Running head: IPO UNDERPRICING AND AFTERMARKET PERFORMANCE IPO UNDERPRICING AND AFTERMARKET PERFORMANCE IN OMX BALTIC A Thesis Presented to the Faculty of ISM University of Management and Economics in Partial Fulfillment of the Requirements for the Degree of Master in Financial Economics By Kęstutis Ivanauskas May 2015 IPO UNDERPRICING AND AFTERMARKET PERFORMANCE 2 Abstract This thesis analyzes the phenomena of IPO underpricing and subsequent aftermarket performance as well as factors influencing this type of behavior of new equity issues in Nasdaq OMX Baltic during the period of 2004-2014. The aim of this analysis is to provide new knowledge about the IPO market behavior in the Baltic countries. The analysis uses descriptive statistical techniques to estimate the magnitude of the IPO underpricing, Buy and Hold Abnormal Returns method for the comparison of IPO performance to benchmark portfolios, and regression analysis for the testing of possible explanatory variables influencing IPO underpricing. It was found that new issues floated on Nasdaq OMX Baltic tended to be underpriced by an average of 7.54%. A statically significant explanatory model was created which established the relationship between IPO underpricing and factors influencing this behavior, of which proceeds raised during the IPO proved to be the strongest negative influence on IPO underpricing. Finally, while not statistically significant, it was found that after high first day returns new issues were underperforming their size matched equally weighted benchmark portfolios by -3.62% during the 1 year holding period and -0.08% during the 3 year holding period. Keywords: IPO underpricing, IPO underperformance, Nasdaq OMX Baltic, Baltic states IPO UNDERPRICING AND AFTERMARKET PERFORMANCE 3 Table of Contents List of Figures ................................................................................................................................. 5 List of Tables .................................................................................................................................. 5 Introduction ..................................................................................................................................... 7 Literature Review.......................................................................................................................... 11 IPO Theory ................................................................................................................................ 11 IPO concept ........................................................................................................................... 11 IPO research puzzles ............................................................................................................. 13 IPO process ............................................................................................................................ 14 IPO Underpricing Theories ....................................................................................................... 18 Winners curse hypothesis ...................................................................................................... 23 Market feedback hypothesis. ................................................................................................. 23 Asymmetric information and signaling ................................................................................. 24 Principal agent problem. ........................................................................................................ 24 IPO Underpricing Influencing Factors ...................................................................................... 24 Offer size ............................................................................................................................... 25 Offer price .............................................................................................................................. 25 Market capitalization ............................................................................................................. 26 Firm’s age .............................................................................................................................. 26 Industry .................................................................................................................................. 27 Management ownership ......................................................................................................... 27 Recent market movements..................................................................................................... 27 Turnover ................................................................................................................................ 28 Underwriter reputation .......................................................................................................... 29 Financial crisis ....................................................................................................................... 29 Long-term Aftermarket Performance Phenomena .................................................................... 30 Baltic Stock Markets ................................................................................................................. 33 IPO process in the Baltics ...................................................................................................... 35 General IPO market trends in the Baltics. ............................................................................. 37 Baltic Listings in Warsaw Stock Exchange (WSE) .................................................................. 40 IPO activity on Warsaw Stock Exchange (WSE). ................................................................. 43 Research Problem ...................................................................................................................... 45 Empirical Research ....................................................................................................................... 46 IPO UNDERPRICING AND AFTERMARKET PERFORMANCE 4 IPO Underpricing and Underperformance Measuring Methods ............................................... 46 Measuring underpricing ......................................................................................................... 47 Measuring underperformance ................................................................................................ 47 Regression analysis................................................................................................................ 49 Description of variables ......................................................................................................... 49 Data Selection ........................................................................................................................... 50 Empirical Research Results and Discussion ............................................................................. 51 IPO underpricing ................................................................................................................... 52 IPO underperformance .......................................................................................................... 59 IPO underpricing influencing factors in Baltic stock market ................................................ 68 Conclusions ................................................................................................................................... 78 References ..................................................................................................................................... 81 Appendices .................................................................................................................................... 87 IPO UNDERPRICING AND AFTERMARKET PERFORMANCE 5 List of Figures Figure 1. Visualization of interconnectedness of the lead underwriter and all the other remaining parties 17 Figure 2. Comparison of IPO underpricing observed in different countries. 19 Figure 3. Year by year analysis of “money left on the table” by IPOs in USA 21 Figure 4. Regression residuals (GRETL output). 72 Figure 5. Actual vs fitted values (GRETL output) 73 List of Tables Table 1. ......................................................................................................................................... 31 Aftermarket performance summary of IPOs in USA during 1970-2014. ..................................... 31 Table 2. ......................................................................................................................................... 37 IPOs and SPOs market in the Baltics during the period of 2004-20014. ..................................... 37 Table 3. ......................................................................................................................................... 39 Capital raised from additional contributions during 2004-2013. .................................................. 39 Table 4. ......................................................................................................................................... 41 Number of companies in WSE from 1991 to 2015 (Warsaw Stock Exchange, 2015) ................. 41 Table 5. ......................................................................................................................................... 44 The WSE IPO market descriptive statistics during the period of 2003-2011 ..............................