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IPO performance and earnings expectations: some French evidence

IPO performance and earnings expectations: some French evidence

IPO

IPO performance and earnings expectations : some French evidence Abstract We examine the long-run stock price performance of an exhaustive sample of 243 French IPOs conducted between 1991 and 1998. Using a variety of benchmarks, we find that on average French IPOs do not underperform. Our finding is consistent with Brav and Gompers (1997), who argue that the disappointing stock price performance of U.S. IPOs largely disappears once proper risk adjustments are introduced. We also analyze the cross-section of IPO performance, introducing a number of ex ante variables. None of them exhibits significant explanatory power in our sample, suggesting that no subcategory of IPOs systematically underperforms (or overperforms) over the entire 36-month period-- at least when the subcategory is defined using information known at the time of the IPO. Next, we ask whether investors’ expectations are embodied in earnings forecasts issued at the time of the IPO. We look at earnings forecasts published in the IPO prospectuses, as well as forecasts by financial analysts. We distinguish between financial analysts affiliated with the bank taking the company public, and unaffiliated analysts. We find that prospectus forecasts and forecasts issued by analysts affiliated to underwriters are more optimistically biased than forecasts issued by unaffiliated financial analysts. Analysts forecasts for IPO companies are not more biased than forecasts issued for non-IPO firms, suggesting that accuracy incentives may be high for analysts dealing with newly listed companies. Finally, we find that analysts’ forecast errors are the main driver of IPOs’ stock price performance: they appear to embody investors’ expectations at the time of the IPO. 2

1. Introduction A number of recent U.S. studies have documented an apparent tendency of IPOs to underperform in the long run. Ritter (1991) finds that over a three-year horizon after the offering, U.S. IPOs underperform on average by 29% relative to comparable firms. In a study on U.S. IPOs and Seasoned Equity Offerings (SEOs), Loughran and Ritter (1995) find that “An investor would have had to invest 44% more money in the issuers than in non-issuers of the same size to have the same wealth five years after the offering date”. Several behavioral explanations have been advanced for these findings. Perhaps investors do not take into account fully the fact that the accounts of companies going public are managed upwards before the IPO (Teoh, Welch, and Wong 1997) and base their valuation of the IPO on a naïve extrapolation of the past. Perhaps investors do not fully disentangle IPO timing strategies: Degeorge and Zeckhauser (1993) argue that companies will choose to go public after unusually high earnings performance. Regression toward the mean predicts that post-IPO earnings performance will be inferior to the pre-IPO record. Failure to take into account this phenomenon would result in inflated IPO valuations. Underwriter incentives might also contribute to excessive IPO valuations. Michaely and Womack (1999) document that financial analysts linked to the underwriter try to push-up IPO prices through positive recommendations. While behavioral approaches have recently gained wider acceptance in finance, the main criticisms of the IPO performance literature have been targeted at the initial finding, i.e. the claim that IPOs underperform in the long run. Brav and Gompers (1997) argue that Ritter's findings essentially disappear once book-to-market and size effects are taken into account: in this view, the new issue puzzle is merely a reincarnation of long known anomalies. In addition, most IPO studies to date have used U.S. data, and are therefore susceptible to the data mining accusation. 3

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