UNDERWRITER REPUTATION AND SHORT-RUN IPO RETURNS: A RE-EVALUATION FOR AN EMERGING MARKET

Nuray Guner, Department of Business Administration, Middle East Technical University, E-mail: nguner@ a!metu!edu!tr Zeynep On er, Department of Management, Bil"ent University, E-mail: #onder@ il"ent!edu!tr Se!a Dan"#$%&u R'$a e#, Department of Business Administration, Middle East Technical University, Email: se#a@ a!metu!edu!tr

A(#)ra*) This study examines the effect of underwriter reputation on the initial-day IPO returns in an emerging market. It uses both a traditional and an extended model given the characteristics of the IPO market under analysis. The results from the traditional model indicate that underwriter reputation does not affect the initial day IPO returns. However after controlling for factors that are important in determining the price of an IPO in an emerging market a complex relationship between underwriter reputation measures and IPO returns is documented. !esults in this paper indicate that it is not appropriate to extend the findings in the "# to other markets without taking into account the uni$ue characteristics of these markets.

The short- and long-run performances of $nitial %u lic &fferings '$%&s( have long een an issue of interest in the finance literature! %revious studies have sho)n that the $%&s of common stoc" yield positive short-run ra) returns and negative long-run mar"et-ad*usted returns '+oc", ,-./0 1og and +iding, ,-.20 Tinic, ,-.., 3inn and 4igham, ,-..0 +itter, ,--,0 5easey and 6hort, ,--70 8evis, ,--90 5un# and Aggar)al, ,--:0 8ee, Taylor and ;alter, ,--/a(! The positive short-run returns documented in the literature are interpreted as an evidence of underpricing in the offer price! <arter and Manaster ',--=( develop an e>uili rium model that e?plains the relationship et)een this underpricing and the prestige of the under)riter )ho rings the issue to the mar"et! According to their model, prestigious under)riters 'those )ith high reputation( are associated )ith lo)er amounts of $%& underpricing! 6ince the early ,-2=s, several studies have tested this argument y using different measures of under)riter reputation 'McDonald and 3isher, ,-270 Bloc" and 6tanley, ,-.=0 @eu erger and 8a<hapelle, ,-.90 Beatty and +itter, ,-./0 1ohnson and Miller, ,-..0 <arter and Manaster, ,--=0 Booth and <hua, ,--/0 @anda and Aun, ,--20 <arter, Dar" and 6ingh, ,--.(! All these studies conclude that, on average, short-run returns are less positive for those $%&s that are rought to the mar"et y more prestigious under)riters! $n this study, the o *ective is to e?amine the relationship et)een under)riter reputation and $%& performance in an emerging mar"et! 6imilar to results from developed mar"ets, several studies document positive a normal initial day $%& returns in emerging mar"ets 'Da)son, ,-.20 Aggar)al, 8eal and 4ernande#, ,--90 8ee, Taylor and ;alter, ,--/ (! &n the other hand, several characteristics of emerging mar"ets might cause the relationship et)een under)riter reputation and $%& performance in these mar"ets to e different than the relationship o served in developed mar"ets '4arvey, ,--B(! $t is usually argued that the information asymmetry is severe and the informational efficiency is lo) in emerging mar"ets! As a result, it ta"es a long time for any information to e fully reflected in asset prices and it is more costly for investors to collect and process information in these mar"ets! 4ence, on one hand, under)riter reputation

