The Performance of Japanese Seasoned Equity Offerings, 1971-1992

Pacific-Basin Finance Journal 6 Ž1998.
395–425
The performance of Japanese seasoned equity

offerings, 1971–1992
a,) b
Jun Cai , Tim Loughran
a
Department of Economics and Finance, City UniÕersity of Hong Kong, Tat Chee AÕenue, Kowloon,
Hong Kong, China
b
Department of Finance, UniÕersity of Iowa, Iowa City, IA, USA
Abstract
Japanese firms conducting 1389 seasoned equity offerings during 1971–1992 signifi-
cantly underperform various benchmarks over a subsequent 5-year period. This poor stock
performance is accompanied by a deterioration of the matching-firm adjusted operating
performance. Neither Keiretsu affiliation nor ownership structure can explain the poor
performance by issuing firms. In contrast to evidence from the U.S., cross-sectional
variation of post-issue performance changes is not related to the level of agency costs prior
to the issue. Our results from the Japanese financial markets are inconsistent with an agency
explanation for the new issues puzzle. q 1998 Elsevier Science B.V. All rights reserved.
JEL classification: G15; G32; G38; F21
Keywords: Japanese seasoned equity offerings; Long run performance; Operating measures; Ownership
structure
1. Introduction
Following the pioneering work of Ritter Ž1991. on the poor subsequent

long-run stock performance of initial public offerings ŽIPOs., the empirical
)
Corresponding author. Tel.: q852 y 2788-8810; fax: q852 y 2788-8810; e-mail:
efjuncai@efspc04.cityu.edu.hk.
0927-538Xr98r$ - see front matter q 1998 Elsevier Science B.V. All rights reserved.
PII: S 0 9 2 7 - 5 3 8 X Ž 9 8 . 0 0 0 1 9 - 5
396 J. Cai, T. Loughranr Pacific-Basin Finance Journal 6 (1998) 395–425
literature on equity offerings has expanded into two research categories. The first
area examines the subsequent operating performance of IPOs wsee Jain and Kini,
1994, Cai et al., 1997, Mikkelson et al., 1997 and Pagano et al., 1998x. The second
research area examines the subsequent performance of seasoned equity offerings
ŽSEOs.. For example, several papers document that firms conducting SEOs in the
U.S. ŽLoughran and Ritter, 1995; Spiess and Affleck-Graves, 1995; McLaughlin et
al., 1996; Loughran and Ritter, 1997. and the U.K. ŽLevis, 1995. also experience
significant downward drift in stock andror operating performance for up to 5
years after the offering.
The two distinct areas are directly related. If one is to believe the premise of
Ritter’s initial work that investors are overoptimistic about the earning potential of
growth firms and that firms take advantage of this overvaluation, investigators
should find both poor subsequent operating performance and low post-issue stock
returns for issuing firms. That is, if managers of IPO firms have the ability to
‘time’ the market, the pattern should also exist for managers of seasoned firms.
Furthermore, the evidence of these patterns Žlow stock returns and poor operating
performance. should also be true in an international context. Managers, who
should possess superior information about the firm’s future prospects, should be
able to occasionally issue overvalued stock to the investing public regardless of
their country of origin.
This paper provides further independent evidence on this controversial issue by
investigating the long-run stock and operating performance of 1389 SEOs listed on
the Tokyo Stock Exchange ŽTSE. during the 1971–1992 period. Examining
Japanese SEOs has several advantages. First, our results may be seen as an
out-of-sample test of the results from the U.S. If we fail to find poor subsequent
performance following a Japanese SEO, then the generality of previous U.S.
empirical evidence should be questioned. The second advantage of a Japanese data
set is its unique features which allow for testing of an agency theory explanation
for the pattern of poor performance for issuing firms commonly known as the
‘‘new issues puzzle’’.
One important motivation for this study is that Japanese corporate governance
mechanisms are, in general, quite different from those in the U.S. wsee Kester
Ž1991. and Kaplan Ž1994.x. In particular, the agency problem is, to a large extent,
Notes to Table 1:
The sample consists of 1389 SEOs conducted by Japanese firms during the 1971–1992 period. To be
included in the sample, an issuing firm must not have issued equity during the 5 years prior to the issue
date, and it must have gross proceeds exceeding 100 million yen. The summary reports the sample size,
the median ratio of gross proceeds to firm size Žgross proceedsrmarket value at the end of the offering
month., and the median gross proceeds in terms of December 1992 purchasing power by calendar year
and by Needs’ industry classification.
J. Cai, T. Loughranr Pacific-Basin Finance Journal 6 (1998) 395–425 397
Table 1
Summary of Japanese SEO sample size and gross proceeds
Panel A: Sample size and median gross proceeds by calendar year
Year Sample Gross proceedsr Gross proceeds Gross proceeds
size firm market Žbillion yen, Žmillion US$,
value Ž%. 1992. 1992.
1971 67 3.32 1.21 9.72
1972 150 8.52 3.84 30.80
1973 114 9.15 1.88 15.09
1974 79 7.16 1.08 8.62
1975 34 6.58 2.05 16.46
1976 47 7.29 2.64 21.12
1977 75 8.05 1.82 14.61
1978 79 8.07 2.02 16.20
1979 97 8.85 1.96 15.71
1980 101 8.04 3.14 25.13
1981 97 8.88 3.87 31.04
1982 67 10.72 2.28 18.31
1983 28 9.27 5.90 47.26
1984 42 10.77 3.07 24.58
1985 39 11.15 2.84 22.80
1986 30 8.44 3.16 25.29
1987 27 8.12 3.83 30.67
1988 59 11.02 4.21 33.73
1989 93 9.30 7.09 56.81
1990 56 9.27 5.97 47.87
1991 7 4.36 5.19 41.61
1992 1 3.68 0.83 6.69
Total 1389 8.37 2.91 23.32
Panel B: Sample size and median gross proceeds by industry classification
Needs’ Sample Gross proceedsr Gross proceeds Gross proceeds
industry size market Žbillion yen, Žmillion US$,
classification value Ž%. 1992. 1992.
Foods 80 7.67 3.19 25.55
Chemicals 122 8.49 2.68 21.50
Nonferrous metal 60 8.79 2.03 16.30
Machinery 118 8.83 3.22 25.84
Electric and 196 8.45 2.91 23.31
electronic equipment
Motor vehicles 65 8.59 2.46 19.68
and auto parts
Construction 164 8.11 2.26 18.10
Wholesale trade 133 8.91 3.09 24.80
Retail trade 56 8.44 5.73 45.91
Other industries 395 7.96 2.90 23.28
mitigated among Japanese firms. 1, 2 Unlike their U.S. counterparts, Japanese

financial institutions, including main banks, are allowed to take large debt and
equity positions in the same firm. The sizable equity stake by these institutions
often serves as an important instrument to maintain effective control of incumbent
managers. Due to these institutional features, we should see better profit-maximiz-
ing investment and lower perquisite consumption by Japanese managers ŽProwse,
1990, 1992.. Further, many Japanese firms exist within a Keiretsu organization
which bands inter-market business groups together.
Financial institutions and industrial corporations are known as ‘stable share-
holders’ whose ownership positions are often motivated by business relations. As
long-term investors, they frequently participate in seasoned equity offerings to
maintain their percentage of ownership as documented in Hodder and Tschoegl
Ž1993.. The median post-issue shareholdings for our sample is 28% held by
financial institutions, 3% held by corporate directors, and 45% held by top-10
owners.
These features make it difficult for Japanese managers to exploit existing and
new shareholders by issuing equity and then wasting funds on negative net present
value projects. Therefore, a Japanese data set on SEOs allows us to directly
examine the agency and timing explanations for the poor subsequent performance
of issuers. It should be noted that the timing explanation doesn’t necessarily imply
that managers are knowingly selling overvalued equity, see Lee Ž1997..
To summarize the findings of this paper, the long-run stock return performance
for a comprehensive sample of 1389 Japanese SEOs during the 1971–1992 period
are as disappointing as the stock performance for U.S. SEOs. An equally weighted
portfolio of SEO firms produces a 3-year buy-and-hold return of 34% compared to
52% from an equally weighted portfolio of non-issuing firms of similar market
capitalization. Firm and offering characteristics such as size, length of time since
the IPO date, prior year stock return, new issue volume, and pre-issue firm growth
cannot explain the low stock returns for our SEO sample. Keiretsu affiliation and
ownership structure also fail to explain the underperformance. In contrast to
evidence from the U.S., our sample of issuers underperform in both ‘hot’ and
‘cold’ equity volume markets. Our findings offer guidelines for investors who can
short underperforming stocks, and for corporations who can raise funds at a low
cost of capital when stock prices are high.
Consistent with the poor stock performance, our Japanese SEO sample also
exhibits a significant post-issue decline in operating performance following the
new equity offering. This decline occurs both before and after adjusting for the
1
Our paper focuses on potential agency problems between managers and shareholders. Of course,
other possible agency problems may exist between various groups such as shareholders and creditors.
2
Porter Ž1992. suggests that Japanese firms focus more on measures of long-term performance such
as market-share, than ‘short-term’ measures such as stock prices.
matching firms’ operating performance. This finding is important. The rapid

