Why Does IPO Volume Fluctuate So Much?

(Lowry, 2003)
IPO volume fluctuates substantially over time. This paper compares the
extent to which the aggregate capital demands of private firms, the
adverse-selection costs of issuing equity, and the level of investor
optimism can explain these fluctuations. Empirical tests include both
aggregate and industry-level time-series regressions using proxies for the
above factors and an analysis of the relation between post-IPO stock
returns and IPO volume. Results indicate that firms demands for capital
and investor sentiment are important determinants of IPO volume, in both
statistical and economic terms. Adverse-selection costs are also
statistically significant, but their economic effect appears small.
In summary, results indicate that changes in firms demands for capital
and changes in the level of investor optimism explain a substantial portion
of the variation in IPO volume. Adverse selection costs are marginally
significant and appear to be of secondary importance. Notably, the prior
literature has focused on only one potential determinant of IPO volume,
investor sentiment. While sentiment does appear to affect the timing of
IPOs, evidence indicates that it is not the only relevant factor. Despite the
large literature on IPOs, we still have relatively little understanding of why
the number of IPOs fluctuates so substantially over time. This paper seeks
to shed light on this issue. Specifically, I investigate the factors that lead
so many companies to have IPOs during some periods, versus so few
during other times. Results indicate that companies demand for capital
and the level of investor sentiment explain a significant amount of the
variation in IPO volume. In economic terms, an increase of 23,000 new
corporations and a 25% decrease in future market returns (i.e., a one
standard deviation change in each variable) are each associated with
about 75 more IPOs in 1985, and a decrease of 7.9 percentage points in
the closed-end fund discount (one standard deviation) is associated with
approximately 151 more IPOs in 1985. Adverse selection costs are also
statistically significant, but they are not significant in economic terms,
suggesting that they are of secondary importance.
In summary, the results suggest that IPO volume is positively related to
companies demands for capital and the level of investor sentiment. Firms
are also marginally more likely to have an IPO when adverse selection
costs are lower. With respect to all of these factors, dynamics at both the
economy-wide level and at the industry level significantly affect firms
decisions.
Local underwriter oligopolies and IPO underpricing (Xiaoding Liu, Jay R.
Ritter)
We develop a theory of initial public offering (IPO) underpricing based on
differentiated underwriting services and localized competition. Even
though a large number of investment banks compete for IPOs, if issuers
care about non-price dimensions of underwriting, then the industry
structure is best characterized as a series of local oligopolies. We test our
model implications on all-star analyst coverage, industry expertise, and
other non-price dimensions. Furthermore, we posit that venture capitalists

(VCs) are especially focused on all-star analyst coverage, and develop the
analyst lust theory of the underpricing of VC-backed IPOs. Consistent with
this theory, we find that VC-backed IPOs are much more underpriced when
they have coverage from an all-star analyst.
The model also generates a new theory of the underpricing of venture
capital-backed IPOs: the analyst lust theory. We posit that venture
capitalists (VCs) are rationally focused on the market price on the day
when shares in the company are distributed to limited partners, which is
typically six months to 1 year after the IPO. We assume that this market
price is boosted by coverage from influential analysts, which we measure
by using the all-star designation in the October issue of Institutional
Investor magazine. Because of their concern with this price, VCs have a
greater lust for all-star analyst coverage that is bundled with IPO
underwriting, resulting in greater underpricing for VC-backed IPOs with allstar analyst coverage.
Empirically, we find that issuers using a bookrunner that bundles
underwriting with influential analyst coverage are subject to 9% more
underpricing during 19932008. We also find that the incremental
underpricing associated with all-star analyst coverage is higher for issuers
that perceive all-star analyst coverage as more valuable and during
periods when all-star analyst coverage is more important. Moreover, we
find that the effect of all-star analyst coverage on underpricing is lower in
periods when the IPO volume in an industry is low.
Using venture capital-backing as a proxy for a greater willingness to pay
for coverage from an influential analyst, we find that VC-backed issuers
have 20% more underpricing (e.g., 38% rather than 18%) when they have
all-star coverage than when they do not, holding other things constant.
Moreover, when the relation between VC-backing and all-star analyst
coverage is controlled for, the effect of VC-backing itself on underpricing is
reduced by more than 50%, suggesting that most of the effect of VCbacking on underpricing is due to the greater focus by venture capitalists
on all-star analyst coverage. Surprisingly, there is no reliable relation
between all-star analyst coverage and underpricing for non-VC-backed
IPOs
Where have al the IPOs Gone ? (Gao & Ritter)
During 19802000, an average of 310 companies per year went public in
the United States. Since 2000, the average has been only 99 initial public
offerings (IPOs) per year, with the drop especially precipitous among small
firms. Many have blamed the Sarbanes-Oxley Act of 2002 and the 2003
Global Settlements effects on analyst coverage for the decline in IPO
activity. We find very little support for the conventional wisdom, and we
offer an alternative explanation. Our economies of scope hypothesis posits
that the advantages of selling out to a larger organization, which can
speed a product to market and realize economies of scope, have increased
relative to the benefits of operating as an independent firm.

