Upload
zakariahegazy
View
224
Download
0
Embed Size (px)
DESCRIPTION
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering Perspective, Ph.D. thesis, Strathclyde University, U.K. 2.2.5 EXPLANATIONS OF THE LONG-RUN PRICE PERFORMANCE OF IPOS In this section, a conceptual background relevant to the price performance of the IPOs in the long-run is provided. The survey revealed some hypotheses suggested in explaining the aftermarket performance of the IPOs; namely: 1. The divergence of opinion hypothesis; 2. The insiders-dumping hypothesis;
Citation preview
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
82
2.2.5 EXPLANATIONS OF THE LONG-RUN PRICE PERFORMANCE OF IPOS
In this section, a conceptual background relevant to the price performance of
the IPOs in the long-run is provided. The survey revealed some hypotheses suggested
in explaining the aftermarket performance of the IPOs; namely:
1. The divergence of opinion hypothesis;
2. The insiders-dumping hypothesis;
3. The efficient market hypothesis;
4. The impresario hypothesis;
5. The windows opportunities hypothesis;
6. The speculative bubble hypothesis; and
7. The seasoning effect hypothesis.
Briefly, each of these hypotheses is reviewed as follows:
2.2.5.1 The Divergence of Opinion Hypothesis
The present hypothesis predicts that if there is a great deal of uncertainty
about the value of an IPO the evaluations of optimistic investors may be much higher
than those of pessimistic investors. As time goes on and more information becomes
available, the divergence of opinion between optimistic and pessimistic investors will
narrow, and consequently, the market price will drop.
For this reason, Miller (1977) argues that investors who are most
opportunistic about IPO will be the buyers and he predicts that IPOs will
underperform in the long-run. Miller (1977), explained his prediction by curve ABC
plotted in Figure 2-2 below. This figure shows the cumulative distribution of the
number of investors with estimates above a certain value for the amount received at
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
83
liquidation of the investment. It can also be interpreted as the number of shares
investors are willing to hold at each price.
Figure 2-4 The cumulative distribution of the number of
investors with estimate above a certain value for the amount
received at liquidation of investment.
Miller (1977) assumes that:
Any single investor is able to purchase only one share and there are N shares
available.
The shares will end up being owned by the N investors with the highest
evaluation of the return.
From curve ABC it can be seen that:
There are N investors who estimate the final value to be R or above.
The selling price of the stock will be R.
If it was lower,
- there would be more than N investors who wished to hold the stock, and
- bidding against each other they would soon bid the stock up to R.
D F
Number of investors
F A D
B
E C J
Q
R
M
G H
Number of investors N
Estimate
of
Value
Source: Miller (1977:1152).
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
84
If it was above,
- some of those holding the security would feel it over valued, and
- would attempt to sell their share, driving the price back down to R.
The curve ABC in Figure 2-4 is a demand curve for the security. The supply
curve is a vertical line at the number of shares available.
The price is determined by the interaction of the demand and the supply curves.
Several results follow from this simple model. As long as the entire supply of
the security can be absorbed by a minority of the potential purchasers the market
price will be above the mean evaluation of the potential investors. Also as long as a
minority of potential investors can absorb the issue, an increase in the divergence of
opinion will increase the market clearing up. This can be seen by noting that:
If curve ABC is replaced with curve FBJ, representing a greater divergence of
opinions about the security. The market clearing price rises from R to Q.
On the other hand, if the divergence of opinion decreases, causing curve ABC to
be replaced with curve GBE, the market clearing price falls from R to M.
In the limit, where there is no disagreement about the return from the security,
curve ABC becomes the straight line GBH, and the market price falls to G. Only
in this case is the market price determined by the average evaluation of the
potential investors (Miller 1977:1152-53).
Direct evidence does support Miller’s prediction that many investors are periodically
overoptimistic about companies. For example, Shiller (1990) provides evidence via a
survey of investors of IPOs, that only 26 % of the respondents in his sample did
some fundamental analysis of the relation between the offer period and the firm's
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
85
underlying value. Moreover, Jain and Kini (1994) provide evidence that the earnings
per share of companies going public actually declined in the first few years after the
IPO [see Figure 2-5].
