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 I IPOs offer few tangible information I S-1 filing offers ample amount of intangible information I I important impact on investors’ assessment Research question: I Can S-1 language, by measuring uncertainty, explain first-day returns and subsequent volatility? Contribution and related literature I I I Beatty and Ritter (1986) I reputation problem of underwriter: underpricing equilibrium I too low initial return, investor cease doing business with her I higher ex ante uncertainty → higher underpricing (1st-day return) How to measure ex-ante uncertainty? I Previous literature offer few ex-ante proxies for uncertainty I Papers with focus on final IPO prospectus I This paper: exploit use in S-1 filings of uncertain/weak modal words or negative words Related papers I Loughran and McDonald (2011): 10-K and subsequent volatility I Hanley and Hoberg (2010): standard vs. informative language I Hanley and Hoberg (2012): litigation and information disclosure Data and sample statistics I Sample of 1,887 completed US IPOs during 1997-2010 I How uncertain text is measured? 6 word lists I 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 I I Underwriter take advantage of issuers in weak informational position (Loughran and Ritter, 2002) I lowball initial offer price I only partly increase final offer price I indirect benefit of allocating underpriced shares Absolute revision in offer price: bookbuilding (Sherman and Titman, 2002) I issuers using language to attract information production I 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 I Change in % use of words from S-1 to 424 I no significant effect on Up revisions I Uncertain language correlated with VC and lower sales I 793 withdrawn IPOs I uncertain language marginally raise probability of withdraw Conclusion I Evidence supporting link between ex-ante uncertainty and underpricing I Word lists on S-1 provide measure of uncertainty that are I I direct, ex-ante, firm-specific, measured well before the IPO Criticisms I some results sensitive to word counting (Ferris, Hao, and Liao, forthcoming) I macroeconomic conditions → price volatility and uncertain text Backup slides Table 3: First day returns back
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