Splines, Heat, and IPOs: Advances in the Measurement of Aggregate IPO Issuance and Performance

The objective of this chapter is to provide an update to the literature on initial public offering (IPO) performance and issuance focusing explicitly on the methodological approaches used to conduct these analyses and to develop a more general approach to evaluating aggregate IPO issuance and performance. Traditionally, empirical studies of IPO performance have been critically dependent on the general methodology that researchers use to adjust the individual IPO’s returns to account for market performance and the time horizon of the study; however, more recent studies have examined the patterns of returns that IPOs emit, in general, sometimes prior to performance adjustments. In the US market, for instance, changes in the regulatory regime as a result of the introduction of the JOB’s Act and events such as the financial collapse have led to a period of relatively benign issuance associated with IPOs. This has recently led to new questions about the true relationship between the volume of IPO issuance and performance. Historically, we have assumed that hot and cold market cycles affect performance; however, recently the methodology used to capture whether markets are indeed hot or cold has been questioned. In addition, there has been a renaissance of late as researchers critically examine the validity of research projects that claim to identify hot and cold markets or identify cyclicality in the performance of IPO. The research has evolved from a segmentation of a population of IPO returns into quartiles or terciles and referring to the segments of these populations hot and cold, to Markov two and three state regime-shifting models, to more recent applications of event specific and spline regression models; researchers have been working to uncover what actually causes the IPO markets to move and the cyclical nature of IPO performance and issuance seems to indicate that the current state of research on IPOs needs some restructuring and clarification. This chapter has important implications for financial markets participants, portfolio managers, investment bankers, regulatory bodies, and business owners. Furthermore, this review chapter can aid in the setting of benchmarks for the valuation of IPOs, help investors, business owners, and the managers of businesses to understand the relationship between IPO performance and issuance so that they are better positioned to make wise investment decisions when purchasing IPOs or when issuing their IPOs and enable researchers to think more critically about developing their models of IPO issuance and performance.