Jurnal Going Concern 4 PDF

Review of Quantitative Finance and Accounting
https://doi.org/10.1007/s11156-018-0747-0
ORIGINAL RESEARCH
Going concern opinions and IPO pricing accuracy
Natalia Matanova1 · Tanja Steigner2 · Bingsheng Yi3 · Qiancheng Zheng2
© Springer Science+Business Media, LLC, part of Springer Nature 2018
Abstract
In a marked shift, it has become relatively more common for ordinary initial public offer-
ings (IPOs) to contain going concern opinions (GCOs) in their offering documents. Exam-
ining the implications of such GCOs for IPO investors in a sample of ordinary IPOs from
2001 to 2012, we find that GCOs increase price accuracy by reducing price revisions and
underpricing. Further, we show that GCO IPOs with reputable underwriters experience
higher price revisions. Our underpricing analysis supports the lawsuit avoidance theory.
We also provide novel evidence that the market can distinguish between temporarily con-
strained GCO IPOs and those with persistent problems that receive a second GCO post-
IPO. Overall, this paper contributes to the existing literature by shedding light on whether
GCOs contained in IPO prospectuses provide material information and result in better pric-
ing mechanisms.
Keywords Going concern opinions · Ordinary IPOs · Underpricing · Price revisions ·

Pricing accuracy · Lawsuit avoidance hypothesis
JEL Classification G12 · G14 · M42 · G33 · G28 · K22
* Qiancheng Zheng
qzheng@emporia.edu
Natalia Matanova
nxm40@psu.edu
Tanja Steigner
tsteigne@emporia.edu
Bingsheng Yi
byi@csudh.edu
1
Pennsylvania State University, Abington, PA 19001, USA
2
School of Business, Emporia State University, Emporia, KS 66801, USA
3
Department of Accounting and Finance, California State University, Dominguez Hills, Carson,
CA 90747, USA
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N. Matanova et al.
1 Introduction
The issue of IPO pricing accuracy remains to be puzzling for investors, practitioners and
academics (Roosenboom 2012). This is of particular importance considering that prior
research has examined an impressive array of factors that impact pricing accuracy (e.g.,
Dawson 1987; Sherman and Titman 2002; Derrien 2005; Boeh and Dunbar 2016); yet,
the puzzle has not been solved. This paper sheds light on the link between pricing accu-
racy and independent auditors’ going concern opinions. It has already been established that
going concern opinions impact stock prices (Chen and Church 1996; Taffler et al. 2004);
however, their impact on IPO pricing still needs to be examined.
In the process of going public, a firm prepares an IPO prospectus, which contains
audited financial statements. The prospectus may include a going concern opinion (GCO),
if the auditor has substantial doubt about the firm’s ability to continue as a going con-
cern during the next year. Due to limited knowledge of private firms’ operations, there is a
significant degree of information asymmetry. GCOs in IPO filings inform the market and
potential investors of auditors’ concerns. Hence, a GCO is a material piece of information
and is very important to issuing firms, investors and the market.
To illustrate the language of a GCO for an IPO firm, we take the following excerpt from
Briazz’s IPO filing dated February 1, 2001, which can be found under the “Report of Inde-
pendent Accountants” section:
The accompanying financial statements have been prepared assuming that the Com-
pany will continue as a going concern. As discussed in Note 2 to the financial state-
ments, the Company has reported operating losses since inception and needs to raise
additional capital to fund future operating losses and planned growth. These are
conditions that raise substantial doubt about its ability to continue as a going con-
cern. Management’s plans in regard to these matters are also described in Note 2.
The financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Prior studies have examined GCOs’ predictive power of delisting post-flotation and the
effect on underpricing for a niche group of offerings: highly speculative “microcap” or
“penny stocks” (Willenborg and McKeown 2000; Weber and Willenborg 2003). Interest-
ingly, in a marked shift, it has become more common for ordinary IPOs to contain GCOs
in their offering documents. In 2014, almost half of all 530 auditors’ GCOs were issued for
IPO filings (McKenna 2016).1
However, it is still unknown whether GCOs matter for regular IPOs. The aim of this
paper is threefold. First, we examine whether GCOs issued by auditors result in greater
price accuracy for regular IPOs. We argue that GCOs provide important information to
potential investors in establishing equity value for issuers, which should result in lower
price adjustments and lower underpricing.
To test this hypothesis, we examine a sample of 784 US firms that went public between
2001 and 2012. In our analysis, we differentiate between the following two types of going
concern opinions: (1) “GCO,” a firm has received a GCO once at the time of flotation
and (2) “Year2 GCO,” a firm has received a GCO at the time of flotation and also in its
1
GCOs were issued even for prominent firms such as Glaukos Corp. and Sciences Ltd. that listed on the
New York Stock Exchange and fifteen firms which floated on the Nasdaq (McKenna 2016).
13
second annual report post-flotation.2 This setup allows us to investigate the market’s abil-
ity to distinguish between IPOs that might experience temporary financial constraints until
the required capital is raised (GCO), and those IPOs that are likely to experience systemic
financial or structural problems that cannot be easily solved with additional capital (Year2
GCO).
We present evidence that GCOs offer informative content and increase price accuracy.
Specifically, GCO IPOs experience lower price revisions in general, while GCO IPOs with
highly reputable underwriters experience greater price adjustments. This finding is consist-
ent with Lowry and Schwert (2004), who find that more reputable investment banks tend
to lowball the initial price range, especially for riskier firms. This allows underwriters to
avoid situations where the final offer price is less than the filing range, which might send a
negative signal to investors. Further, GCOs reduce underpricing for venture capital (VC)-
backed GCO IPOs. We also provide evidence that the market distinguishes between IPOs
with temporary GCO status (GCO), and those that receive a second GCO after going pub-
lic (Year2 GCO).
Second, to contribute to the lawsuit avoidance hypothesis examined in previous liter-
ature (e.g., Field et al. 2005; Hanley and Hoberg 2012), we investigate how GCOs and
underpricing affect the probability of future class action lawsuits post-flotation. Consistent
with Hanley and Hoberg (2012), we find that GCOs do not affect the probability of Sec-
tion 11 lawsuits but do increase the probability of Section 10b lawsuits.3
To cross-validate the price accuracy effect of GCOs, we examine the impact of GCOs
on post-IPO stock return volatility and illiquidity. If GCOs are associated with greater price
accuracy for IPOs, we expect that GCO IPOs are not associated with greater stock price
volatility or illiquidity post-issuance. Consistent with our prediction, we find that there is
in general no difference in post-IPO stock illiquidity and idiosyncratic volatility between
GCO IPOs and non-GCO IPOs. However, VC-backed GCO IPOs experience greater vola-
tility, and Year2 GCO IPOs are more illiquid in the secondary market. This result further
supports the argument that, at the time of the IPO, investors can distinguish between firms
with temporary constraints and those with persistent structural problems.
Third, we examine whether private firms are more likely to withdraw their IPO plans
after receiving GCOs, and whether GCO IPOs are more likely to delist for performance-
related reasons post-flotation. We evaluate if GCOs signal any information about the firm’s
post-IPO performance. We find that private firms with GCOs are more likely to discontinue
their IPO efforts, and GCO IPOs are more likely to delist than Non-GCO IPOs. Further, we
present evidences that, upon conditional successful completion of the IPO process, firms
with GCOs demonstrate inferior post-IPO (stock and operating) long-run performance,
which suggests that investors ignore the very strong warning concerning the GCOs. Lastly,
our analysis shows that GCO IPOs tend to time their decision to go public based on their
operating and profitability performance.
Overall, we contribute to the literature by examining the implications of GCOs for ordi-
nary IPO companies and their investors. To the best of our knowledge, no paper to date
has examined the relationship between GCOs issued for ordinary IPOs and price accuracy,
lawsuit likelihood, volatility and illiquidity.
2
A GCO issued in the first annual report would not be as informative since annual reports are frequently
issued soon after the IPO. Hence, we focus on identifying whether an IPO firm receives another GCO in the
second annual report post-flotation (Year2 GCO).
3
Differences between these two types of lawsuits are explained in Sect. 2.2.
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N. Matanova et al.
Further research in this area is warranted and we contribute to the literature in the fol-
lowing ways. First, since an IPO represents a corporate event with high degree of informa-
tion asymmetry, any information revealed by auditors and underwriters in prospectuses is
likely to have a material impact on pricing accuracy. Second, we are expanding the lit-
erature on lawsuit avoidance behavior by linking GCO to securities class action lawsuits.
Third, although there is a significantly higher number of ordinary IPOs compared to penny
and unit stock IPOs,4 studies on the impact of GCOs among IPO firms are extremely
limited. Prior literature has primarily examined the implications of GCOs for penny and
microcap stocks (Willenborg and McKeown 2000; Weber and Willenborg 2003). However,
these two types of companies differ significantly from ordinary IPOs with respect to char-
acteristics such as trading volume, underpricing, lock-up agreements and long-run perfor-
mance (Liu et al. 2011; Bradley et al. 2006). Hence, it is essential to examine whether and
how GCOs impact ordinary IPOs.
The remainder of the paper proceeds as follows. Section 2 reviews prior research and
develops a set of hypotheses to be empirically tested. Section 3 introduces data and meth-
ods. Section 4 presents our results, and Sect. 5 concludes.
2 Prior research and hypotheses
2.1 Price accuracy: underpricing and price revisions
Previous literature has examined how information gathered by underwriters pre-IPO affects
underpricing, price revisions, and the final offer price. Hanley (1993) finds that the final
offer price does not fully adjust to new information underwriters gather during the pre-
issue period.5 Ibbotson (1975) and Tinic (1988) suggest that IPO underpricing serves as
insurance against future lawsuits, while Hughes and Thakor (1992) link underpricing to
litigation risk under Section 11 of the Securities Acts of 1933 and 1934. In an empirical
test of the lawsuit avoidance hypothesis, Drake and Vetsuypens (1993) examine 93 IPOs
that were later sued and find that negative news about the firm that are released during
aftermarket trading are more strongly related to suing (based primarily on Section 10b of
the Securities Acts of 1933 and 1934) than IPO overpricing.
Prior literature has established that underpricing is lower when more information is
revealed about an issuing firm. For example, Ritter and Welch (2002) argue that if there is
a positive relation between asymmetric information and underpricing, then more informa-
tion disclosure should result in less underpricing. Voluntary disclosure such as earnings
forecasts (Jog and McConomy 2003) and specific use-of-proceeds information in the IPO
prospectus (Leone et al. 2007) are examples of reduced information asymmetry and ex-
ante uncertainty that are associated with less IPO underpricing. Results persist even on a
4
For example, there were 1340 ordinary IPOs compared to only 64 unit and penny stock IPOs between
2001 and 2013 (Ritter 2016).
5
The finance literature offers numerous possible explanations for this phenomenon such as the winner’s
curse (Beatty and Ritter 1986; Rock 1986), signaling (Allen and Faulhaber 1989; Grinblatt and Hwang
1989; Welch 1989), promotion strategies (Habib and Ljungqvist 2001), cascading (Welch 1992; Amihud
et al. 2003), and after-market liquidity (Ellul and Pagano 2006). In addition, Ljungqvist (2007) provides a
detailed review of institution, control, and behavioral theories. Loughran and Ritter (2004) focus on chang-
ing risk composition, realignment of incentives (also see Ljungqvist and Wilhelm 2003), spinning, and ana-
lyst lust.
13
global level, where IPOs are less underpriced in countries with better earnings information
(Boulton et al. 2011).
In addition to the amount of published information, previous studies conclude that the
tone, length, and information contained in SEC filings have a material impact on inves-
tors’ ability to estimate issuers’ value. Hanley and Hoberg (2010) find that issuing firms
with greater informative (as opposed to standard) content in their IPO prospectuses exhibit
greater price accuracy, which is reflected in less underpricing and lower price revisions.
Subsequently, Hanley and Hoberg (2012) present evidence that better disclosure deters
both Sections 11 and 10b lawsuits, while underpricing only deters Section 11 lawsuits.
Loughran and McDonald (2013) examine whether the tone companies use to characterize
their business strategy and operations in S-16 SEC filings affects investors’ ability to value
the IPO. The authors find that firms with a higher proportion of weak and uncertain words
demonstrate higher absolute price revisions, upward revisions, underpricing, and aftermar-
ket stock return volatility.
To link auditors to IPO pricing, Willenborg (1999) studies the importance of auditing as
a disclosure tool that mitigates asymmetric information in small IPOs with issuance pro-
ceeds of up to $10m. His results confirm that auditors fulfill an insurance role, where larger
auditors are seen as insurance of investment losses in potential future lawsuits. In recent
years, auditors have started to issue GCOs in ordinary IPOs. A GCO issued in a compa-
ny’s IPO registration statement indicates that the auditor has substantial doubts about the
company’s “ability to continue as a going concern for a reasonable period of time, not
to exceed 1 year beyond the date of the financial statements being audited.”7 Willenborg
and McKeown (2000) find empirical support that the GCO lowers ex-ante uncertainty and
is therefore connected with lower IPO underpricing. Weber and Willenborg (2003)8 show
that larger/more prestigious auditors tend to provide more informative and accurate GCOs.
We contribute to the existing literature by examining GCOs as a means of additional
informative disclosure.9 We argue that GCOs in IPO prospectuses are likely to have a
material impact on IPO price accuracy. Specifically, we hypothesize that if GCOs provide
valuable information disclosure to investors, the disclosure will reduce underpricing. Fur-
ther, auditors’ GCOs can lead to less ex-ante uncertainty about a private issuer since this
information would help investors to assess equity market values more accurately.10 If this is
the case, issuers with GCOs will demonstrate greater price accuracy, which is reflected in
lower price revisions. Hence, we test the following null hypotheses:
6
In the IPO process, S-1 is the first filing an issuing firm needs to complete with the Securities and
Exchange Commission (SEC).
7
