European Financial Management, Vol. 3, No. 1, 1997, pp.

45–62

The arrival rate of initial public offers

in the UK
William P. Rees*
Department of Accounting and Finance, University of Glasgow, 65–71 Southpark Avenue,
Glasgow G12 8LE, UK e-mail b.rees@accfin.gla.ac.uk

Abstract

The Initial Public Offer (IPO) is an important event in the development of a

firm yet there is little evidence regarding why firms choose certain times to
come to the market. This paper extends the available evidence, concentrating
on UK data and addressing a number of econometric problems with earlier
papers. These advances include acknowledging the non-negative integer
characteristics of count data, compensating for non-stationarity in the data,
and explicitly testing for causality. The paper examines the incentives to
conduct an IPO and the results suggest that both the value and number of
IPOs are positively and significantly associated with the level of the stock
market, with the introduction of the USM, and, in the case of the number of
IPOs, positively and significantly associated with a business cycle indicator.
Tests of causality suggest that the stock index predicts both the value and
number of IPOs.

Keywords: IPOs; UK; arrivals; time-series; causality.

JEL classification: G32.

1. Introduction
The initial public offering (IPO) is a significant stage in the development of a
firm and has been subject to a considerable amount of academic scrutiny.
However, there is relatively little evidence concerning those factors which affect
the owners’ and managers’ decision to go public, even though the number of
firms coming to a market in a given time period seems to vary considerably. In
some ways this lack of attention is surprising as subsequent aspects of the IPO
process are all dependent on the initial decision to go public. Variation in the
secondary aspects of the IPO, such as the pricing of issues, the initial returns to
investors, and the long run performance of issued equity, may well be related to
the variation in the incentives to go public. This paper contributes to the

* I would like to thank the participants of the 1996 EFM Congress for their constructive
comments, and particularly the reviewer, P. Ragharendra Rau, for his encouragement
and help.

© Blackwell Publishers Ltd 1997, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA
46 William P. Rees

emerging literature concerned with the timing of the IPO decision [Loughran et
al. (1994), Ljungqvist (1995) and Pagano et al. (1995)].
That the IPO is an important event in the development of a firm hardly needs
confirmation. It presents the owners with a method of realising part of their
investment, provides the firm with an opportunity to raise capital, and, in the
newly quoted equity, a currency with which to acquire other firms and fund
employee participation schemes. A stock market quotation may raise the
prestige of the firm. The IPO process also represents an important opportunity
for professional and private investors, and for stock market institutions acting as
brokers, sponsors and underwriters. The original owners or investors may use
the IPO as a method of liquidating their involvement in the firm by issuing their
shares in the IPO, or by disposing of them in the open market after the IPO has
taken place.
The decision to go public is not straightforward. The incentives mentioned
above have to be weighed against considerable costs, including the fees of
advisors and of the stock exchange, management time and commitment and the
substantial discount conventionally offered on an IPO. Many firms choose not to
go public and for others the timing of the issue will be a matter of evaluating
costs and benefits. In essence this paper examines the balance of these consid-
erations by analysing the number of firms that decide to go public in a particular
period together with indicators of the relative costs and benefits.
To date academic interest in IPOs has largely focused on their apparent
‘underpricing’. The returns available on IPOs during the first week of trading in
different markets have been estimated to range from 4% to 80% with most
developed stock markets falling in a narrower band of around 7% to 16%.
Evidence also suggests that the pattern of initial returns on IPOs through time
is not random and there have been sustained ‘hot issue’ periods when the
number of IPOs and the initial returns are substantially greater than at other
times. Byrne and Rees (1994) investigated the time series behaviour of the first
week’s returns on UK IPOs during 1984–1990. They confirm that initial returns
are related to firm size, method of issue, the market in which the issue is made,
and the concurrent return on the market index. Even after allowing for the
impact of these variables the pattern of average monthly returns demonstrates
cyclical behaviour. This behaviour can be partly modelled by market wide
characteristics, most notably the price-to-earnings ratio, but tests of the residuals
show that certain periods demonstrate excess returns which are not susceptible
to modelling.
More recently academic interest has focused on another anomaly. Several
researchers, notably Aggarwal and Rivoli (1990), Ritter (1991), and Loughran
and Ritter (1993), for the US and Levis (1993) for the UK, have found that for
periods of up to three years IPOs tend to under perform both the market as a
whole and the shares of comparable firms whose initial offerings were more
distant. This provides an alternative interpretation of the large initial returns on
IPOs which have conventionally been attributed to deliberate underpricing. They
may be the result of temporary optimistic overvaluation of the issuing firms’
prospects by investors in the early ‘aftermarket’. Aggarwal and Rivoli refer to
such a phenomenon as a ‘fad’.
Whereas the findings of long-run under performance appear to be clear they
are surprising. The conventional assumption that financial markets are charac-
© Blackwell Publishers Ltd, 1997
 The Arrival Rate of Initial Public Offers in the UK 47

