AH ANALYSiS OF THE FREE BEHAViOR 0F [NWAL WMON STOSK OFFERINGS Thesis for the Degree of Ph. D, MICHIGAN STATE UNWERSITY MES DEAN BLUM ’ 1971 'HEQ‘JE‘ This is to certify that the thesis entitled AN ANALYSIS OF THE PRICE BEHAVIOR OF INITIAL COMMON STOCK OFFERINGS presented by James Dean Blum has been accepted towards fulfillment of the requirements for Ph.D Finance degree in ' 44.) 11‘“th j Major professor Dat/ a/z-m 1, /g/‘? 7/ 0-7639 -- an 1'__~:‘- " - ‘| "'r LIB '{ARY Michi in State Un- F l "crsit Y r s ABSTRACT AN ANALYSIS OF THE PRICE BEHAVIOR OF INITIAL COMMON STOCK OFFERINGS BY James Dean Blum Purpose of Study Two objectives motivated the study of initial common stock offerings and their market price behavior. These two objectives were: first, to determine how initial common stock offerings have performed in the past, and second, to determine if capital market institutions have been able or willing to bring initial offerings to the market in equilibrium with the over-the-counter market. In order to evaluate these two questions accurately the fact that initial offerings are not exactly homogeneous needed to be taken into account. The three basic types of initial offering distributions are: primary, secondary and mixture. Thus, initial offerings were stratified according to who received the proceeds from the sale of the offering, the company and/or selling stockholders. Another aspect of this study has been to determine if variations in market rates of return on the various types of initial offering distributions could be explained by James Dean Blum differentials in risk. Methodology The total period covered by the study extended from January 19, 1965 (when the first initial offering was selected) to June 30, 1970 (a year after the last initial offering was selected). A random sample of 400 initial common stock offerings was drawn. The market returns and risks associated with these 400 issues were calculated for sixteen time periods, ranging from one week to one year after the offering date. A performance relative index was develOped to determine whether initial offerings' market price movements paralleled the performance of the Over-the-Counter Indus- trial Average. The 400 initial offerings were stratified into four subsamples according to who received the proceeds from the sale of the offering. Initial mixture offerings were subdivided into mainly primary and mainly secondary, based on who received the majority of the proceeds, the company or selling stockholders. The other two types of distri- butions were initial primary and secondary offerings. The market returns and risks of these four stratified groups James Dean Blum were compared to ascertain if variations in return existed and the extent to which such variations in return could be explained by differentials in risk. Findings The major findings of this study were: (1) Initial common stock offerings have shown higher than normal market rates of return. The mean market rates of return oninitial offerings ranged from a low of 32.43 per cent within the first week after the offering date to a high of 64.33 per cent nine months after the offering date. (2) Initial common stock offerings' market price performance has been in disequilibrium with the performance of the Over-the-Counter Average. The market rate of return on initial offerings, even after a risk adjustment for the shifting of capital from seasoned to unseasoned securities, showed superior performance in relation to the OTC Average in both the short and long run. (3) Initial primary common stock offerings have proved to be a better investment than initial mainly pri- mary, mainly secondary, and secondary offerings. They have both a higher market rate of return and have had less risk -- of decl In othe initial differe that in pushed ' they he warrant floated per cen cent 0% per cer initial distrik \ James Dean Blum risk -- as measured by relative variability and probability of decline —— than the other three types of distributions. In other words, the variations in return between types of initial offering distributions could not be eXplained by differentials in risk. This finding strongly indicates that investment bankers have either underpriced and/or pushed in the after—market those initial offerings in which they held greatest financial interest. Underwriters held warrants in 78.1 per cent of the initial primary offerings floated in 1968, whereas they held warrants in only 45.0 per cent of the initial mainly primary offerings, 30.8 per cent of the initial mainly secondary offerings, and 16.7 per cent of the secondary offerings floated in 1968. The mean market rates of return on the sample of initial offerings and the various types of initial offering distributions were as follows: Mean Percentage Rates of Return All Mainly Mainly Time Offerings Primary Primary Secondary Secondary One Week 32.4 46.1 25.7 18.6 15.5 Six Weeks 40.8 58.3 32.4 21.9 20.4 Three Months 54.7 78.6 46.3 24.0 26.2 One Year 59.5 77.2 68.6 15.1 36.2 the in‘ Little date. possib This 8: initia buying demons equiti James Dean Blum Contributions of the Study This research effort should help to fill a gap in the investment literature on initial common stock offerings. Little research has been done on this group of offerings to date. Secondly, it provides a guide to risk and return possibilities encountered in initial offering investing. This examination may aid investors interested in the initial offerings' market determine Optimal strategies of buying and selling such offerings. It could also serve to demonstrate to the securities authorities that many in- equities have existed in the initial offerings' market. AN ANALYSIS OF THE PRICE BEHAVIOR OF INITIAL COMMON STOCK OFFERINGS BY James Dean Blum A THESIS Submitted to Michigan State university in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Financial Administration 1971 AI"; / if? "1 ,f ‘ I! . I. i, j t/ (i ©Copyright by JAMES DEAN BLUM 197]. ACKNOWLEDGMENTS Throughout my period of study at Michigan State University I received invaluable academic and personal sup— port from a host of faculty members. Any list of acknowl- edgments excludes many of those who contributed their efforts in my quest for the degree, but their assistance was vital and I appreciated it very much. To Professor Alan E. Grunewald who supervised this dissertation go my very sincere thanks. His suggestions sparked much of the analysis, and his criticisms and com— ments on my various attempts added greatly to the study. I am indebted to Professor R. Hayden Howard for his aid in working out the fine details and careful editing of the study. I would, also, like to thank Professor Eli P. Cox for his impartial comments and criticisms which contributed greatly to the study. My parents played major roles in the program, the sc0pe of which cannot be described, but without would have made the attainment of my degree impossible. Their patience, understanding, and good humor made the tomorrow possible even during the most difficult days, and there were a few of them along the way. ii Finally, to my wife, Mary, whose patience, under- standing, and love made it possible for me to successfully complete my dissertation. iii TABLE OF CONTENTS ACMOWLEDMNTS O O O O O O O O O O O O O O O O O 0 LIST OF TABLES O O O O O O O O O C O O O O O O O 0 Chapter 1. 2. INTRODUCTION . . . . . . . . . . . . . . . Purpose of Study . . . . . . . . . . . . Characteristics of the New Common Stock Offerings Market. . . . . . . . . Review of Initial Offering Terminology . New Common Stock Offering Initial Common Stock Offering Seasoned Common Stock Offering Unseasoned Common Stock Offering Primary Stock Offering Secondary Stock Offering Mixture Stock Offering Mainly Primary Stock Offering Mainly Secondary Stock Offering Red Herring Prospectus Effective Date Underwriter Underwriting Syndicate Selling Group Risk Premium Rate of Return ROLE OF CAPITAL MARKETS. . . . . . . . . . Capital Markets and Investment Spending. Efficiency of Capital Markets. . . . . . Role of the Investment Banker. . . . . . Factors Influencing Initial Offering Pricing . . . . . . . . . . . . . . . . BACKGROUND AND REVIEW OF LITERATURE. . . . RESEARCH DESIGN. 0 O O C O O O O C C O O . iv Page ii H 17 23 37 Chapter Methodology. . . . . . . . . . . . . Procedural Steps . . . . . . . . . . 3. ANALYSIS OF RESULTS. . . . . . . . . . Return and Risk of Initial Offerings Short Run . . . . . . . . . . . . . Return and Risk of Initial Offerings Long Run . . . . . . . . . . . .'. Performance Relative Analysis. . . . Empirical Results Types of Distributions Analysis. . . Empirical Results Limiting Factors of the Study. . . . 4. SUMMARY AND CONTRIBUTIONS. . . . . . . Summary. . . . . . . . . . . . . . . Purpose of Study Findings, Implications, and Recommendations Contributions of the Study . . . . . APPENDICES O O O O O O O O O O O O O O O O O O BI BLIOGRAPIH C O C O O O O O O O O O O O O O O Page 37 39 51 52 56 58 66 77 80 80 84 85 102 LIST OF TABLES Table Page 1-1 Average Percentage Change in Price After Offering . . . . . . . . . . . . . . 34 3-1 Short Term Return of Initial Offerings and OTC Average 0 O O O O O O O O O I O O O 54 3-2 Short Term Risk of Initial Offerings and OTC Average. . . . . . . . . . . . . . 56 3-3 Long Term Return and Risk of Initial Common Stock Offerings . . . . . . . . . . 57 3-4 Long Term Return and Risk of the National Quotation Bureau Over-the-Counter Industrial Average . . . . . . . . . . . . 57 3—5 Mean Performance Relatives . . . . . . . . . 64 3-6 Mean Rate of Return —- Types of Distributions. . . . . . . . . . . . . . . 70 3-7 Coefficient of Variation -- Types of Distributions. . . . . . . . . . . . . . . 73 3-8 Probability of Decline -- Types of Distributions. . . . . . . . . . . . . . . 75 Appendix Tables A—l Total New Common Stock Offerings . . . . . . 85 A—2 Percentage of Warrants Held by Underwriters . . . . . . . . . . . . . . . 85 B-l-lO Initial Common Stock Offerings Sample. . . . 86 C-1 Types of Distribution - t-Tests of Equity Means . . . . . . . . . . . . . . . 96 D—l Types of Distributions - Z-Tests of Probability of Decline . . . . . . . . . . 97 E-1-4 Risk of Premium Rate of Return . . . . . . . 98 vi CHAPTER I INTRODUCTION Purpose of Study The purpose of this study is two-fold. The first objective is to determine how initial common stock offer- ings have performed. The second objective is to determine if capital market institutions have been able or willing to bring initial offerings to the market at their equilib- rium offering price. In order to answer or examine each of these questions the fact that initial offerings are not exactly homogeneous needs to be taken into account. It seems very important to stratify initial offerings accord- ing to who receives the proceeds from the sale of the offering, the company and/or selling stockholders. This point has been apparently overlodked by most investors and all researchers to date. Characteristics of the New Common Stock Offerings Market During recent years the growth of new common stock offerings has accelerated. In 1962 the dollar value of all new common stock offerings totaled $1,314 million. 1 2 By 1969 the dollar volume of new offerings had grown to over $7,714 million.1 A very important segment of new offerings has been initial common stock offerings from companies going public for the first time. Approximately 40 per cent of the new offerings in the past have been initial common stock offerings. DeSpite the fast rate of growth in initial common stock offerings, relatively little research has been done on their market price behavior. In fact, only one research study has dealt exclusively with initial common stock offerings, and it was for a relatively short time period.2 Of even more concern is the fact that the research studies completed on new offerings have generally covered relatively short time periods during bullish markets. During bullish market periods an enormous number of initial offerings are floated and generally are sold out prior to their effective date. Venture capital seems unlimited during a good market and almost nonexistent 1New common stock offering dollar figures were obtained from the Federal Reserve Bulletin. See Appendix A, Table A-1, for recent yearly dollar totals. 2The only short study dealing exclusively with initial offerings is: Frank K. Reilly and Kenneth Hatfield, "Investor Experience With New Stock Issues," Financial Analysts JOurnal, Sept.-Oct., 1969, pp. 73-80. 3 during a poor market. During poor market periods new offerings are almost impossible to sell to investors. Apparently, most investors have little or now knowledge of exactly what they are purchasing. It seems during a bullish market little consideration is given by the investor to the financial facts of the firm, such as, the firm's assets, earnings potential, use of the proceeds, who receives the proceeds from the sale of the offering, etc. The influencing factor is more apt to be whether or not the investor is able to obtain new offerings allocated by stock brokers to preferred customers. A study by David Clurman,l Assistant Attorney General of the State of New York, analyzing 103 new offerings floated in 1968-69 and 122 persons who bought new offerings during this period, concluded that in most cases the prospectus was not even used by the investor. In fact, the only knowledge the in- vestor had was that he was purchasing a new offering. Review of Initial Offering Terminology Much of the confusion in the new offering area lies in its terminology. A basic understanding of the terminology may be of extreme importance to the investor. 1David Clurman, A Report to the Honorable Louis J. l;efkowitz, Attorney General of the State of New York, Pursuant of Section 352 of the General Business Law on New Issues of Securities, September, 1969. 