Analysis of IPO advertising

• Main Author: Dumrongwong, Konpanas
• Other Authors: Gregory, Alan
• Published: University of Exeter 2013
• Subjects: 658
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.615548

This research investigated the market conditions caused by IPO advertising by examining the impact of IPO advertising, based on the US stock market from 1986 to 2009. The relationship between advertising intensity in the IPO year and the degree of IPO underpricing was examined. It was found that IPO advertising is an inappropriate way to convey a firm's true value of IPO to market participants. An increase in advertising intensity around an IPO event increases the degree of initial returns. Simultaneously, however, advertising intensity around an IPO event also increases the post-IPO initial-return uncertainty, which raises the question as to whether advertising serves primarily as a mechanism to convey a firm's true value to investors. The theoretical valuation of IPO, the relation between IPO advertising and the degree of stock overvaluation and the relation between IPO advertising and long-run performance of IPO are discussed. Based on the Peasnell (1982)'s residual income valuation framework (henceforth RIV), IPO advertising was proved to cause stock price to be more overvalued in the secondary market: a positive relationship was found between advertising and the degree of stock overvaluation relative to its theoretical value. The stock price tends to revert back to its fundamental value in the long run a few years after IPO. The link between advertising intensity and long-run performance was investigated. The Fama French 3-factor model and Carhart 4-factor model were employed, with investment horizons of one, two, three and four years. While advertising is relevant to a firm’s value in the IPO year, the degree of advertising in the IPO year is unrelated to its value two and three years following the IPO event. The view that advertising serves primarily as a form of intangible asset that enhances future earnings (i.e., a 4 firm's value) is unable to account for the degree of underpricing. Accordingly, an alternative hypothesis, that advertising inflates the short-run stock price, was proposed. The results of this study are consistent with the view of Purnanandam and Swaminathan (2004), namely that the stock price of newly listed firms can be overvalued.