Leverage, liquidity and long-run IPO returns

Abstract

It is well known that IPO stocks on average substantially underperform (over 3-5 years) non-IPO stocks matched on firm size. With a large sample of Nasdaq IPOs, this paper presents systematic evidence that IPO stocks are less risky than the size-matched firms and thus have lower expected return. We show that, in the years immediately following the issue, IPO stocks have lower leverage ratios and higher liquidity (turnover) than matched firms. A model with macroeconomic risk factors further reveals that IPO stocks have lower exposures than matched firms to leverage-related factors such as unexpected inflation and term-structure spreads. Moreover, when we introduce liquidity as a risk factor in a Fama-French type of model, we find that the liquidity factor also reduces expected returns to IPO stocks relative to matched firms. Controlling for risk using either factor model, we cannot reject the hypothesis of zero abnormal returns to IPO stocks.