4 Below are several terms with which the reader will need to be familiar. New Common Stock Offering (New Offeringl: A new common stock offering is the sale of any common stock not presently being traded in the market. It may be new stock issued by the firm or insiders (selling stockholders)l selling a significant block of their holdings in the firm. This includes both initial offerings and seasoned common stock offerings. This category is the all inclusive one and includes all of the types defined below. Most research studies so far have dealt with this general classification of common stock issues. Initial Common Stock Offering (Initial Offering): An initial common stock offering is any equity financing by a firm or liquidation by selling stockholders of common stock that has never had a previous public market. The offering price is determined through negotiations between the company and/or selling stockholders and the underwriter. Seasoned Common Stock Offeripg: A seasoned common stock offering is common stock issued by a firm or selling stockholders whose previously outstanding shares were lSelling stockholders refers, in this study, to original owners, develOpers, etc. who have outstanding shares purchased or given to them for services rendered from the firm. These shares have never been traded in any market previously. publi but n capit comnm> stock is a the 0 ing i: 0f the iSag the o: holdei iSSuQ selli‘I StOck 99 pe 5 publicly traded, for example, AT & T selling authorized but not outstanding shares to the public to raise new capital. Unseasoned Common Stock Offering: An unseasoned common stock offering is another name for an initial common stock offering. Primary Stock Offering: A primary stock offering is a stock offering in which the proceeds from the sale of the offering go to the issuing company. Secondary Stock Offering: A secondary stock offer- ing is a stock offering in which the proceeds from the sale of the offering go to the selling stockholders. Mixture Stock Offering: A mixture stock offering is a stock offering in which the proceeds from the sale of the offering go to both the company and selling stock— holders. In other words, part of the shares sold are issued by the company and part of the shares sold are from selling stockholders. Mainly Primary Stock Offering: A mainly primary stock offering is a mixture stock offering in which 50 to 99 per cent of the proceeds go to the company. Mainly Secondary Stock Offering: A mainly second— ary stock offering is a mixture stock offering in which one to 49 per cent of the proceeds go to the company. ring i coming and dc is ser sellir also i securi panied which . ing. r COmmiss a block for the to inve the mar< securitl the pub] veStOr o fOrms of Spread. 6 Red Herring (Preliminary Prospectus): A red her- ring is a report which gives a description of a forth— coming security issue, but contains no underwriting data and does not constitute an offer to sell the security. It is sent out before the effective date. Prospectus: A prospectus is a report used as a selling document. It is the same as a red herring, but it also includes underwriting data and is an offer to sell the security. Any offer to sell a new offering must be accom- panied by a prospectus. Effective Date: The effective date is the date on which one may legally begin selling a new security offer- ing. This date is set by the Securities and Exchange Commission (SEC). Underwriter: An underwriter is anyone who purchases a block of securities from a firm or selling stockholders for the purpose of reselling the securities immediately to investors. The underwriter receives for his services the margin or spread between the price he pays for the security and the price at which the security is resold to the public. There are no brokerage commissions to the in- vestor on the purchase of new offerings. Other contingent forms of compensation are often used in addition to the spread. exists i to purc? underwr selling bution invests ing, t( and fi: of off securi initia SGCUr; ri3k ] to Sh 7 Underwriting Syndicate: An underwriting syndicate exists when two or more underwriters pool their resources to purchase a new offering. Sellinngroup: A selling group is a syndicate of underwriters and brdkers organized for the purpose of selling a security offering. It is formed to speed distri- bution and thus increase the turnover of the underwriter's invested capital, to obtain a wider market for the offer- ing, to spread the risk of completely selling the offering, and finally, to assure underwriters of receiving a variety of offerings to sell throughout the year. Risk Premium Rate of Return for an Unseasoned Security: The risk premium rate of return for an unseasoned security is the rate of return demanded by investors on initial offerings to compensate them for investing in a security that has not had a previous public market. This risk premium rate of return is needed to induce investors to shift investment capital from seasoned securities to unseasoned securities. 8 ROLE OF CAPITAL MARKETS Capital Markets and Investment Spending The primary function of capital markets is to make possible the transfer of funds from household, business, and government units with surpluses, i.e., excess of saving over invest- ment, to units with deficits, i.e., excess of investment over saving.l An economy grows by committing present economic goods to create additional capacity to produce and to im- prove technology. Decisions to invest today determine tomorrow's products and costs, which influence every facet of the economy. In a capitalistic economy, decisions to invest real capital goods are made largely by private individuals and business managers. Governments at all levels may attempt to encourage capital formation by means of tax incentives, subsidies, and low interest loans, but the initiative primarily lies with the entrepreneur. Through capital markets, entrepreneurs have poten- tial sources of funds to finance their projects. Also, through capital markets the Opportunity cost of funds, to users and investors alike, is established. This is accom- plished by providing investment alternatives to use as a 1James L. Duesenbury, "Criteria for Judging the Performance of Capital Markets," Elements of Investments, ed. H. K. Wu and A. J. zakon (New York: Holt, Rinehart and Winston, Inc., 1965), p. 1. 9 basis Of comparison for an investment under consideration. Entrepreneurs, through investment bankers, contract with investors and receive current funds in exchange for rights to future funds. The rate Which equates expected future funds flows with the certain outlay on the part Of the investor is known as the interest rate (or expected rate Of return on investment). At some expected rate, an investor is indifferent between holding cash and trans- ferring control Of his funds in exchange for expected future funds. When any doubt exists concerning either the size or timing Of future receipts, an investor must deter- mine his scale Of preferences between holding the right to a stream Of uncertain returns and a stream Of certain returns. The rate for a particular company (entrepreneur) is not established in isolation; but rather it is deter- mined relative to the Opportunity cost Of investing in similar risk situations. Thus, the rate Of return demanded by investors on new undertakings, for example, initial Offerings, is closely tied to the market rates of return on existing Opportunities, for example, seasoned securities. Efficiency Of Capital Markets Theoretically, capital market institutions attempt 10 tO bring together investors and users of capital in the most efficient manner possible. The performance Of the different portions Of the capital markets may be analyzed by two sets Of criteria. These are commonly referred to as Operational efficiency and allocational efficiency. Capital market institutions are meeting accepted standards of Operational efficiency if they perform their functions at a minimum cost. This study will not attempt to analyze Operational efficiency. The main concern of this study is whether capital markets have met accepted standards Of allocational effi- ciency. Allocational efficiency, which may be regarded as the most important economic service provided by the new issues markets, relates to the ability Of these markets to maintain equivalent rates of return or costs Of financing on comparable invest- ments. For the initial Offerings market, this would imply that for society's best interest tO be served, capital needs to be allocated to its best uses first. We assume that best uses are expected to yield the highest return per risk taken. The efficiency Of this allocation process can be assessed, at least in retrospect, by the 1Irwin Friend et a1, Investment Banking and the New Issuengarket (Cleveland: The World Publishing Com- pany, 1967), p. 7. 11 extent to which there are variations in return between different types Of new issues and espe— cially between new and comparable outstanding securities, and by the extent to which these variations can be explained by differentials in risk. Underwriting compensation may be re- garded as a cost paid to attain allocational efficiency.l Therefore, initial Offerings, or other investment Opportunities available tO investors supplying capital, should be available at prices consistent with existing investment Opportunities with respect tO risk and return. This means that capital market institutions should attempt to price initial Offerings such that their market price behavior parallels equivalent investment Opportunities. John R. S. Shad, senior vice president, E. F. Hutton & CO., Inc., in a speech sponsored by Corporate Seminars on October 3, 1968, made the following statements about initial Offerings: A new issue must compete with existing investment Opportunities in a free auction market. In order to assure a successful Offering and a favorable after-issue market, initial Offerings are priced at a modest discount from the current market prices of the most comparable securities which already enjoyed seasoned public markets. . . . This is not to say a new issue must go up, for security markets are of course subject to fluctu- ations, but if the financing was soundly conceived Ibid. 12 and executed, the stock will not go down more than comparable investment Opportunities.1 Mr. Shad makes two important points about the pricing of initial Offerings: (1) Initial Offerings should be priced at a modest discount from comparable securities, and (2) Initial Offerings should not go down more than comparable securities in the event of a general market decline. Mr. Shad seems to be making the point that initial Offer- ings' market performance should parallel the general mar- ket. For testing purposes, the securities Of the over-the- counter market are used as the investors' most comparable outstanding investment Opportunities. The over-the-counter securities are used because these securities are traded in the same manner as initial offerings, which are really a part of the over-the-counter market. Also, such attributes as asset size, age, market publicity and information, etc. Of firms Obtaining capital by an initial Offering would be more comparable to those firms whose shares are traded on the over-the-counter market than firms listed on any of the exchanges. If initial offerings are in equilibrium with 1John R. S. Shad, "Critical Considerations for Companies 'Going Public'," Commercial and Financial Chronicle, Vol. 208, NO. 6828, October 10, 1968, p. 23. 13 the rest of the over—the-counter market, the only justifi- cation for greater returns on initial Offerings to in- vestors would be that initial Offerings have more risk associated with them than seasoned over-the-counter secu- rities. The results in this study indicate that initial offerings have had, during the period studied, less risk associated with them than the Over-the-Counter (OTC) Aver- age. However, a risk premium rate Of return adjustment is made when comparing initial Offerings with the OTC Average. This risk premium adjustment is not made because initial Offerings have had more risk associated with them than the OTC Average, but rather may be needed to induce investors into shifting capital from seasoned to unseasoned securi- ties. Otherwise, there would be no inducement for in- vestors to exert the additional time and effort needed in examining and analyzing initial Offerings. Thus, if initial Offerings have had: (1) The same/or less investor risk associated with them than the OTC Average, and (2) The investor is compensated for shifting 1The reasons additional time and effort would be needed in analyzing initial Offerings, is because Of the lack Of availability of facts about the firm through the normal investment sources. Also, past price patterns (movements) are not available to the investor. capi then age the beta vari risk type ary, in r broug °fferj °f ini anCe O l4 capital from seasoned to unseasoned securities, then allocational efficiency exists if an only if the aver- age market rate Of return on initial Offerings is equal to the market rate Of return on the OTC Average. Finally, allocational efficiency is accomplished between the various types of initial Offerings only if variations in return can be explained by differentials in risk. Thus, any variations in return between the different type of initial Offering distributions (primary, second- ary, and mixture) should be explainable by differentials in risk. The Role Of the Investment Banker Investment bankers presumably can contribute most to this allocational function Of the capital markets by careful security analysis leading to apprOpriate pricing, and by seeing that the issue is well publicized, that all possible relevant information is deveIOped and disclosed, and that the issue is placed as much as possible in the hands of the ultimate investors. In order to do this, initial Offerings must be brought to the market at their equilibrium Offering price. lFriend et al, Op. cit., p. 8. 2Equilibrium Offering price is assumed to be the Offering price at which the after—market price performance of initial Offerings parallels the market price perform- ance of the over-the-counter market. This a re powe tior firm (cas dema: ing : supp] the 5 Press SS, L Price the de an ini Price, ings ar aVerage to indu l-lI'ISeasOI 15 This requires the investment banker to determine not only a realistic value Of a firm's assets and future earnings power, but also to anticipate the existing market condi- tions. The main service an underwriter provides for a firm (selling stockholders) seeking additional equity (cash) from the investing public is to shift the security's demand curve upward by spreading publicity about the issu- ing firm. If this is done properly an increase in the supply of the firm's shares will not immediately depress the stock's price. Figure l-A shows that if no shift upwards in the present demand curve, DD, occurs and the present supply, SS, is increased, the effect will be a reduction in the price from P0 to P1. The underwriter will attempt to shift the demand curve upward from DD to DD' and thereby allow an initial offering to enter the market at its equilibrium price, Pe‘ Thus, if underwriters properly price initial Offer- ings and stimulate demand correctly, initial offerings' average price movement (adjusted for a risk premium needed to induce the investor to shift capital from seasoned to unseasoned securities) should parallel the OTC Average's price movement. 