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Initial Underpricing and the Euronext Lisbon-listed Companies

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This study aims to determine the level of initial underpricing in the Euronext Lisbon-listed companies during a period (1990 - 2010) that includes the effects of the current global financial crisis. We employed two methods of analysis: one for the short-term (i.e. the market adjusted abnormal returns (MAAR)), and the other for the long-term (i.e. the buy-and-hold abnormal returns (BHAR)). The results suggest the existence of low efficiency in the Portuguese stock market, generating underpricing for Initial Public Offerings (IPOs) in the short-term with positive MAARs. The same situation occurs for the long-term, where companies present positive BHARs.
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P r o c e d i a - S o c i a l a n d B e h a v i o r a l S c i e n c e s 1 1 0 ( 2 0 1 4 ) 1 1 1 6 1 1 2 3
1877-0428 © 2014 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license.
Selection and peer-review under responsibility of the Contemporary Issues in Business, Management and Education conference.
doi: 10.1016/j.sbspro.2013.12.958
ScienceDirect
Contemporary Issues in Business, Management and Education 2013
Initial underpricing and the Euronext Lisbon-listed companies
Matias N. Isola
a
, Fernando J. C. S. N. Teixeira
b
, Fernando A. F. Ferreira
cd
*
a
School of Management and Technology, Polytechnic Institute of Santarém, Apartado
295, 2001-904 Santarém, Portugal
b
School of Technology and Management, Polytechnic Institute of Beja, R. Pedro Soares, 7800-295 Beja, Portugal
c
ISCTE Business School, University Institute of Lisbon, Avenida das Forças Armadas, 1649-026 Lisbon, Portugal
d
Fogelman College of Business and Economics, University of Memphis, Memphis, TN 38152-3120, USA
Abstract
This study aims to determine the level of initial underpricing in the Euronext Lisbon-listed companies during a period (1990–
2010) that includes the effects of the current global financial crisis. We employed two methods of analysis: one for the short-term
(i.e. the market adjusted abnormal returns (MAAR)), and the other for the long-term (i.e. the buy-and-hold abnormal returns
(BHAR)). The results suggest the existence of low efficiency in the Portuguese stock market, generating underpricing for Initial
Public Offerings (IPOs) in the short-term with positive MAARs. The same situation occurs for the long-term, where companies
present positive BHARs.
© 2014 Isola, Teixeira & Ferreira. Published by Elsevier Ltd.
Selection and peer-review under responsibility of the Contemporary Issues in Business, Management and Education conference.
Keywords: Initial Public Offering (IPO); Underpricing; Financial Markets.
1. Introduction
The study of Initial Public Offerings (IPOs) is one of the most important topics in the area of corporate finance,
presenting a robust theoretical background in terms of different approaches. This evidence is conveyed by the words
of Cheung, Ouyang & Tan (2009) who state, “there has been a lot of research conducted on IPOs, documenting
short-run underpricing and long-run underperformance” (for further developments, see also Welch, 1996; An &
Chan, 2008; Beneda & Zhang, 2009; Chemmanur & He, 2011). Thus, the analysis of IPOs has revealed a wide range
* Corresponding author. Tel.: +351- 217903437.
E-mail address: fernando.alberto.ferreira@iscte.pt
Available online at www.sciencedirect.com
© 2014 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license.
Selection and peer-review under responsibility of the Contemporary Issues in Business, Management and Education conference.
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Matias N. Isola et al. / Procedia - Social and Behavioral Sciences 110 ( 2014 ) 1116 – 1123
of variables that help to understand the process of long-term financial decision making. These variables relate not
only to
operational and financial fundamentals, but also to environmental factors related to the capital market
conditions and corporate and individual taxing policies.
For many years, the high abnormal returns revealed by IPOs were one of the greatest challenges to market
efficiency. Consequently, many studies have been done in order to explain this phenomenon. Ibbotson & Jaffe
(1975), for example, identified a significant correlation between the number of IPOs and the monthly average returns
on the first day. To Aggarwal & Rivoli (1990), there are two possible explanations for the abnormal returns found in
the new U.S. emissions: underpricing and aftermarket inefficiencies (Zheng & Li, 2008). Ritter (1991) showed that
the strategy of investing in IPOs at the end of the first day of public trading, and retaining them for three years, has
left investors with only 83 cents for each dollar invested in a group of companies listed on the American Express
(AMEX) or the New York Stock Exchange (NYSE). Younger firms and firms that have been inserted on the stock
exchange in years of strong volume perform even worse than the average. The evidence presented so far is broadly
consistent with the notion that many companies are introduced “in the bag” near the summit of “fads” of specific
industries.