terised by rational investors operating in efficient markets is inconsistent with

long-run under performance by IPOs, and with the notion that the high initial
returns were the product of aftermarket overvaluation by investors. The findings
suggest that market participants, who in the UK are mainly professional fund
managers, are prepared to hold newly issued stocks ‘knowing’ that they will
probably under perform the market. If these fund managers were rational they
would dispose of the stocks forcing down prices. Under such circumstances the
under performance would be sharp not gradual. However the evidence of
gradual long-term under-performance in IPOs is becoming compelling.
This research does not attempt to directly test the link between the decision to
go public, under pricing and long run returns. There is a strong case for such an
analysis best performed using a firm level investigation of the IPO decision, such
as Pagano et al. (1995). The analysis in this paper is based on a macro-level
investigation of the factors which affect the number of IPOs coming to the
market as a whole. Nevertheless the results provide a framework for a subse-
quent micro-analysis and cast some light on the various anomalies relating to
IPOs.

2. Evidence on IPO arrival rates

Evidence concerning the temporal variation in the arrival rate of IPOs to the
markets has been confined to Loughran et al.’s (1994, and hereafter LR&R)
paper examining IPO arrival rates in 15 countries, and more recent contributions
from Ljungqvist (1995) focusing on German evidence and the Pagano et al.
(1995) investigation of Italian firms’ decisions to go public.
LR&R’s international review of the timing of initial public offers is founded
on the hypothesis that IPOs are timed to take advantage of periods of favourable
investor sentiment. Their analysis demonstrates that there is considerable varia-
tion in the pattern of arrivals between 1970 and 1991 and they examine the
impact of the inflation adjusted level of the local stock market index on the
number of IPOs. In some cases, Japan for example, the hypothesis looks
convincing, whereas for others such as Germany, it appears to be rather tenuous
(see Figures 1a and 1b). Indeed Rydqvist and Högholm (1994) note that high
stock prices during the 1960s in Austria, Finland, Germany, Sweden and Switzer-
land were not associated with large numbers of IPOs, and Pagano et al. (1995)
report a similar lack of response to high stock prices in Italy during the late
1940s and the 1950s and 1960s.
LR&R’s review is wide ranging and informative but in achieving scope some
detail was necessarily lost. There are two non-controversial sections of the
LR&R paper. They start with a review of initial returns in many countries and
also collect information regarding the institutional arrangements in these
countries. They are able to draw a number of interesting and convincing results
from this investigation although their analysis is based on reasoned argument
rather than conclusive evidence. Furthermore, to test the issuers ability to time
the market, LR&R report (in their table 6) the results of OLS regressions of the
annual return on the market, using the number of IPOs in the previous year as
the explanatory variable. As might be expected, if the markets are efficient, there
is no evidence that issuers can time the market.
© Blackwell Publishers Ltd, 1997
48 William P. Rees

Fig. 1a. The annual number of IPOs and stock index level for the German market,
1961–1991.

Fig. 1b. The annual number of IPOs and the stock index level for the Japenese market,
1968–1991.

LR&R also focus on the timing of the IPO. Their review of data from 15
countries seems to provide evidence of a relationship between the level of the
stock market and the number of IPOs. They model the number of issues by the
inflation adjusted stock index and future GNP growth. In general their models
have high explanatory power and the stock index coefficient is normally positive
and significant. It seems reasonable to admit that most countries have experi-
© Blackwell Publishers Ltd, 1997
 The Arrival Rate of Initial Public Offers in the UK 49

enced more IPOs than usual when the stock market index is at inflation adjusted
highs. However, their investigation analyses count data as if it were a continuous
variable rather than a non-negative integer, ignores the possibility of non-statio-
narity in the data, restricts the influence of the trend term, applies a sparse
model with no variation to account for national differences, and uses annual
data which limits the opportunities for testing causality.
Some of the difficulties experienced by LR&R are due to the wide focus
which inevitably restricts the opportunities for accommodating national differ-
ences and using detailed data. Ljungqvist’s (1995) investigation of arrival rates in
Germany is able to overcome some of the difficulties. His model is considerably
more detailed being based on quarterly data, incorporating tax and institutional
changes, and applying a poisson estimation technique which explicitly allows for
dependant variables which are non-negative integers. His results are consistent
with IPO arrival rates being positively associated with a high stock index, a good
business environment, a competitive market for intermediary services, and
following high levels of underpricing of IPOs. The introduction of institutional
considerations allows Ljungqvist to effectively model IPO arrival rates in
Germany despite the limited association between stock prices and arrival rates
noted by Rydqvist and Högholm (1994). Some reservations are worth noting
regarding these results. The poisson estimation technique is unreliable where the
dependant variable exhibits ‘overdispersion’, as appears to be normal with IPO
arrival data, and Ljungqvist does not consider questions of stationarity. If these
problems are relevant for Ljungqvist’s analysis they would tend to bias his tests
in favour of rejecting the null hypotheses.
The analysis of Pegano et al. (1995) is somewhat different in type from those
conducted by LR&R and by Ljungqvist (1995). They are concerned to investi-
gate the impact of the various costs and benefits attached to conducting an IPO
on the propensity of individual firms to go public. Insofar as the costs and
benefits vary across time these may affect the arrival rate but this aspect is not
the focus of their analysis. However, in distinguishing 66 IPO firms from some
12,000 firms that do not go public in the period under review (1982–1992) they
determine that the size of the firm and the book to market ratio of the industry
sector are both important determinants of the probability of an IPO. With
regard to independent IPOs in particular (i.e. not subsidiaries of publicly quoted
firms), the probability of an IPO is also positively related to capital expenditure,
growth and profitability. Whereas there is no comparable evidence for the UK1
it is clear that such an analysis would usefully complement the time-series
approach used in this paper.