16 FIGURE l-A THE EFFECTS ON EQUILIBRIUM PRICE OF AN INCREASE IN THE NUMBER OF SHARES OUTSTANDING Price per share Number Of shares outstanding Allocational efficiency between the various types of initial Offering distributions (primary, secondary, and mixture) is just as important as allocational efficiency between the over-the-counter market and initial Offerings. If the various types of distributions are brought to the market at their equilibrium price by the underwriter, any variations in return should be explainable by differentials in risk. The reason one can analyze underwriters' ability or willingness to perform their allocational function efficiently or inefficiently is they have great control 17 over the market performance Of unseasoned Offerings. First, underwriters determine the Offering price through negotia- tions with the company and/or selling stockholders. Secondly, since the general investing public has little knowledge and can Obtain only limited amounts Of knowledge from normal investment literature and sources, investors must rely mainly on the selling brOkerage house (under- writer) for information about the firm for the first year. Determination of the Offering price and major control over after—market publicity give the underwriter maximum control over initial offerings' market performance. Thus his ability or willingness to prOperly price and stimulate demand for all types Of initial Offerings can be analyzed in comparison to seasoned over-the-counter securities and between the different types Of initial Offering distri- butions. Factors Influencing Initial Offering Pricing A priori expectations are for a downward bias in the Offering price of initial common stock offerings. The main reason for this downward bias in the offering price is that the price is not determined entirely by a competi- tive market. For a company going public for the first time, the price is normally determined through negotiations 18 between the company and/or selling stockholders and an underwriter. Because the investigation costs are high, an underwriter will not analyze a firm's potential Offering unless he is the only underwriter negotiating for the Offering. Also, because only after a complete analysis of the firm can an underwriter determine the Offering price, the firm and/or selling stockholders must contract with an underwriter before the time an established Offering price has been set. Thus, the Offering price is not determined in a competitive market. Once an underwriter has agreed to underwrite an Offering, he then generally organizes a "selling group." The original underwriter, like the rest Of the selling group, then becomes the broker who sells the Offering to the investing public. Thus, an underwriter must satisfy both the company and/or selling stockholders and the in- vestors (clients) who purchase the Offering. The reasons an underwriter will have a downward bias in pricing initial Offerings are: (1) The risk and time Of Obtaining enough members in the selling group tO assure a successful Offering is minimized the more the Offering is undervalued. A success- ful Offering is one that sells quickly. Since an under- writer generally must borrow large amounts to purchase the l9 offering, the longer it takes to sell the Offering the more it costs the underwriter. Rapid turnover of borrowed capital is important to an underwriter's profitability. (2) The discount the original underwriter will have to give the selling group members is minimized the more the Offering is undervalued. (3) The risk Of having to support the stock's price in the after-market is minimized the more the Offer- ing is undervalued. (4) The underwriter assures himself Of being able to place future initial Offerings and Of being asked to participate in other underwriters' Offerings the more his Offering is undervalued. (5) If any part Of the underwriter's fees are in the form Of stock or warrants, a maximum return will accrue to the underwriter the more the Offering is undervalued.1 (6) Finally, as the underwriter becomes a part of the selling group (broker), the benefit Of an undervalued Offering really becomes apparent. The best way a broker or underwriter can make a satisfied customer is to recommend and sell him a security that increases in price. Satisfied 1A sample of initial Offerings in 1968 showed that in 51.9 per cent Of the cases underwriters had war- rants in the offering. See Appendix A, Table A-2, for warrants held by underwriters. 20 customers tend to purchase future initial Offerings and other securities. The only constraint to the underpricing of an initial Offering is the possible complaint by the issuing company and/or selling stockholders that could have received more capital from the offering. Such concern is minimized by the following: (1) The original owners (management) desire to run the business as they see fit and to be left alone by the new stockholders. New stockholders are generally satisfied with a purchase Of an Offering that rises in price and tend to leave the running Of the business to the original management. (2) The original owners, like the underwriters, Often receive stock Options or warrants at prices close to the Offering price. Given these Options or warrants, they likewise benefit directly from an Offering that rises sub— stantially in price. (3) Most corporations (selling stockholders) do not attempt to fulfill all of their planned capital (cash) needs in the initial offering. They will be able tO float a future stock Offering to satisfied stockholders and possibly an eager investing public if the initial Offering has had a good market appreciation record. 21 On the basis Of several strong arguments for under- writers undervaluing initial offerings and nO substantial constraints, it is hypothesized that the rate Of return on initial Offerings less a risk premium rate for never having had a previous public market is significantly greater than the rate Of return on the OTC Average. On an anpriori basis, expectations are that the investment worthiness (return per risk) of primary Offerings is greater than that of secondary and mixture Offerings. Mixture Offerings in this study are further subdivided into mainly primary and mainly secondary, according to who receives the majority of the proceeds. The reason one would expect primary Offerings to outperform secondary and mixture Offerings is the degree of financial involvement of the underwriter in the various types of distributions. The underwriter's fee is the dollar spread between the offering price and the price at which the underwriter purchases the security plus other forms Of contingent fees. The main type of contingent fee is the sale of warrants to the underwriter at a nominal price, generally a penny a warrant. In most cases the warrants are exercisable at or within ten per cent of the Offering price one year after the offering date and expire in three tO five years. A sample of 77 initial Offerings in 1968 showed that in writers fact t1 offeri: per ce warran ture O offeri cent O warran have p second are ab $611in¢ the of Second; the unc as hec‘ push ar will me \ results writers 22 that in approximately 52 per cent of the Offerings under- writers received warrants. More striking, however, is the fact that in 78 per cent of the cases involving primary Offerings underwriters Obtained warrants, while in only 17 per cent Of the secondary cases did underwriters receive warrants. The above relationship held true, also, for mix- ture Offerings. In 45 per cent of the mainly primary Offerings underwriters held warrants, while in only 31 per cent of the mainly secondary Offerings underwriters held warrants.1 Thus, it is more beneficial for underwriters to have primary offerings appreciate in market price than secondary and mixture Offerings. To the extent underwriters are able, through negotiating powers with the firm and/or selling stockholders, one would eXpect them to surpress the Offering price of primary Offerings in more cases than secondary or mixture Offerings. Also, in the after-market the underwriter is able tO publicize the Offering as much as he desires. It will be beneficial for underwriters to push an Offering in which they have warrants, whereas it will merely increase costs and therefore reduce their 1See Appendix A, Table A—2, for the 1968 sample results of the percentage of Offerings in Which under- writers held warrants. 23 profits to push an offering in which they have no contin— gent interest. All in all, it seems logical to assume that under- writers will be inclined tO suppress the Offering price and push in the after-market initial Offerings in which they have a contingent interest over ones in which their fee is fixed. Should this study show that initial primary Offer- ings significantly outperformed initial secondary and mix- ture Offerings, the underlying reason for this may be in the general method of compensating the underwriter. Con- tingent fees, such as warrants, may be a poor method of compensating underwriters. BACKGROUND AND REVIEW OF LITERATURE The initial common stock offerings' market has long been associated with speculation and left to the large, wealthy investor who has a good cushion to fall back on if he suffers market reversals. Yet, the general public in its desire to find roads to fast riches, as buyers, gobbled up millions of dollars worth of new common stock offerings in two eras, 1961 and 1968. As a recent Forbes' writer so colorfully put it: The great South Sea Bubble burst in 1720 and set the pattern for every financial orgy since. 24 Everyone with a few shillings wanted a piece Of the lucrative overseas markets Opening up for British investors. It was El Dorado, every man a lord. What started with a joint stock company to exploit a trading monOpoly escalated into madness.l The Securities Act of 1933 was enacted to compel disclosure Of the facts to investors. This Act relates primarily to the initial distribution, rather than to post distribution trading which is covered under the Securities Exchange Act of 1934. The Securities Act Of 1933 has two principal pur- poses. The first is tO make available full and fair dis- closure tO potential investors of essential information about new Offerings. The second is to protect the investor against fraud and misrepresentation. These Objectives are achieved by the requirement of a registration statement which must be filed with the Securities and Exchange Com— mission and a prospectus which must be distributed to investors. The Act sometimes referred to as "the-truth—in- securities act" does not take away from the citizen "his 2 inalienable right to make a fool Of himself." The l"Golden Eggs? Or Lemons?" Forbes, July 15. 1969' p. 24. 2Gerald J. Robinson, Going Public: Successful Securities Underwriting (Clark Boardman Company, 1962), p. 92. 25 Securities and Exchange Commission, Which oversees new Offerings, does not pass judgment as to the Offering's merit, but rather assures the investor of fair and full disclosure so that he is in the position to make a rational decision regarding an offering. Many financial and legal authorities believe the regulation of new Offerings does not go far enough to pro- tect the general investor. A study by David Clurman,l Assistant Attorney General of the State of New York, analyzing 103 new Offerings floated in 1968-1969 and 122 persons who bought initial Offerings in New York during this period concluded: (l) The traditional disclosure approach to the regulation of security Offerings is totally ineffective. In only a minority Of cases did investors state that the prospectus had any influence on their decisions. (2) The big winners were underwriters, insiders of the companies and those who had contacts with these groups. underwriters withheld part Of the shares for their own account and then resold when they thought the market had reached its peak. In 67 per cent of the issues analyzed, underwriters Obtained warrants generally at a lClurman, Op. cit. 26 price Of one cent each which may be exercised at or within 10 per cent of the original Offering price during a three to five year period beginning one year after the Offering. As for corporate insiders, they acquired large blocks of stock at nominal prices. The average dilution in bOOk value was 65 per cent from such purchases. Finally, 23 per cent of the insiders sold portions of their stock shortly after the issue's effective date. (3) BrOkerage memorandums were Often inconsistent with offering literature and the prospectus. Where the prospectus painted a picture of substantial risk, broker- age memos talked Of exchange listing for the issue. (4) The power to allocate meant the ability to make a gift to the favorite few. Allocation was generally on the basis of the investor's past transactions. (5) Finally, many constraints were placed on in- vestors of new Offerings. For example, they could not sell for two weeks, they had to purchase some of the issue in the after-market, and they had tO take less attractive, seasoned secondary issues. All such constraints were used to initially limit supply and increase demand. In summary, the study concludes that when initial offerings are highly attractive present laws do not pro— tect the general investing public. Manipulation by 27 underwriters and brokers can readily reduce the supply of the Offering. On the other hand, stimulation of demand through brokerage memorandums and tips may cause an already heated market to overheat. The effects of such manipula— tive practices Often lead to skyrocketing prices and eventual large losses to some investors who jump in at the last moment. TO the extent this study demonstrates initial offerings and/or the various types Of distributions of initial Offerings to be in disequilibrium with the over- the—counter market and each other, it may add support to Mr. Clurman's results and recommendations for stronger security laws. A large vacuum seems to exist in the investment literature concerning the performance Of initial common stock offerings. The quantity Of past articles on initial Offerings seems to have correlated quite well with their market activity. A rash of articles appeared in 1961 and 1962 explaining how well initial Offerings were doing. In the later part Of 1962 a variety Of articles appeared ex- plaining why the bubble had burst. NO research, in gen- eral, determined how initial Offerings performed during this period. It becomes quite evident from the literature that in 1961 and 1962 any equity financing that could Ill.' 1"} 28 legally be labeled and sold as a new Offering was highly successful. The market decline in 1962 ended the new Offerings fever Of 1961 and many investors in new Offerings were severely burned. In fact, it tOOk four years, 1962-1966, before the general investing public returned to the new Offerings market. The new Offering fever hit again in the later part of 1967 and the early part Of 1968. However, there are two main differences between the 1961 and 1968 periods. These are: (1) Regulation A securities predominated in the 1961 market, while in the 1968 market larger distributions were offered. (2) The 1968 era saw the so-called "go-go" and "hedge" funds gobble up new Offerings. These two differences were used by the financial world to explain how the 1968 new Offerings market was stronger than the 1961 new Offerings market. Larger and stronger firms were going public and a market stabilizer was built in because it was thought the funds would always take up the slack if there was a market down turn. History has a reputation of repeating itself. Consequently, new offerings' fever ended with the market 29 decline in 1969. Although there have been quite a few studies on how new Offerings have performed, the literature has been scanty as to how initial Offerings have performed. A few small scale studies have been conducted. Merrill, Lynch, Pierce, Fenner & Smith1 did a study on 1961-1962 "Regulation A" new Offerings and their price performance five years later. In a sample Of 99 Offerings from JUne 30, 1961, to June 30, 1962, the Offering prices were compared to their November, 1967, market price. Two-thirds of the Offerings showed latest quotation prices below their original Offering price. The average rate of return (not computed in the study) for five years in 170.9 per cent or approximately 35.5 per cent annually. In the study one new Offering's, Lum Corporation, market price appreciated by over 9000 per cent. Thus, even if all 66 new Offerings that had a decline in market price had completely failed, Lum Corporation alone would have given the sample a positive rate of return. The study tends to support the idea that a large diversified investor does all right, while the small investor assumes consid- erable risk when investing in new Offerings. It should be noted that the study was Of only small distributions and l"Sad Tale Of Many Small Offerings Of 1961-1962." Investor's Reader, November 15, 1967, pp. 14-17. 