In this paper, we introduce a new explanation for the prolonged low level
of U.S. IPO volume, which we term the economies of scope hypothesis. We
posit that there is an ongoing change in the economy that has reduced the
profitability of small companies, whether public or private. We contend
that many small firms can create greater operating profits by selling out in
a trade sale (being acquired by a firm in the same or a related industry)
rather than operating as an independent firm and relying on organic (i.e.,
internal) growth. Earnings will be higher as part of a larger organization
that can realize economies of scope and bring new technology to market
faster.2 We posit that the importance of getting big fast has increased over
time due to an increase in the speed of technological innovation in many
industries, with profitable growth opportunities potentially lost if they are
not quickly seized.
To the best of our knowledge, our economies of scope hypothesis offers a
completely new explanation for the drop in U.S. IPO activity after 2000.
Although our evidence supporting the hypothesis is largely indirect, our
hypothesis is consistent with several patterns for which there has been no
consistent explanation: a decline in small-firm profitability starting in the
early 1980s, an increase in the probability of being involved in merger and
acquisition (M&A) activity begin- ning in the mid-1990s, a decrease in the
probability of a venture capital-backed (VC-backed) company exiting via
an IPO starting in the early 1990s, and a lower number of IPOs relative to
what would be predicted on the basis of public mar- ket valuation ratios
starting in 1997. Furthermore, we are unaware of any patterns that are
inconsistent with our explanation. If our economies of scope explanation is
correct, regulatory reforms aimed at restoring the IPO ecosystem will have
only a modest ability to affect IPO volume, and a bull market will not set
off a wave of small-company IPOs.
Stock Market Driven Acquisitions, (Shleifer, 2002)
We present a model of mergers and acquisitions based on stock market
mis valuations of the combining firms. The key ingredients of the model
are the relative valuations of the merging firms and the markets
perception of the synergies from the combination. The model explains who
acquires whom, the choice of the medium of payment, the valuation
consequences of mergers, and merger waves. The model is consistent
with available empirical findings about characteristics and returns of
merging firms, and yields new predictions as well.
We propose a theory of acquisitions related to the neoclassical theory, but
also able to accommodate the additional evidence. In this theory,
transactions are driven by stock market valuations of the merging firms.
The fundamental assumption of the model is that financial markets are
inefficient, so some firms are valued incorrectly. In contrast, managers are
completely rational, understand stock market inefficiencies, and take
advantage of them, in part through merger decisions. Mergers in this
model are a form of arbitrage by rational managers operating in inefficient
markets. This theory is in a way the opposite of Rolls (1986) hubris
hypothesis of corporate takeovers, in which financial markets are rational,

but corporate managers are not. In our theory, managers rationally

respond to less-than-rational markets.
This paper has presented a model of stock-market-driven acquisitions. It
falls into the rapidly growing field of behavioral corporate finance, which
sees corporate policies such as debt and equity issuance, share
repurchases, dividends, and investment as a response to market
mispricing. A good deal of empirical evidence appears to be consistent
with this view. Our model takes mispricing as given. But it also points to a
powerful incentive for firms to get their equity overvalued, so that they
can make acquisitions with stock. In a more general framework, firms with
overvalued equity might be able to make acquisitions, survive, and grow,
while firms with undervalued, or relatively less overvalued, equity become
takeover targets themselves. The benefit of having a high valuation for
making acquisitions also points to an incentive to raise a firms stock price
even through earnings manipulation, a phenomenon whose prevalence is
becoming increasingly apparent. This model is not intended to deny a role
for real rather than just valuation factors. Still, the model helps interpret a
good deal of evidence, and yields new predictions. As such, it may add to
the set of frameworks that financial economists use to examine mergers
and acquisitions.
The Information Content of Share Repurchase Programs (Grullon, 2004)
Contrary to the implications of many payout theories, we find that
announcements of open-market share repurchase programs are not
followed by an increase in operating performance. However, we find that
repurchasing firms experience a significant reduction in systematic risk
and cost of capital relative to non-repurchasing firms. Further, consistent
with the free cash-flow hypothesis, we find that the market reaction to
share repurchase announcements is more positive among those firms that
are more likely to overinvest. Finally, we find evidence to indicate that
investors under- react to repurchase announcements because they initially
underestimate the decline in cost of capital. Our objective in this paper is
to better understand the economic motivations behind the decision to
repurchase shares.
In this paper, we examine whether firms pay out cash to their shareholders
to mitigate potential overinvestment by management or to signal good
news about the firm's prospects. We perform a systematic investigation to
uncover whether the information content of repurchases is about growth in
future earnings (and other profitability measures), or whether it is related
to a reduction in agency conflicts. We cannot find any evidence that
repurchasing firms experience a growth in profitability. If anything, the
evidence indicates that profitability declines in the years after the
repurchase. We also find that repurchasing firms decrease their
investments. This finding precludes the possibility that earnings are likely
to recover in the long run. Our evidence
suggests that the reduction in free cash flows and systematic risk are
sources of the positive market reaction to the repurchase announcement.
We also find that the market reaction to share repurchase announcements
is stronger among those firms that are more likely to overinvest. Thus,