3. A model of the timing of IPOs in the UK

In this section the time series behaviour of IPO arrivals is modelled for UK
firms in rather more detail than in LR&R and some of the advances incor-

1
Mayer and Alexander (1991) demonstrate that large private firms behave somewhat
differently from quoted firms. Public firms are basically more active in raising, investing
and utilising their capital. However, their analysis does not address the issue of whether
the private/public split causes, or is caused by, these differences, and it contains no
evidence regarding the incentives to go public.

© Blackwell Publishers Ltd, 1997

50 William P. Rees

porated in Ljungqvist are extended. Quarterly data is used which, apart from
increasing the number of observations, allows for a more precise modelling of
causality. Two measures of arrival rate are used as dependant variables; the
number of new issues and their value. Five explanatory variables are
investigated:
1. Following LR&R the level of the stock market index is used as an indicator
of the cost of equity capital. This is calculated as the FT All Share Index2
deflated to 1990 equivalent prices by the GDP deflator and can be viewed as
a measure of the price that the issuers receive for the equity issued. An
alternative measure, the price to earnings ratio, was also investigated but gave
very similar results and has therefore been dropped from the analysis.
2. The price of alternative sources of capital is assumed to be represented by the
cost of fixed interest capital, here proxied by the treasury bill rate. Again
alternative measures of fixed interest capital costs were experimented with but
were all highly correlated with the treasury bill rate. There is a countervailing
effect as one of the costs of issuing IPOs is the interest borne by offer for sale
applicants on the application price.3
3. The third indicator used is the Treasury’s ‘short lead indicator’. This is a
composite indicator which includes the stock market and interest rate levels,
but is also influenced by business confidence as measured by CBI surveys,
price indices and investment levels. Obviously when confidence is high issuers
can expect to achieve a good price for their firm but they would also expect
the firm to generate good cash flows in the near future — thus a high price
may simply reflect high value.
4. A further explanatory variable is the opening of the Unlisted Securities
Market which is the major institutional change during the period studied. The
USM substantially reduced the costs of issue and of listing and brought
quotation within the scope of many smaller or younger firms previously
excluded from a full listing (Bank of England, 1990). Under these circum-
stances the number of firms issuing IPOs and their value is expected to be
higher after the opening of the USM. The USM variable is a dummy with the
value 0 before the opening of the USM and 1 afterwards.
5. A trend term is incorporated but, unlike LR&R, the coefficient is not
constrained and it takes that value which best fits the data — thereby
avoiding one bias against the null inherent in the LR&R analysis. The trend
term is a series starting at 1 and increasing by 1 each quarter through to 100.

2
Following the suggestions of the reviewer the sensitivity of the analysis was further
investigated by replacing the market index with indices representing particular sectors.
Unfortunately IPOs in the UK are not particularly concentrated in any sector and there
are no obvious grounds for preferring one sector over another. Instead indices repre-
senting industrial, commercial, and financial sectors were all individually substituted for
the market index. However, the high correlation between these indices ensured that the
results reported in this paper were largely insensitive to the index used.
3
During the period of the analysis the predominant method of IPO was by offers for sale
or by placing, or a mixture of the two. In the first case the public is invited to subscribe
at a predetermined price and in the case of over application partial allotments are made.
In the second case the issue is sold to investment institutions who pass on the shares to
their clients.