can e very helpful for investors in solving their asymmetric information pro lems in such a mar"et! &n the other hand, the information asymmetry might e so severe that, unli"e the case in an informationally efficient mar"et, the under)riter reputation may not e sufficient to reduce this asymmetry et)een the firm going pu lic and investors in an inefficient mar"et! 3urthermore, it might e difficult for investors to assess the reputation of the under)riter itself as a result of the severe information asymmetries! Therefore, even though prior research documents the significant negative impact of under)riter reputation on $%& performance in the U6 mar"et, it may not e plausi le to e?pect such a relationship to e?ist for $%&s in an emerging mar"et! As a result, it is difficult to determine a priori the impact of under)riter reputation on $%& performance in such a mar"et! This is an issue that needs to e e?amined empirically! This paper analy#es the relationship et)een under)riter reputation and $%& underpricing in the $stan ul 6toc" E?change '$6E(! Domestic and foreign investors ali"e )ho are investing in emerging mar"ets )ith characteristics similar to the $6E can enefit from the results of this paper! The sample consists of one hundred and eighteen $%&s that too" place during a period from 1anuary, ,--9 to 1une, ,---! The under)riter reputation is pro?ied y four measures developed using the num er and the dollar magnitude of si#e the offerings an under)riter conducts! ! A traditional model 'used in studies for the U6( and its modified version for an emerging mar"et are estimated to test the relationship et)een under)riter reputation and $%& underpricing! Civen the availa le data on under)riters in Tur"ey, it is not possi le to estimate all of the under)riter reputation measures used in the U6! Therefore, modified versions of the 1ohnson and Miller and the Megginson and ;eiss measures are calculated for the under)riters! Also, t)o ne) reputation measures are suggested given the characteristics of the $%& mar"et in Tur"ey! $n summary, four different reputation measures are calculated for the under)riters! ;hen the traditional model is estimated for the $%&s in Tur"ey 'Ta le $(, no relationship et)een initial day $%& returns and the under)riter reputation is documented regardless of )hich reputation measure is used! The only varia le that e?plains the initial day $%& returns is the ,B-day return on the mar"et inde? efore the first day of trading 'institutional lag varia le(! The relationship et)een initial day $%& returns and this institutional lag varia le is positive! This result implies that if the mar"et increases et)een the $%& date and the first day of trading, the initial day $%& returns )ill e positive as )ell! The traditional model is e?tended to account for the uni>ue characteristics of the $%& mar"et in Tur"ey 'Ta le $$(! T)o reputation measures that account for different aspects of under)riter reputation are included and four more control varia les are added to the models! The first reputation measure assumes that t)o under)riters )ith the highest num er of $%&s lead or co-lead are prestigious and the rest are not! This varia le measures the visi ility of an under)riter in the $%& mar"et! The second reputation varia le in the regression is a pro?y for the volume of $%& usiness 'either in dollar amount or in num er( lead or co-lead y an under)riter! $n this e?tended model, a negative relationship et)een the initial day $%& returns and the visi ility measure is found! This finding indicates that since these under)riters are )ell "no)n y the investors, they underprice to a lesser degree! &n the other hand, the relationship et)een the volume of $%&s and the initial day $%& returns is positive! The more $%&s an under)riter handles, the harder it )ould e to sell the shares! Therefore, these under)riters have to underprice to a higher degree! These results suggest that in contrast to the evidence for the U6 $%&s, the relationship et)een initial day $%& returns and under)riter reputation is rather comple? in the $6E! $n addition to the institutional lag varia le, t)o more control varia les have a statistically significant impact on $%& underpricing! These varia les are the age of the firm and a dummy varia le for relatedness of the $%& firm and the under)riter! The age has a positive and statistically significant coefficient in these regressions indicating that older firms )ill e underpriced to a higher degree! This conflicting finding could e a result of the opa>ue o)nership structure in Tur"ey! The related varia le has positive and statistically significant coefficient as )ell, implying that those $%&s rought to the mar"et y under)riters o)ned y the same parent company as the issuing firm )ill e underpriced to a higher degree! This finding indicates that the

asymmetric information et)een investors and $%& firms is the main determinant of the level of underpricing in Tur"ey! ;hen the under)riter is not related to the $%& firm, the investors have a greater confidence in the certification of the $%& price provided y the independent under)riter! As a result, under)riters that are not o)ned y the same parent company as the issuing firm do not have to underprice as much as the non-related under)riters! &n the other hand, )hen the under)riter and the $%& firm are o)ned y the same parent company, the price certification provided y this under)riter does not have as much value as that provided y an independent under)riter for the investors! Therefore, in this case, investors re>uire a higher discount to participate in these $%&s! The findings of this paper indicate that evidence on under)riter reputation and initial day $%& returns documented in the U6 cannot e e?tended to emerging mar"ets )ithout any modification! The results here can e e?tended to other emerging mar"ets )ith similar characteristics as the $6E! 6ince the participation of international investors in the $%&s of emerging mar"ets is >uite common, the findings of this paper have some investment implications for international investors! REFEREN+ES Aggar)al, +!0 8eal, +! and 4ernande#, 8! DThe After Mar"et %erformance of $nitial %u lic &fferings in 8atin America!D %inancial &anagement, ,--9, 77, pp!:7-B9! Aydogan, 5! and Muradoglu, C! DDo Mar"ets 8earn from E?perienceE %rice +eactions to 6toc" Dividends in the Tur"ish Mar"et!D 'pplied %inancial (conomics, ,--., ., pp! :,-/=! Bala an, E! and 5unter, 5! D3inancial Mar"et Efficiency in A Developing <ountry: The Tur"ish <ase!D Unpu lished manuscript, ,--., +esearch Department, The <entral Ban" of the +epu lic of Tur"ey! Beatty, +!and +itter, 1! D$nvestment Ban"ing, +eputation and Underpricing of $nitial %u lic &fferings!D )ournal of %inancial (conomics, ,-./, ,B, pp! 7,9-797! Bloc", 6!and 6tanley, M! DThe 3inancial <haracteristics and %rice Movement %atterns of <ompanies Approaching the Unseasoned 6ecurities Mar"et in the 8ate ,-2=s!D %inancial &anagement, ,-.=, -':(, pp! 9=-9/! Booth, 1!+! and <hua, 8! D&)nership Dispersion, <ostly $nformation, and $%& Underpricing!D )ournal of %inancial (conomics, ,--/, :,, pp! 7=,-9,=! <arter, +!B!0 Dar", 3!4! and 6ingh, A!5! DUnder)riter +eputation, $nitial +eturns and 8ong +un %erformance of $%& 6toc"s!D The )ournal of %inance, March ,--., B9',(, pp! 7.B-9,,! <arter, +!B! and Manaster, 6! D$nitial %u lic &fferings and Under)riter +eputation!D The )ournal of %inance, 6eptem er ,--=, :B ':(, pp! ,=:B-,=/.! Da)son, M! 6! D6econdary 6toc" Mar"et %erformance of $nitial %u lic &ffers, 4ong 5ong, 6ingapore, and Malaysia: ,-2.-,-.:!D )ournal of *usiness %inance and 'ccounting ,-.2, ,:, pp! /B-2/! 3inn, 3! 1! and 4igham, +! DThe %erformance of Unseasoned @e) E>uity $ssues-cum-stoc" E?change 8istings in Australia!D )ournal of *anking and %inance, ,-.., ,7, pp! 999-9B,! Crin latt, M!, and 4)ang, <! D6ignaling and the %ricing of @e) $ssues!D The )ournal of %inance 1une ,-.-, ::'7(, pp! 9-9-:7=! 4arvey, <! +! D%redicta le +is" and +eturns in Emerging Mar"ets!D The !eview of %inancial #tudies, 3all