when agency conflicts of overinvestment are likely to arise, these firms

increase their payout to shareholders in the form of repurchases. The
potential reduction in agency costs and the information about the
reduction in the cost of capital could explain why the market views these
acts positively. Overall, when we combine our results with the evidence
concerning dividend-increasing firms, it appears that repurchases and
dividends are motivated by similar factors. When future investment
opportunities are contracting, an increase in cash payouts conveys
important information about management commitment to reduce the
agency costs of free cash flow when those costs are potentially more
pronounced. An increase in cash payouts also conveys information about
changes in the risk profile and the cost of capital of the firm.
Investing in Private Equity Funds: A Survey (Phalippou, 2007)
This literature review covers the issues faced by private equity fund
investors. It shows what has currently been established in the literature
and what has yet to be investigated. In particular, it shows the many
important questions to be answered by future research. The survey shows
that the average investor has obtained poor returns from investments in
private equity funds, potentially because of excessive fees. Overall,
investors need to gain familiarity with actual risk, past return, and specific
features of private equity funds. Increased familiarity will improve the
sustainability of this industry that plays such a central role in the economy.
Private equity funds, dubbed capitalisms new kings are investment
vehicles that make two main types of investments: leveraged buyout (BO)
and venture capital (VC). Even though these two types of investment are
quite different and funds focus on either one of them, venture capital
funds and leveraged-buyout funds are typically studied together. The
reason is that private equity firms often invest in both BO and VC, typically
via different funds but with overlapping management teams. BO funds and
VC funds also share the same organizational structure (same fee structure,
illiquidity characteristics, etc.). In addition, a unique feature of private
equity firms is that they play a management role in their portfolio
companies.
Even on a sample that is clearly biased towards winners, if the
average performance is properly aggregated and the sample sufficiently
large, then average performance is low! (The performance of private
equity funds is lower than the performance of the S&P 500 by as much as
3.8 percent a year, and the risk properties of the S&P 500 seem more
attractive.) Research on risk is still in its early stages. There is much to be
done, such as assessing how features like non- tradability or credit line
affect risk estimates. Studying publicly traded instruments could also be
fruitful, especially with publicly traded LPs (Limited Partnerships).
One of the most knowledgeable and successful investors in private
equity funds is David Swensen. He states about this industry: Strangely,
historical results generally fail to reflect the hoped-for enhanced returns,
while risk levels appear to fall below expectations. Unfortunately, poor
returns from private investing probably reflect reality, while the low risk
evident in data describing past returns from private investing constitutes a

