In the 1980s, the average first-day return on initial public offerings (IPOs) was 7%. The average first-day return doubled to almost 15% during 1990-1998, before What explains the severe underpricing of initial public offerings in 1999-2000, when the average first-day return of 65% exceeded any level previously seen before? In this article, we address this and the related question of why IPO underpricing doubled from 7% during 1980-1989 to almost 15% during 1990-1998 before reverting to 12% during the post-bubble period of 2001-2003. Our goal is to explain low-frequency movements in underpricing (or first-day returns) that occur less often than hot and cold issue markets.We examine three hypotheses for the change in underpricing: 1) the changing risk composition hypothesis, 2) the realignment of incentives hypothesis, and 3) a new hypothesis, the changing issuer objective function hypothesis. The changing issuer objective function hypothesis has two components, the spinning hypothesis and the analyst lust hypothesis.The changing risk composition hypothesis, introduced by Ritter (1984), assumes that riskier IPOs will be underpriced by more than less-risky IPOs. This prediction follows from models where underpricing arises as an equilibrium condition to induce investors to participate in the IPO market. If the proportion of IPOs that represent risky stocks increases, there should be greater average underpricing. Risk can reflect either technological or valuation uncertainty. Although there have been some changes in the characteristics of firms going public, these changes are found to be too minor to explain much of the variation in underpricing over time if there is a stationary risk-return relation.The realignment of incentives and the changing issuer objective function hypotheses bothWe thank Hsuan

The underpricing of initial public offerings (IPOs) that has been widely documented appears to be a short-run phenomenon. Issuing firms during 1975-84 substantially underperformed a sample of matching firms from the closing price on the first day of public trading to their three-year anniversaries. There is substantial variation in the underperformance year-to-year and across industries, with companies that went public in high-volume years faring the worst. The patterns are consistent with an IPO market in which (1) investors are periodically overoptimistic about the earnings potential of young growth companies, and (2) firms take advantage of these "windows of opportunity." NUMEROUS STUDIES HAVE DOCUMENTED two anomalies in the pricing of initial public offerings (IPOs) of common stock: (1) the (short-run) underpricing phenomenon, and (2) the "hot issue" market phenomenon. Measured from the offering price to the market price at the end of the first day of trading, IPOs produce an average initial return that has been estimated at 16.4%.1 Furthermore, the extent of this underpricing is highly cyclical, with some periods, lasting many months at a time, in which the average initial return is much higher.2 In this paper, I document a third anomaly: in the long-run, initial public offerings appear to be overpriced. Using a sample of 1,526 IPOs that went public in the U.S. in the 1975-84 period, I find that in the 3 years after going public these firms significantly underperformed a set of comparable firms matched by size and industry.

This paper develops and tests two propositions.We demonstrate that there is a monotone relation between the (expected) underpricing of an initial public offering and the uncertainty of investors regarding its value. We also argue that the resulting underpricing equilibrium is enforced by investment bankers, who have reputation capital at stake. An investment banker who 'cheats' on this underpricing equilibrium will lose either potential investors (if it doesn't underprice enough) or issuers (if it underprices too much), and thus forfeit the value of its reputation capital. Empirical evidence supports our propositions.

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The underpricing of initial public offerings (IPOs) that has been widely documented appears to be a short-run phenomenon. Issuing firms during 1975-84 substantially underperformed a sample of matching firms from the closing price on the first day of public trading to their three-year anniversaries. There is substantial variation in the underperformance year-to-year and across industries, with companies that went public in high-volume years faring the worst. The patterns are consistent with an IPO market in which (1) investors are periodically overoptimistic about the earnings potential of young growth companies, and (2) firms take advantage of these "windows of opportunity." NUMEROUS STUDIES HAVE DOCUMENTED two anomalies in the pricing of initial public offerings (IPOs) of common stock: (1) the (short-run) underpricing phenomenon, and (2) the "hot issue" market phenomenon. Measured from the offering price to the market price at the end of the first day of trading, IPOs produce an average initial return that has been estimated at 16.4%.1 Furthermore, the extent of this underpricing is highly cyclical, with some periods, lasting many months at a time, in which the average initial return is much higher.2 In this paper, I document a third anomaly: in the long-run, initial public offerings appear to be overpriced. Using a sample of 1,526 IPOs that went public in the U.S. in the 1975-84 period, I find that in the 3 years after going public these firms significantly underperformed a set of comparable firms matched by size and industry.

for comments, and Kenneth French for supplying factor returns. The authors maintain a more extensive bibliography of IPO-related work at http://www.iporesources.org. This website further contains links to many IPO-related sites and some reasonably up-to-date information on aggregate IPO activity and IPO working papers. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research.

Companies issuing stock during 1970 to 1990, whether an initial public offer ng or a seasoned equity offering, have been poor long-run investments for investors. During the five years after the issue, investors have received average returns of only 5 percent per year for companies going public and only 7 percent per year for companies conducting a seasoned equity offer. Book-to-market effects account for only a modest portion of the low returns. An investor would have had to invest 44 percent more money in the issuers than in nonissuers of the same size to have the same wealth five years after the offering date.IN THIS ARTICLE, WE show that companies issuing stock during 1970 to 1990, whether an initial public offering (IPO) or a seasoned equity offering (SEO), significantly underperform relative to nonissuing firms for five years after the offering date. The average annual return during the five years after issuing is only 5 percent for firms conducting IPOs, and only 7 percent for firms conducting SEOs. While evidence that firms going public subsequently underperform has been documented previously, our evidence that the same pattern holds for firms conducting SEOs is new.The magnitude of this underperformance is economically important: based upon the realized returns, an investor would have had to invest 44 percent more money in the issuers than in nonissuers of the same size to have the same wealth five years after the offering date. Surprisingly, this number is the same for both IPOs and SEOs. While the difference in returns between issuers and nonissuers on which the 44 percent number is based only holds