subsequent decline in operating performance of various accounting ratios illus-
trates that the poor stock performance is not merely the result of a benchmark
problem from calculating abnormal stock returns.
According to the agency hypothesis of Jensen and Meckling Ž1976., firms with
higher agency costs should show relatively inferior operating performance. An
empirical prediction is that there will be a negative relation between the level of
agency costs prior to the issue and subsequent changes in performance. To actually
test this hypothesis, a free cash flow variable is used to measure the agency costs
of the issuing firm. In contrast to the U.S. evidence of McLaughlin et al. Ž1996.,
the regression results from Japanese SEOs fail to provide any support for the
agency hypothesis prediction. Moreover, there is little evidence that changes in
performance are in any way related to changes in incentive schemes resulting from
reduced managerial ownership or lowered ownership concentration following the
offering. One possible interpretation of our results is that the ‘windows of
opportunity’ or ‘timing’ hypothesis provides a more plausible explanation than the
agency theory justification for the new issues puzzle of Japanese SEOs.
It should be noted that this is not the only paper which examines subsequent
stock returns for Japanese SEOs. A concurrent working paper by Kang et al.
Ž1997. also documents low stock returns for a sample of 919 public and private
offerings of Japanese seasoned equity. Their paper reports that convertible bond
issuers also have low stock returns, but their paper does not examine the operating
performance surrounding the offerings.
The remainder of the paper is organized as follows. Section 2 describes the
sample of Japanese SEO firms and data sources. Section 3 documents the
post-issue long-run stock return underperformance. Section 4 presents evidence on
the deterioration in operating performance and provides a cross-sectional analysis
of the determinants of the post-issue performance changes. Finally, Section 5
concludes the paper.
2. Japanese SEO sample and data sources
The sample of seasoned equity offerings is obtained from the Needs Corporate
Action Related Data provided by Nihon Keizai Shimbun. 3 The Needs data
3
In Japan, new shares can be allocated differently to the existing and new shareholders than in the
U.S. New shareholders always pay the market price. The difference is mainly with respect to the
existing shareholders. For the 1389 SEOs in the sample, there are six different ways to allocate new
shares to the existing shareholders, i.e., market price, non-gratis, gratis, gratis and non-gratis, tie-in, and
preferred offerings.
include various offering information from 1963 to 1994. This study considers
those SEOs conducted on both sections of the TSE. The initial sample consists of
2304 primary offerings during the 1971–1992 period, excluding issuers from
banking, security, credit and leasing, real estate, and utilities Žgas and electricity.
industries. Our sample includes only public offerings of seasoned equity. The
issuers are required to have stock return data on the Pacific-Basin Capital Markets
ŽPACAP. tape and accounting information on the Needs Unconsolidated Annual
Corporate Financial Data.
Before continuing, it is necessary to highlight a potential problem with our
dataset. The PACAP tape does not contain any delisted or merged stocks during
the 1975–1989 period, and it shows only 4 delisted and 15 merged firms for the
period 1990–1993. However, this potential upward bias in stock returns will be
present for both our matching sample universe as well as the issuing firm sample.
Several additional data restrictions are implemented on the sample. To remove
small offerings from our sample, 120 issues with gross proceeds of less than 100
million yen ŽDec. 1992 yen. are excluded. In order to increase the independence of
statistical tests, SEOs that are within 5 years of a firm’s most recent offering are
also eliminated. Thus, once an issuing firm has entered the sample, it cannot
re-enter the sample until 5 years after the initial issue date. This restriction
excludes an additional 795 SEOs, leaving a total of 1389 SEOs in the final sample.
The final sample includes 987 firms involved in the final sample, among which
631 have issued once, 310 have issued twice, and 46 have issued three times.
The Needs Corporate Action Related Data provides detailed offering informa-
tion such as issue date, number of shares outstanding after the issue, number of
shares issued, and gross proceeds of the offering. 4 The Needs Unconsolidated
Annual Corporate Financial Data provides various accounting information sur-
rounding the offering such as total assets, fixed assets, total equity, depreciation,
sales, ordinary income, and operating income. The Needs accounting data also has
ownership information such as percentage of shares held by financial institutions,
corporate directors, and the top-10 shareholders.
The PACAP tape provides monthly returns and market capitalization for each
individual stock. It also provides returns on the TSE equally weighted market
portfolio. Due to the fact that the PACAP does not include stock returns prior to
1975, Daiwa Securities provides the monthly stock market data for the period from
1971–1974.
For the 1389 SEOs in the final sample, issuing firms sell a median of 9% of
total shares outstanding Žincluding the new shares issued.. The median gross
4
Although our data source does not provide information concerning whether the issue is a firm
commitment or best-efforts offering, firm commitment underwritten offers are the dominant underwrit-
ing method in Japan during the sample period. See Kunimura and Iihara Ž1985. for more details
regarding the underwriting agreements in the Japanese equity market.
proceeds are 2.9 billion yen ŽDec. 1992 yen. or US$23.3 million. The median
increase in total assets is 31% from 1 year before to 1 year after the offering.
Table 1 summarizes the median ratio of gross proceeds scaled by market value
and the median gross proceeds by calendar year ŽPanel A. and by Needs’ industry
classification ŽPanel B.. Most of the offerings occur in the 1972–1973, 1979–1981,
and 1989 periods. Compared to the new issue volume in the U.S., however, the
year-to-year variation in Japanese SEOs is much lower. Not surprisingly, given the
dramatic drop in Japanese financial markets, only eight offerings occurred during
the 1991–1992 period. Panel B reports that the sample size varies by industry
from 196 offerings in the electric and electronic equipment classification to 56
offerings from retail trade.
3. Post-issue stock return performance
3.1. Benchmark creation
Selecting the proper benchmark to measure long-run abnormal returns for a

