MARKET SENTIMENT. MEDIA HYPE AND THE UNDERPRICING OF INITIAL PUBLIC OFFERINGS: THE CASE OF AUSTRALIAN TECHNOLOGY IPOS BEAUTY HO, MAYA TAHER, ROBERT LEE AND NEIL FARGHER SCHOOL OF ACCOUNTING THE UNIVERSITY OF NEW SOUTH WALES AUGUST 10. 2001 Acknowledgements The authors thank participants in the Current Developments in Financial Accounting Research Seminar at the University of New South Wales, Elizabeth Carson, and Mike Wilkins for their helpful comments. We gratefully acknowledge the provision of data and assistance from William Huang of the Securities Industry Research Centre of the Asia-Pacific ("SIRCA"), and Atika Lenz from JPMorgan. We also acknowledge the research assistance of Wendy Chan. Any errors or omissions remain the responsibility of the authors alone All data is publicly available
MARKET SENTIMENT, MEDIA HYPE AND THE UNDERPRICING OF INITIAL PUBLIC OFFERINGS: THE CASE OF AUSTRALIAN TECHNOLOGY IPOS. BEAUTY HO, MAYA TAHER, ROBERT LEE AND NEIL FARGHER SCHOOL OF ACCOUNTING THE UNIVERSITY OF NEW SOUTH WALES AUGUST 10, 2001 Acknowledgements The authors thank participants in the Current Developments in Financial Accounting Research Seminar at the University of New South Wales, Elizabeth Carson, and Mike Wilkins for their helpful comments. We gratefully acknowledge the provision of data and assistance from William Huang of the Securities Industry Research Centre of the Asia-Pacific (“SIRCA”), and Atika Lenz from JPMorgan. We also acknowledge the research assistance of Wendy Chan. Any errors or omissions remain the responsibility of the authors alone. All data is publicly available
MARKET SENTIMENT. MEDIA HYPE AND THE UNDERPRICING OF INITIAL PUBLIC OFFERINGS THE CASE OF AUSTRALIAN TECHNOLOGY IPOS Abstract This study examines the relationship between the extent of initial public offering (IPO) underpricing and market sentiment surrounding technology issues listing on the Australian Stock Exchange(AsX) during 1999 and 2000. We consider hype surrounding these issues as reflected in the media and as reflected in the market 's sentiment towards recent offerings by similar firms We also consider the relationship between technology firms' need for follow-on offerings due to cash burn' and the level of underpricing. Finally, we examine the information content of management and accountant going concern warnings as a signalling mechanism to reduce ex ante uncertainty regarding the relative risk of IPO candidates Our preliminary results indicate that the extent of underpricing is systematically related to variables measuring the market sentiment surrounding the listing of an IPO. Specifically, underpricing is higher following high underpricing in similar recent issues. There is some evidence of higher underpricing for firms with higher media interest and in the period of the hot IPO market prior to april 2000. We find that firms that experience a greater rate of cash burn also experience greater underpricing consistent with the conjecture that such firms are more likely to need additional financing shortly after they go public. The association between cash burn and underpricing is however reliant on inclusion of a few issues with very high underpricing. We also find evidence consistent with warnings in the prospectus regarding going concern issues providing a valuable signal to mitigate investors' ex ante uncertainty about the value of an offering, thereby reducing the subsequent level of underpricing achieved by that firm
1 MARKET SENTIMENT, MEDIA HYPE AND THE UNDERPRICING OF INITIAL PUBLIC OFFERINGS: THE CASE OF AUSTRALIAN TECHNOLOGY IPOS. Abstract This study examines the relationship between the extent of initial public offering (IPO) underpricing and market sentiment surrounding technology issues listing on the Australian Stock Exchange (ASX) during 1999 and 2000. We consider ‘hype’ surrounding these issues as reflected in the media and as reflected in the market’s sentiment towards recent offerings by similar firms. We also consider the relationship between technology firms’ need for follow-on offerings due to ‘cash burn’ and the level of underpricing. Finally, we examine the information content of management and accountant going concern warnings as a signalling mechanism to reduce ex ante uncertainty regarding the relative risk of IPO candidates. Our preliminary results indicate that the extent of underpricing is systematically related to variables measuring the market sentiment surrounding the listing of an IPO. Specifically, underpricing is higher following high underpricing in similar recent issues. There is some evidence of higher underpricing for firms with higher media interest and in the period of the hot IPO market prior to April 2000. We find that firms that experience a greater rate of cash burn also experience greater underpricing consistent with the conjecture that such firms are more likely to need additional financing shortly after they go public. The association between cash burn and underpricing is however reliant on inclusion of a few issues with very high underpricing. We also find evidence consistent with warnings in the prospectus regarding going concern issues providing a valuable signal to mitigate investors’ ex ante uncertainty about the value of an offering, thereby reducing the subsequent level of underpricing achieved by that firm
