The Secondary Stock Markets 25

in the global top ten largest (the biggest was the China Construction Bank Corp.s IPO of $9.2 billion). In the United States the average first-day return was 9%, although some firms had spectacular first-day price run-ups. For example, Baidu.com was up 327.8% on its first day of trading, and Citi Trends gained 204.9% for the year. However, not all companies fared so well Nuvim was down 88% its first day, and Refco lost a total of 98% for the year. Even if you are able to identify a hot issue, it is often difficult to purchase shares in the initial offering. These deals are generally oversubscribed, which means that the demand for shares at the offering price exceeds the number of shares issued. In such instances, investment bankers favor large institutional investors (who are their best customers), and small investors find it hard, if not impossible, to get in on the ground floor. They can buy the stock in the aftermarket, but evidence suggests that if you do not get in on the ground floor, the average IPO underperforms the overall market over the long run.7 Before you conclude that it isnt fair to let only the best customers have the stock in an initial offering, think about what it takes to become a best customer. Best customers are usually investors who have done lots of business in the past with the investment banking firms brokerage department. In other words, they have paid large sums as commissions in the past, and they are expected to continue doing so in the future. As is so often true, there is no free lunchmost of the investors who get in on the ground floor of an IPO have in fact paid for this privilege.

Rational Exuberance
The Daily Planet Ltd. made history on May 1, 2003, by becoming the worlds first publicly traded brothel. Technically, the Daily Planet only owns property, including a hotel with 18 rooms, each with a different theme, but all having multiperson showers and very large beds. The Daily Planet charges guests a room fee of A$115 per hour; clients also pay a fee of A$115 directly to individual members of the staff. The IPO was for 7.5 million shares of stock, initially priced at A$0.50. However, the price ended the first day of trading at A$1.09, for a first-day return of 118%. The price closed the second day at A$1.56, for a 2-day return of 212%, one of the largest returns since the days of the dot-com boom. Institutional investors normally buy about 60% to 70% of IPO stock, but they didnt participate in this offering. The Daily Planet plans to use some of the proceeds to pay down debt and the rest for expansion, possibly through franchising. The company is named after the fictitious newspaper where comic strip character Clark Kent was a reporter. All receptionists have Lois Lane nametags, and there is a telephone box in the lobby. What would Superman think!
For updates on IPO activity, see http://www .ipomonitor.com or http://www.hoovers .com/global/ipoc/ index.xhtml. The Wall Street Journal also provides IPO data in its Year End Review of Markets & Finance at http://online .wsj.com.

1.10 The Secondary Stock Markets

The two leading U.S. stock markets today are the New York Stock Exchange and the Nasdaq stock market.
7See

Jay R. Ritter, The Long-Run Performance of Initial Public Offerings, Journal of Finance, March 1991, 327.

Differentiate between an IPO, a seasoned equity offering, and a secondary transaction. Why is it often difficult for the average investor to make money during an IPO?

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