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We examine why many firms disclose internal control weaknesses (ICW) under section 404 of Sarbanes-Oxley Act after previously reporting effective internal control (IC). We find that about half of the cross-sectional ICW determinant variables either do not change significantly from Year T-1 to Year T or change in a direction that is not expected to cause IC deterioration. The reported deterioration in IC can be attributed to increases in audit fee, management turnover, restatement, financial distress, firm size, and decrease in financial activities. Consistent with an agency hypothesis that managers try to manipulate the IC process when firm performance declines, the reported deterioration in IC is also associated with poor stock returns in the year before disclosure. ICW disclosure is more likely when poor stock return is combined with higher sensitivity of executive compensation to stock price change.

We examine the decision to list in the U.S. markets by foreign firms through American Depository Receipts (ADRs). There is a high positive correlation between the valuation of existing ADRs and the number of new ADR listings next year. ADR listing is more likely when existing ADRs are valued higher. The subsequent operating and stock performance of ADR firms listed in hot years is significantly worse than those of ADR firms listed in cold years. These results are consistent with the hypothesis that market timing is an important motivation for foreign firms to list in the U.S. equity markets.

We examine insider selling for initial public offering (IPO) firms using a sample of 1868 IPOs between 1988 and 2012. We find that overvalued IPOs have higher probability of offering secondary shar...

We propose reduced investment as a potential explanation for why firms with internal control weakness (ICW) exhibit lower valuation relative to non-ICW firms. We show that ICW firms significantly reduce investment around ICW disclosure and also have poor stock performance. Additional evidence shows that many of the investment reductions have been announced during the year before ICW disclosure. A possible explanation for investment reductions is the higher costs of financial friction associated with ICW. Consistent with this explanation, we show that ICW firms with credit ratings do not reduce their investment as much and have much better stock performance than ICW firms without credit ratings.

We examine the valuation of ADR IPOs and find that they are valued similarly to U.S. domestic IPOs but significantly higher than U.S. seasoned firms. This higher valuation is not caused by differences in firm size, growth opportunity, profitability, listing exchange, diversification benefit, foreign exchange risk, investor protection, or market liquidity as suggested by previous studies. Moreover, they experience significant declines in earnings and their stocks underperform U.S. seasoned by more than 20% in the three years after IPO. We show that ADR IPOs are timed to take advantage of overoptimistic in U.S. equity markets, supporting windows of opportunity theory.

Using a sample of 4441 IPOs from the US, we find that IPO firms with larger proportional offering size have lower valuation. The sizes of both primary share offering and secondary share offering are negatively related to IPO firm valuation. The valuation measures are positively related to the levels of capital expenditure and R&D before IPO, lending support to explanations based on Jensen (JAMA 76:323–329, 1986)’s free cash flow hypothesis. We also find evidence consistent with negative signals from larger secondary share offering size. Results of tests about long-run IPO stock performance do not support the hypothesis that IPO stock demand curve is downward sloping.

PurposeThe purpose of this paper is to answer the following three questions about the new capital raised in initial public offerings (IPOs): why do some IPO companies raise a lot of new capital while some others do not? Where do the IPO companies use the new capital they raise in IPOs? How does the use of new capital affect the operating performance of IPO companies?Design/methodology/approachMatching firm approach, univariate and regression tests.FindingsThis paper finds that companies with higher research and development (R&D) spending, higher capital expenditure, lower working capital and more long-term debt tend to raise more capital in IPOs. These firms also spend more on R&D and capital expenditure. The results also suggest that the more the new capital firms raise in IPOs, the lower operating performance they have in subsequent years. However, firms spending more new capital on R&D and capital expenditure seem to perform better.Originality/valueThese results help us understand the behavior of IPO firms.

We examine whether alleviating financial constraints is one of the motives for non-U.S. firms to cross-list in stock markets in the United States. Using payout ratio, payout level, and WW index (Whited and Wu, 2006) as measures of financial constraints, we find that firms with higher financial constraints are more likely to cross-list in the U.S. This pattern is driven by small firms, which tend to be financially constrained. After firms cross-list, they significantly increase their payout ratio and payout level. Small firms have more increases in payouts than large firms. WW index decreases for small firms after cross-listing. Tests about cash flow sensitivities of cash also suggest that the decline in financial constraints is more significant for small firms. Overall the results suggest that relief from financial constraints may be an important motive for cross-listing, especially for small firms.