Given the above, an investigation focusing on the initial underpricing of Euronext Lisbon-listed companies seems
to be of great importance, namely because most previous studies in this field took place before the current global
financial crisis, which has impacted the world economies and the functioning of the financial and capital markets.
The remainder of this paper is structured as follows. The next section presents a brief review of the literature,
highlighting the basic principles of the Efficient Market Theory (EMT) and evidence from the Portuguese stock
market. The third section presents the analysis carried out. Section 4 analyses the results and, finally, section 5
concludes the paper.
Nomenclature
AMEX American Express
BHAR Buy-and-Hold Abnormal Returns
EMT Efficient Market Theory
IPO Initial Public Offering
MAAR Market Adjusted Abnormal Returns
NYSE New York Stock Exchange
2. Background
2.1. Principles of the Efficient Market Theory (EMT)
2.1.1 Traditionalist theory of market efficiency
The traditionalist theory of market efficiency was initially introduced by Fama (1965; 1970), and builds on the
classical model of finance, according to which human behavior is rational, utility maximizing and able to optimally
process available information. Markets are operated by agents of unlimited rationality. However, this theory is based
on several assumptions: (1) perfect competition, in which no single agent can significantly change the prices; (2)
homogeneous expectations, since investors have equitable access to information and act rationally; and (3) divisible
assets and no transaction cost. From this perspective, Fama (1970) proposed three forms of efficiency:
Weak form: in this case, prices incorporate all the historical data about assets (i.e. all past information). The
analysis is based on the historical stock prices and fundamental analysis in the financial statements
published by the respective companies in order to predict future initiatives. Expected return is a function of
the risk involved (Famá, Cioffi, & Coelho, 2008). Thus, all investors have the same information and may
not obtain superior profits in comparison to other agents, as the data available for pricing is indifferent to
1118 Matias N. Isola et al. / Procedia - Social and Behavioral Sciences 110 ( 2014 ) 1116 – 1123
everyone and all use the same knowledge to make relevant decisions. However, they can obtain
extraordinary profits as a result of luck or access to privileged information;
Semi-strong form: this hypothesis describes the situation in which stock prices reflect not only past data,
but also other public information (e.g. financial statements, historical pricing data, announcements about
dividends, profits, mergers, acquisitions, investments, divestitures and emissions of new shares). Several
studies confirm that the market is generally efficient in the semi-strong form;
Strong form: this hypothesis considers all available information for pricing, public and non-public,
implying that even inside traders can achieve excess returns using insider information. This is one extreme
hypothesis, which is almost impossible to happen (i.e. would only be possible in a perfect market).
2.1.2 Behaviorist theory
This theory arose as a result of the need to explain certain anomalies that take place in the capital market (e.g.
financial “bubbles”, predictability in asset prices, excessive volatility, naive diversification), questioning the
existence of market efficiency (see Chang (2011) for further developments).
In the early 1980s, the development of computers made research easier in areas in which computing skills were
an asset. This was the case of the financial sector, which benefited greatly from this technological advancement.
Consequently, it became possible to observe that there are abnormal returns in financial assets, which, to some
extent, questions the fundamental assumptions of market efficiency. The most recognizable precursors of this theory
are Mullainathan & Thaler (2000), who analyze the behavior of economic agents based on their limitations and
difficulties in making decisions. Subsequently, Barberis, & Thaler (2003) continued this line of analytic thinking,
observing and theorizing individual behavior, and questioning agents’ rationality underlined to the traditionalist
theory. In their research, the authors start from the premise that people make decisions that are not always based on
an unlimited rationality, taking into account psychological and sociological factors that affect the agents’ rationality.
The lever behind the development of the Behaviorist Theory relies on obtaining the necessary explanations to fill the
gaps in the existing anomalies in the capital markets.