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 The Arrival Rate of Initial Public Offers in the UK 51

Thus the estimated model of the value or number of IPO arrivals is:

(lgN t or lgVt ) = a 0+a 1FTAt+a 2SLIt+a 3TBRt+a 4USMt+a 5Tt+e t (1)

Where lgVt and lgNt are the log of the value and number of IPOs in quarter t,
FTAt is the inflation adjusted Financial Times All Share Index, SLIt is the
Treasury short lead indicator, TBRt is the treasury bill rate, USMt is a dummy
variable which is set at one after the USM opened and zero before, and Tt is the
trend term. The value and number of new issues was transformed to its natural
log to mitigate the effect of the skewness in the data. Thus equation 1 simply
models the measure of IPO arrival rates in particular periods — either in
number or value, using variables from the same period which are indicators of
the price that will be received, the business cycle, the cost of borrowing, the
institutional environment, and the impact of any linear trend.
When modelling the number of IPO arrivals the specification given in
equation (1) is contentious. Where there are many small integer values or zeros
in the dependent variable the discrete nature of the data implies that it should
be possible to improve on OLS estimation. In such cases the poisson regression
approach is sometimes used (Greene, 1993). The main drawback of the poisson
approach is the implicit assumption that the variance and the mean of the
dependant variable are equal. For many, if not most, economic time series this
is unlikely to be the case. In such circumstance the most convenient approach is
to utilise negative binomial models. Consequently the model used for investi-
gating the impact of the explanatory variables on the number of IPOs is also
estimated using:

lnl = b 0 FTAt+b 1 SLIt+b 2TBRt+b 3 USMt+b 4Tt+e t (2)

where the probability of observing a particular number of IPOs is a non-linear

function of l (Cameron and Trivedi, 1986).4 As the subsequent analysis incor-
porates co-integration techniques, and these have not been developed for
negative binomial estimation, the principal results reported focus on the OLS
estimates. The negative binomial results are used as a sensitivity check on these
results.

4. Results of tests of association

The data regarding the IPOs is gathered from various issues of the Stock
Exchange Quality of Markets Survey. The earliest quarter for which data is
available is the first quarter of 1970 and the last quarter used was the final one
in 1994, i.e. 100 quarters. Only non-privatisation UK issues of equity are used in
this analysis but this does include introductions as well as placings and offers for

4
Here exp(b) is a gamma distribution with mean 1.0 and variance a. In the version
employed here the probability distribution is Prob[Y = yi | b] = eµl exp(b)l yi /y i ! and the rela-
i i

tionship between the varience of y and its mean is Var[ yi] = E[ y i]{1+aE[ y i]}. [See
Cameron and Trivedi (1986) model NEGBIN II].

© Blackwell Publishers Ltd, 1997

52 William P. Rees

sale.5 The inclusion of introductions in the sample is appropriate as it is clear

that exactly the same net affect can be achieved by offering a certain proportion
of equity directly via an IPO, or by an issuer introducing a new issue and then
disposing of a proportion in the secondary market. The value data is available
from the first quarter of 1972 until the end of 1994 and is restricted to non-pri-
vatisation issues of UK firms equity. The explanatory variables were all collected
from Datastream. The deflated stock market index and the short term lead
indicator are both available from 1970 but the treasury bill rate was only avail-
able from 1972. Table 1 presents descriptive statistics for the various series used
in the analysis. The most striking aspect of the variables studied is the degree of
variation observed in the 25 years under review. The treasury bill rate swings
from 4.5% to 17%, the maximum market index reading is almost five times the
minimum, the short lead indicator varies by almost 10% from the mean in both
directions, and the number and value of IPOs extends from 2 to 89 and from
zero to £4444m. It would appear that the period under investigation is one of
some instability in both the explanatory and dependent variables. The number
and value of IPOs for each quarter together with the deflated market index are
presented in Figures 2a and b.
Table 2 records the correlations between the variables. There would appear to
be no problem with collinearity among the explanatory variables, the maximum

Fig. 2a. Number of UK IPOs and stock index level per quarter, 1970–1994.

5
Introductions constitute the third important method of conducting an IPO during the
period under review. In this case firms which already comply with the conditions of the
market in which they are seeking a listing — most notably the requirements regarding
the distribution of ownership, can come to the market without offering existing or new
equity for sale. In many cases firms are introduced to a full listing from the USM without
further issue of equity. Such transfers between markets are not counted as IPOs for the
purposes of this paper but introductions which bring a new firm to one of the markets
are counted.

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 The Arrival Rate of Initial Public Offers in the UK 53

Fig. 2b. Value of UK IPOs and stock index level per quarter, 1972–1994.

correlation estimated between the explanatory variables is less than 0.4, and it is
interesting to see that the two alternative dependant variables, although
collinear, still exhibit a considerable degree of independence. The cross-correla-
tion between the two versions of the dependent variable (lgN and lgV ) reveal a
strong association with the stock market index (FTA), a relatively weak negative
correlation with the treasury bill rate (TBR), and a positive correlation between
the short lead indicator (SLI) which is modest in the case of the number of IPOs
and weak with regards to the value of IPOs. This final relationship is the only
correlation which is not significantly different from zero at the 5% level.
Where the variables in a time series regression are non-stationary it has been
shown by simulation (Granger and Newbold, 1974) and theoretically (Phillips,
1986) that conventional significance tests are unreliable and may lead to
spurious conclusions regarding the association between dependent and indepen-
dent variables. Dickey and Fuller (1979, 1981) have developed tests for statio-
narity which are applicable where the series may have a unit root. However, if
unit roots cannot be rejected for the test variables it may be that the residuals
from the time series model are stationary. The series are then said to be
co-integrated [Engle and Granger (1987) and others]. In these circumstances
conventional statistical tests are reliable and preferable to differencing the
original series to produce stationary variables as the long run characteristic of
the model can be examined.
Dickey–Fuller (D–F) and augmented Dickey–Fuller (AD–F) tests of unit
roots were conducted for all series.6 These are estimated with and without a
6
The augmented version of the Dickey–Fuller test, of order AR(1) is:
ytµy tµ1 = m+b t+gy tµ1+y ( y tµ1µy tµ2)+e t
Beta is constrained to be zero where the model is estimated without a trend term and
theta is constrained to be zero where the non-augmented D–F version is estimated. The