30 included both seasoned and unseasoned Offerings. Forbes1 periodically prints a list Of new Offerings and their market performances. A list of 52 new Offerings floated between January 1, and June 15, 1967, showed the following characteristics: (1) Forty Of the 52 new Offerings had a price appreciation over the Offering price by mid-June 1967. (2) Seventeen had achieved gains Of over 100 per cent, nine over 200 per cent, and four over 300 per cent by mid—June 1967. (3) Finally, the mean rate Of return Of the 52 new Offerings was 48.1 per cent by mid-June 1967. A list Of 107 new Offerings floated between Jan- uary l, and August 31, 1968, showed the following charac- teristics: (1) Ninety—eight out of the 107 new Offerings had a price appreciation over the Offering price by mid- September 1968. (2) Forty—three had gains Of over 100 per cent, 17 over 200 per cent, and ten over 300 per cent by mid- September 1968. (3) Finally, the mean rate Of return on the 107 l"Bull Market in New Issues," Forbes, September 15. 1968. PP. 53-55. 31 new offerings was 108.6 per cent by mid-September 1968. Although Forbes lists the new Offerings mainly to give its readers an idea Of how new Offerings are per- forming, the articles do get the pOint across that when the new Offerings market is "hot" new Offerings fever Opens the door to some fantastic investment Opportunities. The above two studies were Of abnormal times and do not take into account a long enough time period to draw any conclusions as to how investors in new Offerings have fared. Also, the studies included both seasoned and un- seasoned offerings. The first and only study to test fully how initial Offerings have performed in the past was carried out by Reilly and Hatfield.l They examined all the initial com- mon stock Offerings floated during two subperiods, December 1963 to August 1964 and January 1965 to June 1965. There were 53 initial Offerings floated during these two subperiods. The results of their study show that: (l) The number of initial Offerings that outper- formed the market, Dow JOnes Industrial Average (DJIA) or OTC Average, in the short run, first Friday after the offering and the fourth Friday after the Offering, was not '1Reilly and Hatfield, Op. cit. 32 significantly more than could be explained by random occurrence. (2) The investor's downside risk was slight, with substantial upside potential. The average loss, the mean loss on initial Offerings that did worse than the indexes compared to the indexes, was only 2.2 per cent: while the relative gain was 20.5 per cent. (3) The average rate of return on the initial Offerings by the first Friday after Offering was 9.9 per cent (DJIA, 0.3%), while the average rate of return by the fourth Friday after the Offering date was only 8.7 per cent. This tends tO indicate that the bulk Of the short run adjustment was accomplished almost immediately after the Offering. (4) The results in the long run, one year after Offering, showed initial Offerings with a 43.7 per cent gain, OTC Average 23.1 per cent, and the DJIA 6.8 per cent. One interesting note was that in none of the fifty-three cases was the OTC Average down, only four times was the DJIA down, while 16 of the initial Offerings declined from their Offering price. Assuming risk as the probability of decline, these results would indicate that there is greater risk involved in investing in initial Offerings than in investing in seasoned market securities. 33 (5) Comparing the 53 initial offerings to a ran- dom selection of 53 OTC stocks yielded the same results in the short and long run as when initial Offerings were com- pared tO the DJIA and the OTC Average. (6) Finally, a strategy of purchasing just the initial Offerings that gained relative to the market indexes on the fourth Friday after offering and selling them one year later proved to be the best investment strategy of all. An Obvious limitation of the Reilly and Hatfield study is that it only embraces two short subperiods Of time. Although these subperiods were not considered strong periods for initial Offerings, an interesting fact about the study is that initial Offerings had a higher rate of return than competitive forms Of investment. It seems that the strong bull market of 1964 and 1965 moved in and made initial Offerings far stronger as time moved along. This would account for the fantastic results that occurred in holding initial offerings for a year. A recent study by William R. Sloanl on Optimum pricing Of new Offerings gives the mean rate Of return on a sample Of 347 new Offerings floated in 1967 and 1968. 1William R. Sloane, "Growth Through New Stock, Optimum Pricing, and Equivalency Of Certain Valuation Models-Empirical Study," unpublished paper, Drake University, 1970. 34 The sample included only Offerings that had a positive earnings per share figure. The results shown in Mr. Sloane's study are given in Table 1-1. TABLE l-l AVERAGE PERCENTAGE CHANGE IN PRICE AFTER OFFERING Number of One One Six One Companies Week" Month Months Year No Previous Market 186 58.9 66.7 75.9 54.1 New York Exchange 25 15.3 18.6 18.4 21.7 Over-the- Counter 96 10.9 15.6 26.4 17.5 American Exchange 40 3.0 2.2 6.8 -7.3 Total 347 36.0 41.6 50.1 34.5 Although these results were only a by-product of Professor Sloane's study, they do point out the enormous returns initial Offerings showed as compared to seasoned security offerings. The major limitation of this data is its short time duration and the fact that it was done during an abnormally bullish market. Also, the Sloane sample included only 35 firms that had positive earnings per share. Finally, a study by Irwin Friend Of the price per- formance Of both seasoned and unseasoned common stock Offerings between 1958-1962 concluded: On the basis Of evidence presented in this Study, it appears that, with one notable exception,. both the average price experience Of and the overall rate of return on new stock issues in recent years were reasonably close to those of comparable outstanding issues. The exception was industrial primary issues. They performed poorly compared to the general market. Friend's study in— cluded both seasoned and unseasoned common stock offerings. His results cannot be used to reach a conclusion on whether unseasoned common stock Offerings (initial offerings as defined in this study) were in equilibrium with other capital markets in the late fifties and early sixties. It is the past confusion in initial common stock Offering performance that this study hOpes to resolve. Both Reilly and Hatfield's and Friend's study showed that new Offerings perform in a close parallel to the market. Forbes' and Sloane's data showed initial offerings to have superior results to other offerings. The major contribu- tion this study will make is to test whether or not the 1Irwin Friend, Investment Banking and the New Issues Market SummaryLVOlume (University of Pennsylvania, 1965). p. 78. 36 initial common stock offerings portion of the capital mar- kets has been in equilibrium with the over-the-counter market and the extent to which certain various types of initial offerings distributions have been in equilibrium with each other. CHAPTER 2 RESEARCH DESIGN Methodology Stated briefly, the methodology is concerned with analyzing: (1) The overall returns and risk associated with initial offerings, (2) The past relative market performance of initial offerings with that of the over-the-counter market, and (3) The past returns and risk (investment worthi- ness) associated with the three basic types of initial Offering's distributions. The first objective is to examine the past returns and risk associated with initial common stock offerings. The second Objective is to determine if the initial Offer- ings' market performance has paralleled the over-the- counter's market performance. It will be statistically determined whether the mean performance relative indexes of these securities differs from the population mean of 37 38 1.0 at some pre-determined degree of confidence.1 Since initial offerings are not exactly homogeneous, a third objective is to analyze the returns and risk of the various types of initial Offering's distributions. Initial offerings are stratified into four types of stock distribu— tions. These are: (1) Primary. (2) Mainly primary, (3) Mainly secondary (4) Secondary. The test will be to determine statistically whether the return per risk (investment worthiness) of each type differs significantly from one another at some pre-deter— mined degree of confidence. In other words, can variations in return between the various types of initial offering distributions be explained by differentials in risk? In the first objective the past market performance and risk of initial offerings will be presented to demon- strate how investors have fared. Given a significance level (a) equal to .05, the null hypothesis (HO) for the second objective is that the mean performance relative Of initial offerings and the 1The performance relative index is equal to the rate of return on an initial Offering (adjusted for a risk premium) for a certain time period divided by the OTC Average's rate of return for the same time period. If both the offering and the market are moving together the index should equal 1.0. 39 over-the-counter market will not differ significantly from the pOpulation mean of 1.0; in other words, the market rate of return on initial offerings after being adjusted for the risk premium rate of return (9) is the same as the market rate of return for the over-the-counter securities. The alternative hypothesis (H1) is that the mean performance relative does vary significantly from the pOpulation mean of 1.0. The null hypothesis (H6) for the third objective is that the mean returns of the four types of initial offerings do not differ from one another, and the coeffi- cients of variability (o/u), risk,1 of the four types of initial offerings do not differ from one another; in other words, the investment worthiness of all four types of initial offerings is the same. The alternative hypothe— sis (Hi) is that the four types of initial offerings do vary significantly in their respective investment worthiness. Procedural Steps The basic procedural steps in testing the null hypothesis (HO) and (H6) are shown below. lSince relative variability measures both upward and downward price movements and few investors are adverse to upward movements, a second measure of risk,the prob- ability of decline, will also be used. 40 Step 1. A random sample of 400 initial common stock offerings (Xi) is drawn. The sample covers the four and one-half year period from January 1, 1965, to JUne 30, 1969. The universe includes only those initial offerings listed in the Over—the—Counter Securities Review. Xi = (X1,X2,X3, ........... X400). Step 2. The offering price, offering date, number of shares floated, type of offering (primary, mainly pri- mary, mainly secondary, secondary), and the price/earnings ratio of the firms that had positive earnings for three years prior to their offering date are recorded for the 400 initial Offerings. Step 3. The National Quotation Bureau's Over-the- Counter Industrial Average (Nj) is recorded on the offering date of each of the above corresponding initial offerings. Nj = (N1,N2, ...N400) . Step 4. The price for each of the initial offer— ings and the corresponding N. Q. B. Over-the-Counter Indus- trial Average (OTC) is recorded on the following dates: a. The first Tuesday following the offering (t=l). b. The second Tuesday following the offering (t=2). 1Over-the-Counter Securities Review (published monthly by Review Publishing CO., Jenkintown, Pa.), January, 1965 — July, 1969. 41 c. The third Tuesday following the offering (t=3). m. Three months following the offering (t=13). n. Six months following the offering (t=14). 0. Nine months following the offering (t=15). p. One year following the Offering (t=l6). These price data were gathered from the Commercial and Financial Chronicle.l Step 5. The rate of return for each initial offer- ing (int) and the OTC Average (Rth) is computed for the sixteen time periods defined in Step 4. Step 6. The mean rate of return is computed for: a. Initial Offerings, - 400 = 400 2 R for t-1,..16. th 1/ i=1 Xit' b. OTC Average, 400 Z ’ = 1/400 RNi: j-l RN-t for t-1,....l6. J I Step 7. The price earnings ratio for the N. Q. B. OTC Average is computed in the following manner: 1In the first quarter of 1965, before the Thursday edition of the Chronicle began listing new offerings, these price data were gathered on Friday instead of Tuesday from the Monday edition of the Chronicle. 2See Appendix E for computation of the National Quotation Bureau Over-the-Counter price/earnings ratio. 42 a. By recording the yearly average price/earnings ratio for the 35 companies in the Average on January 1, 1969, as given by the Value Line Investment Survey for the years 1965, 1966, 1967, 1968, and 1969. b. By calculating the average price/earnings ratio of the 35 companies for each of the above years. This is simply the summation of the firm's individual price/earn- ings ratio for a given year divided by 35. c. Finally, by weighting each year's average price/ earnings ratio by the percentage of initial offerings floated in that particular year and totaling these to obtain an overall mean price/earnings for the Average that is equivalent in time to the price/earnings ratio of initial offerings. Step 8. The "risk premium rate of return" is calculated by the spread between the mean OTC Average's P/E ratio (PEN) as computed in Step 7 and the mean initial offerings' P/E ratio (PEI) for those initial offerings that have had a positive earnings figure for three years prior to the offering date.1 n PEI = 1/e 2 PE k=1 k 9 = (PEN- PEI)/PEI 1See Appendix E for computation of the "risk premium rate of return.” 