1. INTRODUCTION We examine the economic factors determining the level of underpricing in recent initial public offerings(IPOs") by Australian technology firms during 1999 and 2000. The paper contributes to the existing literature by extending the findings of DuCharme et al. (2001)that link and a firm's need for follow-on financing. Secondly, we examine the information content or o unprecedented levels of underpricing achieved by technology firms with measures of stock hy management and accountant warnings regarding going concern issues as a signalling mechanism to mitigate ex ante uncertainty for IPO candidates(Willenborg and McKeown 2000)during a period where regulatory changes facilitated the listing of companies with high levels of inherent The volatile market conditions experienced by so called"new economy'firms in recent years have, on average, culminated in very high levels of underpricing of IPOs. KPMG reports in their 1999 capital markets survey that Australian technology stocks achieved an average level of first day underpricing of 57 per cent to issue prices. Underpricing varied within the converging business sector from a positive return of 236 per cent for Liberty One to a decline of 45 per cent for Spike Networks. Whether the high levels of valuation for technology stock offerings regarded as rationally reflecting very high growth options, or is an example of a ' hot issue market'(e.g. Ritter 1984)that reflects hypaethral(excessive, open to the sky ) expectations for future growth for these firms, the period examined provides a suitable period in which to examine the association between market sentiment and IPO underpricing. In such markets a 'hype develops surrounding the market for new issues. We view hype as a measure of the excitement surrounding a pending issue. We use the term hype' to includ excitement generated by: (1) the print and electronic media in relation to an IPO candidates listing, and(2) the hype derived from the equity markets sentiment towards public offerings by technology firms as reflected in recent offerings. DuCharme et al(2001) find that the extent of underpricing is systematically related to greater levels of news exposure for the IPO candidate in a seven-day period prior to the IPO fo sample of US-based internet companies. This paper examines the degree to which DuCharme et al's(2001)results for a narrow set of internet stocks may be generalised for a broader sample of Australian firms operating in the so called convergent business sector.Further, we expand the notion of hype as it was operationalised by DuCharme et al. (2001)to include both hype While we measure several sources of hype' we readily acknowledge that all the characteristics of hype'are clustered in a hot IPO market and can not be regarded as independent factors
2 1. INTRODUCTION We examine the economic factors determining the level of underpricing in recent initial public offerings (“IPOs”) by Australian technology firms during 1999 and 2000. The paper contributes to the existing literature by extending the findings of DuCharme et al. (2001) that link unprecedented levels of underpricing achieved by technology firms with measures of stock hype and a firm’s need for follow-on financing. Secondly, we examine the information content of management and accountant warnings regarding going concern issues as a signalling mechanism to mitigate ex ante uncertainty for IPO candidates (Willenborg and McKeown 2000) during a period where regulatory changes facilitated the listing of companies with high levels of inherent risk. The volatile market conditions experienced by so called ‘new economy’ firms in recent years have, on average, culminated in very high levels of underpricing of IPOs. KPMG reports in their 1999 capital markets survey that Australian technology stocks achieved an average level of first day underpricing of 57 per cent to issue prices. Underpricing varied within the converging business sector from a positive return of 236 per cent for LibertyOne to a decline of 45 per cent for Spike Networks. Whether the high levels of valuation for technology stock offerings is regarded as rationally reflecting very high growth options, or is an example of a ‘hot issue market’ (e.g. Ritter 1984) that reflects hypaethral (excessive, open to the sky) expectations for future growth for these firms, the period examined provides a suitable period in which to examine the association between market sentiment and IPO underpricing. In such markets a ‘hype’ develops surrounding the market for new issues. We view ‘hype’ as a measure of the excitement surrounding a pending issue. We use the term ‘hype’ to include excitement generated by: (1) the print and electronic media in relation to an IPO candidate’s listing, and (2) the hype derived from the equity market’s sentiment towards public offerings by technology firms as reflected in recent offerings.1 DuCharme et al.(2001) find that the extent of underpricing is systematically related to greater levels of news exposure for the IPO candidate in a seven-day period prior to the IPO for a sample of US-based internet companies. This paper examines the degree to which DuCharme et al.’s (2001) results for a narrow set of internet stocks may be generalised for a broader sample of Australian firms operating in the so called ‘convergent business sector’.2 Further, we expand the notion of hype as it was operationalised by DuCharme et al. (2001) to include both hype 1 While we measure several sources of ‘hype’ we readily acknowledge that all the characteristics of ‘hype’ are clustered in a ‘hot IPO’ market and can not be regarded as independent factors
generated by the print and electronic media, and hype derived from the equity markets sentiment towards public offerings by technology firms Previous research by Willenborg and McKeown(2000)suggests the role of going-concern opinions in reducing information asymmetry, and therefore ex ante uncertainty, for IPO candidates. We extend this research on the information content of audit qualifications issued pre IPO to an Australian setting where recent amendments to the asX Listing rules have tempered e emphasis on profitability as a prerequisite to raising public equity. We also introduce a broader measure of going concern warnings' beyond an audit qualification designed to incorporate circumstances where investigating accountants may formally approve an entitys accounts while implicitly questioning the ability of that firm to operate as a going-concern We examine initial public offerings by technology companies on the AsX during 1999 and 2000. This two-year period includes a period of high growth expectations for technology stocks and a period of diminished expectations following the dramatic reduction in technology share prices that occurred in April 2000. By restricting our analysis to technology industry IPOs we examine variation within a relatively homogeneous sample of firms, but we expect cross- sectional variation in underpricing and market hype surrounding these issues across the period examined Our preliminary