© Blackwell Publishers Ltd, 1997

© Blackwell Publishers Ltd, 1997

54
Table 1
Descriptive statistics
The Treasury Bill Rate is the one month discount rate. FTA Index is the Financial Times All Share Index deflated by the GDP deflator
to 1990 prices. The Short Lead Indicator is a composite statistic calculated by the Treasury designed to predict changes in the business
cycle. It is a composit of business confidence surveys, investment levels, price indices, stock prices and interest rates. The Number of IPOs
is the number of firms coming to the Official List or USM for the first time, including introductions, but excluding privatisations and
transfers between the markets. The Value of IPOs is the value of new capital raised, excluding privatisations.

William P. Rees
Treasury FTA Short Lead Number of Log of Value of Log of
Bill Rate Index Indicator IPOs Number IPOs Value

Mean 10.7 14.42 100.52 31.97 3.108 506 5.13

Minimum 4.5 2.98 92.93 2.0 0.693 0.0 0.0
Maximum 17.0 8.66 110.63 89.0 4.489 4444 8.399
Standard deviation 2.93 3.09 4.24 21.69 1.001 688 1.99
Skewness µ0.016 µ0.031 0.232 0.485 µ0.793 3.0 µ1.14
Kurtosis µ0.511 µ1.42 µ0.93 µ0.502 µ0.459 12.0 0.88
Period 1972–1994 1970–1994 1970–1994 1970–1994 1970–1994 1972–1994 1972–1994
 The Arrival Rate of Initial Public Offers in the UK 55
Table 2
Correlation matrix
The statistics reported are the Pearson correlations between the variables employed in
the model as described in Table 1, Descriptive statistics. All correlations are significantly
different from zero at 5% confidence level save for those between SLI and V, and
between SLI and lgV.

Log of Log of
Number Value Number Value FTA SLI
Value (V ) 0.629
Log of number (lgN) 0.678 0.655
Log of value (lgV) 0.913 0.526 0.761
FT All Share Index (FTA) 0.686 0.562 0.707 0.617
Short Lead Indicator (SLI) 0.375 0.164 0.321 0.151 0.344
Treasury Bill Rate (TBR) µ0.329 µ0.343 µ0.222 µ0.214 µ0.398 µ0.365

trend term, and with and without a lagged dependant variable. The test statistics
were calculated with lags of up to four periods. From these results it is fairly
clear that all three explanatory series are, or are probably, non-stationary. A
marginal case could be made that the short term indicator does not exhibit a
unit root, as would be expected given the method of its computation. However,
the distinction is not crucial as the co-integration with the explanatory variable
will be the point at issue. With regards to the number of IPOs the D–F and
AD–F results conflict but tests of the model reveal severe auto-correlation in the
residuals and the augmented approach, which does not reject the unit root, is the
appropriate method. Perhaps surprisingly the test for a unit root in the series
recording the value of IPOs suggests, quite strongly, that a unit root can indeed
be rejected.
Equation 1 is estimated in an iterative manner, starting with the full model,
then eliminating any variables which appear to be ineffective. These are defined
as any where the conventional test of significance fails to reject the null that the
coefficient is equal to zero at a confidence level of 75% or better. However
explanatory variables were not eliminated where this damaged the specification
of the model as revealed by conventional diagnostic measures testing residual
autocorrelation, heteroscedasticity, normality and function form. Where auto-
correlation is present in the residuals the model is also estimated using the
Cochrane–Orcutt (1949) method with four lags. Four lags are chosen due to the
seasonality in the data. The variables in the models may, or may not, be co-inte-
grated. This is investigated by using Dickey–Fuller tests on the residuals,
estimated using AR(0) through AR(4).
Table 3 reports the tests of association between the value of new issues in
each quarter and the stock index, short lead indicator, treasury bill rate, USM
dummy and a trend term. There is little evidence to suggest that either the short
lead indicator or the treasury bill rate have any significant influence on the

unit root test for the model without a trend term is that gamma is zero, and for the
version which includes a trend term the test is the restriction that beta and gamma are
zero. For the sake of brevity the Dickey–Fuller results relating to tests of the stationarity
of the regression variables, and subsequently of the regression residuals, have been
omitted from the paper. These are available from the author on request.

