Can a Company’s Pre-IPO return on Assets (ROA), Return on Equity (ROA) and Initial Returns Predict Post-IPO Performance?

Joseph K. Mutai^1,

¹Moi University, P.O. Box 3900-30100, Eldoret

Cite this paper:
Joseph K. Mutai. Can a Company’s Pre-IPO return on Assets (ROA), Return on Equity (ROA) and Initial Returns Predict Post-IPO Performance?. Journal of Finance and Economics. 2020; 8(3):93-99. doi: 10.12691/jfe-8-3-1

Abstract

Initial Public Offerings (IPOs), the offering by companies of stock to the public for the first time, have long been characterised by two anomalous phenomena: an abnormal increase in share price on the first day of trading and a long-run decline in performance. Some researchershave suggested that long run performance of IPOs could be a function of the firm’s pre-IPO performance and initial returns. However, few studies have looked at these relationships in listed companies in Kenya. The objectives of this study were to determine the relationship between pre-IPO and post-IPO performances of companies listed on NSE, and assess the relationship between initial return and post-IPO performance of the companies. An explanatory survey design was adopted for the study. The target population of the study was 12 companies that had sold shares to the public between January 1996 and December 2013 and 54 other companies on the Stock Exchange, which were used to compute benchmarks (NSE-20 share index), against which the companies that had issued IPOs in the study were compared. The entire population (census) of the companies was used in the study. The study analysed company data (prospectuses and annual statements). In addition, daily stock share prices, volumes and NSE indices were collected from the NSE. The study found an average under-pricing of 55.36% and a median under-pricing of 24.71%. The average CAR, M= -0.98, SD=2.08, t(11) = -1.97, p<.05, and ROE, M= -10.07, SD=24.0, z= -1.96, p<.05, were significantly less in three years after an offering than in three before the offering, suggesting a decline in company performance after the offering. Both pre-IPO ROA and ROE could not predict post-IPO ROA and ROE, respectively. Moderate and statistically significant negative relationships were found between initial return and both ROA and ROE differentials, showing that companies with larger abnormal returns had poor long run performance. The study recommends that investors looking for investment in IPOs must study more firm’s statistics, not just ROA and ROE, before choosing to buy stock.

Keywords:
initial return ROA ROE

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