results indicate that the extent of underpricing is systematically related to variables measuring the hype surrounding the listing of an IPO candidate on the AsX. We find that the market sentiment as reflected in the underpricing of recent, comparable IPO candidates is systematically related to the underpricing performance of the current technology offerings Excluding a few IPOs from the sample, based upon statistical criteria, there is greater underpricing of technology IPO candidates prior to the technology market correction in April 2000. Stock hype as measured by the print and electronic media coverage of IPO candidates in the period preceding their listing on the asX is only marginally significant in explaining subsequent underpricing achieved upon listing for the full sample. The media coverage is associated with underpricing when extreme observations are excluded based upon statistical criteri There is evidence that some Australian technology firms that experienced high underpricing also had a greater rate of cash burn, consistent with the conjecture that such firms are more likely to need additional financing shortly after they go public. Finally we find that going concer warnings' issued by management or the investigating accountant for an IPO candidate are The convergent business sector'generally refers to those firms operating in the sectors of
3 generated by the print and electronic media, and hype derived from the equity market’s sentiment towards public offerings by technology firms. Previous research by Willenborg and McKeown (2000) suggests the role of going-concern opinions in reducing information asymmetry, and therefore ex ante uncertainty, for IPO candidates. We extend this research on the information content of audit qualifications issued preIPO to an Australian setting where recent amendments to the ASX Listing Rules have tempered the emphasis on profitability as a prerequisite to raising public equity. We also introduce a broader measure of ‘going concern warnings’ beyond an audit qualification designed to incorporate circumstances where investigating accountants may formally approve an entity’s accounts while implicitly questioning the ability of that firm to operate as a going-concern. We examine initial public offerings by technology companies on the ASX during 1999 and 2000. This two-year period includes a period of high growth expectations for technology stocks and a period of diminished expectations following the dramatic reduction in technology share prices that occurred in April 2000. By restricting our analysis to technology industry IPOs we examine variation within a relatively homogeneous sample of firms, but we expect crosssectional variation in underpricing and market hype surrounding these issues across the period examined. Our preliminary results indicate that the extent of underpricing is systematically related to variables measuring the hype surrounding the listing of an IPO candidate on the ASX. We find that the market sentiment as reflected in the underpricing of recent, comparable IPO candidates is systematically related to the underpricing performance of the current technology offerings. Excluding a few IPOs from the sample, based upon statistical criteria, there is greater underpricing of technology IPO candidates prior to the technology market correction in April 2000. Stock hype as measured by the print and electronic media coverage of IPO candidates in the period preceding their listing on the ASX is only marginally significant in explaining subsequent underpricing achieved upon listing for the full sample. The media coverage is associated with underpricing when extreme observations are excluded based upon statistical criteria. There is evidence that some Australian technology firms that experienced high underpricing also had a greater rate of cash burn, consistent with the conjecture that such firms are more likely to need additional financing shortly after they go public. Finally, we find that ‘going concern warnings’ issued by management or the investigating accountant for an IPO candidate are 2 The ‘convergent business sector’ generally refers to those firms operating in the sectors of
valuable in mitigating investors' ex ante uncertainty about the true' value of an offering, thereby reducing the subsequent level of underpricing achieved by that firm This paper is structured as follows. Section 2 discusses background literature with a focus on the theoretical models that have been developed in a US setting to explain underpricing. There is also consideration given to the direction that underpricing research has taken in an Australian etting. Section 3 is concerned with the development of hypotheses. Sample selection empirical design and the definition and measurement of explanatory variables used to test the hypotheses is considered in Section 4. Section 5 presents the empirical findings Concluding remarks are offered in Section 6 2. REVIEW OF PRIOR LITERATURE 2.1 General background An IPO is the first effort by private firms to raise capital in the public equity market. Many empirical studies have documented that IPOs are typically underpriced, that is, an investor who purchases new issues at the offering price can, on average, make relatively large returns Loughran and Ritter(2000)report that for the period 1990 to 1998, IPO candidates left over US$27 billion of potential IPO proceeds on the table' because of underpricing. For the same period, the first day returns of IPOs averaged approximately 15 per cent, indicating there is a systematic downward bias in the offer price compared with the price in the secondary trading market. However, recent years have witnessed unprecedented levels of underpricing driven largely by the spectacular stock exchange debuts achieved by firms with Internet-focused business models. Ritter(2001)reports that uS$65 billion was left on the table from all IPOs during 1999 and 2000 alone. Further, DuCharme et al. (2001)document that the mean(median) underpricing of 238 Internet IPOs listed in the US during the period 1988 through 1999 was a staggering 113. 8 per cent (45.6 per cent) Various theoretical models have been developed to explain underpricing as an equilibrium phenomenon in the IPO market. These include models based on the institutional framework hypothesis( Chalk and Peavy 1986, Finn and Higham 1988, and Taylor and Walter 1990), the litigation hypothesis(Tinic 1988), and the information asymmetry hypothesis, which includes consideration of reputation effects for auditors and underwriters of new issues(Titman and Trueman 1986, Beatty 1989, and Balvers, McDonald and Miller 1988)and the signalling telecommunications, information technology, electronics, multimedia, the Internet, or biotechnology Ibbotson and ritter(1993), How(1994)and Loughran et al. (1994)summarise international evidence of IPO underpricing, as well as potential determinants thereof