Figure 2-5 Market Expectations and Earnings Performance
0 1 2 3 4 5
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
0 1 2 3 4 5
Year relative to IPO
Earn
ing
per
sh
are
IPO sample Ind sample
Source: Jain and Kini (1994: 1724)
2.2.5.2 The Insiders-Dumping Hypothesis
A further explanation considers the possibility that after an initial price
increase for underpricing, stock prices might fall in the aftermarket due to the effects
of insiders-dumping on listings. The present hypothesis implies that a downward
sloping demand curve for a firm’s stock exists so that an increase in the supply of
stock leads to a stock price decline [see Myers and Majluf (1984) and Greenwald,
Stiglitz and Weiss (1984)].
Direct evidence does not support the hypothesis that insiders may dump their
stock on listing, causing a large increase in the supply of stocks on the market. The
empirical results of McConnel and Sanger (1987) do not confirm such explanation.
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
86
Table 2-27 illustrates the results of investigating the insider-dumping explanation of
negative post-listing returns in the work of McConnel and Sanger (1987).
Table 2-27 Average monthly raw returns and average monthly market-adjusted returns
following listing for 305 common stocks that listed on the NYSE over the period 1973-
1978 categorised according to volume of insider trading
Sample in which insider
sales exceeded insider
purchases
(sample size = 48)
Sample in which insider
purchases exceeded
insider sales
(sample size = 66)
Sample in which no
insider trade were
reported
(sample size =191)
Time interval
following
listing
Average
raw return
(percent)
Average market
adjusted returna
(percent)
Average
raw return
(percent)
Average market
adjusted returna
(percent
Average
raw return
(percent)
Average market
adjusted returna
(percent
First month 194 0.62
(0.33)
0.64
-1.33
(-0.79)
-1.34 -2.04
(-2.46)*
Second month 1.68 1.47
(1.00)
-1.22 -2.75
(-2.11)*
1.42 0.41
(0.57)
Third through
twelfth
months
0.29 -0.63
(-1.22)
1.32 0.29
(0.56)
0.87 0.02
(0.77)
Source: McConnel and Sanger (1987).
a t-statistic to test the null hypothesis that the average market-adjusted return equal to zero is contained in parentheses.
* Significance at the 0.05 level.
In this table, of the 305 firms examined, only 48 were classified as having net
insider sales, while 66 were classified as having net insider purchases. Almost two
thirds (191) of the companies experienced no insider trading activity. Contrary to the
insider-dumping explanation of negative post-offering returns, for the 'net insider-
sales' group, the first- and second -month average raw and market-adjusted returns
are positive although not statistically significant. For the 'net-insider-purchases'
group, the first-month average raw return is negative and both the first- and second-
month market-adjusted returns are negative. Only the second month market-adjusted
return is statistically significantly different from zero. Finally, only the 'no-insider-
trading group exhibits negative average raw return in the first month following
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
87
listing, and only for this sample is the market-adjusted return statistically
significantly different from zero.
The results of the analysis led no support to the insider-dumping explanation
of negative post-listing stock returns. To the contrary, of the firms examined, in the
work of McConnel and Sanger (1987), those that experienced net insider selling
earned higher average returns following listing than those firms with either net
insider purchases or no insider activity. As a result, it may be suggested that insider
selling can not explain negative post-listing stock-returns.
2.2.5.3 The Efficient Market Hypothesis
In its weak-form version, the Efficient Market Hypothesis (EMH) predicts
that all information regarding past price movements are reflected in the current stock
price. This form of the EMH can be supported by a confirmation of the random walk
theory upon which stock price changes are independent over time [see Levy and
Sarnat (1984), and Hudson ; Dempsey and Keasey (1996)]. Thus, the return from any
initial underpricing should also be independent of subsequent returns [see McDonald
and Fisher (1972) and Ibbotson (1975)]. Moreover, the weak-form of the EMH
suggests that it is not possible to establish profitable trading rules based on the prior
performance of a share.
For example, if a new issue performs well initially, there is no reason to
believe that its subsequent performance will be superior or inferior. If such
predictions were possible, profitable trading rules could be established thus
invalidating the EMH [see Ibbotson and Jaffe (1975), Block and Stanley (1980),
Ibbotson (1975), Logue (1973), McDonald and Fisher (1972), Neuberger and
Hammond (1974), and Fischer and Jordan (1991)].
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
88
In brief, the EMH suggests that underpricing in the IPOs is associated with
initial mispricing and that stock prices adjust to their true level in early trading to
remove this underpricing. As a consequence, high returns would not be attainable, on
a continuous basis, over the longer term. Eventually, this hypothesis is supported in
the present thesis.