See Statement on Auditing Standards (SAS) No. 59.
8
Prior studies have examined the implications of GCOs for penny and microcap stock IPOs. Willen-
borg and McKeown (2000) study the GCOs’ predictive power of delisting post-flotation and the effect on
underpricing using a sample of 270 Nasdaq micro-cap issuers (raising $10 m or less) between 1993 and
1994. Weber and Willenborg (2003) shed light on the relationship between GCOs and post-IPO underper-
formance and delisting using a sample of 233 non-VC-backed Nasdaq micro IPOs over the same period.
9
While GCOs represent mandatory disclosures, they are only given to some firms with perceived going
concern challenges. In practice, therefore, the impact is more closely to voluntary, albeit negative, informa-
tion.
10
Prior studies argue that IPO companies with more ex-ante uncertainty have higher underpricing (Rock
1986; Beatty and Ritter 1986).
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N. Matanova et al.
Hypothesis 1a GCO IPOs demonstrate significantly lower underpricing than Non-GCO
IPOs.
Hypothesis 1b GCO IPOs demonstrate significantly lower price revisions than Non-
GCO IPOs.
We differentiate between two types of going concerns: firms that received a GCO once
at the time of flotation (GCO) and firms that received a GCO at the time of flotation and
also in their second annual report post-flotation (Year2 GCO). Some GCO IPOs might go
public to reduce debt levels and obtain cash, thereby relaxing financial resource constraints
(Kim and Weisbach 2005; Ball and Shivakumar 2008). If the firm has positive net present
value (NPV) projects to invest in, those firms will successfully grow and not have any sub-
sequent GCOs in the next year. However, other firms might lack positive NPV investment
opportunities or experience serious and systemic financial problems that cannot be reme-
died easily by becoming a public firm. Those firms are likely to receive further GCOs post-
IPO. If investors can differentiate these firms at the time of flotation, then the GCO in the
latter case might actually increase uncertainty about the IPO firm and, therefore, increase
underpricing and price revisions. Hence, the following expectation emerges: Year2 GCO
IPOs demonstrate significantly higher underpricing and price revisions than other firms.
We also examine how the reputation and experience of VC investors, underwriters
and auditors impact the relationship between price accuracy and GCOs. Brau and Faw-
cett (2006) find that chief financial officers consider investment banks’ connections and
institutional client base to be important factors in selecting a particular underwriter. Lowry
and Schwert (2004) suggest that high-quality investment banks lowball the initial offering
range to avoid final offer prices below that range, which could send a very negative signal
about the IPO to the market. In that sense reputable investment banks can take advantage
of issuers with limited negotiation power. Weber and Willenborg (2003) find that GCOs
published by larger auditors are more informative and predictive of post-IPO stock delist-
ing. Consequently, top-tier underwriters (Carter et al. 1998) and auditors (Michaely and
Shaw 1995) are associated with less IPO underpricing.11 Similarly, having a pre-IPO back-
ing by VC investors is beneficial to firms because of the reputation, certification and moni-
toring effects (Shu et al. 2011; Barry et al. 1990; Megginson and Weiss 1991). However,
VC investors are considered to be capital providers of last resort (Loughran and McDonald
2013) and are subject to the grandstanding argument proposed by Gompers (1996). Lee
and Wahal (2004) find support for the grandstanding hypothesis where VC backing leads
to greater underpricing. Hence, we control for underwriters’ and auditors’ reputation, as
well as for VC-backing, and expand the current literature by examining their impact on the
relationship between price accuracy and GCOs.
2.2 Lawsuits
The existing literature has not reached a definite conclusion regarding the complex rela-
tionship between disclosure and subsequent litigation risk following IPOs. On the one
11
Loughran and Ritter (2004) suggested that the negative relation between underwriter reputation and
underpricing has reversed in the 1990s with U.S. IPOs. Dimovski et al. (2011) also find that more prestig-
ious underwriters are associated with a higher level of underpricing in a sample of 358 Australian industrial
and mining company IPOs from 1994 to 1999.
13
hand, Field et al. (2005) document that disclosure deters some types of litigation after the
enactment of the Private Securities Litigation Reform Act of 1995 (PSLRA). On the other
hand, Rogers and Van Buskirk (2009) provide evidence that firms decrease the precision
and magnitude of disclosure after being sued, and suggest that managers of sued firms per-
ceive disclosure to act as a trigger for future lawsuits.
It is important to distinguish between lawsuits under Sections 11 and 10b. Section 11
allows IPO investors in the primary market to sue the issuing firm and every person who
is named in the registration statement if they incurred financial damages and the registra-
tion statement contained a material misstatement or omission. Section 10b, on the other
hand, allows all investors (IPO and aftermarket investors) to sue after incurring financial
damages but with the additional burden to prove scienter, which is the intentional mate-
rial misstatement or omission in the registration statement.12 Hanley and Hoberg (2012)
emphasize that both, investment losses and material omission in the prospectus, must be
present for investors to sue; therefore, it is sufficient to hedge the risk of litigation by either
greater underpricing (hence lower, if any, investment losses) or better disclose (hence less,
if any, material omission). They find evidence that strong disclosure serves as a substitute
for underpricing and provides an effective hedge for all types of lawsuits.
Lowry and Shu (2002) emphasize that litigation costs include more than just potential
damages to be paid; it also consists of tarnished reputations, legal fees, and management
time diverted from productive business operations. The authors provide support for an
insurance effect (positive relation between expected litigation risk and underpricing) and a
deterrence effect (negative relation between IPO underpricing and probability of lawsuit).
As one of the most important sources of accounting disclosure, auditors’ GCOs in IPO
filings and the subsequent probability of lawsuits offer us an opportunity for testing an
unsettled relationship and contribute to the ongoing debate. In line with the lawsuit avoid-
ance hypothesis (Hanley and Hoberg 2012), we examine GCOs’ effect on the probability of
future class action lawsuits via the following hypothesis:
Hypothesis 2 GCO IPOs are less likely to be sued in class action lawsuits post-IPO than
Non-GCO IPOs.
In addition, since reputable underwriters and auditors are likely to be concerned with
maintaining their reputational capital, we expect GCO IPOs underwritten and audited by
more reputable investment banks and auditors to exhibit a lower probability to be sued than
peers with less reputable intermediaries. Also, in case VC investors provide certification
and monitoring for the companies they invest in, we expect GCO IPOs with VC-backing to
have a lower probability of a lawsuit under Sections 11 or 10b post-flotation.
2.3 Post‑IPO idiosyncratic return volatility
To shed additional light on the impact of GCOs on IPO price accuracy, we examine the
post-IPO idiosyncratic return volatility. Prior research has mainly considered post-IPO idi-
osyncratic volatility from two perspectives. First, stock return volatility is generally asso-
ciated with negative outcomes at the firm level. For example, in the event of CEO turno-
ver, the company’s stock price experiences higher volatility (Clayton et al. 2005). Further,
12
See Lowry and Shu (2002) for a more detailed summary of both sections.
13
N. Matanova et al.
unfavorable management disclosures and news stories are linked to higher stock return
volatility (Kothari et al. 2009). Similarly, Gaspar and Massa (2006) find that firms with
higher market power in more concentrated industries have lower idiosyncratic volatility.
The authors suggest that market power lowers the information uncertainty faced by these
firms.
Second, to the extent that post-IPO idiosyncratic volatility reflects firm-specific price
variation, IPOs with higher information asymmetry should have higher post-IPO idiosyn-
cratic volatility. Boone et al. (2016) find that those IPO firms that successfully request
confidential treatment of proprietary information and redact information from contracts or
agreements show greater idiosyncratic return volatility in the post-IPO period than those
that do not redact any information. Prior research also suggests that the stock trading pro-
cess incorporates private information into the stock price (Dasgupta et al. 2010). Therefore,
more firm-specific variations, such as private information, should result in higher post-IPO
idiosyncratic volatility.
If GCOs are considered to be negative announcements akin to CEO turnover or unfa-
vorable management disclosure, we should expect GCO IPOs to experience greater post-
IPO idiosyncratic volatility. However, there is a clear difference with regard to the timing
of such an announcement/disclosure. GCOs are clearly stated in the prospectus before any
public trading begins; therefore, it does not have the element of surprise that hits the mar-
ket while active trading is in process. Furthermore, we do not expect GCO IPOs to enjoy
great market power, which would lower their post-IPO idiosyncratic volatility. Therefore,
we argue that GCOs should not have any impact on the post-IPO idiosyncratic volatility.
Hypothesis 3 GCO IPOs are not associated with higher post-IPO idiosyncratic return
volatility.
However, the existence of GCOs and other certification effects from top underwriters
and auditors do not rule out the possibility of heightened level of post-IPO idiosyncratic
return volatility for those GCO IPOs that are backed by VCs. Although researchers gen-
erally recognize the advising and monitoring benefits provided by VCs for private com-
panies (Barry et al. 1990), the role of VCs in the IPO pricing process has not yet been
clearly determined. VCs are often viewed as capital providers of last resort (Loughran and
McDonald 2013). Further, less mature VC investors might try to establish their reputation
to attract new funds in the future, thus, they might engage in grandstanding by bringing
companies to the public markets pre-maturely and incurring higher underpricing (Gomp-
ers 1996). In addition, Field and Hanka (2001) find that following the lock-up agreement
expiration companies experience a significant increase in trading volume, which is more
concentrated in VC-backed IPOs. Regardless of whether the VC investment is viewed
positively or negatively, it is likely to increase the post-IPO idiosyncratic return volatility.
Hence, we expect GCO IPOs backed by VCs to be positively associated with post-IPO idi-
osyncratic return volatility.
2.4 Post‑IPO illiquidity
Recent studies document that GCOs provide valuable information to investors and, conse-
quently, the market reacts significantly to news on GCOs (Minon and Williams 2010; Blay
et al. 2011; Khan et al. 2017). Prior research shows that stock liquidity is of great impor-
tance to firms and their investors. Specifically, firms with greater stock market liquidity
13
have lower cost of capital (Butler et al. 2005; Liang and Wei 2012), and the opportunity to
trade retained shares under more favorable terms (Aggarwal et al. 2002). IPO firms even
trade underpricing for post-listing liquidity (Hahan et al. 2013).
How might GCOs impact systematic risk post-IPO? On the one hand, having a GCO in
the IPO prospectus might increase systematic risk. Feldmann and Read (2010) show that
more than 59% of bankruptcies are preceded by GCOs. Hence, such information might
deter investors from participating in GCO IPOs. Further, more risk-averse institutional
investors might also avoid investments in GCO IPOs. A large body of literature has dem-
onstrated that institutional investors are more sophisticated and influential players in the
financial markets (Sias et al. 2006). While institutional ownership in a company increases
that stock’s liquidity (Rubin 2007; Chung et al. 2010), the lack of institutional investor
demand will decrease such liquidity. Hence, we might find a positive relationship between
GCOs and post-listing illiquidity. On the other hand, firms with GCOs are like lottery
stocks, which might attract investments and trades from retail investors (Kausar et al. 2013)
and institutional investors who are willing to accept the level of risk. Hence, such invest-
ment psychology might decrease the post-listing illiquidity. Therefore, it is an empirical
issue whether and how GCOs affect post-IPO stock illiquidity. This leads us to the follow-
ing null hypothesis:
Hypothesis 4 GCOs are not associated with post-IPO illiquidity.
In line with our prior setup, we argue that an additional GCO received in the post-
flotation period for GCO IPOs confirms systemic financial problems (Year2 GCO IPOs).
Therefore, in case the market can distinguish between these two types of IPO firms, we
expect Year2 GCO IPOs to be associated with greater post-listing illiquidity.
2.5 Long‑run performance, delisting, and withdrawal
It is well documented that IPOs in general underperform over the long run (Ritter 1991;
Loughran and Ritter 1995; Cai et al. 2008). Prior studies show that certain firm and offer-
ing characteristics, such as non-VC backing (Brav and Gompers 1997) and less prestigious
underwriters (Carter et al. 1998) are associated with more severe IPO long-run underper-
formance. In contrast, firms with pre-IPO private equity or VC backing experience better
post-IPO stock returns (Ritter 2016; Levis 2011).
However, there is limited research on identifying internal reasons for the post-IPO
underperformance. GCOs for IPOs indicate that an issuing firm has substantial financial
constraints such that its continual operation and future viability might be an issue of con-
cern. If the market is able to accurately incorporate GCOs into the offer price, we should
not expect to observe any differences in long-run stock performance between GCO IPOs
and Non-GCO IPOs. However, if the risk is not fully incorporated into the initial price, we
might observe that GCO IPOs display lower long-run stock performance than Non-GCO
IPOs.
Weber and Willenborg (2003) document that GCOs issued by large auditors are more
predictive of post-IPO negative stock delistings for penny stocks. Willenborg and McKe-
own (2000) find that microcap GCO IPOs are more likely to be delisted within 3 years after
the IPO. This finding should hold also for ordinary IPOs. In addition, Tsai et al. (2009)
find the usefulness of auditors’ GCOs and other opinions in predicting financial distress of
13
N. Matanova et al.
Taiwanese firms. Therefore, we expect to find a positive relationship between GCOs and
delisting.
A public flotation is not an easy transition for most companies, and as a result, not
all companies complete this process. Prior research has examined the causes and conse-
quences of IPO withdrawals (Busaba et al. 2001; Dunbar and Foerster 2008; Cooney et al.
2009; Hao 2011). Among documented factors, GCOs issued by independent auditors could
possibly be the determinant for a company to withdraw its IPO plans. We expect to find a
positive relationship between GCO IPOs and withdrawal. Overall, we examine the follow-
ing hypotheses:
Hypothesis 5a Conditional on successful completion of the IPO process, GCO IPOs