43 where: n = the number of initial offerings with three years of positive earnings prior to the offering date. PEk = the price/earnings ratio of the kth initial offering. Step 9. The performance relative index (Pth) is' computed for all the 400 initial offerings for the sixteen time periods: rt ”‘10 + 9i0)/Nj0 where: r = i = j - 1,2,3,....400. XiO = The offering price of initial offering Xi' Njo = The OTC Average at the offering date of initial offering Xi. xit = The market price of initial offering Xi at time period t. th = The OTC Average at time period t. 9 The risk premium rate of return. Pth = The performance relative index of initial offering Xi. Step 10. The mean performance relative is calcu- lated for the sixteen time periods. 400 44 Step 11. The standard error of the pOpulation mean (O-— is estimated as follows: PRt) OPRt = s/20 where: s = the standard deviation of the mean performance relative. Step 12. The random sample of 400 initial offer— ings is stratified as follows: a. Primary offerings, XPa = (XP1,XP2,...XPe), where e = the number of primary offerings. b. Mainly primary offerings, XMP b= (mpl'mPZ'... XMPf), where f = the number of mainly primary offerings. c. Mainly secondary offerings, XMSC= (XMSl,XMSZ,.. XMSg), where g = the number of mainly secondary offerings. d. Secondary Offerings, XSd= (XSl,XSZ, ..... XSh), where h = the number of secondary offerings, e+f+g+h=400. Step 13. The mean rate of return for the sixteen time periods is computed for each of the stratified groups above: 45 ._ g c. = l/g Z RXMS RXMSt c=1 ct h - : 2'. th where RXP is the rate of return on the a primary a t offering at time t. Step 14. For each of the sixteen time periods the initial offerings' mean rate of return standard deviation is computed for each of the stratified samples as follows: e -— I a' Sfith = a§1'/RRXPat - Rxpt) /e s— f - 2/ _ R - R f Rxmpt — bgl ( xmpbt XMPt) . s— _ _" 2 c Rxmst ‘ cglv/ARXMSCt RXMSt) /g d. s— = h _ -' 2/ RXSt dElV/QRxsdt RXSt) h Step 15. The standard error of the pOpulation mean (ofi) is estimated for each of the four stratified groups as follows: a . O‘- — S— b. 0-— _ s.— RXMPt ' RXMPt / /?7 46 c. (LI-R3015 = s-fiXMSt / Go 8.... Rxst = Rxst / Jfi' Step 16. The coefficient of variation (VX) is calculated for the four stratified groups as follows: a. V = O— u b. v - a— XMP / t RXMPt “prt C O V = O— XMS t qust /“xmst' XSt RXSt XSt . Step 17. The probability of decline (P(X)) is calculated for each of the four stratified groups as follows: a. P(XP) = ut/e, b. P(XMP) = wt/f, C- P(XMS) = yt/g, d. P(XS) = zt/h, where u,w,y,z are equal to the number of primary, mainly primary, mainly secondary, and secondary offerings respectively that are below their price at time t. 47 Step 18. Given a pre-determined level of signifi- cance (a) equal to .05, the null hypothesis (H0) is: Ho: u PRt 5 1.0, where t=l,2, ..... 16. H1: H PRt > 1.0. If the difference between the population mean (1.0) and the sample mean (uPRt) is less than +1.64505ht, the performance of initial common stock offerings will be con- sidered to be equivalent to, or lower than, the performance of the over-the-counter market. If the difference between the pOpulation mean and the sample mean is greater than +1.645051%, the performance of the initial common stock offerings will be considered to be superior to the over-the- counter market's performance in the last four and one-half years. Thus, the two capital markets are in disequilibrium if the investment worthiness of initial Offerings is greater than that of the general over—the—counter market. Step 19. A two step approach is used to test the null hypotheses: H : H < H o x13t - XMPt , H < H- x1?t - xmst , u u x1>t .<. xs,c ' 48 VXPt > VXMSt or P(XP):> P(XMS), VXPt > szt or P(XP):> P(XS), MXPt > ”XMSt' “Xpt > ”xst' H1. VXPtSVXMPt or p(xp) 5 pump), prt g VXMSt or P(XP) g P(XMS) , vXPt SVXSt or p(xp) _<_ P(XS) . Step 19A. The relationship of the means in the first part is tested by the t-test. t = v 2 where s: + 32 Rxp Imp e f v— (827 (322 -2. e f I If tv is less than to, the null hypothesis is v accepted and when initial primary offerings' mean rate of return was greater than the mean rate of return of initial mainly primary, mainly secondary, or secondary offerings I this may have been due to chance. If tv is greater than th, V the null hypothesis is rejected and initial primary 49 offerings' mean rate of return is statistically greater than that of the mean rate of return on initial mainly pri- mary, mainly secondary, or secondary offerings. A rejec- tion of the null hypothesis in the first part does not lead to the conclusion that the investment worthiness of initial primary offerings has been greater than that of initial mainly primary, mainly secondary, or secondary offerings. The second part of the hypotheses must be tested and the null hypothesis rejected in order to draw any conclusions as to their superior investment worthiness. Step 19B. No statistical test that compares the coefficients of variation of two samples was found. Thus, it will be assumed that when the coefficient of variation Of primary offerings is equal to or less than the coeffi- cient of variation on initial mainly primary, mainly secondary, and secondary offerings, the null hypothesis will be rejected. That is, the risk of relative variability in initial primary offerings is equal or less than that of other types of distributions. If the coefficient of vari- ation of initial primary offerings is greater than the coefficient of variation for initial mainly primary, mainly secondary, or secondary offerings, then the null hypothesis will be accepted and the risk in primary offerings is shown to be greater than that in initial 50 mainly primary, mainly secondary, or secondary offerings. To measure the probability of decline, a Z-test will be used in those cases in which the percentage of initial pri- mary offerings that declined was greater than the percent— age of initial mainly primary, mainly secondary, or secondary offerings. Thus, if we are to conclude that initial primary offerings investment worthiness has been greater than other distributions, the mean rate of return must be sufficiently greater, while the coefficient of variation or probability of decline (risk) must be equal or less than the other distributions. The basic methodology has been concerned with the following three areas: analyzing the return and risk of initial common stock offerings, their performance relative to the performance of the over-the-counter market, and finally, the past return and risk associated with the dif- ferent types of distributions. CHAPTER 3 ANALYSIS OF RESULTS In the past four and one-half years initial common stock offerings have been in disequilibrium with the over- the—counter market. Also, initial primary offerings' in- vestment worthiness has been significantly greater than the investment worthiness of initial secondary and mixture offerings. Underwriters have failed to set a realistic offer- ing price on initial offerings in the period during this study. Underwriters either have: (1) Been unable to place a realistic value on a firm's assets and future earnings, or (2) Been unable to anticipate the strong overall market conditions and great investor acceptance of initial offerings, or (3) Abused their negotiating and/or after market publicity powers in such a manner as to reap enormous pro- fits on initial Offerings in which they held financial interest (warrants). 51 52 Judging from the performance of initial offerings shown in this study, it would be in society's best interest if some aspects of investment banking are changed. The problems lie probably in the method of determining the offering price and the method of compensating underwriters. Underwriters should be financially independent of the after- market price performance of initial offerings. Contingent fees result in a conflict of interest and should be dis- allowed. A solution to the present problem of determining the offering price may be to compensate an underwriter or some other independent person or firm for drawing up a red herring. Then underwriters bid on all or any portion of the offering in the same manner treasury bills are sold. Return and Risk of Initial Offerings -- Short Run A random sample of 400 initial common stock offer- ings1 was drawn from the universe of initial Offerings as 2 The reported in the Over-the-Counter Securities Review. total period covered by the study extended from January 19, 1965 (when the first initial Offering was selected) to 1See Appendix B for the complete list of companies in the sample. 2Over-the-Counter Securities Review, op. cit. 53 June 30, 1970 (a year after the last initial offering was selected). The short run was defined as from one week to three months; the long run was defined as from six months to one year after the offering date. The initial common stock offerings' mean rates of return varied from 32.43 per cent for one week to 54.65 per cent for three months after the offering date. The short run mean rates of return of all 400 initial offerings are presented in Table 3-1. The mean rates of return on initial offerings in- creased week by week from almost 33 per cent in the first week to over 50 per cent by three months after the offering date. Thus, the mean rates of return increased as the period of time they were outstanding increased. During this same period, on the other hand, the OTC Average's mean rates of return varied from 0.14 per cent for one week to 1.09 per cent for three months. The short run mean rates Of return are presented in Table 3-1. In the short run the mean rates of return on initial offerings significantly outperformed the mean rates of return on the OTC Average. Two measures of risk were used. These measures were coefficient of variation (a/u) and probability of decline (P(D)). The use of coefficient of variation as a 54 TABLE 3-1 SHORT TERM RETURN OF INITIAL OFFERINGS AND OTC AVERAGE Percentage Mean Rate of Return* Initial Offerings Over-the-Counter Time (Sample Size = 400) Average t “x “N One Week 32.43 0.14 Two weeks 35.78 0.27 Three Weeks 36.42 0.43 Four Weeks 38.20 0.50 Five Weeks 39.34 0.66 Six Weeks 40.80 0.77) Seven Weeks 42.88 0.88 Eight weeks 44.88 0.96 Nine Weeks 46.85 1.05 Ten weeks 49.01 1.03 Eleven Weeks 50.99 1.08 Twelve weeks 52.32 1.02 Three Months 54.65 1.09 *The mean rate of return is the percentage change in the market price of the sample from its offering price to its price at time periods one week, two weeks,... ..... three months. measurement of risk has its limitations. The rates are not annualized. Perhaps the most objectable feature of the coefficient Of variation is that investors are not interested in total relative dispersion of expected returns, but rather in the probability of cer- tain types of adverse returns. as a check of coef- ficient of variation probability of decline was used as a measure of risk. Market price decline is certainly some- thing all investors in initial offerings desire to avoid. 55 Both measures of risk showed that a portfolio of stock consisting of the OTC Average presented greater risk than a portfolio of initial offerings. The coefficients of variation and probabilities of decline for both initial offerings and the OTC Average are shown in Table 3-2. For initial offerings the coefficients of variation ranged from 0.00722 for one week to 0.0860 for three months after the offering date. On the other hand, the coefficients of variation for the OTC Average ranged from 0.9285 for the first week to 0.40367 for three months after the offering date. Thus, initial common stock offerings have had less risk associated with them than the OTC Average. When probability of decline was used as the measure of risk, similar results as above occur. In approximately 45 per cent of the cases the OTC Average was below its original starting level in the short run. While there was close to a 50 per cent chance that the OTC Average declined below its starting point, the percentage of initial offer- ings that declined below their offering priced varied from a low of 23.75 per cent within the first week to a high of 29.25 eight weeks after the offering date. Clearly, one can conclude that initial common stock offerings have been a better investment than the OTC Aver— age in the short run. Initial offerings have yielded 56 TABLE 3-2 SHORT TERM RISK OF INITIAL OFFERINGS AND OTC AVERAGE Coefficient Probability of Variation of Decline Time Initial OTC Initial OTC t Offerings Average Offerings Average °x/“x “N/“N P(X) P(N) One Week 0.0722 0.9286 0.2375 0.4375 Two Weeks 0.0715 0.6667 0.2750 0.4275 Three Weeks 0.0771 0.4884 0.2775 0.4375 Four Weeks 0.0784 0.4800 0.2850 0.4475 Five Weeks 0.0794 0.4091 0.2900 0.4400 Six Weeks 0.0796 0.3896 0.2950 0.4525 Seven Weeks 0.0782 0.3523 0.2850 0.4575 Eight Weeks 0.0794 0.3438 0.2925 0.4525 Nine Weeks 0.0793 0.3333 0.2750 0.4650 Ten Weeks 0.0813 0.3689 0.2800 0.4625 Eleven Weeks 0.0843 0.3889 0.2850 0.4550 Twelve weeks 0.0872 0.4216 0.2775 0.4775 Three Months 0.0853 0.4037 0.2800 0.4750 greater returns and have had less risk associated with them. Return and Risk of Initial Offerings --LLong Run In the long run (six months, nine months, and one year) similar conclusions to the short run results can be drawn. The initial offerings mean rates of return in the long run were 62.30, 64.33, and 59.48 per cent for six months, nine months, and one year respectively. The mean rates of return, standard deviations, coefficients of vari- ations, and probabilities of decline are presented in Table 323. 57 TABLE 3-3 LONG TERM RETURN AND RISK OF INITIAL COMMON STOCK OFFERINGS Percentage Coefficient Probability Time Mean Rate Standard of of t of Return Deviation Variation Decline “X 0x O'X/IJX P (X) Six Months 62.30 0.0536 0.0860 0.3175 Nine Months 64.33 0.0666 0.1035 0.3750 One Year 59.38 0.0794 0.1335 0.4175 The mean rates Of return on the OTC average, how— ever, for the long run were only 3.29, 6.83, and 6.08 per cent respectively. The mean rates of return, standard deviations, coefficients of variations, and probabilities of decline are presented in Table 3-4. TABLE 3-4 LONG TERM RETURN AND RISK OF THE NATIONAL QUOTATION BUREAU OVER-THE-COUNTER INDUSTRIAL AVERAGE Percentage Coefficient Probability Time Mean Rate Standard of of t of Return Deviation Variation Decline “N ON o'N/"N P (N) Six Months 3.29 0.0062 0.1884 0.4425 Nine Months 6.83 0.0071 0.1040 0.3975 One Year 6.08 0.0091 0.1497 0.4050 58 For both measures of risk, coefficient of variation and probability of decline, initial offerings in the long run had approximately the same/or less risk than the OTC Average. In the long run the coefficients of variation for the OTC Average were 0.1884, 0.1040, and 0.1497 (see Table 3-4), while for initial offerings they were 0.0860, 0.1038, and 0.1335 (see Table 3-3) for six months, nine months, and one year after the offering date respectively. The probabilities of decline for the OTC Average were 44.25, 39.75, and 40.50 per cent (see Table 3-4), while the probabilities of decline for initial offerings were 31.75, 37.75, and 41.75 per cent (see Table 3-3) for six months, nine months, and one year after the offering date respectively. Therefore, one can conclude that the mean rate of return on initial common stock offerings sig- nificantly outperformed the OTC Average and offered rela- tively the same/or less risk to the investor in the long run. Performance Relative Analysis 1 said that an investor evaluates the J. B. Williams future returns expected for each stock, then discounts these for time and risk to establish the highest price he lJOhn Burr Williams, The Theory of Investment Value (Amsterdam: North-Holland Publishing Company, 1938). 