Predicting and Explaining IPO Underperformance

Based on a new methodological framework we investigate IPO (under-)performance in asample of 7,378 firms going public in the 1975-2005 period. We explicitly vary the time horizonin our analysis and document a significant underperformance of IPO firms over the firstyear after going public, while there is virtually no underperformance thereafter. Moreover, bydecomposing the Carhart-alpha we find that IPO underperformance, where present, is due tofundamental differences in firm characteristics (e.g., market-to-book ratio, leverage, and R&Dexpenditures scaled by sales) between IPO companies and more seasoned, non-issuing firms.In fact, our results indicate that IPO firms neither perform materially better nor worse thanmature companies with similar firm characteristics. Finally, we show that IPO underperformanceis partially predictable. IPOs associated with overly optimistic growth prospects (andcorrespondingly high valuation levels) and IPOs going public during hot issue periods performsubstantially worse than other IPOs.