exhibit inferior post-IPO performance compared to Non-GCO IPOs.
Hypothesis 5b Conditional on successful completion of the IPO process, GCO IPOs are
more likely to delist compared to Non-GCO IPOs.
Hypothesis 5c Firms with GCOs are more likely to withdraw their IPO plans than firms
without GCOs.
3 Data and methods
In this section, we introduce the data collection process, descriptive statistics, and empiri-
cal methods for this study.
3.1 Data and main variables
Our sample includes IPO issuances in the US from 2001 to 2012. We use the Thomson
Financial’s Securities Data Company (SDC) database to identify IPOs and to collect IPO
characteristics. After eliminating closed-end funds, spin-offs, unit issues, real estate invest-
ment trusts, limited partnerships, financial institutions (SIC 6000–6999), IPOs with offer
prices less than $5, and IPOs with missing information, we have a total of 1019 IPOs. Fol-
lowing Liu and Ritter (2011), we further delete IPOs that are not listed on CRSP within
6 months of issuing. To avoid delisting bias, we include only IPO firms for which we have
the required data available for all 3 years post listing. Our final sample consists of 784
IPOs: 719 non-GCO IPOs and 65 GCO IPOs. Within the latter group of firms, 11 received
another GCO in the second year post-IPO (Year2 GCO sample). We also collect a sam-
ple of 591 withdrawn IPOs from the SDC database using the same sampling criteria.13
Therefore, our sample for analyzing completed IPOs and withdrawn deals consists of 1375
observations.
We obtain accounting data from Compustat, and 13f institutional holdings data from the
Thomson Reuters Ownership Database. For each company in our sample, we gather infor-
mation on class action lawsuits for 3 years post-IPO from Stanford Law School’s Securi-
ties Class Action Clearinghouse. We obtain stock price data and delisting frequencies from
13
This data is collected for the 2001–2010 time period, which is dictated by the data availability of with-
drawn IPOs.
13
CRSP. Finally, we hand-collect GCOs from IPO filings downloaded from EDGAR. We
examine both Form S-1 (the initial filing) and Form 424B3 (the final prospectus) for evi-
dence of GCOs. IPOs with GCOs are marked with a GCO dummy variable equal to one,
and 0 otherwise.14
In Table 1 we provide distributions and summary statistics for our sample of 784 IPOs.
We present the annual distribution of our sample in Panel A. Between 2004 and 2007 we
have an annual average of 109 IPOs, but significantly lower frequencies in the years before
and after this period. This observation is not surprising since 2001 follows the burst of the
Internet bubble of 1999–2000, and 2008–2009 corresponds to the recent financial crisis.
Gao et al. (2013) ascribe the lower IPO rate in our sample period compared to prior dec-
ades to economies of scope. We have 65 IPOs that received a GCO at the time of flota-
tion. The distribution of these GCO IPOs shows considerable variation. For instance, there
are no GCOs in 2002, 2008, and 2009, while 17% (14%) of IPOs received GCOs in 2003
(2010). Overall, 8.3% of our sample firms have GCOs; this represents a significant increase
for ordinary IPOs compared to previous decades.15 Lastly, we have 11 firms that receive a
GCO also in the second year post-IPO.
Panel B reports descriptive statistics for Non-GCO IPOs, GCO IPOs, and Year2 GCO
IPOs, as well as their differences in means. Several characteristics are immediately appar-
ent. First, GCO IPOs are smaller and have lower offer prices. The average Non-GCO IPO
raises proceeds of $208m with an offer price of $14, and has a market capitalization of
$808m. In contrast, the average GCO IPO (Year2 GCO IPO) raises proceeds of $66m
($38m), has an offer price of $10 ($7) and a market capitalization of $283m ($269m). GCO
IPOs generate higher proceeds compared to Year2 GCO IPOs, and Non-GCO IPOs yield
greater market capitalization compared to Year2 GCO IPOs, both significant at the 10%
level. Mean offer prices reveal an interesting trend: offer prices are the highest for Non-
GCO IPOs, followed by GCO IPOs and Year2 GCO IPOs. All differences are statistically
significant at the 1% level. The market, therefore, appears to value IPOs with systemic
problems (Year2 GCO IPOs) less than firms that have GCOs only during the IPO year.
Of particular interest to this study are the differences in underpricing (Initial return),
price revision (Abs_rev), and lawsuits (Lawsuit, Sections 11, 10b). GCO IPOs have a lower
first day return of 3.38% compared to 13.12% for Non-GCO IPOs, statistically significant at
the 1% level. This finding provides initial support for Hypothesis 1a, indicating that GCO
IPOs are less underpriced. It is possible that firms with GCOs feel that the auditor opin-
ion reveals valuable information and, hence, there is less need to underprice their stocks
in order to hedge against possible lawsuits (Hanley and Hoberg 2012). This substitution
appears to be at least partially successful since there is no statistical difference between
GCO IPOs and Non-GCO IPOs for Section 11 lawsuits and lawsuits in general. However,
there is indication that Non-GCO IPOs are implicated in significantly fewer Section 10b
lawsuits than GCO IPOs. This finding suggests that secondary market investors sue GCO
IPOs relatively more frequently, claiming that material information was intentionally with-
held in the prospectus.
14
In four cases the GCO is removed from the final prospectus. We include these four cases in our GCO
sample, but we also re-run our analyses with them in the Non-GCO sample, and our results remain consist-
ent.
15
The general increase in GCO since the passing of the 2002 Sarbanes–Oxley Act is addressed by Myers
et al. (2014).
13
N. Matanova et al.
Table 1 Descriptive statistics
Year Whole sample Non-GCO IPOs GCO IPOs Year2
GCO
IPOs
Panel A: Number and percentage of GCO IPOs by year

