Market Underreaction to Free Cash Flows from IPOs

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.     

Issuers’ incentives and tests of Baron’s model of IPO underpricing

This paper reexamines the validity of Baron’s (J Financ 37:955–976, 1982) model of IPO underpricing, in which IPO underpricing is caused by asymmetric information between issuers and investment bankers. Muscarella and Vetsuypens (J Financ Econ 24:125–135, 1989) find that lead-manager IPOs are significantly more underpriced than non-self-marketed IPOs and conclude that their empirical results do not support Baron’s model. We compare self-marketed underwriters’ IPOs with non-self-marketed underwriters’ IPOs and with IPOs they lead. Our empirical results show that it is premature to reject Baron’s model of IPO underpricing when we take issuer incentives into account.     

Ownership Structure and IPO Valuation—Evidence from Taiwan

We investigate the effect of ownership structure on initial public offering (IPO) valuation in the Taiwanese market, in which many large shareholders exert control through pyramidal structures and cross-shareholdings with voting rights that are in excess of cash flow rights. Our analysis indicates that outside shareholders incorporate the effect of potential expropriation by entrenched large shareholders in valuing an IPO, since a deviating voting-cash structure is negatively associated with the valuation metric at both the offer and initial secondary market prices relative to the corresponding intrinsic value. We also show that a deviating voting-cash structure correlates negatively with IPO underpricing.     

Cash Flow News and Stock Price Dynamics

We develop a new approach to modeling dynamics in cash flows extracted from daily firm-level dividend announcements. We decompose daily cash flow news into a persistent component, jumps, and temporary shocks. Empirically, we find that the persistent cash flow component is a highly significant predictor of future growth in dividends and consumption. Using a log-linearized present value model, we show that news about the persistent dividend growth component predicts stock returns consistent with asset pricing constraints implied by this model. News about the daily dividend growth process also helps explain concurrent return volatility and the probability of jumps in stock returns.     

Product market competition and the value of corporate cash: An agency theory explanation

In this paper, we document the effect of product market competition on cash value and provide evidence supporting the agency discount mechanism. Using the regulation-induced IPO suspensions in China as shocks to product market competition, we find that reduced competition threat, induced by competitors' IPO delay, decreases incumbent firms' value of cash reserve. The effect of IPO suspension on cash holding is more pronounced for companies with severe agency problems and loose governance mechanisms but not statistically different across high and low predation threats. Furthermore, we show that the marginal value of cash increases when IPO restarts, and our baseline results hold in both a large sample and a matched sample of firms. Our paper contributes to the literature by providing the plausibly causal effect of product market competition on cash value and an explanation from the perspective of competition's disciplinary role in mitigating managers' slack.     

Unit Ipos: The Who,When, And Why Of Warrant Amendment

Although unit initial public offering (IPO) firms reserve the right to amend the original terms of their warrants, only some choose to extend the exercise period, lower the exercise price, or both. We examine the extent of warrant amendment among unit IPOs and find that the decision to amend is related to the need for cash and is generally employed when share prices are closer to the original warrant exercise prices. Furthermore, extension is less likely when the firm is riskier, whereas higher levels of insider ownership significantly reduce the likelihood that a firm will lower the exercise price.     

Why Does the Law Matter? Investor Protection and Its Effects on Investment,Finance, and Growth

Investor protection is associated with greater investment sensitivity to q and lower investment sensitivity to cash flow. Finance plays a role in causing these effects; in countries with strong investor protection, external finance increases more strongly with q, and declines more strongly with cash flow. We further find that q and cash flow sensitivities are associated with ex post investment efficiency; investment predicts growth and profits more strongly in countries with greater q sensitivities and lower cash flow sensitivities. The paper's findings are broadly consistent with investor protection promoting accurate share prices, reducing financial constraints, and encouraging efficient investment.     