4 valuable in mitigating investors’ ex ante uncertainty about the ‘true’ value of an offering, thereby reducing the subsequent level of underpricing achieved by that firm. This paper is structured as follows. Section 2 discusses background literature with a focus on the theoretical models that have been developed in a US setting to explain underpricing. There is also consideration given to the direction that underpricing research has taken in an Australian setting. Section 3 is concerned with the development of hypotheses. Sample selection, empirical design and the definition and measurement of explanatory variables used to test the hypotheses is considered in Section 4. Section 5 presents the empirical findings. Concluding remarks are offered in Section 6. 2. REVIEW OF PRIOR LITERATURE 2.1 General Background An IPO is the first effort by private firms to raise capital in the public equity market. Many empirical studies have documented that IPOs are typically underpriced, that is, an investor who purchases new issues at the offering price can, on average, make relatively large returns 3 . Loughran and Ritter (2000) report that for the period 1990 to 1998, IPO candidates left over US$27 billion of potential IPO proceeds ‘on the table’ because of underpricing. For the same period, the first day returns of IPOs averaged approximately 15 per cent, indicating there is a systematic downward bias in the offer price compared with the price in the secondary trading market. However, recent years have witnessed unprecedented levels of underpricing driven largely by the spectacular stock exchange debuts achieved by firms with Internet-focused business models. Ritter (2001) reports that US$65 billion was left on the table from all IPOs during 1999 and 2000 alone. Further, DuCharme et al. (2001) document that the mean (median) underpricing of 238 Internet IPOs listed in the US during the period 1988 through 1999 was a staggering 113.8 per cent (45.6 per cent). Various theoretical models have been developed to explain underpricing as an equilibrium phenomenon in the IPO market. These include models based on the institutional framework hypothesis (Chalk and Peavy 1986, Finn and Higham 1988, and Taylor and Walter 1990), the litigation hypothesis (Tinic 1988), and the information asymmetry hypothesis, which includes consideration of reputation effects for auditors and underwriters of new issues (Titman and Trueman 1986, Beatty 1989, and Balvers, McDonald and Miller 1988) and the signalling telecommunications, information technology, electronics, multimedia, the Internet, or biotechnology. 3 Ibbotson and Ritter (1993), How (1994) and Loughran et al. (1994) summarise international evidence of IPO underpricing, as well as potential determinants thereof
hypothesis( Grinblatt and Hwang 1989, Welch 1989, Allen and Faulhaber 1989 and How and Low 1993) The phenomenon of underpricing has not received as much attention in an Australian setting by researchers when compared to the significant literature that has emerged in the US Lee, Taylor and Walter(1996a)find that Australian IPO underpricing varies in a manner consistent with the model of Rock(1986), and the extension of this by beatty and Ritter(1986) In contrast to Lee, Taylor and Walter(1996a), How(2000)documents that the degree of underpricing is not systematically related to long run returns for mining companies. The underpricing literature in Australia has also examined the robustness of the predictions generated by the signalling model of Datar, Feltham and Hughes(1991). To this end, Lee, Stokes, Taylor and Walter(1999)report a significant positive relation between ex ante proxies for an IPO candidate's firm-specific risk and the selection of a high quality auditor as an indication to the market of the underlying quality of the IPO candidate 2.2 Underpricing and stock Hype Lang and Lundholm(2000)suggest that increasing disclosure can be used to hype the stock and thereby reduce the firms' cost of equity. Lang and Lundholm(2000)examined the disclosure practices and associated stock market responses of 4 1 small companies in the US around the time of seasoned equity offerings The authors report significant results in support of their hypothesis that a higher level of disclosure during the period leading up to a stock-offering announcement is associated with higher stock returns. On announcement date, however, Lang and Lundholm found that the market penalises firms that achieved higher levels of disclosure by altering their previous disclosure patterns and they interpret this as evidence that firms hyped their stock However, the full penalty is not imposed on the announcement date for those firms that actively inflated their stock prices without an economic basis. The stock prices of these companies continue to decline for a period up to 390 days after the equity offering is announced