sample is always problematic. To ensure that our results are not being driven by
potential benchmark problems, we employ six different benchmarks in measuring
abnormal returns. Our six benchmark are: Ž1. the equally weighted TSE market,
Ž2. equally weighted industry portfolios, Ž3. size-matched firms, Ž4. market-to-book
matched firms, Ž5. size and market-to-book matched firms, and Ž6. book assets
and industry matched firms. 5 Our justification for a single firm matching proce-
dure in four of the benchmarks comes from Barber and Lyon Ž1997.. The authors
document that when long-run buy-and-hold abnormal returns are calculated using
a reference portfolio composed of a number of stocks, the test-statistics are
negatively biased. Their documented bias is not present when abnormal returns are
calculated as the returns of a sample firm less the return of a single control firm.
The equally weighed market Žindustry. portfolios are constructed using all firms
Žfirms in the same industry as the issuing firm. in both sections of the TSE. For
the size-matched portfolio, each issuing firm is matched annually with a firm that
has not issued new shares during the past 5 years and has the closest market value
at the end of the issuing calendar month.
The procedure for matching by market-to-book ratio is the same except that the
market-to-book ratio for each fiscal year, including and following the issuing fiscal
year, is used instead. To control for both the size and market-to-book effects, a
non-issuer of the previous 5 years is chosen annually such that the absolute
5
Chan et al. Ž1991. find that size and market-to-book ratio are the two most important determinants
of cross-sectional stock returns in Japan.
percentage differences between sizes Žat the end of the issuing calendar month.
and market-to-book ratios Žfor each fiscal year including and following the issuing
year. are minimal.
The final benchmark involves matching by book assets and industry. A
non-issuer from the same industry is chosen at the time of the offering. The
matching firm has the closest book assets for the issuing fiscal year. For the four
firm-matched portfolios, if a chosen matching firm subsequently issues stock, a
second Žand, if necessary, third, fourth, etc.. matching firm is spliced in after the
issuing date of the first matching firm. Any possible replacement firm has the
closest size, market-to-book, etc. on the original ranking date. No look-ahead bias
is present in our matching procedures.
Buy-and-hold returns over 1-, 3- and 5-year windows are created by compound-
ing monthly returns on issuing firms and benchmark portfolios. Holding-period
returns are calculated starting from the end of the issuing month. Panel A of Table
2 reports the average buy-and-hold returns and wealth relatives for issuing firms
for 1-, 3- and 5-years after the offering. Over the 3-year window, the average
buy-and-hold return is 34% for issuing firms versus 52% for non-issuing firms of
similar market capitalization, with a wealth relative of 0.88. A wealth relative is
defined as the average gross buy-and-hold return for the issuing firms divided by
the average gross buy-and-hold return on the particular benchmark. Our docu-
mented underperformance is slightly weaker than the underperformance recorded
in the U.S. For example, using this same benchmark, Loughran and Ritter Ž1995.
report a 3-year wealth relative of 0.78. Spiess and Affleck-Graves Ž1995. report a
wealth relative of 0.88 during the 3 years after the seasoned offering using size
and industry matched benchmark.
Furthermore, Panel A reports that the underperformance is robust to alternative
benchmarks. Issuing firms significantly underperform all six benchmarks over
each of the 3- and 5-year holding periods. Issuing firms underperform by the most,
relative to the market-to-book-matched portfolio, with 3- and 5-year wealth
relatives being 0.84 and 0.75, respectively. The smallest degree of underperfor-
mance is found when using size and market-to-book matching firms, with respec-
tive 3- and 5-year wealth relatives of 0.92 and 0.86. 6
To examine when the underperformance occurs, Panel B of Table 2 reports the
annual returns for issuing firms and benchmarks for each of the 5 years following
the issue. The underperformance is most significant in the first 2 years after the
offering. For example, in the first year following the offering, SEOs have annual
returns of less than 10% compared to 15% or more for all of the benchmarks. The
6
The long-run performance for the 915 excluded SEOs is also examined. The conclusions are
remarkably similar. Relative to each of the six benchmarks, the underperformance is highly significant
over all three horizons. The 3-year wealth relatives range from 0.80 to 0.89. The 5-year wealth relatives
range from 0.72 to 0.83.
Table 2
Long-run stock returns for Japanese SEOs, relative to alternative benchmarks
Panel A: Post-issue long-run stock returns and wealth relatives
Stock return Ž%. Wealth relative
Benchmark portfolio 1-year 3-year 5-year 1-year 3-year 5-year
SEO firms 9.8 33.7 74.1
TSE ew 17.2 b 53.4 b 122.0 b 0.94 0.87 0.78
Industry ew 15.3 b 52.5 b 121.3 b 0.95 0.88 0.79
Size-matched 16.2 a 51.5 b 112.9 b 0.95 0.88 0.82
MrB-matched 19.1b 59.6 b 131.7 b 0.92 0.84 0.75
Size-and-MrB-matched 15.5 b 45.3 103.2 b 0.95 0.92 0.86
Book-assets-and-industry-matched 16.0 b 50.8 b 115.8 b 0.95 0.88 0.80
Panel B: Post-issue annual stock returns
1st year 2nd 3rd 4th 5th
SEO firms 9.8 9.1 13.9 18.8 14.5
TSE ew 17.2 b 13.3 b 13.9 19.6 19.1b
Industry ew 15.3 b 13.7 b 15.5 21.8 b 18.8 b
Size-matched 16.2 a 13.9 12.5 18.0 19.3 b
MrB-matched 19.1b 15.5 b 13.3 21.9 20.1a
Size-and-MrB-matched 15.5 b 11.0 11.5 17.4 16.7
Book-assets-and-industry-matched 16.0 b 14.3 b 14.7 22.0 21.8 b
Panel A summarizes the mean stock returns of post-issue 1-, 3- and 5-year buy-and-hold strategies and
wealth relatives for Japanese SEO firms in 1971–1992, relative to the following six benchmark
portfolios including the equally-weighted TSE index and industry portfolios, the size-, market-to-book-,
size-and-market-to-book-, and book-assets-and-industry-matched portfolios. Holding period returns are
measured from the end of the issuing month until whichever is earlier between either the 3-year
Ž5-year. anniversary of the SEO or December 1995, Žwhen the 1995 PACAP dataset ends.. Wealth
relatives are defined as the average gross buy-and-hold return on the issuing firms divided by average
gross buy-and-hold return on the benchmarks. For example, the 3-year wealth relative of 0.88 against
the size-matched portfolio is calculated as 133.7%r151.5%s 0.88. Panel B summarizes the mean
stock returns of post-issue annual buy-and-hold strategies. ‘‘ a ’’ and ‘‘ b ’’ indicate significant difference
in returns from the SEO firms at the 10 and 5% level, respectively. To take into account the
cross-sectional dependence of sample observations, the t-statistics are based on the estimated non-diag-
onal variance–covariance matrix as in Lyon et al. Ž1998..
geometric average annual return is 13% for issuing firms versus 16% for the
size-matched benchmark.
A common problem in event studies involving long-run abnormal returns is the
cross-sectional dependence in sample observations ŽBrav, 1998.. This can happen
either due to the calendar clustering of the events ŽSEOs in our case. or due to the
overlapping periods of return calculation for the same firm. Cross-sectional
dependence inflates test-statistics, since the number of sample firms overstates the
number of independent observations. We adopt the approach in Lyon et al. Ž1998.
to adjust for the cross-sectional dependence. Specifically, we estimate a non-diag-
onal variance–covariance for event-time abnormal returns and apply it to the

calculation of the t-statistics in Tables 2 and 5. The details of the procedure and
the Lyon et al. Ž1998. t-statistics are provided in Appendix A. The adjustment
does reduce the magnitude of the test-statistics Žconventional t-statistics available
upon request.. But the long-run underperformance of SEOs remain highly signifi-
cant. This procedure is also used by Jegadeesh Ž1998. to examine the effects of
benchmark errors and expectation biases on the long-run performance of SEOs in
the U.S.
3.2. Performance by firm size, length of time since IPO date, and prior year stock
return
Table 3 examines whether firm size, length of time since the initial offering, or
prior year stock return can explain the poor stock performance of our SEO sample.
For example, it may be that low returns on small firms are driving our empirical
results. Another possibility is that the low returns on IPOs Žwhich also do a
seasoned offering., can explain the poor stock performance. For U.S. firms, Welch
Ž1989. and Carter Ž1992. report that IPOs tend to conduct seasoned equity
offerings soon after going public. Panel A of Table 3 reports the long-run
performance of SEOs and size-based matching firms grouped by SEO market
capitalization.
During most of our sample period, the Japanese stock market continued its
rapid rise. In particular, the soaring stock market of the last half of the 1980s is
unprecedented. To minimize its impact on comparing market capitalization over
different calendar years, issuing firms are categorized into size groups based on
percentile ranking. Percentile ranking is defined as the number of firms with a
market capitalization less than the issuing firm divided by the total number of all
Notes to Table 3:
a
The breakpoints for size quartiles based on the percentile ranking of market capitalization are 38, 59
and 81% for the 3-year window and 40, 61, and 81% for the 5-year window.
b
The breakpoints for market-adjusted prior year stock return quartiles are y16, 6 and 34% for both the
3- and 5-year windows. Market return is the return on the equally-weighted TSE market portfolio.
This table summarizes the mean stock returns of post-issue 3- and 5-year buy-and-hold strategies for
Japanese SEO firms in 1971–1992, categorized by firm size, length of time since IPO date on the TSE,
and market-adjusted prior year stock return. Holding period returns are measured from the end of the
issuing calendar month until whichever is earlier between either the 3-year Ž5-year. anniversary of the
SEO or December 1995, Žwhen the 1995 PACAP dataset ends.. Matching firms are chosen annually
based on size. HPR refers to average holding period return in percent. The fraction underperforming is
the fraction of issuing firms whose holding period returns are less than their matched firms’ holding
period returns. ‘‘ c ’’ indicates significant difference from 0.5 at the 10% level; ‘‘ d ’’ indicates significant
difference from 0.5 at the 5% level.
Table 3
Long-run stock returns for Japanese SEOs, categorized by firm size, length of time since IPO date, and prior year stock return
J. Cai, T. Loughranr Pacific-Basin Finance Journal 6 (1998) 395–425