59 will pay for the security, and the number of shares he will buy at that price. Where prices are lower than this maxi- mum price, he may buy additional shares since the issue then offers to him, based on his expectations, risk evalu- ation, and the rates presently available in the market, a premium return. For a seasoned security all of the above is accomplished by a free auction market between many in- vestors, such that the marginal investor sets the security's price at any moment in time. However, for an unseasoned security (initial offering) this is not true. The offering price is determined through negotiations between an under- writer and the firm and/or selling stockholders. Theoreti- cally, the objective of the underwriter should be to evalu- ate the future returns and discount them at the going mar- ket rate of return for time and risk to establish the highest price at which the securities can be floated to the public. In order to test whether or not initial offerings have been prOperly priced a performance relative index was develOped. The index adjusted initial offerings for the additional risk to the investor who has no previous public market record for reference in analyzing past investor appraisal of a firm's value. The performance relative index is: 60 pp = Xit/th rt (x. + 8Xi0)/N 10 j0 or rewriting the performance relative index as: xit/(Xio + 9X10) Pth = ' th/NjO it becomes clearer that the performance relative index re- lates the change in price of an initial offering, adjusted for the risk premium rate of return, to the change in the OTC Average between the offering date and any other date, t. It is hypothesized that the market price perform- ance of initial offerings, adjusted for a risk premium, in the period between January 1, 1965, and June 30, 1970, has performed in a manner superior to that of the OTC Average. The OTC Average is assumed to represent the mean perform- ance of the pOpulation. The expectation is that the mean performance relative of initial offerings adjusted for a risk premium will be significantly greater than the pOpula— tion mean of 1.0. The risk premium rate of return is the discount underwriters provide to investors to induce them to shift investment capital from seasoned to unseasoned securities. The risk premium may be needed to compensate the investor for the additional time and effort he must exert in 61 analyzing an initial offering as an investment Opportunity. It is assumed that the risk premium given by under— writers in the past has been in the form of a lower price/ earnings ratio on initial offerings relative to the price/ earnings ratio on existing over-the-counter securities. The risk premium is calculated by the spread between the price/earnings ratio of initial Offerings and the OTC Average's price/earnings ratio for the same time period.2 The risk premium was calculated to be 13.2 per cent.3 1The reasons additional time and effort would be needed in analyzing initial offerings is because of the lack of availability of facts about the firm through the normal investment sources. An investor must either exert additional effort to obtain these facts or rely on the underwriter's recommendations and past record. Also, past price patterns (movements) are not available to the investor. 2In calculating the average price/earnings ratio on initial offerings, only offerings that had three con- secutive years of positive earnings were used. The price/ earnings ratio was calculated by dividing the offering price by the Offering's last years earnings per share. 3See Appendix E for the actual computation of the risk premium. In the past the risk premium may or may not have been correct. It might have been that a lower dis- count could have been used. This would mean that the mean performance relative indices were too low and the initial offerings performance relative to the OTC Average would have been greater than calculated in this study. On the other hand, one might argue that a higher risk premium was needed in the past. However, this study would indi- cate that until the risk premium approximated 38 per cent initial Offering would have outperformed the OTC Average. Any risk premium below 38 per cent would mean initial Offerings were in disequilibrium with the OTC Average. 62 This study has already shown that the investor's risk on initial offering has been the same/or less than on that on the OTC Average. Therefore, the market price appreciation on initial offerings adjusted for the risk premium should be equivalent to that of the OTC Average's market price appreciation. Any return on initial offerings after the 13.2 per cent risk premium adjustment greater than the return on the OTC Average, in this study, would mean investors would have been receiving economic rent. The reasons for this economic rent may be any one or a combination of the following: (1) Over speculation by investors in initial offerings at certain times, (2) Under pricing of initial offerings by under— writers,1 (3) Over stimulation of this particular area of the stock market by underwriters and brokers. The pOpulation mean performance relative is 1.0 because if initial offerings' mean market rate of return adjusted for the risk premium is equal to the OTC Average's 1It may have been that the initial offerings' actual value had been above the price/earnings ratio of the OTC Average's price/earnings ratio because of initial Offerings greater future earnings growth potential. 63 mean rate of return the performance relative index would eqmllfi. A difference between the mean performance relative of initial offerings and the population mean of 1.0 will be considered significant if it can not reasonably by attri- buted to chance. For tests of significance of differences, the assumption is that the average performance relatives (PRt) has a probability distribution with mean (HPRt) and variance 05%?400 and thus by the Central Limit Theorem is approximately normally distributed. The data presented in Table 3-5 in this chapter includes the mean performance relatives, the standard devi- ations of this mean, and the acceptances or rejections for 16 time periods of the following test: IA 1.0 1.0 a: t IV In order to test for significance, the standard error of the population mean (Chi).fi ) must be estimated as follows: t OPR£ - s/JB , where s is the standard deviation of the mean performance relative and n is the number of initial offerings (400). The difference between the population mean and the sample mean will be considered to be due to chance if it is less 64 pummmm mmmmo.o mooo.o ~mm~.o ~m¢m.s use» mco pumnmm omomo.o m~wo.o mmem.o «mem.a mausoz mcaz pumflom ammao.o meeo.o mmkm.o ~mam.a mauaos xam nomnmm msooo.o moeo.o maem.o maem.a mango: amaze hummus mmeoo.o mmmo.o mamm.o mamm.a mamas m>amze somhmm ~maoo.o ammo.o mkam.o meam.a mxwmz_cm>mam uumnmm mmamo.o memo.o Haem.o Haom.a mxmmz ems pummmm mammo.o mmmo.o mam~.o mamm.a mamas ocaz somflmm cosmo.o camo.o Hom~.o Hoo~.a mxmoz names somhmm cameo.o mmmo.o Hom~.o Homm.a mamas am>mm uomflmm mmmeo.o ~m~o.o m~m~.o m~m~.H mama: xam nomflmm e>eeo.o memo.o 6H-.o 6H-.H mamas m>am uumnmm cameo.o memo.o oeam.o oeH~.H name: upon scones omovo.o memo.o Hoo~.o Hoom.a mamas mouse uumnmm sonmo.o m-o.o mama.o mama.a mamas ose uomflmm mnemo.o camo.o omoa.o omea.a xmmz ago D mve.a o o.H u mm: mm; wAm uomnom .Q.w m¢©.H :oflumw>mn o.H mmmq O>Humamm O>Humamm mafia ewm umooo< Ohmucmum mocmeuowuom coo: wocmfiuomumm new: m e m m a o.H. «an new omma.o u m o.Hw mm; "om mM>HB€Amm m02¢2m0mmmm Z VXMPt or P(XPt) > P(XMPt), VXPt > VXMSt or P(XPt) > P(XMSt), VXPt > VXSt or P(XPt) > P(XSt). H1: VXPt < VXMPt or P(XPt) 5 P(XMPt) , VXPt S VXMSt or P(XPt) S P(XMSt), VXPt S VXSt or P(XPt) s P(XSt). A rejection of the null hypothesis of part two would mean that the market risk to investors associated with initial primary distributions, in the past, has been the same/or less than the market risk associated with initial mainly primary, mainly secondary, and secondary distributions. Finally, a rejection of the null hypothesis in part one coupled with a rejection of the null hypothesis 69 in the second part, would lead to the conclusion that the investment worthiness of initial primary distributions has been greater than that of initial mainly primary, mainly secondary, and secondary distributions. This would mean that the variations in returns between the various types of initial offering distributions can not be explained by differentials in risk. Empirical Results. Table 3-6 presents a week by week breakdown of the mean rates of return for the initial stock offerings sample, initial primary offerings, initial mainly primary offerings, initial mainly secondary offer- ings, and initial secondary offerings for sixteen time periods. It can easily be seen that the mean rates of return on initial primary offerings have been superior in all time periods to the mean rates of return on the other stratified types of distributions. Table 3-6, also, shows that the greatest relative differential in mean returns existed in the first few weeks: over time this relative mean rate of return between primary offerings and the total sample, mainly primary, and secondary offerings became smaller. For example, the first week's mean rate of return on initial primary offerings (46.1%) was three times greater than the mean rate of return on initial 70 .moamEMm Ooamaumuum Ho OHQSMm on» How mcfluommo Houmm moaum ca omcmso ommucoouom mop maouoe non oouaamoccm no: mum moumu one .umom moo ........mxmoz mossy .mxoo3 o3u .xoo3 moo mo muofluom was“ an coaum may 0» OOflum mcwuowmo o3» Scum omomso oowum uwxume ommucoouom may ma eunuch mo mum“ zoos eras Hm.om oa.mH om.mm ma.hh mv.mm ummw moo ~O.mm mm.mH om.mb mo.mm mm.¢o mango: ocaz mv.mm em.vm NN.NO oo.mm Om.mm msuooz me v~.mm mo.¢m mm.o¢ Hm.mn mo.¢m mnucoz mouse Ho.m~ mw.m~ Ho.m¢ ma.mh mm.mm mxoo3 O>Ho39 am.m~ NH.¢~ mo.¢¢ am.ah mm.om mxooz co>on mo.- hm.~m mo.m¢ mm.mo Ho.m¢ mxooz owe mm.H~ ¢>.mm on.o¢ om.mo mm.o¢ mxoo3_ocflz, mm.o~ ha.om mm.mm mm.eo mm.ee mamas unmam hm.mH mm.o~ hm.mm ¢@.Hm mm.~¢ mxooz co>om ~¢.o~ mm.H~ o¢.~m hm.mm om.ov mxwo3 Mam em.om mm.om m~.Hm mo.om em.mm mxooz O>Hm Ho.HN NH.o~ mm.mm mm.¢m om.mm mxmoz usom ov.ma mm.om mv.mm mm.am No.0m mxooz mouse Hm.hH mm.HN wh.h~ mm.om mh.mm mxooz 039 Xma.ma XbO.mH xmo.m~ XmH.O¢ Xm¢.mm xooz Odo mm mm Hoa Hma ooa ouam oamsmm mxa max; max: ax: x: u mumocooom mumucooom mumsflum mumEaum mmcflnommo oEHB Macaw: macaw: Ham sszBmm m0 maflm Zflmz mlm mflm<fi 71 secondary offerings (15.5%), whereas one year after the offering date initial primary offerings' mean rate of return (77.2%) was only 2.1 times greater than the mean rate of return on initial secondary offerings (32.2%). Thus, the relative differential in mean returns between primary offerings and the sample, mainly primary, and secondary offerings became smaller the longer the period of time initial offerings were outstanding. How— ever, the relative mean return differential between initial primary Offerings and initial mainly secondary offerings became larger as time passed. This is due to the fact that initial mainly secondary offerings showed little or no market price increase as the length of time they were outstanding in the market increased. It appears that as the length of time an initial offering is outstanding increases the mean rates of return on the different types of distributions move closer to- gether. In fact, in the case of initial mainly primary Offerings this movement was great enough so that in the long run the mean return differential with initial pri- mary offerings was not large enough to be statistically significant at .05 confidence level. In both the short and long run the mean rates of return on initial primary offerings significantly 72 outperformed the mean rates of return on initial secondary and mainly secondary Offerings in all sixteen time periods (see Appendix C, Table C-l, for a week by week breakdown of the t-tests). Initial primary offerings' mean rates of return significantly outperformed the mean rates of return on initial mainly primary offerings in the short run. However, in the long run (six months, nine months, and one year), although the mean rates of return for initial pri- mary offerings have been above that of the mean rates Of return for the initial mainly primary offerings, these occurrences could be attributed to chance and have not been great enough to lead to the statistical premise that primary offerings outperformed mainly primary offerings at a level of confidence of .05 (see Appendix C). Thus, in all cases except in the relationship be- tween primary and mainly primary offerings in the long run the mean rates of return of initial primary offerings have been significantly greater than other types of distribu- tions' mean rates of return. The risk, when measured by coefficient of varia- tion, has, in all cases and time periods, been less for initial primary offerings than initial mainly primary, mainly secondary, and secondary offerings. Table 3-7 pre- sents a week by week breakdown of the coefficients of till 73 hmam.o wmhm.o Hmo~.o Hth.o mmma.o HMO? moo momm.o mm~¢.o omma.o ~¢MH.O mmoa.o mnucoz OGHZ wwe~.o ¢¢0m.o hmha.o mmoa.o ommo.o mango: New Haom.o woe~.o emoa.o hoaa.o mmmo.o mnuooz conga Hmam.o omm~.o mo¢H.o Hmaa.o unwo.o mxmoz O>Ho3a mmam.o mHm~.o H¢¢H.o oaaa.o mvmo.o mxmm3 GO>OHm mvam.o mam~.o mmva.o mooa.o mamo.o mxooz COB «Hem.o emvm.o mmma.o Naoa.o mmbo.o mxmo3 OCHZ bhvm.o ma¢~.o mm¢H.o ommo.o emho.o mxmmz Osman memm.o mvam.o Nm¢H.o memo.o m®>o.o mxmoz co>om mmmm.o mmo~.o mmaa.o mmmo.o ombo.o mxooz xam momm.o momm.o mmea.o Ohmo.o emho.o mxmoz o>wm mamm.o mvmm.o mmva.o memo.o emho.o mxmoz Hoom mnmm.o memm.o mmma.o mmmo.o Hhho.o axon: moans comm.o whoa.o mnma.o mamo.o maho.o axooz O39 mmHm.o mmvH.o mnHH.o Hemo.o mmbo.o xooz woo mx1\mx6 mzx1\mzx6 mzx1\mSXD mx1\mxo x1\xo u mnmocooom mnmocooom mumEHum mnmawum mmcwuommo mafia mange: macaw: Had ZOHBflHMfiS m0 BZmHUHmmmOU him mflmfla 74 variation for the initial Offerings sample, primary, mainly primary, mainly secondary, and secondary offerings. Finally, when the probability of decline was used as the measure of risk, almost all cases showed a lower percent- age Of decline in initial primary offerings relative to the percentage of initial mainly primary, mainly secondary, or secondary offerings that declined. Table 3-8 shows a week by week breakdown of the probabilities of decline for the initial offerings sample, primary, mainly primary, mainly secondary, and secondary offerings. Table 3-8, also, shows that the difference in the probability of decline between the various types of dis- tributions became smaller the longer initial offerings were outstanding. For example, the probability of decline in the first week for initial primary offerings (19.3%) was much smaller than the probability of decline for initial secondary offerings (32.7% ; whereas one year after the offering date the probability of decline for initial pri- mary offerings (42.0%) was slightly greater than the prob- ability of decline for initial secondary offerings (34.0%). In other words, as time passed, the probability of decline for the four types of distributions moved from being ex- tremely unequal in the short run to approximately equal in the long run. 75 .Ammamamm OOAMAMMHumV OHmEmm on“ a“ mmcflnmmmo mo Henson mop an ocoow>flu moaum moflummmo may 3oaon mm3 .nmo» Odo on as mxoo3 oougu .mxmm3 O3u .MOOB moo .mOOflHmm OEflu um mogum umthfi Om0£3 mmcfiummmo mo HOAESZe om.mm m~.me mm.oe mm.ae me.ae one» meo 45.nm No.44 no.6m 6m.mm om.am mango: maaz e$.