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Ta(&e I Re%re##"$n - Tra ")"$na& M$ e& This ta le reports the regression estimates of initial $%& returns on four different reputation measures and five control varia les! The regression model is a linear specification of the follo)ing e>uation: IPO return I f '+eputation, Age of $ssuing firm, $nsider shares, &ffer si#e, +is", Mar"et %erformance( $%& return is the simple one-day return calculated from the offer price and the closing price on the first trading day of the $%& shares +eputation is one of the four reputation measures used in the study! +E%, is the Megginson and ;eiss 'M;( measure )here reputation is measured as the ratio of the total dollar amount of $%&s rought to the mar"et y the lead under)riter of a given $%& to the total dollar amount of all $%&s in the sample! +E%7 is calculated y ta"ing the ratio of the num er of $%&s under)ritten y an under)riter to the total num er of $%&s during the sample period! +E%9 is a :-scale measure and it classifies under)riters into four groups ased on their +E%, measure! +E%: is a 7-level scale measure! $t ta"es a value of , if the under)riter is one of the first t)o under)riters )ith the highest +E%7 score in the sample and a value of = for the rest! Age of the issuing firm is the num er of years the issuing firm has een in operation et)een its inception and 1une 9=, ,---! $nsider shares is the percentage of the $%& issue that is offered from the holdings of the shareholders! +is" is the standard deviation of $%& returns over a 7=-day period starting from the second day of trading! &ffer si#e is the si#e of the $%& issue in millions of dollars! Mar"et performance is the ,B-day return on the mar"et inde? prior to the first trading day of the $%& shares!

Ta(&e II Re%re##"$n - E,)en e M$ e& This ta le reports the regression estimates of initial $%& returns on four different reputation measures and five control varia les! The regression model is a linear specification of the follo)ing e>uation: IPO return I f '+eputation, Age of $ssuing firm, $nsider shares, &ffer si#e, +is", Mar"et %erformance, Ban", +elated, 6ales method, +e>uirement( $%& return is the simple one-day return calculated from the offer price and the closing price on the first trading day of the $%& shares +eputation is one of the four reputation measures used in the study! +E%, is the Megginson and ;eiss 'M;( measure )here reputation is measured as the ratio of the total dollar amount of $%&s rought to the mar"et y the lead under)riter of a given $%& to the total dollar amount of all $%&s in the sample! +E%7 is calculated y ta"ing the ratio of the num er of $%&s under)ritten y an under)riter to the total num er of $%&s during the sample period! +E%9 is a :-scale measure and it classifies under)riters into four groups ased on their +E%, measure! +E%: is a 7-level scale measure! $t ta"es a value of , if the under)riter is one of the first t)o under)riters )ith the highest +E%7 score in the sample and a value of = for the rest! Age of the issuing firm is the num er of years the issuing firm has een in operation et)een its inception and 1une 9=, ,---! $nsider shares is the percentage of the $%& issue that is offered from the holdings of the shareholders! +is" is the standard deviation of $%& returns over a 7=-day period starting from the second day of trading! &ffer si#e is the si#e of the $%& issue in millions of dollars! Mar"et performance is the ,B-day return on the mar"et inde? prior to the first trading day of the $%& shares! Ban" is a dummy varia le that ta"es a value of , for an"s or an"-affiliated under)riters! +elated is a dummy varia le that ta"es a value of , if the issuing firm and the under)riter are o)ned y the same individuals or y the same parent company! 6ales method, is a dummy varia le that ta"es a value of one if the sales method in under)riting is a fi?ed price offer and #ero if the shares are either sold directly on the $stan ul 6toc" E?change or the oo"- uilding method is used! +e>uirement is a dummy varia le that ta"es a value of , if the issuing firm and the under)riter are o)ned y the same individuals or y the same parent company!