2001 39 35 4 2
2002 41 41 0 0
2003 41 34 7 0
2004 116 106 10 1
2005 102 96 6 1
2006 110 102 8 1
2007 107 99 8 2
2008 13 13 0 0
2009 32 32 0 0
2010 65 56 9 1
2011 57 50 7 1
2012 61 55 6 2
Total 784 719 65 11
Descriptive statistics: means Differences-in-means
Non-GCO IPOs GCO IPOs Year2 GCO Mean Mean Mean
(a) (b) IPOs (c) (a–b) (a–c) (b–c)
Panel B: Descriptive statistics for non-GCO IPOs, GCO IPOs, and Year2 GCO IPOs
Proceeds 208.46 65.65 37.77 142.82 160.86 33.55*
Offer price 14.21 9.87 7.36 4.34*** 6.58*** 3.02**
IPO valuation 211.89 65.65 37.77 146.24 164.27 33.55
Log (IPO valu- 4.69 3.82 3.28 0.87*** 1.35*** 0.65**
ation)
Initial return 13.12 3.38 6.30 9.74*** 6.82 − 3.51
Lawsuit 0.13 0.15 0.18 − 0.03 − 0.05 − 0.03
Section 11 0.06 0.08 0.00 − 0.02 0.06 0.09
Section 10b 0.08 0.15 0.18 − 0.07** − 0.10 − 0.03
Abs_rev 11.05 10.83 15.07 0.22 − 4.02 − 5.10
VC-backing 0.48 0.55 0.45 − 0.07 0.03 0.12
Underwriter rank 8.27 6.92 5.91 1.34*** 2.28*** 1.22*
Top tier 0.83 0.52 0.27 0.31*** 0.56*** 0.30
Big5_audit 0.89 0.77 0.82 0.12*** 0.07 − 0.06
Delist 0.07 0.28 0.36 − 0.21*** − 0.30 − 0.10
Illiquid 4.19 7.74 13.63 − 3.55*** − 9.44*** − 7.09
Multi-class 0.09 0.05 0.00 0.05 0.09 0.06
Earnings nve 0.54 0.84 0.89 − 0.30*** − 0.34** − 0.05
High tech 0.40 0.20 0.09 0.20*** 0.31** 0.13
Insti. ownership 55.35 37.87 26.45 17.48*** 28.90*** 13.74
Internet IPO 0.11 0.03 0.00 0.08** 0.11 0.04
Shares overhang 2.07 2.56 4.29 − 0.49 − 2.22 − 2.08
Partial − 3.47 − 3.85 − 8.25 0.38 4.78 5.29
Volatility 30.40 38.98 37.98 − 8.58*** − 7.58 1.20
13
Table 1 (continued)
This table presents descriptive statistics comparing Non-GCO IPOs, GCO IPOs and Year2 GCO IPOs.
The IPO sample spans the years from 2001 to 2012. The initial sample of IPOs is from Thomson Finan-
cial’s Securities Data Company (SDC) database. We exclude closed-end funds, spin-offs, unit issues, real
estate investment trusts, limited partnerships, financials (SIC 6000–6999), IPOs with offer prices < $5, and
IPOs with critical information missing from their SEC filings or CRSP, and further delete IPOs that are
not listed on CRSP within 6 months of issuing, following Liu and Ritter (2011). SDC is the source for a
variety of additional IPO characteristics such as names of lead underwriters and auditors, proceeds, offer
price, VC-backing, share overhang, and high-tech industry classification. Panel A presents the number and
percentage of GCO IPOs by year. Panel B presents descriptive statistics for IPO firm characteristics. The
GCO dummy (GCO IPO) information for IPOs is from the Securities and Exchange Commission (SEC)’s
IPO final prospectuses (424B). Proceeds is the proceeds (in millions) in the final prospectus as recorded by
SDC. Offer price is the offer price (USD) for an IPO firm as indicated in SDC Database. IPO valuation is
defined as offer price multiplied by the pre-IPO number of shares expected to exist after the IPO in the IPO
prospectus. Initial return is the percentage difference between the closing price on the first day of trading
and the offer price. Lawsuits is a dummy variable with a value of one if the IPO gets a class action lawsuit
after the IPO date up to 3 years after its public offering, and zero if it does not get a lawsuit in this period.
Section 11 is a dummy variable with a value of one if the IPO gets a Section 11 class action lawsuit after
the IPO date up to 3 years after its public offering, and zero if it does not get a lawsuit in this period. Sec-
tion 10b is a dummy variable with a value of one if the IPO gets a Section 10b class action lawsuit after the
IPO date up to 3 years after its public offering, and zero if it does not get a lawsuit in this period. Abs_rev
is the absolute value of price revision calculated as the percentage differences from the offer price to the
midpoint of the file range. VC-backing is a dummy variable equal to one if the firm is VC-backed, zero oth-
erwise. Underwriter rank is the average rank on a Carter–Manaster ranking on a 1–9 point scale. Top tier is
the percentage of firms that were taken public by an investment bank with a Carter–Manaster ranking of 8
or higher. Big5_audit is the indicator variable for companies that hire the following five auditors: KPMG,
PricewaterhouseCoopers LLP, Deloitte, Ernst & Young LLP, Grant Thornton LLP. Delist is a dummy vari-
able with a value of one if the stock is delisted within 3 years of the IPO for a deleterious reason (CRSP
delisting codes 550-572 and 574-584), and zero otherwise. Illiquid indicates the spread implied by the daily
high and low prices and is calculated using the formula from Corwin and Schultz (2012) . Multi-class is a
dummy variable with a value of one for firms with more than one class of stock, and zero otherwise. Earn-
ings nve is a dummy variable with a value of one if an IPO firm had negative earnings per share (EPS) over
a period of 1 year after initial public offerings, based on COMPUSTAT quarterly data. High tech is the high
technology industry classification from SDC’s new issue database. Insti. ownership is the mean ownership
for the stock in the first quarter after the initial public offering in institutional holding (13f) data. Internet
IPO is the dummy variable with value one if the IPO is classified as an internet IPO, and zero otherwise.
Share overhang is defined as pre-IPO shares retained for all classes divided by shares filed (including pri-
mary and secondary shares), following Bradley and Jordan (2002). Partial is the percentage difference from
the offer price to the midpoint of the file range. Volatility is defined as the market model root-mean square
error (multiplied by 1000) for each firm over day + 5 to day + 64 relative to the offer day, as in Loughran
and McDonald (2013). The significance for mean difference is based on T test, and the significance for the
median difference is based on Kruskal–Wallis test. ***, **, and * indicate statistical significance levels 1, 5,
and 10%, respectively
There is no statistical difference in the mean price revision between the Non-GCO and
GCO IPO subsets. Further, in contrast to Non-GCO sample, GCO IPOs are more likely
to delist, have greater post-IPO volatility and illiquidity, have more negative earnings per
share, smaller proportions of high-tech and internet firms as well as lower institutional
ownership during the first quarter post-IPO. About half of the Non-GCO IPOs and GCO
IPOs in our sample are backed by VC firms. GCO IPOs have lower participation of reputa-
ble underwriters (Top tier) and auditing firms (Big5_audit) compared to Non-GCO IPOs;
these differences are statistically significant at the 1% level. Turning to underwriters and
VC firms we find that Non-GCO IPOs use more reputable underwriters (Underwriter rank)
than GCO IPOs and Year2 GCO IPOs, and GCO IPOs use more reputable underwriters
than Year2 GCO IPOs. This finding suggests that underwriters and auditors might be more
13
N. Matanova et al.
reserved to engage with “weaker” IPOs, those that receive a GCO; this might be in part
motivated by concerns about future lawsuits for GCO IPOs. VC firms are naturally also
concerned about potential lawsuits. However, they select firms while those are still very
young, and then VC investors typically stay with them through the IPO process and often-
times beyond (Barry et al. 1990). This explains why we find a more even distribution of
VC backing among our Non-GCO and GCO IPO subsets.
3.2 Empirical methods
3.2.1 Multivariate regression analyses
We use ordinary least squares (OLS) regression to test the determinants of IPO underpric-
ing, price revision, stock price volatility and illiquidity. The basic OLS model is specified
as follows:
DVi = 𝛽0 + 𝛽1 GCO IPO + 𝛽2 Year2 GCO
+ Y� Xi + Industry Fixed Effects + Year Fixed Effects + 𝜀i
We use logistic regression to examine the factors that influence the probability of post-
IPO class action lawsuits, post-IPO delisting, and withdrawal of IPO plans. The basic
logistic regression model is specified as follows:
LOG (Pi ∕1 − Pi ) = 𝛽0 + 𝛽1 GCO IPO + 𝛽2 Year2 GCO
+ Y� Xi + Industry Fixed Effects + Year Fixed Effects + 𝜀i
where DVi is the dependent variable in our OLS models, and Pi is the probability of the
dependent variable taking the value one in our logistic regressions. Xi is a vector of other
determinants of the dependent variables (Log (IPO valuation), Partial, Shares overhang,
Multi_class, Market return, High tech, Internet IPO, Earnings nve, Insti. Ownership, VC-
backing, Top tier, Big5_audit, and interaction variables).16ʏ is a vector of the correspond-
ing regression coefficients of the variables in Xi. We also add industry fixed effects and
year fixed effects as a proxy for unmeasured industry and time characteristics and also to
account for other potential omitted variable bias. All variables are defined in Table 11 in
“Appendix”.
3.2.2 Long‑run stock performance
This paper employs three different methodologies to compare the long-run performance
between GCO IPOs and Non-GCO IPOs, since each method assumes different investment
strategies that could be used by different investors.
We first report the 3-year buy-and-hold abnormal returns (BHARs) and the 3-year
cumulative abnormal returns (CARs) for GCO IPOs and Non-GCO IPOs, respectively, and
test their differences in means. Following Lyon et al. (1999), we compute BHARs for 3
years post-IPO, using the returns of the size and book-to-market (BM) ratio matched port-
folios as benchmarks. We obtain the size/BM breakpoints from Kenneth French’s website17
16
GCO*VC-backing, GCO*Top tier and GCO*Big5_audit.
17
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.
13
and match each firm to one of the 25 corresponding size/BM portfolios at the end of the
offering year. The delisting returns are included, and the proceeds in the matching size/
BM portfolio are re-invested if a stock stops trading prior to the end of the event window.
Therefore, BHAR is computed as follows:
T T
∏ ) ∏
(1)
( ( )
BHARit = 1 + Rit − 1 + Rmt
t=1 t=1
where Rmt is the return of the corresponding value-weighted size/book-to-market portfolio

