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5 years ago

* I would like to thank Frank Dobbin, Christopher Marquis, Peter ...

* I would like to thank Frank Dobbin, Christopher Marquis, Peter ...

IPOs in the U.S. since

IPOs in the U.S. since the late 1990s. These non-bookbuilt IPOs exhibit far lower first-day returns (Purnanandam and Swaminathan 2004). However, such non-bookbuilt IPOs remain a rarity. An exposition on the institutionalization of current U.S. IPO practices following the aftermath of the Great Depression is beyond the scope of this paper. 11 � � For instance, examination of Derrien’s (2005) model reveals that ���� ��� ������ and � second-stage return outcomes are: ���� ��� ����� ����������. However, nothing can be � said about first-stage return outcomes, as this formulation cannot address the relation of ���� to the price range with regard to the underwriter’s profit-maximization motive. This again highlights the incompleteness of this model of first-day returns, as studies indicate that pricing above the range is far and away the most important factor in determining first-day returns. 12 The lead underwriter serves as a primary trader for the newly listed stock with the goal of stabilizing the price for the first several months following the IPO. This is the only legal exception to anti-manipulation trading laws allowed by the SEC. The stabilization agent can short sell the stock if necessary, and cover the shorts by calling on more shares from the issuer through a “greenshoe” mechanism. Named after the first company to grant an over-allotment option to its underwriters (Green Shoe Manufacturing Company, since renamed Stride Rite Corporation), the greenshoe is basically a free call option for an additional 15 percent of the original number of IPO shares at the final offer price to institutional investors granted to the lead underwriter by the issuer. 13 All quotes by industry practitioners are drawn from a qualitative study of IPO processes conducted between September 2009 and August 2010. The study interviewed senior managers of key IPO participants (underwriters, institutional investors, and private-equity backed issuers) selected from a stratified random sample of top-tier firms, achieving a combined response rate of 75 percent. See Feng (forthcoming) for details on the data and qualitative analysis procedures. 14 If we take Derrien’s (2005) model of underwriter profit-maximization, the lack of a costly price support ������É� ���� � � ������ � � � � �� �� 46 �� � ��� ��� ����� means underwriters should � � increase POPR to the maximum price given δ sentiment levels, or ���� ��� ��� ����. In such a formulation, δ would predict price level but not returns, as P1 = POPR and first-day returns should again equal zero, with underwriters effectively selling to sentiment investors when δ > z0. Furthermore, if underwriters do not seek private information to estimate the intrinsic value of the issuer, there would be no need to sell to rational investors, unless the underwriters are purposively trying to generate profits from spinning, quid pro quo, and stabilization activity from high first-day returns, or when sentiment levels are sufficiently low: δ < z0. ��� 15 If we take the discrete DPV equation from footnote 5:���� � �� ; IRR is i, the initial ������ ��� funding provided by limited partners is DPV, the investment gain is FVt-DPV, and we can rewrite the equation as: �������������� �� (for simplicity, assuming gains gross of fees and carried interest for a one investment discrete fund), and �� �� ��������������, so for ������� ��, IRRs decrease with increasing time to realization t. 16 As the partner of a leading Silicon Valley venture capital firm remarked: “We’re not angels. We’re here to make a buck like everyone else . . . its dog eat dog, every VC for himself. Believe me, if I can get out, I sell fast, but I want to sell dear, so I have to make sure what I’m selling has a future, otherwise what idiot is going to buy it from me?” A senior managing director at a leading LBO firm corroborates this viewpoint from the other side: “The media is so biased, all

those propaganda films about how evil PE [private equity, here referring to LBO] firms are. I mean, what the hell, you know who the real assholes are? It's the damn vulture capitalists, the VCs are the first ones looking to get out of Dodge when the shit hits the fan. We’re in there for the long haul . . . so we leverage these companies, make them leaner, more productive, so what? That’s better than the vultures selling before any of the heavy lifting.” 17 As the co-managing partner of a leading global LBO firm commented: “Hey, we’re not the growth guys, in the buy-out business we get what we can whenever we can, and we generate damn good returns without growth . . . if you can squeeze the lemon before the offering and have the IPO pay back the debt, hell, why not?” He had previously referred to dividends to shareholders from leveraged recapitalizations of companies as making lemonade, since you retain share ownership without dilution and simply have to “rehydrate” the dry lemons to squeeze again. Here, the IPO investors are rehydrating the lemons. 18 As a senior partner at a leading global growth capital private equity firm remarked: “we don’t get into the business of layering on debt prior to the offering, unlike the buy-out shops, our companies are growing rapidly. There are far better places to put the [IPO] money than in our own pockets . . . putting it [IPO proceeds] back to work by reinvesting in future growth more than makes up for passing on an immediate payday.” 19 Negative values of debt-to-capitalization where negative equity is greater than debt are inverse coded as one plus the absolute value of the debt ratio. Equity can become negative due to accumulated losses. I add one to preserve the correct relative ranking of leverage since a negative debt ratio represents a higher debt level than a debt ratio of one (i.e., debt equals capitalization because equity is zero). Unadjusted for negative values, the mean, median and standard deviation for debt in the full sample are: 0.79, 0.40, 7.23 (excluding Income logic: 0.41, 0.21, and 2.46, respectively). All analyses utilize inverse coded debt, but use of unadjusted debt does not alter the substantive results. Debt (unadjusted or inverse coded) is never a significant predictor of any response variable. 20 Investment banks conform to a strict status hierarchy best documented by the stringent rulebased name placement ceremony involved in advertising completed transactions. These advertisements are known as “tombstones” because they were originally published in the Wall Street Journal facing the obituaries section. The top-tier underwriters form a distinct group and are referred to as the “bulge-bracket” due to their type font and placement on the tombstones. 21 High-status underwriters achieve greater efficiency by their enhanced ability to assemble a syndicate of co-managers that help sell the stock. Podolny showed that underwriter status lowered debt-underwriting fees, with underwriters passing on cost savings to issuers (1993, 2005). For IPO underwriting, fees are fixed at 7 percent for the majority of offerings, so underwriter status cannot influence fees. Instead, status signal effects could only operate through the price outcome, with underwriters passing along efficiency savings in marketing and distributing the stock back to the issuer in the form of lower first-day returns. 22 VIX was originally introduced in a finance journal article as an index of the implied volatility on the S&P 100 (Whaley 1993). In 2003, a new VIX was developed for the S&P 500. The VIX is the square root of the risk neutral expectation of S&P 500 variance over the next 30 calendar days quoted on an annualized variance basis. 23 EBITDA: earnings before interest, depreciation, and amortization. 24 Rule 144 applies equally to all 5 percent blockholders and investors holding shares issued outside a registered offering (e.g., pre-IPO shares). Such shares cannot be sold until a one-year 47

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