2.2. Evidence from the Portuguese stock market
Nascimento (2007) analyzed the Portuguese market during 1997–2007, obtaining the following conclusion: 42%
of the 26 selected stocks, which had a random walk in prices, held a significant part of the efficiency where the
market players did not enjoy supernormal profits. Nevertheless, the author hints at the possibility of inefficiency due
to the existence of information asymmetries, since 58% of the remaining assets of the sample allowed supernormal
profits to be possible. Duque & Madeira (2004) present empirical evidence on the existence of abnormal returns of
asset prices in the Portuguese Stock Index (PSI) for the period 1996–2001, reaching the conclusion that the
Portuguese stock market has a weak efficiency (i.e. the semi-strong form is rejected). However, in the analysis of the
subsamples, an improvement was identified in market efficiency, which attenuates the abnormal returns. The
authors underline, however, the need to be cautious in this analysis due to the small size of the sample.
Evidence of inefficiency in the Portuguese stock market gives insight into the possibility of over or undervalued
assets (i.e. overpricing or underpricing), which may be a consequence of the presence of information asymmetry
between market participants (Yung & Zender, 2010). Based on the findings obtained in the studies of Ritter &
Welch (2002), in all theories of underpricing where the common element is asymmetric information, the estimated
underpricing is positively related to the degree of information asymmetry; and, when the uncertainty of asymmetric
information approaches zero, undervaluation disappears in these models. Given this, according to Duque & Madeira
(2004), the Portuguese stock market is defined as being able to fit into the weak form of efficiency. To understand
the impact of the effect of underpricing IPOs in Portugal, we first define the degree of informational efficiency in
the stock market, which will allow us to understand the abnormal returns observed, and then consider whether in
fact there is a link between informational efficiency and abnormal returns.
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Matias N. Isola et al. / Procedia - Social and Behavioral Sciences 110 ( 2014 ) 1116 – 1123
3. Empirical Analysis
3.1. Sample characterization
During the period of study (i.e. January 1st, 1990 until December 31st, 2010) 28 IPOs were introduced in the
Euronext Lisbon. Table 1 shows the evolution of the number of IPOs per year.
Table 1. Sample of IPOs
Year # IPOs
IPOs Gross Results
1993 1 121.800.611
1994 1 97.940.476
1995 4 968.041.205
1996 1 303.158.139
1997 5 2.543.293.279
1998 3 133.977.115
1999 2 579.518.942
2000 3 1.898.712.784
2001 1 8.386.000
2003 1 45.465.875
2004 1 250.000.003
2006 2 6.846.574.206
2007 2 2.268.500.000
2008 1 7.348.951.235
Total 28 23.414.319.869
(source: Euronext Lisbon)
As can be seen, there are two moments of great activity in the emergence of IPOs: (1) the period between 1995
and 2000, in which 18 new companies have emerged, most of them via privatization of public enterprises; and (2)
during the years 2006 and 2007, with the appearance of four companies.
3.2. Methodology
Based on a study by Toniato (2007), which evaluated the performance of IPOs in the UK market during the
period between 1998 and 2003, in this study we used two different methodologies (i.e. one for the short-term and the
other for the long-term). For the measurement of the short-term performance, the initial abnormal returns were
evaluated in accordance with the formulation (1) and (2) (Aggarwal, Leal, & Hernandez, 1993).
0
1
t
t
Ps
Rs
Ps
=−
(1)
0
1
t
t
Pb
Rb
Pb
=−
(2)
Rs
t
is the total return on the shares of each company studied, taking as variables the share price at the close of the
market on the t-th trading day (Ps
t
) and the share price at the close of the market on the first trading day (Ps
0
). In
turn, Rb
t
is the total return of the PSI Geral index, having as variables the closing price of the PSI Geral index on the
t-th trading day (Pb
t
) and the closing price of the PSI Geral index on the first trading day of the IPO to evaluate
1120 Matias N. Isola et al. / Procedia - Social and Behavioral Sciences 110 ( 2014 ) 1116 – 1123
(Pb
0
). After obtaining these returns, we will calculate the market adjusted abnormal return from the first trading day
until the t-th trading day, according to the formula (3).
(
)
()
1
100 1
1
t
i
t
Rs
MAAR x
Rb
⎧⎫
⎡⎤
+
⎪⎪
=−
⎢⎥
⎨⎬
+
⎢⎥
⎪⎪
⎣⎦
⎩⎭
(3)
For the measurement of long-term performance, we will use the model of Barber and Lyon (1997). This method
allows the range of total returns of the company and the abnormal returns to be added, using the strategy buy-and-
hold, where BHAR
i
is the buy-and-hold abnormal return for the shares of the selected firm in period i, as shown in
formulation (4).