Panel A: Groups by firm size a
3-year 5-year
Sample SEO Matched Wealth Fraction SEO Matched Wealth Fraction
size %HPR firm %HPR relative underperform %HPR firm %HPR relative underperform
Smallest 348 31.3 54.4 0.85 0.53 85.1 115.4 0.86 0.50
2 347 40.9 59.1 0.89 0.54 71.1 133.3 0.73 0.55 c
3 347 33.3 50.5 0.89 0.54 70.0 111.6 0.80 0.56 d
Largest 347 29.3 41.8 0.91 0.52 70.0 91.3 0.89 0.56 d
Panel B: Groups by length of time since IPO date on the TSE
( 3 years 207 32.3 52.6 0.87 0.52 59.5 115.7 0.74 0.53
) 3 years 1182 33.9 51.3 0.89 0.54 d 76.6 112.4 0.83 0.54 d
( 5 years 248 31.2 50.5 0.87 0.52 58.9 112.9 0.75 0.54
) 5 years 1141 34.2 51.7 0.88 0.54 d 77.4 112.9 0.83 0.54 d
All 1389 33.7 51.5 0.88 0.53 d 74.1 112.9 0.82 0.54 d
Panel C: Groups by market-adjusted prior year stock returnb
Lowest 321 26.1 39.5 0.90 0.50 61.1 75.5 0.92 0.49
2 321 35.2 41.3 0.96 0.50 86.5 95.9 0.95 0.48
3 321 40.0 52.2 0.92 0.51 84.2 123.7 0.82 0.53
Highest 320 35.1 57.4 0.86 0.58 d 59.3 132.9 0.68 0.63 d
All 1283 34.1 47.6 0.91 0.52 c 72.8 107.0 0.83 0.53 d
405
Fig. 1. Volume of new issues on the TSE from 1971 to 1992. Panel A: Yen volume in terms of the
purchasing power of December 1992 Yen Žbillion.. Panel B: Yen volume scaled by total market
capitalization scaled volume Ž%..
firms present in that particular year. 7 Wealth relatives are less than 1 for all size
groups. In contrast to Loughran and Ritter Ž1997., smaller issues do not tend to
underperform more. We fail to reject the null hypothesis, that the smallest size
group has the same mean excess holding period return as the largest size group, at
the 10% level.
When our sample is divided into groups based on the length of time on the TSE
since the IPO date, no clear pattern emerges over a 3-year performance window.
Panel B of Table 3 shows that the wealth relative for firms listed on the TSE for
less than 3 years is 0.87 compared to 0.89 for firms with more than 3 years on the
7
The mean and median percentile ranking based on market value are 58 and 59%, respectively. The
mean and median market values are 114 and 35 billion yen ŽDecember 1992., respectively.
Table 4
Long-run stock returns for Japanese SEOs, categorized by real and scaled yen volume

Panel A: Groups by real yen volumea
3-year 5-year
size %HPR firm %HPR relative under-perform %HPR firm %HPR relative under-perform
Cold 174 47.2 87.2 0.79 0.60 d 84.1 128.1 0.81 0.55
Normal 506 43.1 72.5 0.83 0.56 d 93.4 154.4 0.76 0.58 d
Hot 709 23.7 27.7 0.97 0.50 57.9 79.6 0.88 0.51
Panel B: Groups by scaled yen volumeb
Cold 132 62.3 104.6 0.79 0.59 d 40.2 78.3 0.79 0.58 c
Normal 601 25.4 41.0 0.89 0.53 77.5 113.4 0.83 0.53
Hot 656 35.5 50.4 0.90 0.53 77.8 119.4 0.81 0.55d
All 1389 33.7 51.5 0.88 0.53 d 74.1 112.9 0.82 0.54 d
a
The breakpoints for the ‘cold’, ‘normal’ and ‘hot’ market periods using monthly real yen volume are 37 and 74 billion yen for both horizons.
b
The breakpoints for the ‘cold’, ‘normal’ and ‘hot’ market periods using scaled yen volume are 0.020 and 0.069% of the total market capitalization on the
TSE for both horizons.
This table summarizes the mean stock returns of post-issue 3- and 5-year buy-and-hold strategies for Japanese SEO firms in 1971–1992, categorized by real
and scaled yen volume on the TSE. Real yen volume is the monthly nominal volume measured in terms of the purchasing power of December 1992. Scaled
yen volume is the monthly nominal volume divided by the month-end total market capitalization on the TSE. Holding period returns are measured from the
end of the issuing calendar month until whichever is earlier between either the 3-year Ž5-year. anniversary of the SEO or December 1995 Žwhen the 1995
PACAP dataset ends.. Matching firms are chosen annually based on size. HPR refers to average holding period return in percent. The fraction
underperforming is the fraction of issuing firms whose holding period returns are less than their matched firms’ holding period returns. ‘‘ c ’’ indicates
significant difference from 0.5 at the 10% level; ‘‘ d ’’ indicates significant difference from 0.5 at the 5% level.
407
TSE. However, there is evidence that the underperformance is slightly more severe
for young SEO firms Žless than 3 years on the TSE. than it is for more seasoned
SEOs Žmore than 3 years on the TSE. over a longer horizon. Over the 5-year
horizon, both young and old SEOs underperform the size-matched firm bench-
mark.
Table 5
Long-run stock returns for Japanese SEOs, categorized by Keiretsu affiliation
Panel A: Post-issue long-run stock returns for 151 Keiretsu issuers
1-year 3-year 5-year 1-year 3-year 5-year
Benchmark portfolio Stock return Ž%. Wealth relative
SEO firms 6.1 20.9 68.4
TSE ew 15.9 a 50.8 b 125.5 b 0.92 0.80 0.75
Industry ew 15.2 a 47.9 b 119.9 b 0.92 0.82 0.77
Size-matched 12.7 35.1 74.3 0.94 0.89 0.97
MrB-matched 15.0 a 60.3 b 150.5 b 0.92 0.75 0.67
Size-and-MrB-matched 14.5 b 30.5 71.8 0.93 0.93 0.98
Book-assets-and-industry-matched 11.7 34.0 a 86.4 0.95 0.90 0.90
Panel B: Post-issue long-run stock returns for 1238 non-Keiretsu issuers
SEO firms 10.3 35.2 74.8
TSE ew 17.4 b 53.7 b 121.6 b 0.94 0.88 0.79
Industry ew 15.4 b 53.1b 121.5 b 0.96 0.88 0.79
Size-matched 16.6 a 53.5 b 117.6 b 0.95 0.88 0.80
MrB-matched 19.6 b 59.5 b 129.4 b 0.92 0.85 0.76
Size-and-MrB-matched 15.6 a 47.0 107.0 a 0.95 0.92 0.84
Book-assets-and-industry-matched 16.5 b 52.8 b 119.4 b 0.95 0.88 0.79
Panel C: t-statistics for the difference in benchmark adjusted excess returns between Keiretsu and
non-Keiretsu issuers
Difference in excess return Ž%. t-statistic
TSE ew y2.6 y11.5 y10.3 y0.44 y1.07 y0.69
Industry ew y4.0 y9.1 y4.8 y0.70 y0.90 y0.33
Size-matched y0.2 4.0 36.9 y0.04 0.41 1.87 a
MrB-matched 0.4 y15.2 y27.4 0.07 y1.27 y1.75a
Size-and-MrB-matched y3.1 2.1 28.8 y0.57 0.23 1.57
Book-assets-and-industry-matched 0.8 5.0 27.2 0.17 0.82 1.51
Panels A and B summarize the mean stock returns of post-issue 1-, 3- and 5-year buy-and-hold
strategies and wealth relatives for Japanese SEO firms in 1971–1992, categorized by Keiretsu
affiliation. Panel C tests for the difference in benchmark adjusted excess returns between Keiretsu and
non-Keiretsu issuers for each of the six benchmark portfolios in Table 2. Holding period returns are
measured from the end of the issuing month until whichever is earlier between either the 3-year
Ž5-year. anniversary of the SEO or December 1995, Žwhen the 1995 PACAP dataset ends.. ‘‘ a ’’ and
‘‘ b ’’ indicate significant difference in returns from the SEO firms at the 10 and 5% level, respectively.
To take into account the cross-sectional dependence of sample observations, the t-statistics are based
on the estimated non-diagonal variance–covariance matrix as in Lyon et al. Ž1998..
Panel C of Table 3 reports the performance of SEO firms categorized by prior