constructed by Fama and French (1993).
To obtain CARs, we sum the abnormal returns as follows:
T
∑
CARit = (Rit − Rmt ) (2)
t=1
where Rit is the simple monthly return for sample firm i, and Rmt is the simple monthly
return for the corresponding value-weighted size/book-to-market portfolio constructed
by Fama and French (1993). We match each firm with one of the 25 corresponding size/
BM portfolios at the beginning of the announcement year, using the size/BM breakpoints
from Kenneth French’s website. We report both equal-weighted (EW) and value-weighted
(VW) average CARs for GCO IPOs and Non-GCO IPOs. For VW returns, we construct the
weights using the IPO’s first available market capitalization (shares outstanding multiplied
by closing price) from the CRSP daily data, scaled by the level of the CRSP VW index at
that date.
Both BHARs and CARs suffer from a lack of independence and cross-correlation in
event-time returns, which may lead to biased test statistics (Fama 1998). Therefore, we
also apply the calendar-time regression approach to estimate the average abnormal monthly
returns. The time-series variation in portfolio returns mitigates the effect of any cross-
correlation on the variance of abnormal returns that could plague the BHARs and CARs
methods. Thus, we form portfolios of GCO and Non-GCO IPOs in every calendar month
over the sample period. The following regression model examines the effect of long-run
stock returns of GCO IPOs and Non-GCO IPOs:
(3)
( )
Rpt − Rft = a + bp Rmt − Rft + sp SMBt + hp HMLt + up UMDt + ept
where Rpt is the simple monthly return on the calendar-time portfolio (for both EW and
VW), Rft is the monthly return on 3-month Treasury bills, and Rmt is the return on the
corresponding VW size/book-to-market portfolio constructed by Fama and French (1993).
SMBt is the difference in the returns of VW portfolios of small stocks and big stocks,
HMLt is the difference in the returns of VW portfolios of high book-to-market stocks and
low book-to-market stocks. UMDt is the momentum factor adopted according to Carhart
(1997). The parameter estimates bp , sp , hp and up are generated as regression outputs. The
error term of the regression is denoted by ept . The intercept estimate a tests the null hypoth-
esis that the mean monthly excess return on the calendar-time portfolio is not significantly
different from zero.
We also form a zero-investment hedge portfolio that goes short in GCO IPOs and long
in Non-GCO IPOs. To compare the short-term differences in performance, we incor-
porate those GCO IPOs and Non-GCO IPOs with issue dates within 6 months prior to
the calendar date in the portfolios. To compare the long-term performance differences,
13
N. Matanova et al.
we incorporate those GCO IPOs and Non-GCO IPOs with issue dates within 12 and
36 months prior to the calendar date in the portfolios. After creating portfolios, we regress
the time series of portfolio returns on the three stock market factors: market, size and book-
to-market, as suggested by Fama and French (1993), and examine the intercepts as abnor-
mal monthly returns. We require at least five observations per month to form portfolios
for each category. The reported P values are based on heteroskedasticity-adjusted standard
errors (White 1980) to account for the changing portfolio constituents.
4 Results
4.1 Underpricing
In Table 2 we summarize our multivariate analysis of underpricing, where our dependent

variable, Initial return, is the percent difference between the closing price on the first day
of trading and the offer price.
Supporting Hypothesis 1a, we find that GCO IPOs are associated with significantly
less underpricing in our basic models (1) and (2). In line with Willenborg and McKeown
(2000) and Ritter and Welch (2002), this finding suggests that the GCO does indeed pro-
vide valuable information to investors. Specifically, GCOs might act as a substitute hedge
for underpricing, where GCO serves as disclosure that reduces the likelihood of being
sued (Hanley and Hoberg 2012).18 However, once we introduce the typical intermediaries
(underwriters, auditors, and VC firms) in our regressions [model (3) onwards], the coeffi-
cient of GCO IPO is no longer statistically significant. Interestingly, the initial reduction in
underpricing reemerges for GCO IPOs that have VC-backing [model (7)], while VC back-
ing itself is associated with greater underpricing [models (3) through (7)]. One possible
explanation for our finding is that VC firms promote underpricing either due to grandstand-
ing (Gompers 1996; Lee and Wahal 2004) or to avert potential lawsuits (Ibbotson 1975;
Tinic 1988; Hughes and Thakor 1992; Hensler 1996), but they substitute underpricing
with greater disclosure in the case of GCO IPOs (Hanley and Hoberg 2012). Top tier and
Big5_audit are dummy variables indicating whether an IPO retains a top tier underwriter
(Carter–Manaster ranking of 8 or higher) or a Big-5 auditing firm, respectively. The coef-
ficient for Big5_audit is positive and significant (at 10% level) in model (3) through (5),
indicating that hiring a Big-5 auditor is associated with slightly higher underpricing.
We further add to the literature by introducing a second year GCO dummy variable
(Year2 GCO), capturing firms with persistent financial challenges that were not remedied
after the capital infusion of the IPO. In support of our expectation, we find that Year2 GCO
is positively associated with underpricing in all but three models [models (1), (4) and (7)].
This finding could suggest that the language and tone in the prospectus of a more seriously
struggling IPO firm (which will continue to receive a GCO post-IPO) are weaker and more
uncertain (in line with Loughran and McDonald 2013), and that investors can differentiate
between a temporarily weakened GCO IPO and a more systematically struggling Year2
GCO IPO at the time of flotation.
18
Of course, the firm might have preferred to underprice rather than receiving a GCO. However, once the
GCO is issued, firms might take advantage of the additional disclosure by reducing the underpricing.
13
Table 2 Underpricing regressions
Variables (1) (2) (3) (4) (5) (6) (7)
Initial return Initial return Initial return Initial return Initial return Initial return Initial return
GCO IPO − 7.33*** − 7.09*** − 6.01** − 1.66 − 8.74 − 6.48 − 5.69

(− 3.85) (− 3.58) (− 3.04) (− 0.34) (− 1.36) (− 0.84) (− 0.54)
Year2 GCO 2.17 6.51** 7.83** 6.74 8.69* 7.80** 7.27
(1.22) (2.71) (2.45) (1.78) (1.86) (2.61) (1.51)
Log (IPO valuation) − 0.80 − 1.00* − 0.76 − 0.97* − 1.00* − 0.71
(− 1.08) (− 2.04) (− 1.11) (− 1.96) (− 1.88) (− 1.12)
Partial 0.45*** 0.45*** 0.45*** 0.45*** 0.45*** 0.45***
(5.30) (6.07) (5.87) (6.10) (6.00) (5.91)
Shares overhang 0.27* 0.21 0.20 0.20 0.21 0.19
(1.84) (1.36) (1.22) (1.30) (1.35) (1.17)

Multi_class 2.29 3.09 2.81 3.08 3.09 2.77
(0.78) (1.01) (0.96) (1.00) (1.02) (0.94)
Market return − 0.16 − 0.17 − 0.16 − 0.17 − 0.17 − 0.15
(− 1.54) (− 1.44) (− 1.27) (− 1.41) (− 1.44) (− 1.27)
High tech − 2.66 − 1.17 − 1.23 − 1.22 − 1.17 − 1.29
(− 1.03) (− 0.51) (− 0.55) (− 0.53) (− 0.51) (− 0.56)
Internet IPO 6.90*** 6.01*** 5.93*** 6.00*** 6.01*** 5.91***
(13.08) (10.31) (10.87) (10.39) (10.45) (10.67)
Earnings nve − 0.50 − 0.55 − 0.59 − 0.54 − 0.55 − 0.59
(− 0.27) (− 0.34) (− 0.38) (− 0.33) (− 0.34) (− 0.38)
Insti. ownership 0.14*** 0.12*** 0.12*** 0.12*** 0.12*** 0.12***
(5.09) (6.03) (5.87) (6.10) (6.00) (5.98)
VC-backing 5.89** 6.62*** 5.95** 5.87** 6.73***
(2.73) (3.88) (2.73) (2.99) (3.80)
Top tier 0.33 − 0.04 − 0.24 0.33 − 0.63
13
(0.33) (− 0.04) (− 0.16) (0.34) (− 0.53)