We find that firms reporting internal control material weakness (ICW) under Section 404 of Sarbanes–Oxley Act (SOX) have 13% lower valuation than non-ICW firms based on Tobin's q. This valuation difference is mainly driven by stock underperformance of more than 13% during the year before ICW disclosure. The ICW firms that remedy the internal control weakness in the subsequent year have much better stock performance compared to those firms that fail to remedy existing ICW problems. We further show a better stock performance in the year before disclosure if a SOX 404 ICW firm has prior SOX 302 ICW disclosure more than one year earlier. All these results are consistent with the hypothesis that the equity market has incorporated the negative information associated with SOX 404 ICW reports before the actual disclosures are made.

We examine private issuance of public equity (PIPE) in China, and our results suggest that PIPE investors benefit from the price manipulation before and after issuance. These investors tend to cash out after lockup expiration and make large profits. We also find evidence that the trading of PIPE investors after lockup expiration is informed. Tests about the abnormal returns in the three years after lockup expiration suggest that at least part of the benefits PIPE investors receive come from wealth transfer from outside investors. Overall, PIPE issuers in China seem to use an opaque mechanism to compensate PIPE investors.

We revisit the relationship between ownership dispersion and market liquidity. For ownership dispersion, we consider two dimensions: number of shareholders and blockholder ownership. For market liquidity, we consider four categories of liquidity measures: spreads, probability of informed trading (PIN), depth, and volume. Our sample includes NASDAQ firms in addition to NYSE and AMEX firms. We find several relations that are not documented in the extant Finance literature. Overall, our test results are consistent with the idea that higher ownership dispersion improves market liquidity.

Booth and Chua [Booth J., Chua L. Ownership dispersion, costly information, and IPO underpricing. Journal of Financial Economics 1996; 41; 291–310] hypothesize that IPOs are underpriced to promote ownership dispersion, which in turn increases aftermarket liquidity of IPO stocks. We examine a sample of 1179 Nasdaq IPOs and find that underpricing is positively correlated with the number of non-block institutional shareholders after IPO but negatively correlated with the changes in the total number of shareholders. Firms with many non-block institutional shareholders tend to have high liquidity in the secondary market. These results provide support to Booth and Chua's hypothesis. Underpricing also has direct effects on secondary market liquidity after controlling for ownership structure and other factors.

We fi nd that IPO underpricing is positively related to post-IPO growth in sales and EBITDA, but is not signifi cantly related to growth in earnings. Our evidence suggests that accrual reversals or earnings management may cause this inconsistency. We interpret the growth rates of sales and EBITDA as measures of fi rm quality, and conclude that our evidence supports the notion that IPO fi rms with greater underpricing are of better quality. Our tests on analysts’ earnings forecast errors show that analysts are less positively biased in their earnings forecasts for IPO fi rms that have greater underpricing. In this paper we examine the relation between initial public offering (IPO) underpricing and postIPO growth rates of accounting performance variables. Previous research on IPOs suggests that IPO underpricing is related to the quality of the IPO fi rms (Allen and Faulhaber, 1989, Welch, 1989, Grinblatt and Hwang, 1989, and Rock, 1986). If we use growth rates of accounting performance variables (such as earnings) as measures of fi rm quality, then this suggestion implies a positive relation between IPO underpricing and growth rates. Our hypothesis is that IPO fi rms with greater underpricing should have higher post-IPO growth rates of accounting performance variables. However, rather than just concentrate on growth in earnings, we also include growth in EBITDA and growth in sales. Relative to earnings, these latter variables are more diffi cult for managers to manipulate. Thus, to reduce the possible contamination of our analysis by earnings management strategies, we consider the growth rates of earnings, EBITDA, and sales, and how they relate to IPO underpricing. Consistent with our hypothesis, we fi nd that underpricing is positively related to growth in sales and EBITDA in the fi ve years following an IPO. These results suggest that the IPOs with greater underpricing have higher quality. We also fi nd that IPO growth rates in earnings are much lower than the growth rates in sales and EBITDA. Further tests show that this inconsistency is likely caused by earnings management at the time of the IPO, which infl ates earnings initially and thus reduces earnings growth rates in subsequent years. This result suggests that earnings growth rates may not be accurate measures of IPO fi rm quality compared to sales and EBITDA growth rates. We fi nd that the fi rms with greater underpricing experience larger decreases in accruals after the fi rst year. This fi nding implies that earnings management may also reduce the correlation between IPO underpricing and earnings growth rates. We examine the accuracy of analysts’ earnings forecasts to determine how analysts react to the relation between IPO growth rates and IPO underpricing. If analysts are misled by earnings We thank Mark Huson, participants at the 2005 Northern Finance Association Conference, and, in particular, Bill Christie (the Editor) and an anonymous referee for helpful comments and suggestions. The authors gratefully acknowledge the contribution of Thompson Financial for providing earnings forecast data, available through I/B/E/S (Institutional Brokers Estimate System).