()()
11
11
ii
it t
tt
B
HAR Rs Rb
==
=++
∏∏
(4)
3.3. Hypotheses
The objective of this analysis is to evaluate the performance of each company studied, proving the existence of
underpricing by comparing the abnormal returns against the market returns (i.e. PSI Geral index), during the first
day, a week and one month after its introduction in the Euronext Lisbon. Thus, the first null hypothesis is the
absence of excess returns compared to the returns registered in the PSI Geral index during the 1st, 5th and 21th
trading days. I.e.:
days 21,5,1 periodeach andcompany each for ;0:
1
1
days 21,5,1 periodeach andcompany each for ;0:
0
1
=>
=
i
i
MAARH
i
i
MAARH
The second hypothesis consists in evaluating the returns of the companies that perform better than market returns
(i.e. PSI Geral index). To test this hypothesis, we constructed the BHARs of each company for periods of 1, 2 and 3
years after the first day of trading. Our null hypothesis 2 will build on the idea that the BHARs of each company
will have underperformed the PSI Geral index during the periods 1, 2 and 3 years from the first day of trading of the
company in the Euronext Lisbon. I.e.:
months 36,24,12 periodeach andcompany each for ;0:
1
2
months 36,24,12 periodeach andcompany each for ;0:
0
2
=<
=
i
i
BHARH
i
i
BHARH
4. Results
4.1. Short-term results
The short-term results for the 28 IPOs listed on the Euronext Lisbon indicate that, on the first day of trading,
there is an abnormal return of 32.428% over the return of the PSI Geral index, with a significance level of 0.1%.
When analyzing the IPOs on the fifth trading day, they have, on average, an abnormal return declining to 0.6% over
the return of the PSI Geral index, with a significance level of 5%. Finally, on the twenty-first day of trading, there is
an abnormal return of –0.1% compared to the return of the PSI Geral index, with a significance level of 10%. Table
2 summarizes the results obtained.
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Matias N. Isola et al. / Procedia - Social and Behavioral Sciences 110 ( 2014 ) 1116 – 1123
Table 2. Short-term results (MAARs)
Sample (A) PSI Geral Index (B) Difference (A-B)
Day Mean Median Mean Median Mean P-value Median P-value
1 1.32573 1.099127 1.00145 1.000595 0.32428 0.014** 0.098532 0.000***
5 1.00809 1 1.00206 0.999968 0.00603 0.016** 0.0000322 0.385
21 0.99908 1 1.00017 1.000477 0.00109 0.070* 0.00048 0.844
*** Significance level of 0.1%.
** Significance level of 5%.
* Significance level of 10%.
In the analysis developed by Ritter (2011) for the U.S. market, during the period 1980–2008, for a sample of
7314 IPOs, there were average abnormal returns of 18.1% for the first day of trading, values that correspond to the
ones evidenced in the Portuguese market. In the study by Almeida & Duque (2000) for the Portuguese market,
during the period 1992–1998 and for a sample of 21 IPOs, results show the existence of abnormal returns on the first
trading day, although the authors present a methodology different from that one used in the present study (i.e.
Cumulative Abnormal Returns (CARs)), with values of 10.55%.
4.2. Long-term results
For a sample of 28 IPOs, we found average abnormal returns of 44.18% over the PSI Geral index, for the first
twelve months of trading, with a significance level of 5%. For the first twenty-four months of negotiation, we
obtained an average abnormal return of 26% over the PSI Geral index with a significance level of 0.1%. When
analyzing the first thirty-six months of trading, IPOs had average abnormal returns of –12.54% over the PSI Geral
index, with a significance level of 10%. Table 3 summarizes the results obtained.
Table 3. Long-term results (BHARs)
Sample (A) PSI Geral Index (B) Difference (A-B)
Month Mean Median Mean Median Mean P-value Median P-value
12 1.54755 1.123872 1.10571 1.109886 0.44184 0.028** 0.013987 0.367
24 1.46016 1.081775 1.20015 1.297821 0.26001 0.001*** –0.21605 0.635
36 1.29927 0.689881 1.42469 1.095295 –0.12542 0.085* –0.40541 0.194
*** Significance level of 0.1%.
** Significance level of 5%.
* Significance level of 10%.