Wall of cash: The investment-cash flow sensitivity when capital becomes abundant

In the mid 2000s the oil and gas industry was hit by what might be best described as a ‘wall of cash’ as oil prices successively reached new record levels and access to external financing improved greatly. In this article we investigate what this sudden abundance of liquidity implied for the investment-cash flow relationship, the interpretation of which continues to generate controversy in the literature. For financially constrained firms we find that the investment-cash flow sensitivity decreases in the abundance period (2005–2008), suggesting that the financing constraints became less binding in this period. For financially unconstrained firms the investment-cash flow sensitivity instead increases over time, suggesting that this relationship is driven by agency problems related to free cash flow. Our paper is the first in the investment-cash flow literature to bring evidence from a natural experiment in which there was an unexpected, exogenous, substantial, and persistent decrease in the cost of external financing.     

The Enron Bankruptcy: When did the options market in Enron lose it’s smirk?

The Enron Corporation went from a $65 billion dollar market capitalization to bankruptcy in just 16 months. Using statistical techniques for extracting the implied probability distributions built into option prices, I examine the market’s expectation of Enron’s risk of collapse. I find that the options market remained far too optimistic about the stock until just weeks before their bankruptcy filing. I thank Oded Palmon and an anonymous referee for helpful comments. JEL Classification G13 · G14     

Do core and non-core cash flows from operations persist differentially in predicting future cash flows?

This study investigates the persistence of cash flow components (core and non-core cash flows) using a cash flow prediction model. By extending the Barth, Cram, and Nelson (Account Rev 76(January):27–58, 2001) model, we examine the role of cash flow components in predicting future cash flows beyond that of accrual components. We propose a cash flow prediction model that decomposes cash flows from operations into core and non-core cash flow components that parallel the presentation and format of operating income from the income statement. Consistent with the AICPA and financial analysts’ recommendations, and as predicted, we find that core and non-core cash flows defined in our paper are differentially persistent in predicting future cash flows; and these cash flow components enhance the in-sample predictive ability of cash flow prediction models. We also analyze the association of in-sample prediction errors with earnings, cash flow and accruals variability. We find that disaggregating cash flows improve in-sample prediction, especially for large firms with high cash flows and earnings variability.

The reputation effect of venture capital

The main purpose of this paper to examine how the reputation effect of venture capital (VC) is associated with the initial return and ex-post performance of its invested IPO firms. In this paper, we use 267 Taiwanese IPO firms in 1994–2007 periods and find that VC-backed firms outperform non-VC-backed firms in terms of ex-post equity market-to-book ratio, ROA and R&D expenditure ratio. For those VC-backed IPOs, reputable VC-backed firms outperform mediocre VC-backed ones. Moreover, among the four proxies of VC reputation, the market share with respect to total IPO proceeds is most promising in explaining IPO firms’ ex-post performance. The overall result confirms the reputation effect associated with VC.     

Underwriter Compensation Structure: Can It Really Bond Underwriters?

Underwriter compensation can be structured as all cash or a combination of cash and warrants. Using a sample of small initial public offerings (IPOs), we find that underwriter compensation contracts that include warrants in exchange for cash can serve as certification for IPO firms by substituting for reputation capital. When underwriters accept warrants when they could have received more cash compensation, the IPOs avoid the well documented long‐run underperformance. However, when underwriters receive warrants after maximizing cash compensation, the IPO experiences higher underpricing and poorer long‐run performance. The findings are consistent with a motivation by the underwriters to circumvent regulatory constraints.     

Can long-term performance plans mitigate the negative effects of stock consideration and high cash for acquirers?

Following Travlos (J Finance 42: 943–963, 1987), Loughran and Vijh (J Finance 52: 1765–1790, 1997), Harford (J Finance 54: 1969–1997, 1999), and Oler (Rev Acc Stud 13: 479–511, 2008), we investigate whether acquisitions involving stock consideration and acquirers with high cash levels are associated with poor performance or not. In addition, we investigate whether including a long-term performance plan in top management’s compensation package can mitigate these negative effects. We find that acquirers with a long-term performance plan are less likely to hold a high cash balance and are less likely to use stock consideration, thus avoiding scenarios that are more likely to be value-destructive. Even if an acquirer with a long-term performance plan carries a high cash balance or uses stock, we find that the plan is associated with improved fundamental performance; however, this relationship does not flow through to improved post-acquisition returns.     