Purnanandam and Swaminathan [Purnanandam, A., Swaminathan, B. 2004. Are IPOs really underpriced? Review of Financial Studies, 17, 811–848.] find that IPOs are overvalued at the offer price relative to value metrics based on industry peer price multiples. I discuss some possible problems in their valuation methodology and find that IPOs are not overvalued after steps are taken to address the problems. More importantly, when I examine the long-run performance of IPO firms and their industry peers, I find that IPOs do not underperform their industry peers in the 5 years after IPO. This casts doubt to the argument that IPOs are overvalued.

I examine the relation between initial public offering (IPO) long-run stock performance and the amount of cash raised by the firm in the offering. I find that IPOs raising more cash have poorer long-run performance. The result is robust to different measurement methods. The evidence suggests that the market underreacts to free cash flow related agency problems in IPOs. Consistent with this interpretation, I find that IPO long-run performance is more sensitive to the new cash raised in the offering if an IPO firm has lower capital expenditure or higher opening bid-ask spread.

We argue that in an initial public offering (IPO), pre-IPO owners make decisions regarding underpricing, share retention, and share lockup simultaneously and optimally to maximize aftermarket liquidity. We predict that underpricing fosters higher trading volume in both the short run and the long run. Also, liquidity is negatively related to the proportion of shares retained by pre-IPO owners, ceteris paribus, so IPO underpricing should be positively related to the proportion of shares retained, as an offset. We document evidence consistent with these predictions. In addition, we find that, for IPOs with a lockup restriction, underpricing is more substantial and the positive relation between share retention and underpricing is much stronger. We also find that the relationship between underpricing and trading volume is stronger for IPOs with lockup. IPOs with lockup have higher trading volume, and a significant portion of this difference is associated with the effect of underpricing.

PurposeTo test the effects of underpricing and share retention (i.e. the proportion of shares retained by the pre‐initial‐public‐offering (IPO) owners) on IPO aftermarket liquidity.Design/methodology/approachUses both percentage spread and turnover ratio to measure liquidity. The percentage spread is the quoted bid‐ask spread divided by the quoted midpoint and measures the trading cost relative to share price. Turnover ratio is the daily trading volume divided by the number of shares offered and measures the speed of transaction. Both non‐parametric analyses and multiple regressions are conducted to investigate the effects of underpricing and share retention on liquidity.FindingsResults indicate that initial return is positively related to turnover ratio and negatively related to percentage spread. These relations are significant even after controlling for other factors. Also finds that the pre‐IPO owners’ retention rate is positively related to turnover ratio and negatively related to percentage spread. High retention rates attract more trades, provide quality assurance, and improve IPO aftermarket liquidity.Originality/valueThis paper investigates the theoretical links between underpricing and liquidity and provides direct evidence on Booth and Chua's liquidity theory. In addition, this is one of the first empirical studies to analyze the effect of share retention on aftermarket liquidity.

In this paper, we examine how analysts react to IPO percentage offering size. We find that analysts predict lower long-term earnings growth rates for IPOs with larger percentage offering size. The sizes of both primary and secondary offering are negatively related to long-term growth rate forecasts. We find evidence that the free cash flow effect may be related to the negative relation between primary offering size and growth forecast.

We attempt to answer the following three questions about the new capital raised in IPOs: Why do some IPO companies raise a lot of new capital while some others don’t? Where do the IPO companies use the new capital they raise in IPO? How does the use of new capital affect the operating performance of IPO companies? We find that companies with higher R&D spending, higher capital expenditure, lower working capital and more long term debt tend to raise more capital in IPOs. These firms also spend more on R&D and capital expenditure. The more new capital firms raise in IPOs, the lower sales growth rate they have. However, firms spending a higher proportion of new capital on R&D seem to have higher sales growth rate.