When IPO shares are sold sequentially, later potential investors can learn from the purchasing decisions of earlier investors. This can lead rapidly to "cascades" in which subsequent investors optimally ignore their private information and imitate earlier investors. Although rationing in this situation gives rise to a winner's curse, it is irrelevant. The model predicts that: (1) Offerings succeed or fail rapidly. (2) Demand can be so elastic that even risk-neutral issuers underprice to completely avoid failure. (3) Issuers with good inside information can price their shares so high that they sometimes fail. (4) An underwriter may want to reduce the communication among investors by spreading the selling effort over a more segmented market.
Several recent paprs present signaling models in which firms underprice their initial public offerings of equity (IPOs) so that they can subsequently issue seasoned equity at more favorable prices. We test the implications of these models. We find a positive relation between IPO underpricing and the probability and size of subsequent seasoned offerings. Although these results are consistent with the implications of the signaling hypotheses, the economic significance appears weak. We conduct additional tests to evaluate other explanations for these findings and find the alternatives more compelling.
Announcements of successful leveraged buyouts (LBOs) during January 1985 to April 1989 caused a significantly negative return on outstanding publicly traded nonconvertible bonds. Yet the average risk-adjusted debt bolder losses are less than 7 percent of the wage risk-adjusted equity holder gains. Bond losses are related to the pre- LBO rating but only weakly to equity holder gains. We demonstrate that trader-quoted data from a major investment bank offers conclusions about the effects of LBOs on debt holders different from those drawn from commonly used matrix and exchange-based data (such as Standard & Poor's Bond Guide data]. This has important implica- tions for event studies involving debt instruments.
This paper briefly describes recent papers on the economics of rational herding in financial markets. Some models can predict perfect herding, in which rational agents all act alike without any countervailing force. Such herding typically arises either from direct payoff externalities (negative externalities in bank runs; positive externalities in the generation of trading liquidity or in information acquisition), principal-agent problems (based on managerial desire to protect or signal reputation), or informational learning (cascades). The paper also provides a few pointers to related literature and suggests issues to be addressed in future research.
An issuer of an initial public offering (IPO) faces numerous decisions, of which the selection and compensation of "experts"--the legal counsel, the auditor, and the investment banker--are among the most important. The close relation between underwriter compensation and offering size is apparent in Table 2, which classifies average expert compensation by offering size. (A Big 6 auditor [15 points market share] reduces percentage underwriter compensation by about 1.5 percent. As to other expert compensation, note that we multiply residual percentage underwriter compensation from the first-step regression by offering size to compute a dollar compensation figure (used here and in the subsequent lawyer compensation regression). The dispersion regressions confirm the findings for IPO underpricing: firms with better underwriters and more underwriter compensation have more IPO underpricing dispersion; firms with better auditors and low-price stocks had lower underpricing dispersion. Therefore, we are confident that the relation between IPO underpricing and underwriter compensation has reversed due to differences in the economic environment. The positive relation between underwriter compensation and IPO underpricing (documented in Table 8) is only among firms claiming few risk factors. For firms claiming high risks, underwriter compensation actually correlates differently (negatively) with IPO underpricing across risk groups. Without size/scale controls, underwriter market share predicts underwriter compensation negatively, reflecting the economies of scale in underwriting.
This theory can explain why bank debt is universally senior, consistent with the presence of conflict (lawyers) and absolute priority violations in financial distress: Better organized banks would more strongly contest priority in financial distress if they were junior. Because "deterrence" can reduce creditors' total expenses in a priority contest, the ex post stronger lobbyist/litigant should be senior ex ante. For equivalent reasons, the theory can advise when public debt should be senior to trade credit and/or implicit contracts, and can even suggest one rationale for the absolute priority rule (APR). This article further shows that Chapter 11 creditor reimbursement procedures can lower overall costs.