These results are significantly different from the ones obtained by Ritter (2011) when he analyzed 7314 IPOs in
the U.S. market for the period 1980 to 2008, which exhibited an average abnormal return of 20.8% for the first thirty
six months of trading. However, these results corroborate the ones obtained by Almeida & Duque (2000), for the
Portuguese market, which showed accumulation of abnormal returns of 20.48% for the selected sample of 21 IPOs
during the period 1992–1998. Furthermore, in a study by Jaskiewicz, González, Menéndez & Schiereck, (2005), for
the German and Spanish markets, during the 1990–2000 period, there are negative abnormal returns (i.e. –32.5% for
German and –38% in the Spanish case), when compared with the respective market during the first thirty-six months
of trading.
1122 Matias N. Isola et al. / Procedia - Social and Behavioral Sciences 110 ( 2014 ) 1116 – 1123
5. Conclusion
As stated at the beginning of this study, the IPO market is assuming growing importance in terms of economic
development. Su & Brookfield (2013) have recently reinforced this premise, noting that “an effective and active
IPO market is a pre-condition for the development of the nascent stock market”. From this standpoint, the main
contribution of this study is to demonstrate the existence of IPO underpricing in the Euronext Lisbon, during the
period of 1990–2010, reinforcing the results presented by other authors who have studied the Portuguese market
(Almeida & Duque, 2000) and other markets, both developed (UK, US, Germany and Spain) and developing
(Brazil). According to Chang (2011), “on average, the offer price of IPO shares is substantially lower than the
closing price on the first day of trading. The first-day abnormal returns of IPO shares, on average, are
economically and statistically significant”. Through further analyses, one for the short-term (MAARs) and the other
for the long-term (BHARs), we can conclude that an investor who buys shares in the subscription period and sells
them on the 1st day of trading in the Euronext Lisbon tends to get a return of 32%. This return decreases after the
5th day (i.e. the investor would get a return of 6%) and 21st day of trading (i.e. the investor would get a return
similar to the market). Thus, we can assume that the efficiency in the Portuguese market increases over time. When
compared with the results presented by Aggarwal, Leal, & Hernandez, (1993), the Brazilian market had a similar
performance during the first day of trading (36%). In the case of Khurshed & Mudambi (2002) for the UK, returns
were lower than the values registered in the Portuguese case (6.56%), as well as in the study by Ritter (2011) for the
U.S. market (18.1%). All these values are different from the results achieved by Chi & Padgett (2002), with 129%
(i.e. well above those achieved in the Euronext Lisbon (see also Deb & Marisetty, 2010)). In the long-term analysis,
we can argue that, during the first year of trading, the investor who bought through the initial subscription and sold
after 12 months would get a return of 44%. If the share is kept for 24 months, the investor would get a return of
26%, but if kept for 36 months, the return would be –12%. In this sense, one can conclude that, over time, the
market efficiency in the Euronext Lisbon increases, reducing the information imperfections that may have caused
the initial underpricing in the IPOs. When compared with the results obtained by Ritter (2011) for the North
American market, which presented returns of 20.8% for the first three years of negotiation, the results achieved are
considerably different. However, in the case of the Spanish and German markets, where the performance over three
years was negative (i.e. –32.5% and –38% in Germany and Spain, respectively), the trend is close to the one
revealed by the Portuguese stock market (i.e. 12%).
In looking ahead to future research, we recommend an increase in both sample and time period. In addition, it is
convenient to study the abnormal returns by sector of activity and/or groups of companies (e.g. private vs.
companies subject to privatization). This would allow conclusions on market efficiency to be enhanced. As already
point out by Ruud (1993), “evidence of underpricing of initial public offerings (IPOs) has spawned considerable
[...] literature attempting to explain the apparent contradiction to market efficiency”.
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... 10.36%, 39.9% and respectively 13.48%. In addition, study of listed securities at Portuguese stock exchange, by Isola et al. (2014) who examined the initial underpricing in Euro next Lisbon companies from 1990-2010 of 28 IPOs. They found that first day trading abnormal initial return of 32.428% in the global financial crisis period. ...
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