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In the often murky world of IPOs, a little glowing enthusiasm in the media can go a long way, new Academy study suggests

December 1, 2003

For more information, contact: Benjamin Haimowitz, HHaimowitz@aol.com

Press coverage has more impact than prospectus info on IPO prices and tends to inhibit underpricing as well, research finds

With initial public offerings increasing in frequency after a hiatus of several years, new research from the Academy of Management offers some surprising insights into the tricky IPO market.

A study in the current issue of the Academy of Management Journal suggests that, when it comes to finding IPO bargains, less may be more. The best bargains are more likely to be IPOs that get a small amount of all-favorable press coverage than those that receive a large amount of mostly favorable coverage.

The former group of stocks, according to the study, is more prone to be underpriced by investment banks; in other words, the stocks' price at the end of the first day of trading is higher relative to the initial offering price set by the banks. In general, the study finds, IPOs of companies that receive a lot of press coverage are less likely than those of more obscure companies to be underpriced.

"In the often murky world of IPOs, where little-known firms are liable to have their stocks underpriced, a little glowing enthusiasm in the media can go a long way," comments Timothy G. Pollock, of the University of Maryland, co-author of the study with Maryland colleague Violina P. Rindova.

Pollock and Rindova also find that IPO underpricing is likely to have effects well beyond a stock's first day of trading. It tends to increase the volume of post-IPO media coverage, which, in turn, is associated with superior price performance in the 60-day period following the initial day of trading.

The Academy of Management Journal study is based on data from IPOs marketed in 1992, a year chosen because the IPO market was neither overheated nor dormant. About 250 companies went public that year, compared to about 500 in 1999 and about 50 through mid-November 2003. The average level of underpricing during the study period, about 12 percent, was similar to that of the current IPO market. Some 225 companies form the sample for the research.

The study seeks to gauge the effect on IPOs of two aspects of media coverage -- 1) volume of coverage, determined by the number of articles on each firm in the Lexis-Nexis database during the 12 months prior to registering the IPO with the SEC; and 2) tenor of coverage, determined by a formula that takes into account favorable articles, unfavorable articles, and neutral articles.

The volume of articles per company ranged from zero to 56, with an average of slightly over two. The forumula used to determine tenor, which has been used in a number of media studies, gives scores ranging from 100 to minus-100, with even a small amount of coverage earning the maximum of 100 if it is all positive.

Thus, Callaway Golf' had a tenor of 100, with two positive articles and no negative or neutral ones. It also turned out to be one of the most underpriced stocks of the sample, offered by underwriters at $20 a share and rising to $32.38 by the end of the first day of trading, for a jump of about 62 percent.

In contrast, Starbucks, with a volume of 15 articles, had a lot more press coverage than Callaway, but the tenor of the articles was more mixed -- seven positive, one negative, and seven neutral. Starbucks also turned out to be underpriced but its rise for during the first day of trading was a more modest 26.5 percent.

In general, the study finds, "increasingly positive tenor has little or no impact up to a point, but after this 'tipping point' [it] affects underpricing at a positive, non-linear rate," -- in other words, at a sharply steeper rate.

In documenting the significant impact of media coverage on the IPO market, the new study in the Academy of Management Journal complements recent research that found little relationship between information disclosed in IPO prospectuses and the stocks' initial offering price. The new study concludes that "in a market such as the IPO market, with many sophisticated and skeptical buyers, it is media-provided, rather than company-provided, information that has the credibility and/or reach necessary to influence investor behaviors systematically."

In the research on prospectuses, presented at the 2003 annual meeting of the Academy of Management, Catherine Daily of Indiana University and colleagues investigated the relationship between the information provided in 213 IPO prospectuses and two variables -- 1) the offer price spread -- that is, the investment bank's preliminary estimate of the stock's price expressed as a range between a high and low value; and 2) the offer price, at which the investment bank sold stock to initial investors on the opening day of trading. Boiling the most frequently provided information down to 10 variables, the professors found that only one of the 10 (the proportion of outsiders on the board of the IPO firm) had a significant effect on the offer price spread and only two of the 10 (firm size and age) had a significant effect on the offer price.

Why the lack of relationship between information and price? Daily, who says the SEC should re-examine its filing requirements, notes that investment banks have frequently been criticized for pushing the offering price of IPOs down so that favored clients of the banks reap rich rewards when the stock rises to a more appropriate price. A plausible interpretation of the study's findings, she says, is that "low price trumps data."

What the new study in the Academy of Management Journal suggests is that media coverage tends to inhibit such underpricing. "The media," Pollock and Rindova write, "through their ability to expose investors to companies, can increase both the financial capital a firm captures from its IPO and the demand for its shares."

The Academy of Management Journal, a peer-reviewed publication now in its 46th year, is published every other month by the academy, the largest organization in the world devoted to management research. The academy's 2003 annual meeting drew 6,500 scholars and practitioners to Seattle for more than 1,000 sessions on a host of issues relating to corporate organization, the workplace, technology development, and other management-related subjects.

Media Coverage:
Reuters. Glare of publicity key in IPO success. (Sunday, December 07, 2003).
The Wall Street Journal. IPO price setters don't rely on the prospectus. (Monday, December 29, 2003).

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