Which, Why, and for How Long Do IPOs Underperform?

Based on a sample of 7,378 firms going public in the 1975-2005 period, we document a significant underperformance of IPO firms over the first year after going public, while there is virtually no underperformance thereafter. Moreover, by decomposing the Carhart-alpha we find that IPO underperformance, where present, is mainly due to fundamental differences in firm characteristics (e.g., market-to-book ratio, leverage, and R&D expenditures 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 than mature companies with similar firm characteristics. Finally, we show that IPO underperformance is partially predictable. IPOs associated with overly optimistic growth prospects (and correspondingly high valuation levels) and IPOs going public during hot issue periods perform substantially worse than other IPOs.