Issuers of initial public offerings ~IPOs! can report earnings in excess of cash f lows by taking positive accruals. This paper provides evidence that issuers with unusu- ally high accruals in the IPO year experience poor stock return performance in the three years thereafter. IPO issuers in the most "aggressive" quartile of earnings managers have a three-year aftermarket stock return of approximately 20 percent less than IPO issuers in the most "conservative" quartile. They also issue about 20 percent fewer seasoned equity offerings. These differences are statistically and economically significant in a variety of specifications.
Seasoned equity issuers can raise reported earnings by altering discretionary accounting accruals. We find that issuers who adjust discretionary current accruals to report higher net income prior to the offering have lower post-issue long-run abnormal stock returns and net income. Interestingly, the relation between discretionary current accruals and future returns (adjusted for firm size and book-to-market ratio) is stronger and more persistent for seasoned equity issuers than for non-issuers. The evidence is consistent with investors naively extrapolating pre-issue earnings without fully adjusting for the potential manipulation of reported earnings.
The consensus of 226 academic financial economists forecasts...
This paper explains why some firms prefer to pay dividends rather than repurchase shares. When institutional investors are relatively less taxed than individual investors, dividends induce "ownership clientele" effects. Firms paying dividends attract relatively more institutions, which have a relative advantage in detecting high firm quality and in ensuring firms are well managed. The theory is consistent with some documented regularities, specifically both the presence and stickiness of dividends, and offers novel empirical implications, e.g., a prediction that it is the tax difference between institutions and retail investors that determines dividend payments, not the absolute tax payments.
The paper shows that the buy or sell recommendations of security analysts have a signi"cant positive influence on the recommendations of the next two analysts. This influence can be traced to short-lived information in the most recent revisions. In contrast, the influence of the prevailing consensus is not stronger if the consensus accurately forecasts subsequent stock price movements. This indicates consensus herding consistent with models in which analysts herd based on little information. The consensus also has a stronger influence when market conditions are favorable. The resulting poorer information aggregation could cause bull markets to be intrinsically more `fragile" (e.g., Bikhchandani et al., J. Political Economy 100(5) (1992) 992}1026).
Schmalenbach Business Review x Vol. 52 x April 2000 x pp. 103 136
This study predicts cross-sectional investment (asset-normalized capital expenditures) innovations within the United States, Canada, Great Britain, (mainland) Europe, and Japan. We find that lagged stock returns are the most important cross-sectional predictors of investment increases except in mainland Europe. American firms tend to react more than Japanese firms but less than Canadian and British firms. However, the differences between Japanese firms and U.S. firms are small. In contrast, European firms appear to conduct their investment policy without much regard for their own lagged stock performance.
This paper explains why seemingly irrational overcon dent behavior can persist. Information aggregation is poor in groups in which most individuals herd. By ignoring the herd, the actions of overcon dent individuals ("entrepreneurs") convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades off the positive information externality against high attrition rates of entrepreneurs, and depends on the size of the group, on the degree of overcon dence, and on the accuracy of individuals' private information. The stationary distribution trades off the tness of the group against the tness of overconfident individuals.
This paper examines the effect of memory loss on the continuity of behavior. We consider a player (individual or rm) who remembers previous actions but not underlying rationales. In a stable environment, relative to a full-recall scenario, memory loss increases the probability of following old policies (inertia). In a volatile environment, memory loss can decrease this probability (impulsiveness) . The model provides a memory-loss explanation for some documented psychological biases, implies that inertia and organizational routines should be more important in stable environments than in volatile ones, and provides empirical implications relating memory and environmental variables to economic decisions.
We review the theory and evidence on IPO activity: why firms go public, why they reward first-day investors with considerable underpricing, and how IPOs perform in the long run. Our perspective is threefold: First, we believe that many IPO phenomena are not stationary. Second, we believe research into share allocation issues is the most promising area of research in IPOs at the moment. Third, we argue that asymmetric information is not the primary driver of many IPO phe- nomena. Instead, we believe future progress in the literature will come from non- rational and agency conf lict explanations. We describe some promising such alternatives.