>m oe.mm $6.mm so.s~ me.am anueoz xam Hm.H¢ Hm.~m e$.m~ 6$.m~ oo.m~ mango: mouse mo.mm mm.mm on.mm m$.m~ m$.$m mama: m>Hmse an.$m mm.mm m$.e~ hm.m~ om.m~ mammz cm>mam No.0m mm.mm ma.e~ Hm.e~ oo.m~ mamas cos o¢.me $$.om 6s.m~ o$.m~ om.$~ mxmmz meaz «$.hm mm.mm «$.FN sm.mm m~.m~ mammz names oe.m¢ ma.mm m$.6m am.m~ om.m~ mamas cm>wm m~.me mo.$m H$.m~ am.m~ om.m~ mamas xam em.mm Hm.~m mm.om 6m.v~ oo.m~ mamas m>am e$.am Hm.~m mo.em mm.o~. om.m~ mamas uses No.6m Hm.~m ~5.$~ mo.- m$.$~ memes mange oe.me mo.$~ ma.$~ mo.- om.$~ mxmms 039 $3.2 $3.3. $2..- $3.3 $3.3 x33 95 $5 m 653 a $53 a 35 a so a aumucooom humocooom mumaflum mumEaum mmowummmo mafia >a:wmz wanes: Ham I Y |l *MZHAUMQ ho NBHQHmflmomm mlm mflmfie 76 In those cases where the percentage of decline on initial primary offerings had been above that of the per- centage of decline in mainly primary, mainly secondary, and secondary offerings, a Z—test showed that the percent- age differential could have been attributed to chance and was not statistically significant at a .05 level of con— fidence (see Appendix D for Z-tests of distributions that had a smaller percentage decline ratio than initial pri- mary Offerings). In conclusion it seems that initial primary offer- ings have been a better investment than initial mainly primary offerings in the short run, and than mainly secondary and secondary Offerings in both the short and long run. In other words, the variations in return between the types of initial offering distributions can not be ex— plained by differentials in risk. These conclusions tend to support the idea that underwriters suppress the offer- ing price and/or push in the after-market those offerings they have greatest financial interest.1 Finally, the longer the time initial offerings were outstanding the less the differential in investment worthiness became between the various types of distributions. 1See Appendix A, Table A-2, for the percentage of warrants held by underwriters in the various types of distributions. 77 pimitingFactors of the Study Anyone wishing to apply the results of this study should be familiar with the limiting assumptions applied to the analysis. These limiting assumptions are: (l) A major limitation of most historical studies of securities markets is that past observations may not necessarily lead to valid generalizations about future results. This limitation has been partially overcome by basing observations on a reasonably long period which in- cluded two major bear markets (1966 and 1969) as well as ' two strong bull markets (1966 first half and 1968). Also, the most recent time period possible (to June 30, 1970) was included in the study. (2) The assumption of how long initial offerings would be held, i.e., one week, two weeks,...etc., was arbitrarily established. These durations were used in order to make return and risk calculations for time periods when new influences on the issue presumably had not yet reached the market. (3) Security analysis has been ignored in the selection of initial Offerings. Real world results could be improved or worsened depending on the skill of the investor. (4) The study does not take into account the 78 brOkerage fees on the selling of initial offerings. There are no brokerage fees on the purchase of initial offerings. Also, taxes were excluded. Returns for the entire study would be lower if these two additional expenses were con- sidered. (5) Cash dividends paid by the firms were also not considered. This would lead to only a slight bias in re- turns towards initial offerings, since these companies rarely pay cash dividends, while the Over-the-Counter Average's stocks almost all pay cash dividends. (6) The large sample included in this study assumes one could have purchased a large diversified portfolio of initial offerings at all times. This would be impossible for most investors. (7) The use of coefficient of variation as a measurement of risk has its limitation. Perhaps the most objectionable feature is that investors are not interested in the total distributions of expected returns, but rather in the probability of certain types of adverse returns. Thus, a second measure of risk was employed. The second measure of risk was probability of decline. This measure- ment of risk calculates a condition all investors in initial offerings would be attempting to avoid. (8) The calculation of the risk premium rate of 79 return given by investment bankers to investors in initial offerings might be questioned. The spread between initial offerings' price earnings ratio and the OTC Average's price/earnings ratio was used to set both groups at an equal starting point and then test if the two groups' mar- ket price movements were equal. The high rates of return on initial offerings would indicate that until a risk premium of 38 per cent had been used, initial common stock Offerings would have outperformed the OTC Average. (9) Finally, the question of new security laws may immediately nullify any conclusion that might be drawn from the past. The study assumes initial offerings will continue to be offered by underwriters in the future as they have been in the past. CHAPTER 4 SUMMARY AND CONTRIBUTIONS Summary Purpose of the Study. Two objectives motivated the study of initial common stock offerings and their mar- ket price behavior. These two objectives are: first, to determine how initial common stock offerings have performed in the past, and second, to determine if capital market institutions have been able or willing to bring initial offerings to the market in equilibrium with the over—the- counter market. In order to evaluate these two questions accurately the fact that initial offerings are not exactly homogeneous needs to be taken into account. Thus, it is pertinent to stratify initial offerings according to who is receiving the proceeds from the sale of the offering, the company and/or selling stockholders. Another aspect of this study has been to determine if variations in market rates of return on the various types of initial offering distributions can be explained by differentials in risk. The three basic types of initial offering distributions 80 81 are: primary, secondary, and mixture. A random sample of 400 initial common stock offer- ings was drawn. The total period covered by the study extended from January 19, 1965 (when the first initial offering was selected) to June 30, 1970 (a year after the last initial offering was selected). The market returns and risks associated with these 400 issues were analyzed for sixteen time periods, ranging from one week to one year after the offering date. Findings, Implications, and Recommendations. The results of this study lead to the following findings, impli- cations, and recommendations: (1) Initial common stock offerings have shown higher than normal market rates of return. The mean rates of return on initial offerings ranged from a low of 32.43 per cent within the first week after the offering date, to a high of 62.33 per cent nine months after the offering date. During this same time period, the OTC Average's mean rates of return were only 0.14 and 6.08 per cent respectively. The risk, as measured by coefficient of variation and probability of decline, associated with the OTC Average was greater than the risk associated with the sample of initial offerings. Thus, initial offerings have had greater market rates of return and less risk associated 82 with them than the OTC Average. (2) Initial common stock offerings' market per- formance has been in disequilibrium with the performance of the OTC Average. The market rates of return on initial offerings, even after a risk adjustment of 13.2 per cent for the shifting of capital, showed superior performances in relation to the OTC Average in both the short and long run. On average, initial offerings market price apprecia- tion, even after the 13.2 per cent risk adjustment, was '25 per cent greater than the price appreciation of the OTC Average. (3) The extreme disequilibrium between the OTC Average and initial offerings strongly indicates that in- vestors in initial offerings have been receiving economic rent. The preferred investors, those who have been able to obtain initial offerings, have been given a gift by the investment banking world. (4) All the above leads to the conclusion that: Underwriters have been unable or unwilling to set a realistic offering price on initial offerings. (5) The returns on initial offerings increased as the time they were outstanding increased. The market rate of return on initial offerings one year after the offering date (59.4%) was higher than that at any point 83 (at week intervals) within the first three months. This implies that the market price appreciation on initial offerings has not been merely a short run phenomenon as many researchers have implied. (6) Initial primary common stock offerings have proved to be a better investment than the OTC Average, initial mainly primary, initial mainly secondary, and secondary offerings. They have offered both higher market rates of return and have had less risk, as measured by relative variability and probability of decline, associated with them than the OTC Average and the other three types of distributions. That is, the variations in return between types of initial offering distributions could not be explained by differentials in risk. This, also, applied to initial primary offerings and the OTC Average. (7) Thus, underwriters have under priced and/or pushed in the after-market those initial offerings in which they held greatest financial interest. Underwriters held warrants in 78.1 per cent of the initial primary offerings floated in 1968; whereas they held warrants in only 45.0 per cent of the initial mainly primary offerings, 30.8 per cent of the initial mainly secondary offerings, and 16.7 per cent of the secondary offerings floated in 1968. 84 (8) The above findings lead to two recommendations for change in the investment banking world. (1) The first change needed is in the method of compensating underwriters. Contingent fees result in a conflict Of interest and should be disallowed. (2) The second change needed is in the present method of determining the offering price. A solution may be to compensate an underwriter or some other independent person or firm for drawing up the red herring. Then have underwriters bid on all or any portion of the offering in the same manner treasury bills are sold. Contributions of the Study This research effort should fill a gap in the investment literature on initial common stock offerings. Little research has been done on this group of offerings to date. Secondly, it provides a guide to risk and return possibilities encountered in initial offering investing. This examination may aid investors interested in the initial offerings' market determine Optimal strategies of buying and selling such offerings. It could also serve to demon- strate to the securities authorities that many inequities have existed in the initial offerings' market. APPENDIX A TOTAL NEW COMMON STOCK OFFERINGS & PERCENTAGE OF WARRANTS HELD BY UNDERWRITERS 85 TABLE A91 TOTAL NEW COMMON STOCK OFFERINGS (In million of dollars) Corporate Year Common Stock (cash offerings) 1962 1,314 1963 1,011 1964 2,679 1965 1,547 1966 1,939 1967 1,959 1968 3,946 1969 7,714 Source: Federal Reserve Bulletin, May 1970, Number 5, Volume 56. TABLE A-2 PERCENTAGE OF WARRANTS HELD BY UNDERWRITERS Type of Total # Included* Percentage** Offering Number Warrants of Warrants Primary 32 25 78.1% Mainly Primary 20 9 45.0 Mainly Secondary 13 4 30.8 Secondary .l2 ._2 lppl Total 77 40 51.9% *Number of offerings that the underwriter held warrants or stock in the firm. **Percentage of offerings that the underwriter held warrants or stock in the firm. APPENDIX B INITIAL COMMON STOCK OFFERINGS SAMPLE 86 TABLE B-l INITIAL COMMON STOCK OFFERINGS SAMPLE ‘Number Stock Offering Date 1 Essex Wire Corporation 011965 2 George A. Philbrick Researchers 012765 3 Weis Markets, Inc. 020265 4 ConChemCo, Inc. 020365 5 Memorex Corp. 030365 6 Betz Laboratories, Inc. 030365 7 Fleetwood Enterprises, Inc. 030465 8 DPA, Inc. 031065 9 Skaggs Pay Less Drug Stores 032365 10 Fisher Scientific Co. 032365 11 Martha White Mills, Inc. 033065 12 Coffee-Mat Corp. 040665 13 McDonald's Corp. 042165 14 Denver Chemical Mfg. Co. 042865 15 Southeastern Drilling Inc. 051165 16 Aberdeen Manufacturing Corp. 051265 17 Roos/atkins 051865 18 House of Fabrics 052065 19 Susan Thomas, Inc. 052765 20 Grant Advertising International, Inc. 052765 21 Spencer Packing Co. 061065 22 Star Supermarkets, Inc. 061565 23 Henredon Furniture Industries, Inc. 061765 24 Twenty Grand Marine Service 070765 25 Kearney-National Inc. 081165 26 University Computing Co. 090965 27 Eagle Clothes, Inc. 091365 28 Grey Advertising Inc. 092165 29 C. H. Masland & Sons 092165 30 Stern Metals Corp. 092365 31 Ameco, Inc. 100665 32 General Electrodynamics Corp. 100765 ' 33 Charles Pindych Inc. 100865 34 Applebaums' Food Markets, Inc. 101365 35 Chemical Leaman Tank Lines, Inc. 101365 36 Palm Beach Co. 102665 37 Fairfield-Noble Corp. 102765 38 Home Security Life Insurance Co. 110465 39 Baltimore Business Forms, Inc. 111665 40 Villager, Inc. 111665 In! 87 TABLE B-2 INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 41 Automatic Sprinkler Corp. of America 111765 42 Mercury Chemical Corp. 122165 43 Zions Utah Bancorporation 011266 44 Eagle General Corp. 011766 45 Goya Music Corp. 012066 46 Enstrom (R. J.) Corp. 020166 47 Inflight Motion Pictures, Inc. 021766 48 Wilson Freight Co. 022366 49 Diversified Metals Corp. 030266 50 Sales Follow-Up Corp. 030466 51 Systems Engineerings Laboratories 031666 52 Kentucky Friend Chicken Corp. 031766 53 Morton's Shoe Stores Inc. 032466 54 LIN Broadcasting Corp. 032466 55 Industrial Electronics Associates, Inc. 040466 56 Maryland