Variables (1) (2) (3) (4) (5) (6) (7)
Initial return Initial return Initial return Initial return Initial return Initial return Initial return
13
Big5_audit 4.57* 4.84* 4.53* 4.50 4.49
(1.94) (2.12) (1.95) (1.73) (1.72)
GCO*VC-backing − 6.86 − 8.19***
(− 1.59) (− 3.95)
GCO*Top tier 4.35 4.22
(0.59) (0.59)
GCO*Big5_audit 0.61 2.87
(0.08) (0.56)
Constant 17.19*** 26.82*** 16.98*** 15.20** 17.09*** 17.12*** 15.58**
(3.23e+13) (4.14) (4.61) (3.09) (4.44) (3.42) (2.86)
Observations 784 720 720 720 720 720 720
Adjusted R-squared 0.08 0.28 0.30 0.30 0.30 0.30 0.30
Industry FE YES YES YES YES YES YES YES
Year FE YES YES YES YES YES YES YES
The dependent variable is Initial return, defined as the percent difference between the closing price on the first day of trading and the offer price. The IPO sample spans the
years from 2001 to 2012. All variables are defined in the Table 11 in “Appendix”. Heteroskedasticity-robust and industry-clustered t-statistics are in parentheses. ***, **, and
* indicate statistical significance levels 1, 5, and 10%, respectively
N. Matanova et al.
We also consider commonly used control variables such as the natural logarithm of
firms’ IPO valuation determined by the offer prices and number of shares as expected pre-
IPO (Log(IPO valuation)),19 the percentage difference between the offer price and the mid-
point of the initial file range (Partial), and the pre-IPO shares scaled by shares offered
(Shares overhang). The latter two variables have been shown to be significant predictors
of IPO underpricing (e.g., Hanley 1993; Bradley and Jordan 2002; Loughran and Ritter
2004). We also include an indicator for multiclass IPOs, Multi_class (Smart and Zutter
2003), and the cumulative market return 1 month prior to the offering, Market return. The
coefficient for Partial is positive and highly significant, consistent with the literature. High
tech and Internet IPO are dummy variables that equal one if an IPO is classified as a high-
tech or internet firm, respectively, and zero otherwise. The coefficient for High tech is not
significant, but the coefficient of Internet IPO is positively and significantly (at the 1%
level) related to underpricing. Lastly, we find that institutional ownership (Insti. ownership)
is significantly positively related to underpricing, which is consistent with Aggarwal et al.
(2002).
Taken together, Table 2 suggests that VC-backed GCO IPOs are less underpriced while
Year2 GCO IPOs tend to be more underpriced. This finding is important as it provides a
deeper understanding of the ex-ante information effect of GCOs. We revise Willenborg
and McKeown’s (2000) finding for micro-stock IPOs, providing evidence that GCOs pro-
vide more information for investors about ordinary IPOs, which in turn reduces underpric-
ing. While we replicate this result in our basic model, we find lower underpricing only for
VC-backed GCO IPOs, which is likely linked to Hanley and Hoberg’s (2012) substitution
and lawsuit avoidance theory. In addition, we find support for the market’s ability to dif-
ferentiate between IPO firms that experience short-term financial challenges that will be
overcome post-IPO, and IPO firms with more systemic financial problems that will trigger
a subsequent GCO in the post-flotation period.
4.2 Price revisions
In Table 3 we test the prediction that auditors’ GCOs reduce ex-ante uncertainty about pri-
vate firms, which results in greater price accuracy. The dependent variable is the absolute
price revision for IPOs floated on US stock markets between 2001 and 2012.
We find that a GCO has a significant negative impact on price revisions [model (5), (6)
and (7)], indicating that GCO IPOs tend to experience lower price revisions. Therefore,
auditors’ GCOs seem to provide important information, which leads to greater price accu-
racy. An interesting story unfolds when we consider the interaction between GCO IPOs
and reputable underwriters [models (5) and (7)]. Consistent with Hanley (1993), reputable
underwriters (Top tier) are positively related to price revision. Building upon this logic, if
the issuing firm has a GCO, using such a reputable underwriter should result in even more
changes to the original offer price, as evidenced by our significantly positive coefficient
for the GCO*Top tier interaction term. We have further shown in the descriptive statistics
table that GCO IPOs experience lower offer prices than Non-GCO IPOs. Once we account
for the effect of highly reputable underwriters on GCO IPOs’ price revision, we present
evidence that GCO IPOs in general demonstrate significantly lower absolute price revi-
sions, which is indicative of greater price accuracy and supportive of Hypothesis 1b. Thus,
19
We thank the anonymous referee for suggesting the specification of this variable.
13

Table 3 Price revisions
Variables (1) (2) (3) (4) (5) (6) (7)
Absolute revision Absolute revision Absolute revision Absolute revision Absolute revision Absolute revision Absolute revision
13
GCO IPO − 0.56 − 1.44 − 0.46 − 1.52 − 5.17*** − 4.99* − 7.20***
(− 0.30) (− 0.48) (− 0.16) (− 0.71) (− 3.49) (− 2.18) (− 3.21)
Year2 GCO 6.05 4.13 4.72* 4.98** 6.23** 4.51* 5.91**
(1.76) (1.38) (2.10) (2.37) (3.14) (2.21) (2.65)
Log (IPO valuation) − 2.35 − 3.50 − 3.55 − 3.43 − 3.55 − 3.47
(− 1.44) (− 1.67) (− 1.73) (− 1.66) (− 1.70) (− 1.68)
Shares overhang 0.31* 0.27 0.27 0.25 0.27 0.26
(1.82) (1.58) (1.58) (1.51) (1.61) (1.52)
Initial return 0.05 0.04 0.04 0.03 0.04 0.03
(1.34) (1.10) (1.12) (1.14) (1.14) (1.16)
Multi_class 1.95 2.88** 2.95** 2.87* 2.92* 2.89*
(1.38) (2.24) (2.34) (2.14) (2.19) (2.11)
Market return − 0.10 − 0.12 − 0.13 − 0.11 − 0.13 − 0.12
(− 0.99) (− 1.29) (− 1.33) (− 1.21) (− 1.32) (− 1.26)
High tech − 0.58 0.40 0.41 0.31 0.38 0.31
(− 0.32) (0.22) (0.23) (0.17) (0.20) (0.17)
Internet IPO 3.12 2.70 2.71 2.69 2.72 2.70
(1.44) (1.20) (1.20) (1.19) (1.20) (1.19)
Earnings nve 0.73 0.68 0.69 0.69 0.68 0.69
(0.45) (0.41) (0.42) (0.41) (0.41) (0.41)
Insti. ownership − 0.01 − 0.03 − 0.03 − 0.03 − 0.03 − 0.03
(− 0.38) (− 1.10) (− 1.10) (− 1.18) (− 1.09) (− 1.17)
VC-backing 2.23*** 2.05*** 2.36*** 2.05*** 2.24***
(3.44) (3.25) (3.68) (3.34) (3.40)
Top tier 2.49*** 2.58*** 1.50** 2.55*** 1.66***
N. Matanova et al.
(3.65) (3.81) (3.12) (3.55) (3.68)

Variables (1) (2) (3) (4) (5) (6) (7)
Absolute revision Absolute revision Absolute revision Absolute revision Absolute revision Absolute revision Absolute revision
Big5_audit 6.47*** 6.40*** 6.40*** 5.72** 5.97**

(3.61) (3.50) (3.45) (2.65) (2.63)
GCO*VC-backing 1.68 − 0.06
(0.71) (− 0.04)
GCO*Top tier 7.50** 6.58***
(2.65) (3.67)
(0.98) (0.59)
Constant 33.33*** 41.02*** 36.92*** 37.34*** 37.00*** 38.13*** 37.69***
(2.65e+14) (13.40) (10.85) (12.04) (11.72) (13.05) (13.83)

Observations 784 720 720 720 720 720 720
The dependent variable is Absolute revision (Abs_rev) for the IPO sample between 2001 to 2012. Absolute revision (Abs_rev) is defined as absolute value of the difference
between the offer price and the midpoint of the file range. Other variables are defined in the Table 11 in “Appendix”. Heteroskedasticity-robust and industry-clustered z-statis-
tics are in parentheses. ***, **, and * indicate statistical significance levels 1, 5, and 10%, respectively
13
N. Matanova et al.
this finding provides additional evidence that the GCO in IPO prospectuses represents
informative content, as it lowers price adjustments in general (Hanley and Hoberg 2010).
In line with our expectation, we find further support that Year2 GCO IPOs represent a
distinctive group of firms: in models (3) through (7), they demonstrate significantly higher
price revisions. Again, it seems investors are able to identify those firms which are likely
to experience persistent problems post-flotation even at the time of the IPO. We find that
IPOs with Big-5 auditors, underwritten by more reputable investment banks and those with
VC-backing experience higher price revisions. In contrast to Hanley (1993), we do not find
the market return to affect the absolute price adjustments. This could be explained by the
fact that we measure the market return 6 months prior to the IPO offering or withdrawal,
whereas Hanley (1993) calculates the market return between the preliminary and final pro-
spectus dates.
In sum, we contribute to the existing literature by reporting that GCOs in IPO prospec-
tuses act, in general, as an important disclosure mechanism, which reduces uncertainty
and results in greater price accuracy (or lower price revisions). In addition, IPOs backed
by more reputable underwriters experience higher price adjustments, which is in line with
Lowry and Schwert (2004). Further, Year2 GCO IPOs have significantly more price adjust-
ments than the rest of the sample; hence, investors can differentiate between firms with
short-term financial constraints and those with persistent problems.
4.3 Lawsuits
Descriptive statistics and multivariate analysis of lawsuits are reported in Table 4. In Panel
A, we report the number of lawsuits encountered by IPO firms during the 3-year post-flota-
tion period. Presented results show that GCO IPOs experience a higher relative number of
Sections 10b and 11 lawsuits. For example, 15.38% (10.77%) of GCO IPOs have encoun-
tered Section 10b (Section 11) lawsuits compared to 8.07% (7.09%) of Non-GCO IPO sam-
ple. The mean difference for Section 10b lawsuits is statistically significant at the 5% level.
To shed additional light on the timing of these lawsuits, we report post-IPO annual
filings of lawsuits in Fig. 1. First, we find that lawsuits against GCO firms follow a dis-
tinguishable trend: they peak during the first year post-flotation. About 11% of the GCO
sample is involved in a lawsuit during the first year, followed by 1.54% in the second year,
and 3.08% during the third year. In contrast, the distribution of filed lawsuits involving
Non-GCO firms is more evenly spread out with around 4% of the Non-GCO sample deal-
ing with a lawsuit at any given year post-flotation. We differentiate between Sections 10b
and 11 lawsuits, and the discussed trends still apply. Our results are consistent with Hanley
and Hoberg (2012), who report that the average time from IPO date to a lawsuit is one and
a half years.20 Interestingly, we find that a higher proportion of GCO IPOs compared to
Non-GCO IPOs is dealing with lawsuits (Sections 10b and 11) during the first year post-
flotation only. During the second and third year post-flotation, the two samples have similar
numbers of lawsuits filed against them.
The logistic regression results for lawsuits within 3 years following IPOs are presented
in Panel B (Table 4). In models (1)–(4) we analyze all post-IPO lawsuits, and find that the
following firms are more likely to be sued: larger firms, firms with higher partial price
20
Hanley and Hoberg (2012) concentrate on Sections 11 and 10b lawsuits and report that the number of
days from IPO date to a lawsuit fluctuates between 279 and 623 days, depending on the IPO year.
13
adjustments, and firms with more than one class of stock. Hence, firms which more aggres-
sively raise their offering price (due to new information revealed during bookbuilding or
in hopes of deterring future lawsuits) and those with potentially more complex operations
have a greater lawsuit likelihood. Moreover, having an existing relationship with a more
reputable underwriter (VC firm) benefits (hurts) IPO firms as it decreases (increases) the
likelihood of being sued.
By concentrating on all lawsuits, we find that GCOs do not have an impact on lawsuit
likelihood. However, once we differentiate between Section 11 [models (5)–(8)] and Sec-
tion 10b lawsuits [models (9)–(12)], we show that there is a significantly positive relation-
ship between GCOs and the likelihood of Section 10b lawsuits only. This finding is consist-
ent with our univariate results. All investors (IPO purchasers and aftermarket purchasers)
can file Section 10b lawsuits by showing that there was an omission in the prospectus with
an intent to deceive or defraud. Hence, our finding of a significant relationship between
the GCO variable and Section 10b (and lack of such relationship with Section 11 lawsuits)
suggests that GCO IPOs are more likely to omit some information in their offering docu-
ments with a claimed intent to deceive or defraud the public.
Taking together the underpricing and lawsuit results, our findings are in line with Drake
and Vetsuypens (1993) who state that firms are more likely to be sued under Section 10b
due to negative news during aftermarket trading than due to overpricing. We recall from
the descriptive statistics (Table 1) that GCO IPOs have a significantly lower ownership
by institutional investors during the first quarter post issuance. Therefore, more dispersed
ownership in GCO IPOs by individual IPO investors is likely to result in more intensive
selling of shares in comparison to institutional investors. Hence, this greater turnover from
primary market to secondary market investors increases the likelihood that a lawsuit would
be filed under Section 10b.
However, the probability of a lawsuit under Section 10b is significantly reduced for
GCO IPOs by underwriter prestige and auditor reputation [models (10)–(12)]. Thus, it
seems that these intermediaries are concerned with preserving their reputational capital,
and hence, they minimize the chances of potential plaintiffs filing a class action lawsuit
by either ensuring that there are no material omissions/misstatements in SEC filings of
GCO IPOs and/or by ensuring that managers do not have an intent to defraud or deceive
investors.
Once we account for all three reputational aspects simultaneously (model (12)), we find
that the interaction variable GCO*Big5_audit has the largest significant negative impact on
the probability of Section 10b lawsuits. In addition, the magnitude and significance of the
GCO IPO variable [models (9) and (10)] is reduced once we control for the three interac-
tion variables (GCO*VC-backing, GCO*Top tier, GCO*Big5_audit) in model (12). Thus,
all else equal, the reputational aspect of these intermediaries appears to immunize firms
from lawsuits to a significant degree.
We find that underpricing increases the chances of Section 10b lawsuits to be filed. One
possible explanation for our finding is that potential damages to IPO investors are signifi-
cantly reduced by greater underpricing; therefore, those investors do not have a claim to
sue under Section 11. However, secondary market investors (who are also potential plain-
tiffs under Section 10b lawsuits) buy shares at a higher price in the aftermarket, and hence,
they could experience losses upon negative news announcements and file a lawsuit under
Section 10b (in line with Drake and Vetsuypens 1993). Following our general argument of
substitution, firms that underprice might have done so because they prefer keeping (nega-
tive) information private rather than disclosing it. If investors claim they can prove the
intentional withholding of material information, they can sue under Section 10b.
13