5 hypothesis (Grinblatt and Hwang 1989, Welch 1989, Allen and Faulhaber 1989 and How and Low 1993). The phenomenon of underpricing has not received as much attention in an Australian setting by researchers when compared to the significant literature that has emerged in the US. Lee, Taylor and Walter (1996a) find that Australian IPO underpricing varies in a manner consistent with the model of Rock (1986), and the extension of this by Beatty and Ritter (1986). In contrast to Lee, Taylor and Walter (1996a), How (2000) documents that the degree of underpricing is not systematically related to long run returns for mining companies. The underpricing literature in Australia has also examined the robustness of the predictions generated by the signalling model of Datar, Feltham and Hughes (1991). To this end, Lee, Stokes, Taylor and Walter (1999) report a significant positive relation between ex ante proxies for an IPO candidate’s firm-specific risk and the selection of a high quality auditor as an indication to the market of the underlying quality of the IPO candidate. 2.2 Underpricing and Stock Hype Lang and Lundholm (2000) suggest that increasing disclosure can be used to ‘hype the stock’ and thereby reduce the firms’ cost of equity. Lang and Lundholm (2000) examined the disclosure practices and associated stock market responses of 41 small companies in the US around the time of seasoned equity offerings. The authors report significant results in support of their hypothesis that a higher level of disclosure during the period leading up to a stock-offering announcement is associated with higher stock returns. On announcement date, however, Lang and Lundholm found that the market penalises firms that achieved higher levels of disclosure by altering their previous disclosure patterns and they interpret this as evidence that firms ‘hyped’ their stock4 . 4 However, the full penalty is not imposed on the announcement date for those firms that actively inflated their stock prices without an economic basis. The stock prices of these companies continue to decline for a period up to 390 days after the equity offering is announced
DuCharme et al. (2001)find that the extent of underpricing for US-based Internet ompanies is systematically related to greater levels of news exposure for the IPO candidate in a seven-day period prior to the IPO. Bhartov, Mohanram and Seethamraju(2001) find that, even for non-Internet firms, earnings were significant for valuation prior to 1999 but lost their significance as the market turned a blind eye toward financial statement information in 1999 Further, Loughran and Ritter(2000) found that the higher the expected demand for stock prior to listing, the more likely it is that issuers will accept a lower offer price because of the expected appreciation in share price once the stock is listed. When coupled with the unprecedented first day returns achieved in recent years by firms with Internet-focused business models, the findings of Loughran and ritter(2000)and DuCharme et al. (2001)suggest that stock hype may potentially be playing a significant role in explaining the underpricing in technology IPOs In this paper we argue that the concept of hype is related to the phenomenon of hot IPO markets. It has been well documented that there are pronounced cycles in the number of new issues per month and in the average initial returns per month(e.g. Ibbotson and Jaffe 1975, Ritter 1984, Ibbotson, Ritter and Sinclair 1988, Lowery and Schwert 2001). We use the word hype to capture information effects reflecting market sentiment, whether rational or irrational, in the pre IPO period. We examine the extent to which this sentiment influences underpricing during a hot IPO period Another aspect of media coverage and underpricing is the recent evidence by Demers and Lewellen(2001)that underpricing is associated with post-IPO advertising benefits. That is, the underpricing leads to increased exposure and increased website traffic. While we focus on the period prior to the IPO, Demers and Lewellen suggest that any observed underpricing in the finance market can also provide future benefits from increased exposure in the post-IPO period 2.3 CLERP, Increased Going Concern risk and Underpricing Substantial reforms to the ASX Listing Rules and the Corporations Law through the Corporations Law Economic Reform Act("CLERP Act )were implemented on September 1 1999 and have significantly improved the regulatory environment for small con raise capital from the public equity market in Australia. The prerequisite of profitability that had traditionally prevented loss-making or marginally profitable operations from accessing the asx Lower and Schwert(2001)find that the cycles in initial returns and high volumes in IPOs are predominantly driven by information learned during the registration period and argue that this is more consistent with equential learning. Lower and Schwert measure information content with reference to returns to recent similar IPO firms and the market in general, with the potential that these returns reflect a bubble rather than explain information about future prospects. In this study we consider hype'to include all potential"information'from both news sources and recent market returns. We do not attempt to distinguish between rational or irrational expectations of high future growth
6 DuCharme et al. (2001) find that the extent of underpricing for US-based Internet companies is systematically related to greater levels of news exposure for the IPO candidate in a seven-day period prior to the IPO. Bhartov, Mohanram and Seethamraju (2001) find that, even for non-Internet firms, earnings were significant for valuation prior to 1999 but lost their significance as the market turned a blind eye toward financial statement information in 1999. Further, Loughran and Ritter (2000) found that the higher the expected demand for stock prior to listing, the more likely it is that issuers will accept a lower offer price because of the expected appreciation in share price once the stock is listed. When coupled with the unprecedented first day returns achieved in recent years by firms with Internet-focused business models, the findings of Loughran and Ritter (2000) and DuCharme et al. (2001) suggest that stock hype may potentially be playing a significant role in explaining the underpricing in technology IPOs. In this paper we argue that the concept of hype is related to the phenomenon of ‘hot IPO’ markets. It has been well documented that there are pronounced cycles in the number of new issues per month and in the average initial returns per month (e.g. Ibbotson and Jaffe 1975, Ritter 1984, Ibbotson, Ritter and Sinclair 1988, Lowery and Schwert 2001). We use the word ‘hype’ to capture information effects reflecting market sentiment, whether rational or irrational, in the preIPO period.5 We examine the extent to which this sentiment influences underpricing during a ‘hot IPO’ period. Another aspect of media coverage and underpricing is the recent evidence by Demers and Lewellen (2001) that underpricing is associated with post-IPO advertising benefits. That is, the underpricing leads to increased exposure and increased website traffic. While we focus on the period prior to the IPO, Demers and Lewellen suggest that any observed underpricing in the finance market can also provide future benefits from increased exposure in the post-IPO period. 