Coincident correlations of growth and cash flow in banking

Prior empirical research indicates that loan growth in the banking industry is positively related to cash flow. I offer an alternative methodology that is better able to capture the effect of cash flow on loan growth while controlling for the potentially coincident effect of loan growth on cash flow. Using a sample of 171,389 observations on banks, 1986–2007, I find that causality runs more consistently from growth to cash flow than from cash flow to growth. This extends prior empirical research by Houston and James (1998) and Campello (2002) on cash flow sensitivities in the banking industry.     

Merger-Motivated IPOs

In this paper, we find support for initial public offerings (IPOs) motivated by subsequent acquisition activity. Over a third of newly public firms enter the market for corporate control as acquirers within three years of the IPO. We find that IPOs facilitate acquisitions in a number of ways. Newly public firms benefit from the cash raised in the IPO, from subsequent access to public financing, and from ability to pay with publicly traded stock for acquisitions. IPO firms also benefit by obtaining market feedback and by taking advantage of high post-IPO stock values in making stock-based acquisitions at favorable terms.     

The competitive effects of IPOs on industry rivals

I study the impact of initial public offerings (IPOs) on industry rival performance. Instrumenting for IPO completion with post-IPO filing NASDAQ returns, I find no impact of IPOs on average rival sales growth, return on sales (ROS), or Tobin’s q after 3 years. However, post-IPO rival performance varies with rival financial constraints. Relative to peers, rivals with low cash or high leverage exhibit lower sales growth, ROS, and q values, accompanied by lower capital expenditures and employment growth. I provide causal evidence of the competitive impact of IPOs and highlight the competitive cost of financial constraints following industry IPO activity.     

The option market’s anticipation of information content in earnings announcements

We exploit information in option prices in order to study whether the ex post responsiveness of stock prices to earnings information is reflected from an ex ante, firm- and quarter-specific perspective. Specifically, we develop a measure of anticipated information content (AIC) that isolates the forecasted magnitude of the stock market’s reaction to earnings information. We find that the AIC positively correlates with the ex post magnitude of the stock market sensitivity to unexpected earnings, increases with earnings persistence, firm growth prospects, the richness of firms’ information environments and the presence of (and changes in) sophisticated ownership, and decreases with discount rates. Our paper sheds light on the role that earnings information plays in shaping option-market behavior and offers researchers an option-market approach to studying the responsiveness of stock prices to earnings information.     

Market conditions,default risk and credit spreads

This study empirically examines the impact of the interaction between market and default risk on corporate credit spreads. Using credit default swap (CDS) spreads, we find that average credit spreads decrease in GDP growth rate, but increase in GDP growth volatility and jump risk in the equity market. At the market level, investor sentiment is the most important determinant of credit spreads. At the firm level, credit spreads generally rise with cash flow volatility and beta, with the effect of cash flow beta varying with market conditions. We identify implied volatility as the most significant determinant of default risk among firm-level characteristics. Overall, a major portion of individual credit spreads is accounted for by firm-level determinants of default risk, while macroeconomic variables are directly responsible for a lesser portion.     

Share repurchases of initial public offerings: motives,valuation effects,and the impact of market regulation

This study investigates the motives and valuation effects of share repurchase announcements of German firms during the 1998–2008 period, addressing the question why initial public offering (IPO) firms repurchase shares soon after going public. While our focus is on IPO firms, we also examine the impact of firm size by differentiating between IPO and established DAX/MDAX firms and by analyzing the source of surplus cash holdings, that is, either from equity issuances or from operating cash flows. We further explore the impact of the regulatory environment. Our empirical analysis reveals significant differences between the IPO and DAX/MDAX subsamples regarding their repurchase motives, stock price performance, and explanatory factors. Standard corporate payout theories are essential in explaining the different valuation effects. Our empirical analysis suggests agency costs of free cash flow as the main reason for the observed valuation effects of both IPO and DAX/MDAX firms, yet for different reasons. While DAX/MDAX firms continuously generate high operating cash flows before and after repurchasing shares, IPO firms exhibit low operating cash flows during the entire period but large surplus cash holdings due to the mandatory equity issuance at their public offering. Overall, the repurchase decisions of IPO firms are best explained by the agency costs of cash holdings and the unique rules and regulations of the German stock exchange.