year stock return, adjusted for the return on the equally weighted TSE market
portfolio. The lowest group has an average prior year return of y37% compared
to 86% for the highest group. Over the 3- and 5-year horizon, all groups
underperform the benchmark. Yet, the evidence shows that the highest prior return
group does slightly worse than the other groups.
3.3. Performance categorized by ‘hot’, ‘normal’ and ‘cold’ issue markets
Market conditions around the offering may influence a firm’s decision whether
or not to issue new shares. Choe et al. Ž1994. use macroeconomic criteria to define
different market periods and document that U.S. equity issues cluster in business
cycle expansions. More recently, Bayless and Chaplinsky Ž1996. identify ‘cold’
and ‘hot’ issue markets using real and scaled dollar volume and conclude that
there are few overlaps between the ‘cold’ issue markets and economic recessions.
Similarly, we classify the Japanese market by two measures of total issue
volume: real and scaled yen volume. Real yen issue volume is the monthly,
nominal yen volume measured in terms of December 1992 purchasing power.
Scaled yen volume is the monthly nominal yen volume divided by the month-end
total market capitalization on the TSE. Fig. 1 plots the monthly real ŽPanel A. and
scaled ŽPanel B. yen issue volume using a total of 2836 new industrial issues,
including IPOs, SEOs, and rights issues, on the TSE during the 1971–1992 period.
It is clear from the figure that the early 1970s, the early 1980s, and the late 1980s
are the three ‘hot’ issue markets.
The ‘hot’ volume market of the early 1970s is, to a large extent, associated with
the successful introduction of the public offering method in 1969 by the Japanese
Ministry of Finance. In the late 1980s, the sharp increases in stock prices may
Notes to Table 6:
a
The breakpoints are for the bottom 30, middle 40 and top 30% of the values of the grouping variable.
For both the 3- and 5-year windows, the cutoffs for the quartile groups by holdings of financial
institutions are 17, 26 and 39%, respectively.
b
For both the 3- and 5-year windows, the cutoffs for the quartile groups by holdings of corporate
directors are 1, 3 and 10%, respectively.
c
For both the 3- and 5-year windows, the cutoffs for the quartile groups by holdings of top-10 owners
are 37, 45 and 56%, respectively.
This table summarizes the mean stock returns of post-issue 3- and 5-year buy-and-hold strategies for
Japanese SEO firms in 1971–1992, categorized by shareholdings of financial institutions, corporate
directors, and top-10 owners as of the offering date Žyear 0.. Holding period returns are measured from
the end of the issuing calendar month until whichever is earlier between either the 3-year Ž5-year.
anniversary of the SEO or December 1995 Žwhen the 1995 PACAP dataset ends.. Matching firms are
chosen annually based on size. HPR refers to average holding period return in percent. The fraction
underperforming is the fraction of issuing firms whose holding period returns are less than their
matched firms’ holding period returns. ‘‘ d ’’ indicates significant difference from 0.5 at the 10% level;
‘‘ e ’’ indicates significant difference from 0.5 at the 5% level.
410
Table 6
Long-run stock returns for Japanese SEOs, categorized by post-issue holdings of financial institutions, corporate directors, and top-10 owners

Panel A: Groups by shareholdings of financial institutionsa
3-year 5-year
size %HPR firm %HPR relative underperform %HPR firm %HPR relative underperform
Lowest 303 43.0 56.6 0.91 0.55d 85.8 125.4 0.82 0.54
2 303 41.8 57.7 0.90 0.51 81.0 122.9 0.81 0.52
3 303 32.5 60.7 0.82 0.58 e 72.5 134.7 0.73 0.57 e
Highest 302 26.3 33.4 0.95 0.51 62.5 84.2 0.88 0.54
Panel B: Groups by shareholdings of corporate directorsb
Lowest 303 28.6 42.9 0.90 0.56 e 65.8 95.3 0.85 0.54
2 303 34.7 58.4 0.85 0.55d 84.5 143.6 0.76 0.56 e
3 303 40.2 53.6 0.91 0.50 81.8 123.7 0.81 0.54
Highest 302 40.0 53.6 0.91 0.54 69.8 104.7 0.83 0.54
All 1211 35.9 52.1 0.89 0.54 e 75.5 116.8 0.81 0.55e
Panel C: Groups by shareholdings of top-10 owners c
Lowest 247 25.7 48.2 0.85 0.56 d 75.7 117.9 0.81 0.53
2 246 39.5 50.6 0.93 0.54 74.1 109.8 0.83 0.56 d
3 246 37.9 63.3 0.84 0.57 e 58.0 124.1 0.70 0.61e
Highest 245 40.5 54.5 0.91 0.54 77.3 110.0 0.84 0.52
All 984 35.9 54.1 0.88 0.55e 71.3 115.4 0.79 0.56 e
have given firms strong incentives to raise additional capital. Notice the dramatic
increase in real yen volume in 1989 prior to the collapse of the Japanese stock
market. The discrepancy between real and scaled yen volume in the late 1980s is
mainly due to the unprecedented stock price surge at that time.
Table 4 categorizes the 1389 SEOs into ‘cold’, ‘normal’ or ‘hot’ volume
markets. The break points are based on the top 30%, middle 40% and bottom 30%
of the real and scaled yen issue volume, respectively. Panel A reports the groups
by real yen volume, while Panel B presents the groups by scaled yen volume.
Underperformance is evident for all market periods. Over the 3-year horizon,
issues in the ‘cold’ market have a significantly lower mean excess holding period
return and a higher fraction of underperforming firms than issues in the ‘hot’
market. The performance difference is not significant over the 5-year horizon.
Our evidence in Table 4 is in sharp contrast to the U.S. where issues in the
‘hot’ volume markets fare substantially worse over the long-run. As shown in
Table VIII of Loughran and Ritter Ž1995., new issues in light issue-volume
periods have no statistically significant underperformance. For U.S. firms, it
appears that the most severe underperformance occurs following high volume
periods.
The poor performance of Japanese SEOs is also present using a different
definition of ‘hot’ and ‘cold’ volume markets. For example, classifying different
market periods by the 3-month moving average of monthly returns on the TSE
equally weighted market portfolio or by quarterly growth rate of seasonally-ad-
justed real GNP, the three groups still have low stock returns. Hence, there is no
significant difference in the degree of underperformance across different market
periods. 8
3.4. Performance by Keiretsu affiliation and ownership structure
A unique feature of Japanese industrial organization is the existence of inter-

market business groups or Keiretsu affiliations. These groups are bound by
reciprocal shareholding, lender–borrower and buyer–seller relations. The Keiretsu
affiliation may create a greater mechanism to resolve the conflict of interests
8
Loughran et al. Ž1994. exposit two popular explanations for the variation of volume over time.
First, the cost of raising equity changes over time and managers issue equity when the cost is low Žthe
stock price is high.. Second, the growth opportunities Žfuture cash flows. change over time due to
business cycle effects. To examine these two explanations, annual real and scaled yen volumes
constructed from 1389 SEOs in the sample are regressed on contemporaneous and lagged market
returns on the TSE and 1- and 2-year ahead real growth of GNP. While the coefficients on
contemporaneous and lagged market returns are reliably positive, none of them are significant. Real
growth in GNP explains even less variation in SEO volumes.
Table 7
Operating performance of Japanese SEO firms
Year relative to SEO fiscal year
From From From From
Operating performance Ž%. y3 to y1 y1 to q1 y1 to q3 y1 to q5
Panel A: Ordinary incomer total assets
Median level in year y3
raw s 5.16, adjusteds 0.59
Median change 0.71b y0.40 b y1.37 b y1.47 b
Median matching-firm-adj. change y0.03 y0.10 b y0.39 b y0.77 b
Observations 1307 1355 1324 1165
Panel B: Operating incomer total assets

raw s10.32, adjusteds 0.24
Median change 0.36 b y0.91b y1.97 b y2.67 b
Median matching-firm-adj. change y0.07 y0.31b y0.46 b y0.95 b
Observations 1307 1355 1325 1163
Panel C: Operating cash flowr total assets

raw s 5.04, adjusteds 0.10
Median change 0.48 b y1.37 b y1.42 b y1.86 b
Median matching-firm-adj. change 0.08 y0.27 b y0.29 y0.19
Observations 1223 1243 1229 1101
Panel D: Growth rate of capital expenditure

Median change y3.64 4.38 y16.78 b y3.66 b
Median matching-firm-adj. change y4.39 y3.14 y3.82 y6.79 a
Observations 959 1004 904 808
Panel E: Growth rate of net sales

raw s12.14, adjusteds1.58
Median change 1.81b y3.03 b y7.49 b y9.35 b
Median matching-firm-adj. change 0.51 y1.51b y2.31b y2.54 b
Observations 1199 1213 1192 1080
Panel F: Growth rate of operating income