2.3 CLERP, Increased Going Concern Risk and Underpricing Substantial reforms to the ASX Listing Rules and the Corporations Law through the Corporations Law Economic Reform Act (“CLERP Act”) were implemented on September 1, 1999 and have significantly improved the regulatory environment for small companies seeking to raise capital from the public equity market in Australia. The prerequisite of profitability that had traditionally prevented loss-making or marginally profitable operations from accessing the ASX 5 Lower and Schwert (2001) find that the cycles in initial returns and high volumes in IPO’s are predominantly driven by information learned during the registration period and argue that this is more consistent with sequential learning. Lower and Schwert measure ‘information’ content with reference to returns to recent similar IPO firms and the market in general, with the potential that these returns reflect a bubble rather than explain information about future prospects. In this study we consider ‘hype’ to include all potential ‘information’ from both news sources and recent market returns. We do not attempt to distinguish between rational or irrational expectations of high future growth
Official Listing has been replaced by a broader series of tests designed to evaluate an entity's ability to operate as a going concern. An analysis of AsX listings during the 1999 and 2000 hot IPO market reveals that the regulatory amendments did, in fact, facilitate improved access to public equity capital than what was available for SMEs under the earlier listing framework. A total of 69 technology firms secured an official listing on the AsX during 1999. However, 42 firms from this sub-sample(60.9 per cent) secured their listing in the four months following September 1, 1999 when the amended AsX Listing Rules came into effect. A further 87 technology firms were listed on the ASX during 2000. With profitability no longer a disqualifying factor for the achievement of a listing, we anticipate that the average risk profile and level of ex ante uncertainty associated with technology firm IPO candidates since September 1, 1999 particularly high. This provides a valuable setting in which to examine the effectiveness with which the investigating accountants, auditors and management are able to communicate the nherent risk associated with investing in a technology offering to potential investors One mechanism for increasing the credibility of management statements regarding performance is the independent accountant s report contained in the prospectus documents Willenborg and McKeown(2000) find that for a sample of small U.S. offerings, offering firms with pre-issue going-concern opinions suffer less first-day underpricing than similar securities without going-concern opinions. The Australian Corporations Law effectively prevents companies with a going concern qualification from going public. We therefore consider a broader definition of warnings contained in the prospectus that indicate some need for an investor to specifically consider going concern risk for the IPO candidate firm 3. DEVELOPMENT OF HYPOTHESES 3.1 Underpricing and stock hype One of the objectives of our research is to investigate whether market sentiment surrounding the listing of IPO candidates is a possible explanation of the extent of observed underpricing. As noted above, previous research suggests hype as a measure of the market sentiment and excitement surrounding a pending issue. The interest in an IPO is fostered by investment bankers, managers and potential investors. Hype surrounding an IPO candidate in the period immediately prior to listing assists in fostering a market for the firms shares We consider two types of measures of hype that reflect the level of interest surrounding a pending issue. We consider hype as reflected by exposure in the media and hype as reflected the market for similar issues The exposure in the print and electronic media generates awareness among potential investors, which results in an increase in demand for the newly listed stock. This provides
7 Official Listing has been replaced by a broader series of tests designed to evaluate an entity’s ability to operate as a going concern. An analysis of ASX listings during the 1999 and 2000 hot IPO market reveals that the regulatory amendments did, in fact, facilitate improved access to public equity capital than what was available for SMEs under the earlier listing framework. A total of 69 technology firms secured an official listing on the ASX during 1999. However, 42 firms from this sub-sample (60.9 per cent) secured their listing in the four months following September 1, 1999 when the amended ASX Listing Rules came into effect. A further 87 technology firms were listed on the ASX during 2000. With profitability no longer a disqualifying factor for the achievement of a listing, we anticipate that the average risk profile and level of ex ante uncertainty associated with technology firm IPO candidates since September 1, 1999 is particularly high. This provides a valuable setting in which to examine the effectiveness with which the investigating accountants, auditors and management are able to communicate the inherent risk associated with investing in a technology offering to potential investors. One mechanism for increasing the credibility of management statements regarding performance is the independent accountant’s report contained in the prospectus documents. Willenborg and McKeown (2000) find that for a sample of small U.S. offerings, offering firms with pre-issue