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56 William P. Rees

model. In both the full and reduced form of the model there is a significant
positive relationship between the value of new issues and the stock index level,
the USM dummy and the trend term. Diagnostic tests reveal that autocorrela-
tion is present in the residuals. The Cochrane–Orcutt estimation procedure was
employed but the results of the model are little changed. The conclusion does of
course depend on stationarity but the Dickey–Fuller tests of the residuals from
the model indicate that the unit root assumption can be rejected for the
reported AR models of order 0 to 4. In this case the significance tests reported
should be reliable. Hence the null hypotheses, that high values of new issues are
not associated with high levels of stock indices nor with the introduction of the
USM, can be rejected. The null hypotheses that the value of IPOs is not
associated with the interest rate and the business cycle indicator cannot be
rejected.
The tests of the model of the number of new issues are estimated using OLS
and negative binomial techniques. Again the treasury bill rate appears to be
irrelevant and is dropped from the model. However the stock index, short lead
indicator, USM dummy and trend term all appear to be significant in the
reduced model. The diagnostic tests for autocorrelation suggest that it is not
present. Tests for a unit root in the residuals only allow the hypothesis to be
rejected for the case where autocorrelation is ignored. As this seems tenable for
this model these results are interpreted as being reliable. Negative binomial and
OLS estimation produces similar coefficients and significance estimates
suggesting that the count data characteristic of the dependent variable is not
crucial. (The similar coefficient estimates are a result of using logarithmic values

Table 3
Contemporaneous models of value
OLS model of the value of IPOs:
lgVt = a 0+a 1FTAt+a 2SLIt+a 3TBRt+a 4USMt+a 5Tt+e t (1)
The full model uses all explanatory variables and the second two eliminate insignificant
regressors. The trend term T is also insignificant but its elimination resulted in a decline
in the functional form specification of the model and it is therefore retained. The final
row contains the results of a Cochrane–Orcutt estimate of the model of order 4. The
absolute value of the t-statistics are given in brackets. The R 2 reported is adjusted to
take account of the number of regressors.

R2
Constant FTA SLI TBR USM T F-Statistic

Full Model µ2.182 0.152 0.051 µ0.023 1.464 0.015 0.516

(0.669) (2.011) (1.237) (0.418) (2.645) (1.3e04) 20.43
Reduced µ3.429 0.161 0.537 — 1.459 0.151 0.542
Model 1 (0.872) (2.236) (1.338) (2.649) (1.289) 25.73
Reduced 1.800 0.215 — — 1.410 0.011 0.517
Model 2 (4.084) (3.599) (2.554) (0.959) 33.41
Cochrane– 1.830 0.227 — — 1.483 0.008 0.557
Orcutt AR(4) (4.965) (3.319) (3.077) (0.662) 16.65

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 The Arrival Rate of Initial Public Offers in the UK 57

in the OLS model.) It is worth noting that Poisson estimation, as used by

Ljungqvist (1995), produces very much higher significance values and this may
indicate that it is unreliable in this instance.

5. Causality tests
Where the variables of interest are co-integrated it is possible to test for
causality [in the Granger (1969) sense] using conventional asymptotic signifi-
cance tests. However the normal specification of a Granger causality test is
inappropriate as the coefficients cannot be estimated directly due to the colli-
nearity of the regressors. However Sims et al. (1990) have shown that is it
feasible to estimate the coefficients and test for causality by re-writing the
equation in the following form [where only AR(1) processes are assumed]:
lgVt = g 0+g 1(lgVtµ1µa 0µa 1FTAtµ1µa 2SLItµ1µa 4USMtµ1µa5Ttµ1)
+g 2DFTAtµ1+g 3DlgVtµ1+g 4lgVtµ1+e t (3)
This example is based on the test of the deflated stock index (FTA) ‘Granger’
causing the log of the value of IPOs (lgV). The test for whether FTA Granger
causes lgV is the linear restriction that both a1 and g 2 are zero. Further lags of
DFTA and DlgV can be incorporated but are found to be ineffectual. An intuitive
rationale for the model is worth considering. Equation 3 models the value of
IPOs as a function of an intercept, the previous periods level and change of the
dependent variable, the previous change in the causal variable, and the previous
residual from the long run model as estimated using equation 1 (or equation 2
in the case of the negative binomial technique). This approach investigates
whether the causal variable has predictive value by removing it from the long run
model and from the lagged change variable. The test statistic has an F (g, nµk)
distribution, where g is the number of restrictions, n the sample size, and k the
number of regressors in the unrestricted model, and is based on a comparison of
the explanatory power of restricted and unrestricted models (Sims et al., 1990).
The results contained in Table 5 indicate that the market index level Granger
causes the value of IPOs. This influence seems to work through both the residual
from the long run relationship and the lagged change in the FTA variable.
Table 6 reports the results of the test of the hypothesis that the deflated share
price index Granger causes the number of IPOs. No techniques were identified
which deal with causality in a co-integrated framework using negative binomial
estimation. However, the OLS estimates are replicated using negative binomial
estimates in an identical formulation to that applied for OLS. With regards to
the deflated stock index Granger causing the number of IPOs the results are
convincing whether OLS or negative binomial estimation is utilised. In both
cases the lagged changes in stock market index are individually significant, the
long run estimation has a role in the model of level of the variable, and the
influence of this variable declines if the stock index is removed from the long run
model.
As the contemporaneous association test reported in an earlier section
suggested that the short lead indicator is associated with the number of IPOs
causality tests were performed to see if this variable can be shown to Granger
cause the number of IPOs. However, the null hypothesis cannot be rejected at
© Blackwell Publishers Ltd, 1997
© Blackwell Publishers Ltd, 1997