Median change 7.95 b y21.99 b y21.93 b y23.41b
Median matching-firm-adj. change 5.18 b y9.89 b y5.89 b y8.31b
Observations 1093 1153 1072 979
between shareholders and managers. In the case of SEOs, managers in firms with
Keiretsu affiliation may find it difficult to raise funds and then waste the money
on negative net present value projects. Therefore under the agency hypothesis, one
would expect Keiretsu issuers to underperform by less than non-Keiretsu issuers.
Based on the classification of Nakatani Ž1984., 151 SEOs in our sample are
identified to be conducted by firms belonging to a Keiretsu group. Panels A and B
of Table 5 report the long-run stock returns and wealth relatives for Keiretsu and
non-Keiretsu issuers, respectively. Keiretsu and non-Keiretsu issuers have wealth
relatives less than one compared to the six benchmark portfolios during the 3 and
5 years after the offering. Panel C of Table 5 formally tests for the difference in
mean excess returns between the Keiretsu and non-Keiretsu issuers. Almost all of
the t-statistics are insignificant. Thus, the predicted lower agency costs for
Keiretsu firms does not translate into better subsequent stock performance com-
pared to the non-Keiretsu firms.
Michaely and Shaw Ž1994. and Badrinath et al. Ž1995. argue that institutional
investors are informed investors. Field Ž1996. recently finds support for the
hypothesis that institutional investors have the ability to predict the quality of IPOs
and to avoid those IPOs that will subsequently perform poorly. Prowse Ž1992.
documents that Japanese firms exhibit much higher degrees of ownership concen-
tration than U.S. firms do. Financial institutions predominate among the top five
shareholders. In the case of Japanese SEOs, there is significant variation in the
level of holdings by these informed investors at the time of the issue. For example,
the maximum and minimum holdings by financial institutions in year 0 are 72 and
0.6%, respectively. The median holdings are 26%.
Panel A of Table 6 examines the performance of issuers in quartile groups
categorized by the holdings of financial institutions in the offering year. If
financial institutions are indeed better informed investors, one would expect the
highest group to perform better than the lowest quintile in the long-run. Our results
suggest that although wealth relatives are indeed larger for the highest group, the
difference is not significant statistically. A potential explanation is that financial
institution ownership of Japanese common stocks is usually motivated by business
relationships on a long-term basis and the desire to monitor corporate policy. This
Notes to Table 7:
Median changes in raw and matching-firm-adjusted operating performance are reported for Japanese
SEO firms over the period 1971–1992. Operating performance measures include ordinary income,
operating income and operating cash flow relative to total assets, growth rates of capital expenditure,
net sales and operating income. Growth rate of capital expenditure is calculated from a smoothed,
2-year average of annual expenditure. The changes in operating performance are measured from years
y3 to y1, and y1 to q1, q3 and q5, relative to the offering fiscal year 0. ‘‘ a ’’ indicates
significance at the 10% level; ‘‘ b ’’ indicates significance at the 5% level. The significance levels are
based on the Wilcoxon signed rank test, which assumes that observations are independent.
is in contrast to the U.S. where ownership by institutional investors is motivated

by the investment performance of the stocks. 9
For corporate directors, the maximum and minimum holdings in the SEO
sample are 50 and 0.03%, respectively. The median corporate director holding is
3%. Panel B of Table 6 examines the performance of issuers in quartile groups by
holdings of corporate directors as of the offering year. Corporate directors hold
less than 1% in the lowest group and more than 10% in the highest group. The
results suggest that wealth relatives are essentially the same. The tests for the
equality of mean excess returns in the lowest and highest groups are not rejected
for both horizons.
In Panel C, SEOs are grouped by the holdings of top-10 shareholders, which is
a measure of ownership concentration. Consistent with our other results on
ownership structure, there is no significant difference in the degree of underperfor-
mance between SEOs with low and high ownership concentration. To take into
account the changes in ownership structure over the two decades of the sample
period, the same tests are performed for the 1971–1979 and 1980–1992 sub-peri-
ods, respectively. Again, SEOs underpeform in all the subgroups categorized by
ownership structure, with no significant difference between them.
4. Operating performance of SEO firms

The long-term downward drift of stock returns naturally leads to questioning
the issuing firms’ profitability. After all, stocks are entitlements to a firm’s future
cash flows. If managers take advantage of inflated stock prices to sell new shares,
one would anticipate strong accounting-based operating performance at the time of
the offering. Corresponding to the poor long-run stock performance of our sample,
the operating performance should decline after the offering. This section investi-
gates the operating performance of Japanese SEOs in the years surrounding the
offering. In addition, this section will test whether the agency or the timing
hypothesis can better explain the performance deterioration of Japanese SEOs.
Following earlier studies, median values and median changes for a number of
operating measures are reported. Our measures of operating performance include
ordinary income, operating income, operating cash flow scaled by total assets or
net sales, growth rates of capital expenditure, net sales, and operating income.
Ordinary income is operating income minus depreciation plus interest income and
expenses before taxes. Operating cash flow is operating income less capital
expenditure. To proxy for the agency costs of the firm, a free cash flow measured
9
Field Ž1996. uses the Securities and Exchange Commission’s definition of the 13f institutional
investors. A 13f institutional investment manager is one ‘‘exercising discretion over accounts with
combined equity assets exceeding US$100 millions’’. The institutional investors in the U.S. include
many mutual funds and pension funds that are mostly concerned with the investment performance of
their stocks.
is also created. Following Lang and Litzenberger Ž1989. and others, free cash flow
is defined to be operating income minus interest expense, taxes, and dividend
payments. 10
4.1. A time-series analysis of operating performance
Table 7 reports the median changes and Wilcoxon signed rank tests for both the
raw and matching-firm-adjusted operating performance. For each issuing firm, a
matching firm that has not issued new shares during the past 5 years and has the
closest operating performance Žoperating income relative to total assets. is chosen
annually from the same industry. 11 This procedure follows the suggestion of
Barber and Lyon Ž1996. that a mean-reversion benchmark based on matching both
the industry and pre-event performance reduces potential biases in the test-statis-
tics. Freeman et al. Ž1982. show that there is a mean-reversion tendency in these
operating measures.
Panel A of Table 7 reports that median changes in raw ordinary income relative
to total assets are 0.71% from years y3 to year y1, and y0.40, y1.37 and
y1.47% from year y1 to years q1, q3 and q5, respectively, all being highly
significant. The matching-firm-adjusted numbers show a similar post-issue de-
cline. Using the same performance measure from ordinary income, the median
changes in adjusted numbers are y0.10, y0.39 and y0.77%, respectively, over
the three post-issue windows. The magnitude of the post-issue decline is smaller
than that for Japanese IPO firms reported in Cai et al. Ž1997.. Compared to U.S.
SEOs, the post-issue decline is also smaller. This largely reflects the fact that the
TSE-listed Japanese SEOs tend to be large, well-established firms. Using operat-
ing income or operating cash flow relative to total assets, the pattern remains
highly significant. 12
Panels D, E and F of Table 7 examine the growth of capital expenditure, net
sales and operating income for SEO firms. All three growth rates show significant
declines after the offering. In particular, the post-issue decline in the growth rate
of operating income stands in sharp contrast to its pre-issue rise.
10
Barber and Lyon Ž1996. favor the use of operating income because it is a cleaner measure of the
productivity of operating assets than earnings. They also suggest that for new issue firms, profitability
should be measured relative to net sales since issuing firms involve large increases in book assets with
no commensurate increases in operating incomes immediately after the issue. For Japanese SEOs, the
results using ordinary or operating incomes relative to net sales are similar.
11
Matching firms chosen based on alternative performance measures in year y1 such as operating
income relative to net sales, or ordinary income relative to total assets Žnet sales. yield similar results.
12
The operating pattern of 915 excluded issues is also examined. The conclusions remain unchanged.
Raw ordinary and operating incomes relative to total assets significantly declines by 1.35 and 1.92%,
respectively, from years y1 to q3. The matching-firm-adjusted measures significantly decline by 0.85
and 0.81%, respectively.
Fig. 2. The evolution of operating performance measures. Panel A: ordinary incomertotal assets Ž%..
Panel B: operating incomertotal assets Ž%..
Fig. 2 provides an event year by event year comparison of the operating

performance for SEOs and their matching firms in the years surrounding the
offering. The SEOs generally have increasing profitably levels prior to the
offering, followed by disappointing operating ratios after the equity offering. For
example, in Panel A of Fig. 2, the median ordinary incomertotal assets increases
from 5.1% five years before the offering to 6.5% in the year before the issue. This
Notes to Table 8:
Median changes in raw and matching-firm-adjusted operating performance are compared for Japanese
SEO firms, split by Keiretsu affiliation, and post-issue Žyear q1. holdings of financial institutions,
corporate directors and top-10 owners. Operating performance is measured by operating income
relative to total assets. The changes in operating measures are from years y1 to q1 and q3,
respectively, relative to the offering fiscal year 0. ‘‘ a ’’ indicates significance at the 10% level; ‘‘ b ’’
indicates significance at the 5% level. The significance levels for median changes are based on the
Wilcoxon signed rank test. The significance levels for Z-statistics are based on the Wilcoxon
two-sample signed rank test, which assumes that the observations are independent.
Table 8
Operating performance of Japanese SEO firms, split by Keiretsu affiliation, and post-issue holdings of financial institutions, corporate directors and top-10
owners