TeleCommunications, Inc. 040566 57 Burris Chemical Corp. 040566 58 Tolin Manufacturing Corp. 040566 59 Drilco Oil Tools, Inc. 041166 60 Ogilivy & Mather International Inc. 042666 61 Harvest Markets, Inc. 042866 62 Pat Fashions Industries, Inc. 042966 63 Informatics, Inc. 051066 64 Fine Organics, Inc. 051266 65 Fred Harvey 051866 66 Superscore, Inc. 052366 67 Sun Electric Corp. 060166 68 Jamesway Corp. 061466 69 Tridair Industries 061666 70 Methode Electronic, Inc. 061766 71 Barbara Lynn Stores, Inc. 062166 72 Okonite Co. 062266 73 Riker Video Industries 062266 74 Airstream Inc. 070166 75 Cole Drug CO., Inc. 070666 76 Wean Industries, Inc. 071866 77 Sperti Drug Co. 071966 78 Space Ordinance Systems, Inc. 080366 79 Acushnet Process Co. 081066 80 Buckbee-Mears Co. 092766 and 88 TABLE B-3 INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 81 Alpha Industries, Inc. 102766 82 Spring Mills, Inc. 102766 83 Huffman Manufacturing Co. 111566 84 Mohawk Data Sciences Corp. 111566 85 Elcor Chemical Corp. 120666 86 Penn Engineering & Manufacturing Co. 120666 87 Air California 121566 88 Gilford Instrument Laboratories Inc. 010367 89 Micronetic Corp. 011167 90 Allen Aircraft Radio 020967 91 Farah Manufacturing CO., Inc. 021567 92 Gulf Aerospace Corp. 022067 93 Duplex Products, Inc. 022167 94 Key Pharmaceuticals Inc. 022767 95 Dynell Electronics Inc. 030267 96 Seven-Up Co. 031567 97 Met-Pro Water Treatment Corp. 032267 98 Sanders & Thomas, Inc. 032367 99 Eberline Instrument Corp. 032967 100 Champion Products Inc. 040567 101 Datatab Inc. 040667 102 Milton Roy Co. 041867 103 Motor Club of America 042067 104 Summers Electric Co. 042067 105 WTC Airfreight 042767 106 AITS, Inc. 050367 107 American Institutional Developers, Inc. 050367 108 Houghton-Mifflin Co. 050367 109 Sonderling Broadcasting Corp. 050467 110 Information Displays, Inc. 052767 111 Semtech Corp. 060667 112 Sheffield Watch Corp. 062767 113 Overseas National Airways 062867 114 Administrative Systems, Inc. 062967 115 Corinthian Broadcasting Corp. 070667 116 Saunders Leasing Systems, Inc. 071167 117 Patterson-Smith, Inc. 071767 118 Discon Corp. 071967 119 Grove Press, Inc. 072567 120 Quality Mills, Inc. 080167 89 TABLE B-4 INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 121 Optics Technology, Inc. 081067 122 Old Fort Industries, Inc. 081567 123 Wang Laboratories, Inc. 082367 124 Computest Corp. 082467 125 Domestic Air Express, Inc. 082967 126 National Computer Analysts, Inc. 082967 127 Applied Magnetics Corp. 083167 128 Damon Creation, Inc. 090667 129 Real Eight CO., Inc. 091167 130 Graphic Sciences, Inc. 091267 131 Air Industries Corp. 091367 132 Pacific Electricord Corp. 100367 133 Platronics, Inc. 101767 134 Jet Air Freight 101767 135 Electronic Modules Corp. 110267 136 Adams Dana Silversteine, Inc. 110667 138 Marinduque Mining 5 Industrial Corp. 110967 139 Burns & Towne, Inc. 111567 140 Hudson Leasing Corp. 112167 141 Spectral Dynamics Corp. of San Diego 112867 142 Hamco Machine & Electronics Corp. 112967 143 Noland Co. 113067 144 White Electromagnetic Inc. 120667 145 Chamberlain Manufacturing Corp. 120767 146 Adams-Russell CO., Inc. 121467 147 General Reed Co. 121467 148 Pacific & Southern Broadcasting Co. 122867 149 Childhood Productions 010268 150 Software Systems, Inc. 010668 151 Flight Safety, Inc. 011768 152 Chronetics, Inc. 012368 153 United Convalescent Hospitals 012568 154 Widmann (L. F.) Inc. 021368 155 Yuletide Enterprises, Inc. 021468 156 Juness Industries Inc. 021468 157 Leasing Consultants, Inc. 022968 158 Transmation, Inc. 022968 159 Gay Gibson, Inc. 030568 160 Basic Leasing Corp. 030668 90 TABLE B-S INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 161 Skymark Airlines, Inc. 030668 162 Davis Food Service, Inc. 030768 163 Information International, Inc. 030768 164 Telecom, Inc. 032568 165 C. G. S. Scientific Corp. 032768 166 Brennand-Paige Industries, Inc. 032868 167 Ad/Mar Computer Techniques Corp. 040168 168 M. P. 0., Inc. 040468 169 Computer Investors Group, Inc. 041068 170 Rex Plastics, Inc. 041668 171 Private and Computer Schools, Inc. 041768 172 Barnes Corp. 041768 173 David Crystal, Inc. 041868 174 Curtline of America, Inc. 042468 175 L. S. Ayres & Co. 042568 176 Computer Servicenters, Inc. 042668 177 Hydro-Ski International Corp. 042968 178 Omni Spectra, Inc. 043068 179 LeGran Corp. 043068 180 Minnie Pearl's Chicken System, Inc. 050168 181 Save-Way Barber & Beauty Supplies 050168 182 Superior Surgical Mfg. Co., Inc. 050268 183 Sun-Clo Products Corp. 050968 184 Four Season Nursing Centers of Am. 051068 185 United Dollar Stores, Inc. 051468 186 Griffiths Electronics, Inc. 051668 187 Integrated Container Services 051668 188 Computer devices Corp. 052468 189 Samuel Moore 5 Co. 052868 190 U. N. Alloy Steel Corp. 060668 191 Automation Sciences, Inc. 061168 192 Docktor Pet Center, Inc. 061168 193 Everest & Jennings International 061168 194 Rollins Leasing Corp. 061168 195 Rite Aid Corp. 061368 196 Phelan Sulphur Co. 061368 197 ‘Michael Baker, Jr., Inc. 061468 198 Mr. Swiss of America, Inc. 061768 199 Plain 'n' Fancy Donuts of America 061868 200 Intermediate Nursing Centers, Inc. 062068 91 TABLE B-6 INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 201 Ideal Toy Corp. 062768 202 National Liberty Corp. 070268 203 Hesston Corp. 070268 204 ElectronAMachine Corp. 070368 205 Educasting Systems, Inc. 070868 206 Levitz Furniture Corp. 070968 207 Daniel Industries, Inc. 071168 208 Bonanza International, Inc. 071168 209 Data Systems Analysts, Inc. 071268 210 U. S. Time-Sharing, Inc. 071868 211 Viking Industries, Inc. 071968 212 Camel Manufacturing Co. 072568 213 Valle's Steak House 072968 214 E. C. Ernest, Inc. 073168 215 Food Industries, Inc. 080168 216 URS Systems Corp. 080168 217 Dialscan Systems, Inc. 080568 218 AIC Photo 080668 219 Friendly Ice Cream Corp. 080668 220 E. T. Barwick Industries, Inc. 080868 221 Bowne & Co., Inc. 082068 222 Open Road Campers, Inc. 082068 223 Mary Kay, Inc. 082268 224 Bankers Utilities Corp. 082268 225 Lewton Television, Inc. 082668 226 Mobile Home Industries, Inc. 081068 227 California Health Care, Inc. 091168 228 Venice Industries, Inc. 091268 229 Purification Sciences Inc. 091268 230 Underground Surveys Corp. 091368 231 Ray Proof Corp. 091768 232 Alex Coleman, Inc. 091768 233 Cinema V Distributing, Inc. 091968 234 Kappa Frocks, Inc. 091968 235 Trend Industries, Inc. 091968 236 Veta Precision Laboratories 091968 237 Leigh Products, Inc. 091968 238 Frequency Electronics, Inc. 092068 239 Swedlow, Inc. 100368 240 Scotco Data Leasing, Inc. 100368 92 TABLE B-7 INITIAL COMMON STOCK.OFFERINGS SAMPLE Number Stock Offering Date 241 Scientific Pollution Control Corp. 100668 242 Tad's Enterprises, Inc. 100768 243 Qatron Corp. 100768 244 Data Network Corp. 101068 245 Connecticut Consolidated Industries 101068 246 Valmont Industries, Inc. 101068 247 Aria-Colorado Land & Cattle Co. 101168 248 Comcet, Inc. 101568 249 Datascan, Inc. 101768 250 Base Ten Systems, Inc. 102268 251 Chuck Barris Production, Inc. 102268 252 Elder-Beerman Stores Corp. 102268 253 International Aluminum Corp. 102268 254 Monterey Nursing Inns, Inc. 102268 255 Castagna Electronics Corp. 102468 256 Speciality Restaurants Corp. 102468 257 Winn's Stores, Inc. 102968 258 Edgington Oil Co. 102968 259 Page Airways, Inc. 102968 260 Puritan-Bennett Corp. 102968 261 Roselon Industries, Inc. 111368 262 Storescope TV, Inc. 111568 263 Republic Color Inc. 111568 264 Computer Property Corp. 111968 265 Coldwell, Banker & Co. 112168 266 Burnup & Sims Inc. 112168 267 KPA Computer Techniques, Inc. 112168 268 Martha.Manning Co. 112668 269 Arkansas Best Corp. 112668 270 Arcata National Corp. 120368 271 Data Architects, Inc. 120368 272 Infotec, Inc. 121068 273 Premier Photo Service, Inc. 121068 274 Alexander's Inc. 121268 275 Latham Process Corp. 121268 276 Chesapeake Industries, Inc. 121268 277 Firaco, Inc. 121268 278 S. M. Flickinger Co., Inc. 121268 279 Einson Freeman 8 DeTroy Corp. 121668 280 Armin Poly Film Corp. 121668 93 TABLE B-8 INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 281 Vithabeth, Inc. 121668 282 Computer Time Shareing Corp. 121768 283 William Hodges 5 Co., Inc. 121768 284 Saving Financial 121768 285 Kaysam Corp. of America 121968 286 Elba Systems Corp. 121968 287 Republic Mortgage Investors 122068 288 General Analytics Corp. 122068 289 Canrad Precision Industries, Inc. 122068 290 Alberts, Inc. 122068 291 Serendipity Inc. 122768 292 Information 5 Computing Centers Corp. 010769 293 Jerrico, Inc. 010769 294 Abe Schrader Corp. 010969 295 Programmed Tax Systems, Inc. 011369 296 Moulding, Inc. 011469 297 Skamper Corp. 012369 298 Trans-Industries, Inc. 012469 299 Hamburger Hamlet, Inc. 012869 300 Metrecare Enterprises, Inc. 012869 301 National Hardgoods Distributors, Inc. 012969 302 Wilson Leasing Co. 012969 303 C 5 W Precision Products, Inc. 013069 304 International Systems Associates, Ltd. 020569 305 Acme Shear Co. 020669 306 General Health Services, Inc. 020669 307 Herman Marcus Inc. 020669 308 U. S. Systems 5 Software, Inc. 020769 309 Aberle Industries, Inc. 021269 310 Aldon Industries, Inc. 021369 311 Gro-Plant Industries, Inc. 021769 312 Edmos Products Corp. 021869 313 Snelling 5 Snelling, Inc. 021969 314 StangHydronics, Inc. 021969 315 Tedhnical Publishing Co. 021969 316 American Medical Building Guild, Inc. 022469 317 Electrone, Inc. 022469 318 Products Applications, Inc. 022569 319 Cut 5 Curl, Inc. 022669 320 012969 Osias Organization, Inc. 94 TABLE B-9 INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 321 Peter Eckrich 5 Sons, Inc. 022669 322 Continental Testing Labs., Inc. 022769 323 Leisure Technology Corp. 022769 324 Mangurian's, Inc. 022769 325 Plessey Inc. 022769 326 Four Seasons Equity Corp. 022869 327 National Packaging Corp. 022869 328 Guardian Mortgage Investors 030469 329 A1 Hirt's Sandwich Saloons, Inc. 030469 330 Mark Computer Systems, Inc. 030469 331 Netgo, Ltd. 030469 332 Mason Personnel Associates, Inc. 031069 333 Analog Devices, Inc. 031169 334 National Institute for Better Reading 031269 335 Viatron Computer Systems Corp. 031269 336 Interblsland Mortgage Corp. 031269 337 Seattle Supersonics Corp. 031369 338 Bally Manufacturing Corp. 031769 339 Princeton Electronic Products, Inc. 031869 340 Sorg Printing Co. 031869 341 South Shore Publishing Co., Inc. 031869 342 Datatron Inc. 031969 343 Radiation Technology, Inc. 032169 344 Lovle Products, Inc. 032569 345 Continental Care Centers, Inc. 032769 346 Kit Manufacturing Co. 032769 347 Paramount Leasing Corp. 032769 348 Ram—Hart Systems, Inc. 032769 349 Graham Magnetics, Inc. 032769 350 GSI Computer Inc. 040169 351 Hipotronics, Inc. 040169 352 Mica Products Corp. 040169 353 Management Services, Inc. 040369 354 Voila Foods for Pets, Inc. 040769 355 Class Student Services, Inc. 040969 356 McDonough Co. 040969 357 Computer Circuits Corp. 041069 358 Baumritter Corp. 041569 359 Wynn Oil Co. 041569 360 Convalariums of America, Inc. 041669 95 TABLE B-lO INITIAL COMMON STOCK OFFERINGS SAMPLE Number Stock Offering Date 361 Pier 1 Imports, Inc. 041769 362 Malaker Corp. 042169 363 Computer College of Technology, Inc. 042169 364 Knight Newspapers, Inc.' 042269 365 Pamida, Inc. 042269 366 Grimm 5 Davis, Inc. 042369 367 Moore's Seafood Products, Inc. 042369 368 Continental Hosts, Ltd. 043069 369 Fotomat Corp. 043069 370 Hampton Shirt CO., Inc. 050169 371 AAA Enterprises, Inc. 050269 372 Mr. Swiss of the East, Inc. 050269 373 U.S. Hydrofoils-Lehigh Distribution 050269 374 LaSalle-Deitch Co., Inc. 050669 375 Information Machines Corp. 050769 376 The Newhall Land 5 Farm Co. 050869 377 Parkwood Homes, Inc. 050869 378 Anametrics, Inc. 050969 379 Hills Brothers, Inc. 051269 380 Atlantic Industries, Inc. 051369 381 Pulse Communication, Inc. 051369 382 Sierra Research Corp. 051469 383 Mbnica Simone Cosmetics, Inc. 051569 384 American Biomedical Corp. 052269 385 Computer Image Corp. 052769 386 Floyd Enterprises, Inc. 052769 387 Olshen Overseas Inc. 060369 388 TeleGeneral Corp. 060369 389 Hickory Furniture Co. 060469 390 Riverside Press, Inc. 060469 391 Pathfinder Mobile Homes, Inc. 060569 392 Cogar Corp. 061669 393 Presidents-First Lady Spa. Inc. 061769 394 Oak Cliff Saving 5 Loan Association 061769 395 National Data Processing Corporation 061869 396 Condominiums Northwest 061869 397 Starr Broadcasting Group 061869 398 Kampgrounds of America 062469 399 Ordinance Engineering Associates 062469 400 Mathematical Applications Group, Inc. 063069 APPENDIX C TYPES OF DISTRIBUTION t-TEST OF EQUALITY OF MEANS LOO - 96 TABLE C-l TYPES OF DISTRIBUTION t - Test of Equality of Means Mainly Primary Mainly Secondary Secondary Ho ”Pt 5 "MP ”Pt 5 “us “Pt 5 "s Time H u u u u u u 1 Pt > MP Pt > MS Pt > S t t v v One Week 3.872 5.337 4.658 Two Weeks 3.940 5.041 4.891 Three Weeks 3.407 4.565 4.142 Four Weeks 3.648 4.926 3.955 Five Weeks 3.461 4.876 3.767 Six Weeks 3.454 5.031 3.802 Seven Weeks 3.214 5.527 4.601 Eight Weeks 3.088 5.373 4.568 Nine Weeks 2.904 4.746 4.394 Ten Weeks 2.685 5.082 4.588 Eleven Weeks 2.633 4.949 4.089 Twelve Weeks 3.106 5.060 4.617 Three Mbnths 2.933 3.096 4.455 Six Months 1.475** 5.011 3.367, Nine Months 0.382** 4.593 3.610 One Year 0.381** 3.856 2.611 *The critical region is assumed to be 1.653 or greater. degrees of freedom.varied from 106 to 278. 1.653 the null hypothesis (H ) is rejected and the alternative hypothesis is accepted. If v is less than 1.653 the null hypothesis The If tv is greater than is accepted and the differences in the mean rates of return could possibly be attributed to chance. **Accept the null hypothesis. reject the null hypothesis. In all other cases and periods APPENDIX D TYPES OF DISTRIBUTION Z-TESTS OF PROBABILITY OF DECLINE 97 TABLE D-l PROBABILITY OF DECLINE (Z-TESTS) Ho: P (XP) >P(XMP) H1: P(XP)5P(XMP) Probability of Decline Mainly Time Primary Primary Difference oP+MP OD/o* XP XMP 0D Eleven Weeks 0.2597 0.2475 0.0122 0.0540 0.2258 One Year 0.4199 0.4059 0.0140 0.0613 0.2283 H0: P(XP) P(XMS) H1: P(XP) P(XMS) Probability of Decline Mainly Time Primary Secondary Difference OP-l-MS OD/o XP XMS OD One Week 0.2375 0.2277 0.0098 0.0525 0.1865 Three Weeks 0.2775 0.2772 0.0003 0.0557 0.0054 Six Weeks 0.2950 0.2871 0.0079 0.0565 0.1399 Seven Weeks 0.2850 0.2673 0.0177 0.0556 0.3185 Eight Weeks 0.2925 0.2772 0.0153 0.0560 0.2730 Nine Weeks 0.2750 0.2376 0.0374 0.0539 0.6934 Ten Weeks 0.2800 0.2475 0.0325 0.0545 0.5964 Eleven Weeks 0.2850 0.2475 0.0375 0.0546 0.6869 Twelve Weeks 0.2775 0.2376 0.0399 0.0545 0.7322 Three Months 0.2800 0.2574 0.0226 0.0545 0.4147 Nine Months 0.3750 0.3663 0.0087 0.0601 0.1448 One Year 0.4175 0.4059 0.0116 0.0612 0.1894 HO: P(XP) P(XS) H1: P(XP) P(xs) Time Probability of Decline Primary XP Secondary XS Difference OD °P+s OD/o One Year 0.4175 0.3396 0.0779 0.0598 1.3020 *If ODAJis less than 1.645 the null hypothesis is rejected and In other words, differences in the probability of decline are assumed to be due to chance and not the alternative hypothesis is accepted. significantly different. The null hypothesis is rejected in all cases. 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