58
Table 4
Contemporaneous models of the number of IPOs
OLS model of the log of the number of IPOs:
lgNt = a 0+a 1FTAt+a 2SLIt+a 3TBRt+a 4USMt+a 5Tt+e t (1)
The full model uses all explanatory variables and the second eliminates insignificant regressors. Diagnostic tests reveal no difficulties with
heteroscedasticity, autocorrelation, normality of the residuals, nor functional form. The absolute value of the t-statistics are given in
brackets and the R 2 is adjusted for the number of regressors. In the second panel the model is re-estimated using negative binomial
methods to check the sensitivity of the OLS specification to the count data characteristic of the dependant variable. The a variable is the
measure of overdispersion. The x 2 is a measure of the predictive power of the model.

William P. Rees
R2
Constant FTA SLI TBR USM T a F-statistic
OLS estimation
Full µ4.447 0.136 0.059 0.018 1.838 µ0.015 — 0.795
Model (3.241) (5.549) (4.443) (0.986) (10.199) (3.956) 71.54
Reduced µ2.8637 µ1.555 0.046 — 1.876 µ0.019 — 0.778
Model (2.525) (8.331) (3.935) (10.452) (5.929) 88.00
Negative binomial estimation x2
Full µ3.052 0.136 0.049 µ0.001 1.810 µ0.017 0.089 128.98
Model (2.275) (6.200) (3.789) (0.016) (11.471) (5.429) (3.696)
Reduced µ2.383 0.150 0.042 — 0.184 µ0.019 0.089 151.36
Model (2.355) (8.875) (3.996) (11.494) (7.159) (3.750)
 The Arrival Rate of Initial Public Offers in the UK 59
Table 5
Causality tests for stock index and IPO value
OLS model of the stock index (FTA) Granger causing the value of IPOs (lgV ). The full
model incorporates the residual from the long run contemporaneous regression (RES)
as reported in Table 3, lagged values of the difference and level of the dependant
variable, and lagged values of the difference of the causal variable:
lgVt = g 0+g 1(lgVtµ1µa 0µa 1FTAtµ1µa 4USMtµ1µa 5Ttµ1)
+g 2DFTAtµ1+g 3D lgVtµ1+g4 lgVtµ1+e t (3)
The test statistic is an f-distribution based on a comparison of the explanatory power of
the full model and of a restricted version where a1 and g 2 are constrained to be zero. The
absolute value of the t-statistics are given in brackets and the reported R 2 is adjusted for
the number of regressors.

R2
Constant REStµ1 D FTAtµ1 DlgVtµ1 lgVtµ1 F-statistic

Full 0.262 µ0.972 0.365 µ0.017 0.959 0.565

Model (0.518) (5.420) (1.922) (0.166) (10.066) 29.93
Restricted µ0.061 µ0.791 — µ0.095 1.019 0.491
Model (0.106) (4.577) (0.953) (9.332) 29.65
F-statistic for restriction 8.654

conventional significance levels.7 The adjusted R2 difference between the

restricted and unrestricted models is less than 1% whereas the causality test
using the stock index showed a difference in excess of 4%. There is some
evidence from the negative binomial estimation that the OLS results may under-
state the influence of the cyclical indicator but this result is tenuous.

6. Conclusion
In this paper the arrival rate for IPOs in the UK is investigated and supplements
the sparse evidence available concerning the determinants of the number of
IPOs in a particular period. There are some potential econometric problems
with time series studies of arrival rates. These problems include the non-negative
integer characteristics of count data and the non-stationarity of many of the time
series investigated. It is possible to take account of the non-negative integer
nature of the count data and estimate the relationship between the number of
IPOs and the explanatory variables using negative binomial estimation
techniques. For the analysis reported here the results do not appear to be
sensitive to the choice between OLS and negative binomial estimation. Poisson
regression may also be employed to take account of the count data aspect of the
dependent variable but for the sample investigated in this paper the model
exhibits ‘overdispersion’, as might be expected, and the poisson regression results
are unreliable and biased against the null hypothesis. It might be expected that
with an analysis of the levels of economic time series that some of the variables

7
The results of the tests of the hypothesis that the short lead indicator Granger causes
the number of IPOs have been omitted for the sake of brevity. They are available from
the author on request.

