Initial Public Offering (IPO) Research Paper

This sample Initial Public Offering (IPO) Research Paper is published for educational and informational purposes only. If you need help writing your assignment, please use our research paper writing service and buy a paper on any topic at affordable price. Also check our tips on how to write a research paper, see the lists of research paper topics, and browse research paper examples.

An initial public offering (IPO) is the first (“initial”) sale of equity to the public by a private company, usually through investment banks. The private company thereby becomes a public company (it “goes public”).

The purpose of an IPO is to raise a substantial amount of equity capital and create a public market for company shares to be traded on stock exchanges. The funds raised can be used to finance various projects, such as the expansion of manufacturing, marketing, and research and development (R&D) activities. If a company needs to raise a large sum that cannot be financed by private investors, such as venture capitalists or banks, then an IPO might be the best, albeit a costly, way to obtain the necessary funds (the pecking-order theory). The number of IPOs has fluctuated over time, but in some years, it has exceeded six hundred. According to Jay Ritter and Ivo Welch (2002), there were over six thousand IPOs during the 1980–2001 period, raising (in gross) $488 billion (in 2001 dollars). After the collapse of the bubble in 2000, the number of IPOs declined, but increased to 179 in 2004.

Once public, firms have direct access to the capital markets, enabling them to raise more capital by issuing additional stock in a secondary offering (a seasoned equity offering). Public companies can also more easily raise funds privately.

Some insiders participate in the IPO by selling part of their shareholdings to receive possibly a substantial amount of cash and to diversity their portfolios. This can also be an exit point for many venture capitalists. Insiders can also sell their shares at later dates to convert their equity into cash.

An IPO is an expensive way to finance in three aspects: (1) the fees and expenses; (2) the change in ownership structure; and (3) the disclosure requirements. The underwriting fees (underwriting discount or gross spread ) alone in the United States amounted to 7 percent of the gross proceeds for 90 percent of the IPOs in the late 1990s, although the figures are lower in other countries (Chen and Ritter 2000). By going public, the previous owners (e.g., founders and venture capitalists) sell a slice of their company to dilute their ownership stake, which may reduce their ability to control the enterprise.

Firms must supply detailed information to the potential investors at the time of the IPO (in the registration statement, including a preliminary prospectus—commonly called a red herring—and the final prospectus). This requires costly preparation of reports, as well as possible disclosure of strategic and sensitive information to competitors. Subsequently, firms operating in the United States are required as public companies to file quarterly and annual reports with the Securities and Exchange Commission (less frequently in some countries).

Most IPOs are offered to the public through an underwriting syndicate, consisting of a number of underwriters who agree to purchase the shares from the issuer to sell to investors (best effort or firm commitment). The lead underwriter usually sets the basic terms and structure of the offering, including the allocation of the shares and the offering price. Syndicate members do not necessarily receive equal allocations of securities for sale to their clients. Most underwriters target institutional or wealthy investors in IPO allocations, since they are able to buy large blocks of IPO shares, assume the financial risk, and hold the investment for the long term. Since “hot” IPOs are in high demand, underwriters usually offer those shares to their most valued clients.

IPO companies tend to be young and small companies that lack a long-established record of profitable operation. The median age (from the year of founding) of IPO firms is seven years (Ritter 2006). Roughly one-third of IPO firms reported losses in their IPO prospectuses before going public, although being profitable used to be standard (Ritter and Welch 2002). Ritter (2006) reports that 34.3 percent of IPOs are technology companies, of which 60.6 percent were backed by venture capitalists (compared to 39.9 percent of all IPO companies) for the 1980–2003 period. Therefore, investors purchasing stock in IPOs generally must be prepared to accept large risks for the possibility of large returns.

It is often observed that IPO shares open at a slightly higher price and close at a substantially higher price than the offering price at the end of the first of day of trading (providing a significant return to the IPO participants with the allocated shares). This phenomenon is referred to as IPO underpricing or leaving money on the table and is observed not only in the United States, but also in other countries. A price run-up on the first day occurs when the demand exceeds the supply (the IPO is “hot” or the offering is underpriced).

The first-day return averaged 18.8 percent (the average daily market return is 0.05 percent) during the two decades prior to 2001. It decreased with the collapse of the bubble, but is still substantial at 12.1 percent. Although the first-day return is typically positive, IPOs have in general underperformed in the long run both in terms of stock returns and financial accounting results. Ritter and Welch (2002) report that the average three-year buy-and-hold returns (from the closing price of the first day) of IPOs underperformed by 23.4 percent (compared to the CRSP [Center for Research in Security Prices] value-weighted market index) and by 5.1 percent (compared to seasoned companies with the same market capitalization and book-to-market ratio). Smaller firms (in terms of sales prior to an IPO) appear to do much worse. Underpricing and poor long-run performance do not appear to be related in a systematic manner, however. Why do firms leave so much money on the table? Why do so many IPOs underperform? These questions are important subjects of academic inquiry in finance.

The academic accounting literature documents that many IPO firms engage in earnings management through an aggressive use of (discretionary) accruals to inflate reported earnings around the time of the IPO. Long-run underperformance is more pronounced for firms with more aggressive discretionary accruals (Teoh et al. 1998). Some IPO firms in R&D-intensive industries reduce R&D expenditures below the optimal level to increase reported earnings (Darrough and Rangan 2005). These findings suggest that some managers try and sometimes succeed to influence the perception of investors of IPO firms by manipulating accounting numbers.


  1. Chen, Hsuan-Chi, and Jay Ritter. 2000. The Seven Percent Solution. Journal of Finance 55 (3): 1105–1131.
  2. Darrough, Masako, and Srinivasan Rangan. 2005. Do Insiders Manipulate Earnings When They Sell Their Shares in Initial Public Offerings? Journal of Accounting Research 43 (1): 1–33.
  3. Ritter, Jay, and Ivo Welch. 2002. A Review of IPO Activity, Pricing, and Allocation. Journal of Finance 57 (4): 1795–1828.
  4. Ritter, Jay 2006. Some Factoids about the 2005 IPO Market. Working Paper.
  5. Teoh, Siew Hong, Ivo Welch, and T. J. Wong. 1998. Earnings Management and the Long-Run Market Performance of Initial Public Offerings. Journal of Finance 53 (6): 1935–1974.

See also:

Free research papers are not written to satisfy your specific instructions. You can use our professional writing services to buy a custom research paper on any topic and get your high quality paper at affordable price.


Always on-time


100% Confidentiality
Special offer! Get discount 10% for the first order. Promo code: cd1a428655