Panel A: Groups by Keiretsu affiliation
Operating performance, % Fiscal year y1 to q1 Fiscal year y1 to q3
Žoperating incomertotal assets. Keiretsu Non-Keiretsu Z-statistic Keiretsu Non-Keiretsu Z-statistic
Median change y0.43 b y0.95 b y0.57 y1.09 b y2.05 b y1.87 a
Median matching-firm-adj. change 0.13 y0.35 b y0.36 0.02 y0.58 b y1.79 a
Panel B: Groups by holdings of financial institutions, post-issue medians 28%
- median 0 median - median 0 median
holdings holdings Z-statistic holdings holdings Z-statistic
Median change y0.90 b y0.78 b 0.41 y2.01b y1.85 b 0.55
Median matching-firm-adj. change y0.31b y0.44 b y0.58 y0.79 b y0.40 b 0.70
Panel C: Groups by holdings of corporate directors, post-issue medians 3%
Median change y0.81b y0.85 b y0.33 y1.68 b y2.14 b y1.37
Median matching-firm-adj. change y0.26 b y0.47 b y0.64 y0.24 b y0.99 b y1.88 a
Panel D: Groups by holdings of top-10 owners, post-issue medians 45%
Median change y0.72 b y0.95 b y0.87 y1.56 b y2.07 b y1.21
Median matching-firm-adj. change y0.44 b y0.26 b 0.38 y0.29 b y0.81b y0.97
417
pattern is consistent with the fact that more profitable and successful firms are
better able to offer new shares to the public. The same trend of improving
profitability prior to the offering is present in U.S. SEOs wsee McLaughlin et al.
Ž1996. and Loughran and Ritter Ž1997.x. However, by the third year after the
offering, the median ordinary incomertotal assets is only 4.8%. The same inverted
U-shaped pattern also exists when operating incomertotal assets ŽPanel B. is
examined. Non-issuing matching firms also exhibit a pattern of declining prof-
itability after the offering. But the matching firm decline is smaller in magnitude
compared to the SEOs.
4.2. Keiretsu affiliation, ownership structure, and operating performance
One possible explanation for the post-issue decline in profitability is the agency
theory hypothesis proposed by Jensen and Meckling Ž1976.. New equity issues
often decrease the proportion of equity owned by managers thereby diminishing
manager’s incentives for value maximization. Jain and Kini Ž1994. find evidence
that U.S. IPOs with low levels of retained managerial ownership exhibit relatively
inferior performance after the offering. 13 To examine whether Keiretsu affiliation
or ownership structure is important in explaining the post-issue decline in operat-
ing performance, our SEO sample is split into two groups based on each of the
following variables: a Keiretsu dummy, and the median value of post-issue
percentage holdings of financial institutions, corporate directors, and top-10
shareholders.
Panel A of Table 8 shows that the results are mixed when SEOs are grouped by
the Keiretsu affiliation. From year y1 to q1 relative to the offering fiscal year,
the matching-firm-adjusted median change of 0.13% is insignificant for Keiretsu
issuers, whereas the corresponding median change of y0.35% is significant for
non-Keiretsu issuers. However, Wilcoxon two-sample Z-statistic reveals that the
difference between these two types of issuers is not significant. From year y1 to
q3, the difference is significant at the 10% level only. Overall, there is some
evidence that the deterioration of post-issue performance is less pronounced for
Keiretsu issuers.
Panels B, C and D compare median changes for SEOs grouped by percentage
holdings of management and non-management insiders including financial institu-
tions, corporate directors and top-10 owners. For each of these three grouping
variables, while both groups display a similar post-issue decline, the difference is
not significant based on the Wilcoxon two-sample signed rank test. Therefore, the
13
SEOs typically experience much less of a reduction in managerial ownership than IPO firms.
Specifically, the median decreases of 0.3% in the holdings of corporate directors from one year before
to one year after the offering for Japanese SEOs is much smaller than the corresponding 5% decrease
for Japanese IPOs.
poor performance following SEOs cannot be attributed to the changes in owner-

ship structure which lead to inferior incentive schemes for creating shareholder
wealth.
4.3. Determinants of the post-issue performance decline
So far this paper has examined the median changes and levels in operating
performance surrounding the seasoned offering. While interesting, these results do
not provide information on the determinants of the cross-sectional variation in
post-issue performance. This section further investigates the potential explanations
for the deterioration of post-issue profitability by employing the same cross-sec-
tional approach used in Holthausen and Larcker Ž1996. and Mikkelson et al.
Ž1997.. The primary measures of the change in performance are matching-firm-ad-
justed ordinary and operating income relative to total assets between year y1 and
years q1 and q3. The regression results are similar when ordinary and operating
income are scaled by net sales.
The independent variables include: Ž1. shares offered as a percentage of total
shares outstanding after the issue, Ž2. changes in the holdings of financial
institutions, corporate directors, and top-10 shareholders from years y1 to q1,
Ž3. post-issue Žyear q1. holdings of these three categories by management and
nonmanagement insiders, Ž4. matching-firm-adjusted free cash flow relative to
total assets in year y1, Ž5. growth rate of total assets from years y1 to q1, Ž6.
matching-firm-adjusted operating performance in year y1, Ž7. change in match-
ing-firm-adjusted operating performance from years y2 to y1, Ž8. natural log of
book value of total assets as of December 1992, and Ž9. a dummy variable for
Keiretsu affiliation. 14
The variables measuring the changes in organizational structure are the percent-
age of shares offered and post-issue levels and changes in equity owned by
management and non-management insiders. The level of free cash flow in year
y1 proxies for the agency costs of the issuing firm prior to the offering. The
agency hypothesis predicts a negative relation between the level of free cash flow
and subsequent change in performance. Asset growth proxies for investment in
fixed assets. There should be a positive relation between asset growth and change
in profitability. To control for both the level and run-up in pre-issue performance,
the operating measure in year y1 and the change in operating measure from years
y2 to y1 are included. The natural log of book value of assets controls for a
possible size effect. Finally, a dummy variable is included to capture any Keiretsu
affiliation.
Regression results in Table 9 indicate that changes in operating performance are
significantly negatively related to the level of performance prior to the issue, and
14
Not all ownership variables for three categories of insiders are included in one regression to avoid
multicolinearity problems.
Table 9
Regressions of matching-firm-adjusted operating performance on offering and firm characteristics
Change in operating performance from years i to j
y1 to q1 y1 to q3 y1 to q1 y1 to q3
Regressors Ordinary incomerassets Operating incomerassets
Intercept y0.02 y0.02 y0.03 y0.01
Žy1.11. Žy0.65. Žy1.47. Žy0.44.
Percentage of y0.04 y0.09 0.01 y0.06
shares offered Žy0.77. Žy1.27. Ž0.12. Žy0.90.
Post-issue directors’ 0.03 y0.02 0.02 0.01
ownership in year q1 Ž1.11. Žy0.59. Ž1.12. Ž0.11.
Change in directors’ 0.05 y0.02 0.10 0.06
ownership Žy1 to q1. Ž1.04. Žy0.28. Ž2.33. b Ž1.22.
Adjusted free cash 0.02 0.18 0.07 0.41
flowrassets in year y1 Ž0.26. Ž1.60. Ž0.47. Ž3.35. b
Asset growth 0.01 0.01 0.01 y0.01
from years y1 to q1 Ž1.82. a Ž0.84. Ž0.27. Žy0.14.
Pre-issue adjusted y0.18 y0.29 y0.20 y0.28
performance in year y1 Žy3.93. b Žy5.41. b Žy2.70. b Žy5.28. b
Change in pre-issue adj. y0.33 y0.44 y0.13 y0.46
performance Žy2 to y1. Žy7.06. b Žy7.80. b Žy1.02. Žy3.16. b
Natural log of book 0.01 0.01 0.01 0.01
value of assets Ž1.40. Ž1.04. Ž1.58. Ž0.54.
Keiretsu dummy y0.01 y0.01 y0.01 y0.01
Žy0.81. Žy0.71. Žy0.74. Žy0.10.
F-statistic 9.23 13.26 3.39 5.97
p-value 0.00 c 0.00 c 0.00 c 0.00 c
Adjusted R 2 0.08 0.12 0.02 0.05
Observation 855 832 855 833
This table reports cross-sectional regressions of changes in matching-firm-adjusted operating perfor-

mance on firm and offering characteristics. The dependent variables are the changes in adjusted
ordinary and operating incomes relative to total assets from years y1 to q1 and q3, respectively. The
independent variables include percentage of shares offered, post-issue directors’ ownership in year q1,
change in directors’ ownership from years y1 to q1, adjusted free cash flowrassets in year y1, asset
growth from years y1 to q1, pre-issue adjusted performance in year y1, change in pre-issue adjusted
performance from years y2 to y1, natural log of book value of total assets in terms of the purchasing
power of December 1992, and Keiretsu dummy. t-statistics are in parentheses. The standard errors have
been adjusted for heteroskedasticity using the method described in White Ž1980., when homoskedastic-
ity of error terms is rejected. ‘‘ a ’’ indicates significance at the 10% level and ‘‘ b ’’ indicates
significance at the 5% level. ‘‘ c ’’ indicates rejection of the null hypothesis that all the independent
variables are zero.
significantly negatively related to the run-up in performance prior to the issue. In

other words, the higher the pre-issue level of profitability, and the larger the
pre-issue run up, the greater the post-issue decline. The post-issue levels or
changes in ownership by management and nonmanagement insiders are not
associated with subsequent changes in performance, nor is the Keiretsu dummy

