n d o ffe rin g s: th e p re -N a s d a q e v id e n c e ’, The
its d e te rm in a n ts: th e c a se o f C h in a Jte v ie w ' Journal o f Finance, 5 8 (4 ), 1 3 5 5 -1 3 9 2 .
o f Quantitative Finance and Accounting, G rin b la tt, M & H w a n g , CY. (1 9 8 9 ). S ig n a llin g
3 0 (4 ), 4 1 9 -4 3 2 . a n d th e p r ic in g o f n e w issu e s. 77ze Journal
C h a n , K , W an g , J & W ei, K ,(2 0 0 4 ). U n d e rp ric in g o f Finance, 4 4 (2 ), 3 9 3 -4 2 0 .
a n d lo n g -te rm p e rfo rm a n c e o f IP O s in H o w , J. (2 0 0 0 ). In itia l a n d lo n g -ru n p e rfo rm a n c e
C h in a ’, Journal o f Corporate Finance, o f m in in g IP O s in A u stra lia ’, Australian
1 0(3), 4 0 9 -4 3 0 . ■ Journal ofManagement, 2 5 (1 ), 9 5 -1 1 8 .
C h an ey , P K & L e w is, C M . (1 9 9 5 ). E a rn in g s Ib b o tso n , R . (1 9 7 5 ). P ric e p e rfo rm a n c e of
m a n a g e m e n t a n d firm v a lu a tio n u n d e r c o m m o n s to c k n e w issu e s’, Journal o f
a s y m m e tr ic in f o r m a tio n ’, Journal o f Financial Economics, 2 (3 ), 2 3 5 -2 7 2 .
Corporate Finance, 1(3), 3 1 9 -3 4 5 . J a k o b se n , J & S o re n se n , 0 ,( 2 0 0 1 ) . D e c o m p o s in g
D a S ilv a R o sa , R , V e la y u th e n , G & W alter, T. and te s tin g lo n g -te rm re tu rn s : an
(2 0 0 3 ). T h e s h a re m a rk e t p e rfo rm a n c e o f a p p lic a tio n o n D a n ish IP O s’, European
A u s tra lia n v e n tu re c a p ita l-b a c k e d a n d n o n ­ Financial Management, 7 (3 ), 3 9 3 -4 1 7 .
v e n tu re c a p ita l-b a c k e d IP O s , Pacific- Je n k in so n , T & L ju n g q v ist, A . (2 0 0 1 ). Going
Basin Finance Journal, 11,(2), 1 9 7 -2 1 8 . public: the theory and evidence on how
D e B o n d t, W & T h a le r, R . (1 9 8 7 ). F u rth e r companies raise equity finance, O x fo rd
e v id e n c e o n in v e s to r o v e rre a c tio n a n d U n iv e rsity P re ss, O x fo rd , U K .
s to c k m a rk e t s e a s o n a lity 1, Journal o f J o h n sto n , J & M a d u ra , J 2 0 0 2 , ’T h e p e rfo rm a n c e
Finance, 4 2 (3 ), 5 5 7 -5 8 1 . o f in te rn e t firm s fo llo w in g th e ir in itia l
D im o v sk i, W & B ro o k s, R . (2 0 0 4 ). In itia l p u b lic p u b lic o ffe rin g ’, The Financial Review,
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