going-concern opinions suffer less first-day underpricing than similar securities without going-concern opinions. The Australian Corporations Law effectively prevents companies with a going concern qualification from going public. We therefore consider a broader definition of warnings contained in the prospectus that indicate some need for an investor to specifically consider going concern risk for the IPO candidate firm. 3. DEVELOPMENT OF HYPOTHESES 3.1 Underpricing and Stock Hype One of the objectives of our research is to investigate whether market sentiment surrounding the listing of IPO candidates is a possible explanation of the extent of observed underpricing. As noted above, previous research suggests hype as a measure of the market sentiment and excitement surrounding a pending issue. The interest in an IPO is fostered by investment bankers, managers and potential investors. Hype surrounding an IPO candidate in the period immediately prior to listing assists in fostering a market for the firm’s shares. We consider two types of measures of hype that reflect the level of interest surrounding a pending issue. We consider hype as reflected by exposure in the media and hype as reflected in the market for similar issues. The exposure in the print and electronic media generates awareness among potential investors, which results in an increase in demand for the newly listed stock. This provides
relatively more price ramp up on the actual day of offer, which, in turn, induces more underpricing High underpricing in recent similar offerings can indicate that during the period between the registration of the offer and the initial trading of the issue, investors' perceptions of the prospects for the firm have changed. If these improved perceptions are maintained then high underpricing will result. Such underpricing is consistent with rational revelation of"information about industry prospects"(Lowry and Schwert 2001), or because the underpricing reflects excess demand for these type of stocks(Loughran and Ritter 2000) Our hypothesis that stock hype created by both the media and underlying market sentiment fuels momentum trading in the stock of an IPO candidate on listing date has received support in the prior literature. DuCharme et al. (2001)find that the extent of underpricing for US-based Internet companies is systematically related to greater levels of news exposure for the IPO candidate in a seven-day period prior to the IPO. Further, Loughran and Ritter(2000) found that the higher the expected demand for stock prior to listing, the more likely it is that issuers will accept a lower offer price because of the expected appreciation in share price once the stock is listed. When coupled with the unprecedented first day returns achieved in recent years by firms with Internet-focused business models, the findings of Loughran and Ritter(2000)and DuCharme et al. (2001)suggest that stock hype may potentially be playing a significant role in explaining the underpricing in technology IPOs This study extends the findings of duCharme et al. (2001)in an Australian context where domestic corporate law imposes a seven-day media black-out period pre-listing which prevents systematic attempts by issuers to enhance publicity about a prospective offering by publishing media releases. There are possible real economic actions, other than the IPO, that would reasonably be expected to affect firm value. Therefore we have chosen a 10-day window preceding the 'media black-out period to reduce the likelihood of picking up corporate announcements of economic substance. We expand the notion of hype as it was operationalised by DuCharme et al. (2001)to include hype derived from the australian public equity markets sentiment towards public offerings by technology firms. This dimension is motivated by ritter (2001) who suggests that the secondary market performance of comparable firms is likely to influence investor reaction to the present offering To summarise, we posit that, at least in the period examined (1999 and 2000), the level of stock hype is positively associated with stock returns. We examine the first day of trade for initial public offerings by technology firms and predict that
8 relatively more price ramp up on the actual day of offer, which, in turn, induces more underpricing. High underpricing in recent similar offerings can indicate that during the period between the registration of the offer and the initial trading of the issue, investors’ perceptions of the prospects for the firm have changed. If these improved perceptions are maintained then high underpricing will result. Such underpricing is consistent with rational revelation of “information about industry prospects” (Lowry and Schwert 2001), or because the underpricing reflects excess demand for these type of stocks (Loughran and Ritter 2000). Our hypothesis that stock hype created by both the media and underlying market sentiment fuels momentum trading in the stock of an IPO candidate on listing date has received support in the prior literature. DuCharme et al. (2001) find that the extent of underpricing for US-based Internet companies is systematically related to greater levels of news exposure for the IPO candidate in a seven-day period prior to the IPO. Further, Loughran and Ritter (2000) found that the higher the expected demand for stock prior to listing, the more likely it is that issuers will accept a lower offer price because of the expected appreciation in share price once the stock is listed. When coupled with the unprecedented first day returns achieved in recent years by firms with Internet-focused business models, the findings of Loughran and Ritter (2000) and DuCharme et al. (2001) suggest that stock hype may potentially be playing a significant role in explaining the underpricing in technology IPOs. This study extends the findings of DuCharme et al. (2001) in an Australian context where domestic corporate law imposes a seven-day media black-out period pre-listing which prevents systematic attempts by issuers to enhance publicity about a prospective offering by publishing media releases. There are possible real economic actions, other than the IPO, that would reasonably be expected to affect firm value. Therefore we have chosen a 10-day window preceding the ‘media black-out’ period to reduce the likelihood of picking up corporate announcements of economic substance. We expand the notion of hype as it was operationalised by DuCharme et al. (2001) to include hype derived from the Australian public equity market’s sentiment towards public offerings by technology firms. This dimension is motivated by Ritter (2001) who suggests that the secondary market performance of comparable firms is likely to influence investor reaction to the present offering. To summarise, we posit that, at least in the period examined (1999 and 2000), the level of stock hype is positively associated with stock returns. We examine the first day of trade for initial public offerings by technology firms and predict that:
H1: The extent of first day underpricing of Australian technology IPOs is positively correlated with the degree of stock hype about an IPO candidate prior to listi We measure hype along two dimensions. First, we focus on the reflection of hype in the media as measured by the number of mentions a particular IPO candidate receives in the press and electronic media. Secondly, we measure the underlying sentiment of the market as reflected in recent underpricing of similar IPOs 3.2 Underpricing and the rate of Cash burn DuCharme et al. (2001)observe that the establishment of a systematic relationship between stock hype and the underpricing of technology offerings is valuable in its own right, however it does not explain why an issuing firm would leave potential IPO proceeds on the table. To this end, we examine a second hypothesis, consistent with DuCharme et al. (2001), whereby firms anticipating the need for considerable additional financing in the future to fund growth opportunities have an incentive to tolerate IPO underpricing The decision to go public typically reflects the need for additional equity capital to finance expenditures associated with future growth. Business models in the technology sector during the period we examine were frequently only sustainable to the extent that entrepreneurs were able to return to the capital markets for a follow-on offering as IPO proceeds were consumed (or burnt) This suggests that entrepreneurs, anticipating the need for considerable additional financing in the uture to fund growth opportunities, have an incentive to tolerate greater underpricing so as to leave investors with a sound impression of the firm at the time of going public. We hypothesise that the desire to return to the capital markets, proxied by the rate at which the firm burns through its IPO proceeds on operating activities, is systematically related to the extent of underpricing This suggests the second hypothesis to be examined H2: The extent of underpricing of Australian technology IPOs is positively correlated with the rate at which an IPO candidate is expected to burn cash Explanations of the cross-sectional variation in stock prices for technology firms were prevalent in the literature during the bull market of the late 1990s(e.g. Cohen 1999, Hand 2000a, Hand 2000b). Demers and lev (2001)find that an Internet firms rate of cash burn was a value driver that differed in its pervasiveness as the sector matured and shifted focus towards sustainable business models and bottom(as opposed to top) line financial statement analysis. In 1999, capital markets encouraged aggressive spending behaviour by technology firms to develop the
9 H1: The extent of first day underpricing of Australian technology IPOs is positively correlated with the degree of stock hype about an IPO candidate prior to listing. We measure hype along two dimensions. First, we focus on the reflection of hype in the media as measured by the number of mentions a particular IPO candidate receives in the press and electronic media. Secondly, we measure the underlying sentiment of the market as reflected in recent underpricing of similar IPOs. 3.2 Underpricing and the Rate of Cash Burn DuCharme et al. (2001) observe that the establishment of a systematic relationship between stock hype and the underpricing of technology offerings is valuable in its own right, however it does not explain why an issuing firm would leave potential IPO proceeds on the table. To this end, we examine a second hypothesis, consistent with DuCharme et al. (2001), whereby firms anticipating the need for considerable additional financing in the future to fund growth opportunities have an incentive to tolerate IPO underpricing. The decision to go public typically reflects the need for additional equity capital to finance expenditures associated with future growth. Business models in the technology sector during the period we examine were frequently only sustainable to the extent that entrepreneurs were able to return to the capital markets for a follow-on offering as IPO proceeds were consumed (or ‘burnt’). This suggests that entrepreneurs, anticipating the need for considerable additional financing in the future to fund growth opportunities, have an incentive to tolerate greater underpricing so as to leave investors with a sound impression of the firm at the time of going public. We hypothesise that the desire to return to the capital markets, proxied by the rate at which the firm burns through its IPO proceeds on operating activities, is systematically related to the extent of underpricing. This suggests the second hypothesis to be examined. H2: The extent of underpricing of Australian technology IPOs is positively correlated with the rate at which an IPO candidate is expected to burn cash. Explanations of the cross-sectional variation in stock prices for technology firms were prevalent in the literature during the bull market of the late 1990s (e.g. Cohen 1999, Hand 2000a, Hand 2000b). Demers and Lev (2001) find that an Internet firm’s rate of cash burn was a value driver that differed in its pervasiveness as the sector matured and shifted focus towards sustainable business models and bottom (as opposed to top) line financial statement analysis. In 1999, capital markets encouraged aggressive spending behaviour by technology firms to develop the