2.2.5.4 The Impresario Hypothesis
Shiller (1990) presents an 'impresario' hypothesis in which he argues that the
market for IPOs is subject to fads and that IPOs are underpriced by investment
bankers (the impresarios) to create the appearance of excess demand. Sheller's
hypothesis predicts that companies with highest initial return, should have the lowest
subsequent returns. There is some evidence of this relation in Ritter (1991), [see
Section 2.2.2].
2.2.5.5 The Windows Opportunities Hypothesis
Ritter (1991) and Laughran and Ritter (1995) argue that the low long-run
returns on IPOs are consistent with issues taking advantage of 'windows of
opportunity' in which the market is willing to overpay for their equity. This
framework can be viewed as a dynamic version of Myer's (1984) financing
hierarchy, or pecking order framework. In the static financing hierarchy model,
external equity is always the last choice for financing. In the dynamic financing
hierarchy, or windows of opportunity, model, external equity is sometimes the first
choice for financing, because sometimes a firm can issue overvalued equity. The
windows opportunity framework predicts that this will be low long-run returns on
firms conducting IPOs and on firms conducting seasoned equity offerings.
2.2.5.6 The Speculative Bubble Hypothesis
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
89
This hypothesis suggests that there is a possibility of emerging ‘speculative
bubbles’ in the aftermarket because the market exaggerates the increase of prices in
order to compensate for the perceived level of initial underpricing in the IPOs. An
optimism may also emerge in response to an issue being oversubscribed prior to
trading so that investors unable to purchase the stock, at that time of issue, may
increase demand for the stock in aftermarket trading and add to the increase in the
stock price. At length, however, because the market efficiency causes investors’
expectations to be revised, so that stock prices adjust downwards to their ‘true’ level,
then, this ‘speculative bubble’ will burst.
Direct evidence supports the existence of such phenomenon in the U.S..
Aggarwal and Rivoli (1990) note that such bubbles burst between five and twelve
months following the initial offering. More importantly, investors buying stocks after
the reaction to the initial underpricing are likely to experience negative returns as
investors revise the stock price downwards as progress is made through the
aftermarket in the IPOs.
2.2.5.7 Seasoning Effect Hypothesis
The final explanation in our survey suggests that adjustment for initial
underpricing might be gradual and continues in the aftermarket leading to an increase
in stock prices over time. Reilly and Hatfield (1969) noted that the long-run increase
in stock price as being a gradual and continued adjustment for underpricing. Reilly
and Hatfield argued that this continuing price rise may also be consistent with a
gradual reduction in the shares’ perceived level of risk as they become seasoned.
However, a somewhat different interpretation might be that a gradual and continued
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
90
increase in stock price is related to an emerging of favourable information over the
aftermarket period in the stock.
2.3 SUMMARY
In this chapter, a substantial body of facts and information has been recorded
within the literature review concerning the price performance of the IPOs. These
facts and information were analysed in two sections. The first section focused on the
levels, measurement methods, time intervals and explanations reported in prior
studies for initial returns of IPOs. Then, the second section dealt with examining the
performance of IPOs over the long-run periods of trading.
In conclusion, one can point out that:
The poor-performance of IPOs in the long-run makes the new issues underpricing
phenomenon even more of a puzzle.
The questions of whether or not IPOs underperform in the long-run as well as
why issuers set their IPO price at a level that is lower on average than the market
price at the end of the first day have generated a large literature.
There is no specific model can provide a definitive explanation of the these
anomalies (i.e., short-run underpricing and long-run overpricing].
The evidence of long-run returns for IPO is less extensive (both temporally and
internationally) than evidence of underpricing.
Explanations for poor-abnormal returns in the aftermarket are relatively less
developed than those for initial returns.
Zakaria S.G.Hegazy: Egyptian Stock Market Efficiency: An Initial Public Offering
Perspective, Ph.D. thesis, Strathclyde University, U.K.
91
The evidence of underpricing and long-run performance of the IPOs have been
well documented in the developed stock markets, however, it is not the case for
developing capital markets.
The majority of the literature focuses on the private IPOs, whereas the
privatisation sales in the emerging markets get only a small consideration.
Therefore, due to the limited international evidence of long-run performance
by IPO, further analysis is warranted, especially in terms of the relationship between
initial and long run returns. Thus, the main objective of the following chapters is to
examine the price performance and capital market efficiency in the Egyptian stock
market with specific concentration on the privatisation sales over the period 1994-96.