statistical artefact. Research evidence surveyed in this review appears to

support both of his claims. Poor performance may come as a surprise to
the novice but not to many people in the industry. Indeed, most GPs
(General Partnerships) and some LPs often state that only top-quartile
private equity funds are worth investing in. The question is then for LPs to
identify them so that the other funds go out of business and average
performance looks fair. But there is more to poor performance than a
selection issue. It seems that fees are higher than what most investors
realize, and critics of the industry have said that private equity funds are
a remuneration package dressed up as an investment strategy. If
investors do not learn fast enough about selecting the right funds and/or
designing more investor-friendly contracts, then the industry might
collapse. It would be a terrible scenario because both types of private
equity funds are essential to the market economy: VC funds as growth
catalysts and BO funds as healthy arbitrageurs. It is only with
knowledgeable LPs and trustees that this critically important industry can
experience a sustainable growth.
The Eclipse of the Public Corporation (Jensen, 1989)
The publicly held corporation has outlived its usefulness in many sectors of
the economy. New organizations are emerging. Takeovers, leveraged
buyouts, and other going-private transactions are manifestations of this
change. A central source of waste in the public corporation is the conflict
between owners and managers over free cash flow. This conflict helps
explain the prominent role of debt in the new organizations. The new
organizations resolution of the conflict explains how they can motivate
people and manage resources more effectively than public corporations.
On Secondary Buyouts (Degeorge, Jens Martin ,2015)
Private equity firms increasingly sell companies to each other in secondary
buyouts (SBOs), raising concerns which we examine using novel data sets.
Our evidence paints a nuanced picture. SBOs underperform and destroy
value for investors when they are made by buyers under pressure to
spend. Investors then reduce their capital allocation to the firms doing
those transactions. But not all SBOs are money-burning devices. SBOs
made under no pressure to spend perform as well as other buyouts. When
buyer and seller have complementary skill sets, SBOs outperform other
buyouts. Investors do not pay higher total transaction costs as a result of
SBOs, even if they have a stake in both the buying fund and the selling
fund.
SBOs have become a large share of private equity transactions. The
growth of SBOs has given rise to three major questions: (1) are SBOs
money-burning devices for general partners reaching their deadline for
investing committed capital? (2) what value can a new private equity
owner add that the previous private equity owner has not already added?
(3) when limited partners are invested in both the buying side and the
selling side of an SBO, do they pay an extra layer of transaction costs?

We construct several unique data sets to investigate these questions. We

find that on average, SBOs made close to the investment deadline
underperform, are riskier, and destroy value for investors. Investors
appear to penalize PE firms that make late SBOs: the follow-on-funds of
funds that participate in late SBOs are markedly smaller.
We uncover an important source of value creation in SBOs:
complementary skill sets between the buyer and the seller. SBOs perform
better, and create value for investors, when they occur between a PE firm
focusing on margin growth and a PE firm focusing on sales growth, or
between two PE firms in which the general partners have different
educational backgrounds or career paths. SBOs also create value when a
global fund buys from a regional fund.
Finally, assuming that GPs never return capital to investors, we show that
even when a limited partner is on both sides of an SBO, the transaction
does not generate extra transaction costs for investors, contrary to a
widespread view. Yet the eventuality of LP overlap is relevant for investors:
by investing in funds with complementary skills, LPs stand to gain more
from their PE investments, should they find themselves on both sides of an
SBO transaction.

The disintermediation of financial markets: Direct investing in private

equity (Fang, Ivashina 2015)
We examine 20 years of direct private equity investments by seven large
institutions. These direct investments perform better than public market
indices, especially buyout investments and those made in the 1990s.
Outperformance by the direct investments, however, relative to the
corresponding private equity fund benchmarks is limited and concentrated
among buyout transactions. Co-investments underperform the
corresponding funds with which they co-invest, due to an apparent
adverse selection of transactions available to these investors, while solo
transactions outperform fund benchmarks. Investors ability to resolve
information problems appears to be an important driver of solo deal
outcomes.
Our analysis suggests several conclusions:

The direct investments perform better than tailored public market indices.
The best performance is concentrated in the buyout fund investments and
those made in the 1990s.

There is limited evidence of outperformance of the direct investments

relative to the corresponding private equity fund benchmarks. For venture
capital (VC) deals, we find that direct investments underperform the fund
benchmark, especially in the 1990s. This is consistent with the evidence

on unique skills of VC fundsas reflected in the persistence of their

returns (e.g., Kaplan and Schoar, 2005, Harris et al., 2013 and Korteweg
and Sorensen, 2014).

Co-investments underperform the investments of the corresponding funds

with which they co-invest, with the performance gap widening in the latter
half of our sample. This underperformance of co-investments, which are
executed alongside private equity groups (often the same ones where the
institutions have fund investments) and are the cornerstone of most
institutions direct investment programs, is surprising.4 We provide
evidence that this underperformance appears to be driven by selection (a
lemons problem): institutional investors can only co-invest in deals that
are available to them. In particular, these transactions are substantially
larger than an average sponsors deal and appear to be concentrated at
times when ex post performance is relatively poor. At the same time, it is
important to acknowledge that these direct investments allow firms to put
substantially more funds to work.

We find that solo transactions, i.e., investments initiated and executed by

investors alone, outperform fund investments. Like co-investments, the
performance of solo transactions also exhibited deterioration over time.
Investors ability to resolve information problems appears to be an
important driver of solo deal outcomes: the performance of solo deals over
co-investments is greater in settings where information problems are less
intense, such as local and later-stage transactions.