© Blackwell Publishers Ltd, 1997

60 William P. Rees

would not be stationary. In such circumstances it is possible that the results of

the estimated models will be affected by ‘spurious correlation’. The results of the
tests conducted in this paper suggest that whilst some of the variables are not
stationary the models used are co-integrated which allows models based on
levels variables to be used with confidence. This also permits causality tests
which incorporate both long run and short run effects.
Using quarterly frequency count and value data a detailed study of UK IPO
arrival rates is conducted for the period from 1970 to 1994 inclusive. During this
time in excess of 3000 IPOs were conducted. The analysis reveals a strong
contemporaneous association between the sterling value (adjusted to constant
prices) of IPO arrivals and the level of the stock index (also adjusted to constant
prices) and also with the opening of the USM. No significant link can be
established between the value of IPOs in a quarter year with the business cycle,
nor with interest rates. A similar analysis focusing on the number of IPOs,
whether estimated using OLS or negative binomial techniques, confirms a signi-
ficant association between the number of IPOs and the level of the stock index,

Table 6
Causality tests for stock index and IPO number
OLS model of the stock index (FTA) Granger causing the number of IPOs (lgN). The
full model incorporates the residual from the long run contemporaneous regression
(RES) as reported in Table 4, lagged values of the first difference and level of the
dependent variable, and lagged values of the first difference of the causal variable:
lgNt = g 0+g 1(lgNtµ1µa 0µa 1FTAtµ1µa 2SLItµ1a 4USMtµ1µa 5Ttµ1)
+g2 DFTAtµ1+g3 DlgNtµ1+g4 lgNtµ1+e1 (3)
The test statistic is an F-distribution based on a comparison of the explanatory power of
the full model and of a restricted version where a 1 and g 2 are constrained to be zero.
The absolute value of the t-statistics are given in brackets and the reported R 2 is
adjusted for the number of regressors. In the second panel the equations are derived
from negative binomial estimation to check the sensitivity of the model to the count data
characteristics of the dependent variable. The a variable is the measure of overdisper-
sion. The x 2 is a measure of the predictive power of the model.

R2
Constant REStµ1 D FTA tµ1 DlgNtµ1 lgNtµ1 a F-statistic
OLS estimation
Full 0.464 0.679 0.177 µ0.458 0.855 — 0.889
Model (3.947) (8.905) (3.928) (7.474) (23.506) 194.56
Restricted 0.676 0.526 — µ0.397 0.791 — 0.846
Model (4.574) (7.232) (5.494) (17.257) 178.99
F-statistic for the restriction 18.595
Negative binomial estimation x2
Full 2.198 0.016 0.198 µ0.016 0.034 0.131 204.75
Model (29.351) (4.748) (4.410) (5.101) (16.885) (4.730)
Restricted 2.258 0.098 — µ0.017 0.032 0.172 255.97
Model (25.464) (3.440) (5.541) (13.315) (5.005)

© Blackwell Publishers Ltd, 1997

 The Arrival Rate of Initial Public Offers in the UK 61

the business cycle indicator, and the opening of the USM. No significant link is
apparent between the number of IPOs and interest rates.
As the data is quarterly, and co-integrated, it is possible to examine causality.
Where a co-integrating relationship can be estimated re-parameterisation is
necessary but allows for effective long run and short run causality tests. These
indicate that the level of the stock index does Granger cause IPO arrivals,
whether measured in value or number. The relationship between the index and
subsequent readings for the arrival rate operates through both the short run
changes in the index and the deviation from the long run relationship between
the index and the arrival rate.
A certain amount of caution is advisable in interpreting these results. The
impact of the establishment of the USM is relatively clear. It would appear to
have stimulated both the number and value of IPOs. This is not only a service to
firms looking for access to the equity market but an important source of clients
for the Stock Exchange and the various organisations that offer services to the
issuing firms. It is not surprising that the imminent demise of the USM has been
preceded by the creation of a new and relatively successful junior market, the
Alternative Investments Market (AIM). The other robust result is the influence
of the level of the stock market index on the number and value of new issues.
LR&R suggest that the opportunity to issue equity at a high price relative to the
cash generating potential of the firm is a possible explanation. However when
the index is at historically high levels it is presumably because expectations
regarding future cash flows are also high, and a high price may simply correlate
with high value. For the high price incentive to be a direct explanation of the
variation in arrival rates it has to be supported by an assumption of irrationality
among one or more groups of market participants. Either the issuers are incor-
rect in assuming that they can time the market, or the investors who participate
in the issues are investing unwisely. An alternative is that the high stock index is
associated with institutional factors which combine to produce a less direct link
between index value and the demand for IPOs.

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