Peer firms’ earnings predictability and pricing efficiency – evidence from IPOs

We examine the effect of peer firms’ earnings predictability on initial public offering (IPO) underpricing by investigating whether peer firms’ financial characteristics affect IPO pricing and whether the information disseminated by the IPO firm changes product market competition. Analyzing 5,264 IPOs in the 1976–2012 period using data from multiple sources, we find that IPO firms whose peer firms have long-run earnings predictability tend to have lower underpricing compared to those with short-run earnings predictability. Our study makes three central contributions. First, it shows that investors do not consider IPO firms in isolation from their peer firms and that IPO underpricing is highly dependent on peer firms’ earnings characteristics. Second, it demonstrates that the market does not always consider earnings predictability to be a desirable attribute, which has practical implications for regulators and firms. Third, we find that product market competition from peer firms and managerial ability both affect IPO underpricing. These results suggest that investors might interpret short-run peer firms’ earnings predictability as evidence that a majority of the firms in the industry engage in myopic behaviors, while they might interpret long-run peer firms’ earnings predictability as a signal that the majority of firms in the industry have stable cash flows.