variable. In contrast to McLaughlin et al. Ž1996., the proxy for agency costs, free
cash flow, is not significant. The regression results therefore do not support the
agency hypothesis.
5. Conclusion
One anomaly in corporate finance that has recently received attention is the
economically significant, long-run underperformance of new equity issues. While
the evidence in the U.S. has been mounting, its interpretation remains controver-
sial. This paper provides international evidence by focusing on the Japanese SEO
market. For 1389 SEOs conducted on the TSE during the 1971–1992 period, the
long-term downward drift is similar to that of new issues in other large and
sophisticated capital markets, such as the U.S. and the U.K. A strategy of
investing an equal amount in each SEO firm for 5 years after the offering produces
an average return of 13% versus an average return of 16% from investing an equal
amount in a non-issuing firm with a similar market capitalization. The post-issue
operating performance of the SEO sample is also poor. Within 5 years after the
offering, the median of operating income scaled by total assets for SEO firms
drops from 11.2 to 8.4%, while the corresponding median for matching firms only
drops from 10.9 to 9.2%.
Compared to U.S. firms, Japanese companies are characterized by a higher
level of shareholding by financial institutions and other large stable shareholders.
This ownership structure potentially allows Japanese firms to circumvent the
incentive and asymmetric information problems associated with the typical U.S.
firm. Yet, both the stock and operating performance of our Japanese sample is
poor compared to non-issuers.
To test possible agency explanations of the poor performance, we examine
whether cross-sectional variation in changes in post-issue performance is related to
the level of agency costs prior to the issue and to ownership variables that proxy
for changes in organizational incentives taking place around the time of the
offering. Our evidence is inconsistent with the predication of the agency hypothe-
sis. We find no relation between pre-issue level of free cash flow and subsequent
decline in profitability. The ownership variables are also not statistically signifi-
cant. Hence the results from the Japanese SEO market offer evidence consistent
with the ‘windows of opportunity’ hypothesis for the downward drift following
the seasoned offering.
Acknowledgements
We wish to thank Shigeo Aoki, Warren Bailey Žthe editor., Kalok Chan, K.C.
Chan, Murray Frank, S. Ghon Rhee, Vidhan Goyal, Todd Houge, Chuan-Yang
Hwang, Robert Korajczyk, Ann Sherman, Gopala Vasudevan, K.C. John Wei,
Takeshi Yamada, an anonymous referee and seminar participants at Hong Kong
University of Science and Technology and 1997 Financial Management Associa-
tion European Conference in Zurich for helpful comments. We are particularly
grateful to Jay Ritter who provided valuable comments that have significantly
improved the paper. We also thank Lucy Hyatt and Virginia Unkefer for their
editorial assistance. Financial support from RGC Competitive Earmarked Research
Grants for 1994–1996 and 1996–1998 is gratefully acknowledged.
Appendix A
This appendix documents the method for estimating the variance–covariance

matrix of event–time abnormal returns as in Lyon et al. Ž1998.. To test for the
significance of long-run abnormal returns, the conventional t-statistic is calculated
as
AR
ts ,
s Ž AR t . r'n
where AR t is the sample mean of buy-and-hold abnormal returns, s ŽAR t . is the

cross-sectional standard deviation from a sample of n issuers, and t is the 1-, 3-
or 5-year holding period. The conventional t-statistic assumes that the variance–
covariance matrix of event–time abnormal returns Ž S . is diagonal, and the
cross-sectional standard deviation is the estimate for the n diagonal elements. In
the matrix form, the conventional t-statistic is given by
AR t
ts ,
(v Sv
ˆ X
where v s Ž1rn, . . . ,1rn. is an n = 1 column vector, Sˆ is the estimated vari-

ance–covariance matrix with diagonal elements only.
Following Lyon et al. Ž1998., the non-diagonal variance–covariance matrix is
estimated as follows. Consider two firms: the first firm Ž i . has an abnormal return
calculated from period s to s q m , the second firm Ž j . has an abnormal return
calculated from period s q a to s q m q a. If a 0 m , the covariance between the
abnormal returns is zero. If a - m , the Ž i, j .-th element of the variance–covariance
matrix Ž si j . is estimated as
sq m
1
sˆi j s Ý Ž AR i t yAR i . Ž AR jt yAR j . ,
myay1 tssqa
Table 10
Lyon et al. Ž1998. t-statistics corresponding to Table 2
Panel A: Post-issue long-run stock returns for 1389 SEOs
1-year 3-year 5-year
TSE equal weight 3.25 3.95 6.51
TSE industry 3.11 5.21 9.21
Size adjusted 1.84 2.25 3.59
BrM adjusted 2.92 3.26 4.76
Size and BrM adjusted 2.07 1.61 2.88
Book assets and industry adjusted 2.40 2.91 4.58
Panel B: Post-issue annual stock returns for 1389 SEOs
1st 2nd 3rd 4th 5th year
TSE equal weight 3.25 2.12 0.00 0.43 2.51
TSE industry 3.11 3.00 1.13 2.24 3.04
Size adjusted 1.84 1.50 y0.45 0.32 2.02
BrM adjusted 2.92 2.17 y0.20 1.04 1.86
Size and BrM adjusted 2.07 0.63 y0.84 y0.52 0.86
Book assets and industry adjusted 2.40 2.07 0.39 1.12 2.95
where AR i t is the monthly abnormal return for firm i. The mean abnormal returns
used in the estimates of the covariances are the means for the m y a overlap
periods. The Ž i, j .-th element of the variance–covariance matrix for a holding
period of t month is given by t = si j .
To test for the difference in long-run abnormal returns between Keiretsu and
non-Keiretsu firms as in Table 5, choose the weight vector v as follows. Suppose
Table 11
Lyon et al. Ž1998. t-statistics corresponding to Table 5
Panel A: Post-issue long-run stock returns for 151 Keiretsu issuers
1-year 3-year 5-year
Panel B: Post-issue long-run stock returns for 1238 non-Keiretsu issuers
there are n1 Keiretsu issuers and n 2 non-Keiretsu issuers, then let the first n1
elements of v correspond to the Keiretsu issuers and the remaining n 2 elements
correspond to the non-Keiretsu issuers, i.e., v s Ž1rn1 , . . . ,1rn1 ,y 1rn 2 , . . . ,
y1rn 2 .. The estimated variance–covariance matrix Sˆ should be arranged ac-
cordingly. Tables 10 and 11 provide the Lyon, Barber and Tsai t-statistics that
correspond to Tables 2 and 5 in the paper.
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The Performance of Japanese Seasoned Equity Offerings, 1971-1992

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The Performance of Japanese Seasoned Equity Offerings, 1971-1992

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Pacific-Basin Finance Journal 6 Ž1998.

The performance of Japanese seasoned equity

JEL classification: G15; G32; G38; F21

Following the pioneering work of Ritter Ž1991. on the poor subsequent

mitigated among Japanese firms. 1, 2 Unlike their U.S. counterparts, Japanese

matching firms’ operating performance. This finding is important. The rapid

2. Japanese SEO sample and data sources

3. Post-issue stock return performance

3.1. Benchmark creation

Selecting the proper benchmark to measure long-run abnormal returns for a

onal variance–covariance for event-time abnormal returns and apply it to the

J. Cai, T. Loughranr Pacific-Basin Finance Journal 6 (1998) 395–425

J. Cai, T. Loughranr Pacific-Basin Finance Journal 6 (1998) 395–425

Panel C of Table 3 reports the performance of SEO firms categorized by prior

3.3. Performance categorized by ‘hot’, ‘normal’ and ‘cold’ issue markets

J. Cai, T. Loughranr Pacific-Basin Finance Journal 6 (1998) 395–425

3.4. Performance by Keiretsu affiliation and ownership structure

A unique feature of Japanese industrial organization is the existence of inter-

Panel B: Operating incomer total assets

Panel C: Operating cash flowr total assets

Panel D: Growth rate of capital expenditure

Panel E: Growth rate of net sales

Panel F: Growth rate of operating income

is in contrast to the U.S. where ownership by institutional investors is motivated

4. Operating performance of SEO firms

4.1. A time-series analysis of operating performance

Fig. 2 provides an event year by event year comparison of the operating

J. Cai, T. Loughranr Pacific-Basin Finance Journal 6 (1998) 395–425

4.2. Keiretsu affiliation, ownership structure, and operating performance

poor performance following SEOs cannot be attributed to the changes in owner-

4.3. Determinants of the post-issue performance decline

This table reports cross-sectional regressions of changes in matching-firm-adjusted operating perfor-

significantly negatively related to the run-up in performance prior to the issue. In

associated with subsequent changes in performance, nor is the Keiretsu dummy

This appendix documents the method for estimating the variance–covariance

where AR t is the sample mean of buy-and-hold abnormal returns, s ŽAR t . is the

where v s Ž1rn, . . . ,1rn. is an n = 1 column vector, Sˆ is the estimated vari-

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