What factors drive IPO aftermarket risk?

K. Gleason, James Johnston and J. Madura

Applied Financial Economics, 2008, vol. 18, issue 13, 1099-1110

Abstract: The prospectus of every initial public offering (IPO) provides a lengthy list of factors that exposes investors to risk when investing in an IPO. However, this list is not useful for distinguishing among IPOs for investors who plan to hold IPO shares in the aftermarket. We attempt to identify observable factors that determine the level of aftermarket risk following IPOs. We find that aftermarket risk is higher for firms that experienced a higher level of underpricing (an ex ante measure of risk) at the time of the IPO. Thus, underpricing not only reflects the uncertainty at the time of the offering, but also is a useful indicator of aftermarket risk. We also find that firms using more reputable investment bank underwriters exhibit a higher level of aftermarket risk, which is contrary to the results found by some studies that used underpricing at the time of the offering as a measure of risk. In addition, we find that aftermarket risk is higher for firms backed by venture capital. We attribute our unique findings to our focus on aftermarket risk rather than the perceived uncertainty at the time of the IPO. We also find that aftermarket risk is higher for firms that are listed on the NASDAQ exchange, are in the technology sector, have lower levels of debt and go public during periods of high market volatility.

Date: 2008
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DOI: 10.1080/09603100701466062

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