Table 4 Post-IPO lawsuits
Non-GCO IPOs GCO IPOs Differences-in-means
Obs. No. of lawsuits % of lawsuits Obs. No. of lawsuits % of lawsuits t-stat (a–b) P value (a–b)
13
(a) (b)
Panel A: Post-IPO lawsuits: comparison between Non-GCO versus GCO IPO samples
Section 10b 719 58 8.07 65 10 15.38 − 7.32 0.04
Section 11 719 51 7.09 65 7 10.77 − 3.68 0.28
All Lawsuits 719 92 12.80 65 10 15.38 − 2.59 0.55
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
All law- All law- All law- All law- Section 11 Section 11 Section 11 Section 11 Sec- Sec- Sec- Sec-
suits suits suits suits tion 10b tion 10b tion 10b tion 10b
Panel B: Logistic regressions on lawsuits within 3 years following IPOs

GCO IPO 1.35 1.03 2.19 2.60 1.25 0.91 1.30 2.08 2.36*** 1.99* 3.96* 4.54*
(1.12) (1.19) (1.15) (1.15) (0.73) (0.94) (0.76) (0.81) (2.62) (1.94) (1.92) (1.88)
Log (IPO 0.22 0.15 0.17 0.21 0.88*** 0.76*** 0.75*** 0.85*** − 0.01 − 0.14 − 0.09 − 0.01
valuation) (1.38) (0.64) (0.80) (1.21) (3.72) (2.88) (2.84) (3.43) (− 0.06) (− 0.52) (− 0.43) (− 0.09)
Partial 0.04** 0.04** 0.04** 0.04** 0.03* 0.03* 0.03 0.03* 0.04* 0.03** 0.04** 0.04**
(2.45) (2.49) (2.47) (2.53) (1.67) (1.65) (1.62) (1.69) (1.92) (1.98) (2.01) (2.04)
Shares over- 0.04 0.05** 0.04** 0.04* 0.00 0.01 0.01 0.00 0.04*** 0.05*** 0.05*** 0.05***
hang (1.59) (2.03) (2.05) (1.74) (0.15) (0.28) (0.20) (0.04) (2.89) (3.44) (3.02) (2.95)
Initial return − 0.00 − 0.00 − 0.00 − 0.00 − 0.01 − 0.01 − 0.01 − 0.01 0.01*** 0.02*** 0.02*** 0.02***
(− 0.32) (− 0.04) (− 0.12) (− 0.21) (− 0.90) (− 0.77) (− 0.78) (− 0.86) (3.52) (5.34) (6.42) (5.66)
Multi_class 0.41 0.48* 0.48* 0.44 0.25 0.42 0.42 0.28 0.54* 0.58* 0.57** 0.52*
(1.45) (1.89) (1.95) (1.54) (0.46) (1.01) (1.00) (0.52) (1.75) (1.81) (2.06) (1.81)
Market return − 0.02 − 0.02 − 0.02 − 0.02 − 0.02 − 0.03 − 0.02 − 0.02 − 0.03 − 0.04 − 0.03 − 0.03
(− 1.42) (− 1.27) (− 1.13) (− 1.16) (− 0.67) (− 1.18) (− 0.72) (− 0.57) (− 1.64) (− 1.60) (− 1.38) (− 1.46)
Internet IPO 0.77* 0.75 0.80 0.84 − 0.64* − 0.70* − 0.66** − 0.56 1.60*** 1.58** 1.71** 1.78**
N. Matanova et al.
(1.77) (1.64) (1.54) (1.56) (− 1.91) (− 1.94) (− 2.09) (− 1.61) (2.70) (2.38) (2.35) (2.34)
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
High tech 0.27 0.29 0.29 0.29 0.22 0.22 0.20 0.27 0.16 0.18 0.19 0.19
(1.25) (1.35) (1.29) (1.31) (0.89) (0.86) (0.74) (0.97) (0.53) (0.55) (0.64) (0.67)
VC-backing 0.63*** 0.63*** 0.65*** 0.65*** 1.06** 1.10** 1.11** 1.07** 0.47** 0.46** 0.49** 0.47**
(3.92) (3.99) (3.79) (3.75) (2.14) (2.17) (2.11) (2.07) (2.26) (2.20) (2.19) (2.20)
Top tier − 0.01 − 0.00 − 0.00 − 0.00 − 0.03*** − 0.03** − 0.03** − 0.03** 0.01 0.01 0.01 0.01
(− 0.63) (− 0.50) (− 0.39) (− 0.36) (− 2.78) (− 2.53) (− 2.47) (− 2.33) (1.22) (1.11) (1.14) (1.22)
Big5_audit 0.76 0.55 0.66 0.75 0.53 0.28 0.32 0.51 0.84 0.48 0.68 0.86
(1.54) (1.35) (1.40) (1.47) (0.76) (0.48) (0.55) (0.72) (1.28) (0.91) (1.06) (1.20)
Earnings nve − 0.28 0.00 − 0.23 − 0.20 − 0.03 0.33 0.02 0.09 − 0.21 0.29 − 0.15 − 0.07
(− 0.53) (0.00) (− 0.44) (− 0.34) (− 0.07) (0.52) (0.05) (0.16) (− 0.47) (0.48) (− 0.31) (− 0.13)
Insti. owner- − 0.71** − 0.78** − 0.38 − 0.44 − 1.23*** − 1.30** − 0.95* − 1.10** − 0.41 − 0.49 0.43 0.31
ship (− 1.99) (− 1.99) (− 0.82) (− 0.99) (− 2.58) (− 2.50) (− 1.89) (− 2.14) (− 0.99) (− 1.02) (0.93) (0.74)
GCO*VC- − 2.00 − 0.89 − 2.08 − 1.40 − 2.49 − 1.14
backing (− 1.05) (− 0.57) (− 0.83) (− 0.60) (− 1.51) (− 0.81)
GCO*Top − 1.71 − 0.51 − 1.97 − 1.09 − 2.06* − 0.68
tier (− 1.39) (− 0.73) (− 1.26) (− 1.03) (− 1.80) (− 0.87)
GCO*Big5_ − 3.15 − 2.41 − 2.32 − 1.19 − 4.39* − 3.46**
audit (− 1.30) (− 1.42) (− 1.11) (− 0.93) (− 1.78) (− 1.97)
Constant − 3.43*** − 3.25*** − 3.61*** − 3.82*** − 5.02*** − 4.88*** − 5.33*** − 5.42*** − 4.18*** − 3.84** − 4.84*** − 5.31***
(− 4.59) (− 3.32) (− 4.26) (− 4.49) (− 4.66) (− 4.84) (− 4.30) (− 3.94) (− 3.90) (− 2.40) (− 3.94) (− 4.14)
Observations 529 529 529 529 401 401 401 401 454 454 454 454
Industry FE YES YES YES YES YES YES YES YES YES YES YES YES
Year FE YES YES YES YES YES YES YES YES YES YES YES YES
13

Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
13
Pseudo 0.162 0.159 0.168 0.169 0.239 0.236 0.237 0.242 0.185 0.179 0.199 0.202
R-squared
Log Lik − 204.9 − 205.6 − 203.4 − 203 − 117.7 − 118.1 − 118 − 117.2 − 149 − 150.1 − 146.4 − 145.8
Panel A presents descriptive statistics comparing post-flotation lawsuits of Non-GCO IPOs and GCO IPOs. The time period of 3 years after offerings are examined for Sec-
tion 10b and Section 11 lawsuits. t-stats and P values are reported for mean difference. Panel B summarizes the results of our logistic regressions on lawsuits within 3 years
following IPOs. The dependent variable is all lawsuits (models (1)–(4)), Section 11 (models (5)–(8)), and Section 10b (models (9)–(12)) during the 3 year period post-flota-
tion. The IPO sample spans from 2001 to 2012 and we examine 3 years after offerings to ensure an unbiased estimate of lawsuit propensity for all IPOs. Other variables are
defined in the Table 11 in “Appendix”. Heteroskedasticity-robust and industry-clustered z-statistics are in parentheses. ***, **, and * indicate statistical significance levels 1,
5, and 10%, respectively
N. Matanova et al.
Post-IPO Lawsuits
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 Year 1 Year 2 Year 3
Section 10b Section 11 All Lawsuits
GCO IPO Non-GCO IPO
Fig. 1 Three-year post-IPO lawsuits for GCO and Non-GCO IPOs. This figure presents percentage of post-
IPO lawsuits by year for Non-GCO IPOs and GCO IPOs
We also report that lawsuits under Sections 11 and 10b have diverse determinants, which
is likely to be the result of their structural differences. For example, institutional ownership
and more prestigious underwriters (firm size) have a significant negative (positive) impact
on Section 11 lawsuits only. Due to the costly nature of lawsuits for firms21 and the fact that
the underwriters are more likely to be named in a lawsuit filed under Section 11 than Sec-
tion 10b22 (Hanley and Hoberg 2012), underwriters could try to deter Section 11 lawsuits
and minimize potential reputational damages. Our finding that institutional ownership (first
quarter post-IPO) is negatively related to Section 11 lawsuits is consistent with Barabanov
et al. (2008), who find that institutions are able to avoid litigation targets or predict future
litigation and adjust their equity holdings in these firms in advance accordingly. In addi-
tion, Internet IPO firms are less (more) likely to face a lawsuit under Section 11 (10b).23
Overall, we contribute to the literature by reporting that underpricing is only success-
ful in deterring Section 11 lawsuits, while it significantly increases the likelihood of Sec-
tion 10b lawsuits. In addition, GCO IPOs are more likely to receive claims that they omit-
ted material information in IPO prospectus with intent to defraud or deceive. However,
GCO IPOs can minimize the likelihood of Section 10b lawsuits by hiring more reputable
auditors and underwriters.
4.4 Post‑IPO idiosyncratic return volatility
Table 5 presents the empirical results for the post-IPO idiosyncratic volatility. Our depend-
ent variable in this table is the post-IPO return volatility, computed as the market model
root-mean square error for each firm over day + 5 to day + 64, relative to the offer day
21
Typically, the stock price declines by − 4.66% during the three-day period surrounding the filing date
(Gande and Lewis 2009).
22
Hanley and Hoberg (2012, p. 241): “We find that the underwriter is named 70.3% of the time when the
lawsuit is filed under Section 11, but just 3.3% of the time when the lawsuit is filed only under Section 10b-
5.”
23
Hanley and Hoberg (2012) show that lawsuits are pricey to issuers (settlements are around 8–10% of
sued IPO proceeds) and for underwriters since they result in subsequent loss of market share and reputation.
13
N. Matanova et al.
(Loughran and McDonald 2013). We utilize the same control variables as in previous
sections.
While negative firm announcements are associated with increased stock price volatil-
ity (Clayton et al. 2005; Kothari et al. 2009), we argue that GCOs are a different kind of
negative news. Instead of appearing as surprise news during active public trading, GCOs
in IPOs are disclosed in the prospectus where investors have access to the information
prior to the start of public trading. Once we consider the typical control variables, regres-
sion results suggest that GCOs are not related to stock price volatility. This result supports
Hypothesis 3.
In line with our expectation, VC-backed IPOs are associated with significantly higher
post-IPO idiosyncratic volatility. We find this effect to be even more pronounced in GCO
IPOs. For example, in models (4) and (7) we control for the GCO*VC-backing interaction
term and find that VC-backed GCO IPOs experience a significantly greater post-issuance
stock price volatility. This result supports our expectation, indicating that VC-backed IPOs
are likely to have higher volatility due to VCs’ grandstanding incentive.
Big5_audit and Insti. ownership are significantly negatively associated with post-IPO
idiosyncratic volatility, which is intuitive since the Big-5 auditors are more sophisticated
financial intermediaries, and institutional investors are more likely to be associated with
IPOs with less information asymmetry. Models (5) and (6) include the interactions between
GCO*Top tier, and GCO*Big5_audit respectively, and model (7) tests all three interaction
terms together. The results from these three models confirm that only VC-backed GCO
IPOs are associated with greater volatility, while the interactions of GCO with the other
intermediaries have no impact on volatility.
Taken together, the results in Table 5 support our expectations regarding the relation-
ship between GCOs, VC-backing status, and post-IPO idiosyncratic volatility. As one of
the potential mechanisms for reducing information asymmetry for IPOs, GCOs are not
associated with higher post-IPO idiosyncratic volatility.24 However, VC-backed IPOs,
especially those that receive GCOs, are associated with a higher level of idiosyncratic vola-
tility. In line with Gompers (1996), this result suggests that VCs most likely bring some
private firms with operating losses to the public market with the purpose of building their
reputation prior to the next round of fundraising.
4.5 Post‑IPO illiquidity
Table 6 reports the regression results of illiquidity on our variables of interest and other
control variables. Following Corwin and Schultz (2012), we estimate illiquidity by cal-
culating the spread implied by the daily high and low prices. The larger the spread, the
greater is the stock illiquidity.
GCO IPO and Year2 GCO are the main variables of interest. Once we consider the typi-
cal control variables, regression results suggest that GCOs are not related to post-listing
stock illiquidity, confirming Hypothesis 4. The coefficient of the Year2 GCO variable is
significant at the 5% level in all models, supporting our expectation.25 This result suggests
that among the set of variables controlling for issue and firm characteristics, Year2 GCO
may be the most important determinant on post-IPO stock illiquidity.
24
Once we consider the typical control variables.
25
Except for model (3), where it’s significant at 10% level.
13
Table 5 Volatility
Variables (1) (2) (3) (4) (5) (6) (7)
Volatility Volatility Volatility Volatility Volatility Volatility Volatility
GCO IPO 10.10** 3.70 4.34 − 0.57 5.10 3.47 1.54

(2.94) (1.31) (1.70) (− 0.19) (1.21) (0.42) (0.20)
Year2 GCO − 5.26** − 3.88 − 1.79 − 0.59 − 2.03 − 1.83 − 0.59
(− 2.60) (− 1.47) (− 0.63) (− 0.19) (− 0.74) (− 0.65) (− 0.21)
Log (IPO valuation) − 2.22* − 1.81 − 2.08 − 1.82 − 1.82 − 2.10
(− 2.11) (− 1.27) (− 1.35) (− 1.25) (− 1.33) (− 1.35)
Partial 0.03 0.02 0.02 0.02 0.02 0.02
(0.70) (0.57) (0.60) (0.54) (0.56) (0.56)
Shares overhang − 0.01 − 0.07 − 0.06 − 0.07 − 0.07 − 0.06
(− 0.13) (− 0.81) (− 0.65) (− 0.83) (− 0.77) (− 0.66)
Initial return 0.12** 0.10** 0.10** 0.10** 0.10** 0.10**
(2.68) (2.52) (2.53) (2.50) (2.51) (2.46)
Multi_class 0.62 0.84 1.14 0.84 0.84 1.17
(0.34) (0.47) (0.61) (0.47) (0.47) (0.63)
Market return − 0.10 − 0.09 − 0.11 − 0.10 − 0.10 − 0.11
(− 1.31) (− 0.98) (− 1.30) (− 1.03) (− 0.93) (− 1.25)
High tech − 3.07* − 2.39 − 2.32 − 2.37 − 2.39 − 2.29
(− 1.93) (− 1.41) (− 1.38) (− 1.37) (− 1.40) (− 1.33)
Internet IPO 4.25*** 3.81** 3.88*** 3.81** 3.81** 3.88**
(3.55) (3.05) (3.18) (3.01) (3.12) (3.16)
Earnings nve 2.90 2.75 2.80 2.75 2.75 2.80
(1.49) (1.52) (1.51) (1.51) (1.52) (1.51)
Insti. ownership − 0.09** − 0.10** − 0.10** − 0.10** − 0.10** − 0.10**
(− 2.48) (− 2.70) (− 2.67) (− 2.60) (− 2.61) (− 2.58)
VC-backing 5.34*** 4.49*** 5.32*** 5.31*** 4.45***
(4.83) (3.58) (4.72) (5.51) (3.44)
Top tier 2.71 3.13 2.87 2.72 3.32
(1.45) (1.50) (1.21) (1.49) (1.43)
Big5_audit − 3.75*** − 4.07*** − 3.74*** − 3.89** − 3.78**
(− 6.43) (− 7.66) (− 6.46) (− 3.01) (− 2.83)
GCO*VC-backing 7.76** 8.73**
(2.51) (2.46)
GCO*Top tier − 1.21 − 1.24
(− 0.28) (− 0.46)
GCO*Big5_audit 1.12 − 2.50
(0.13) (− 0.26)
Constant 142.62*** 156.45*** 153.48*** 155.44*** 153.44*** 153.72*** 155.10***
(3.81e+13) (29.96) (32.64) (29.83) (32.52) (30.46) (30.76)
Observations 784 720 720 720 720 720 720
The dependent variable is post-IPO return volatility (Volatility), which is defined as the market model root-
mean square error (RMSE) for each firm over day + 5 to day + 64 relative to the offer day, as in Loughran
and Mcdonald (2013). Other variables are defined in the Table 11 in “Appendix”. Heteroskedasticity-robust
and industry-clustered z-statistics are in parentheses. ***, **, and * indicate statistical significance levels 1,
5, and 10%, respectively
13
N. Matanova et al.
Consistent with prior studies, the coefficient of Log (IPO valuation), our proxy for firm
size, is significantly negative in all regressions, suggesting that stocks of larger IPO firms
are less illiquid. Models (2)–(7) show that institutional stock ownership is negatively asso-
ciated with illiquidity, which is in line with prior research (Rubin 2007; Chung et al. 2010).
We also find that IPO firms with negative earnings per share within 1 year of an IPO have
greater post-IPO illiquidity.
4.6 Long‑run performance
In Table 7, we present descriptive statistics of operating and profitability performance vari-

ables throughout the 3-year period post-flotation.
Presented results suggest that Non-GCO IPOs demonstrate a significantly stronger
ability to generate cash from operations and better profitability after the admission
compared to GCO IPOs. This trend applies to all reported performance variables and
throughout the 3 years post-flotation.26 In the second year post-flotation, Year2 GCO
firms underperform Non-CGO IPOs and CGO IPOs based on all operating performance
measures. Therefore, auditors issue the second GCO for those IPO firms which are
likely to have systematic and persistent problems as public firms.
We find that Non-GCO IPOs’ profitability and ability to generate cash flows improve
following the admission. In contrast, firms with going concern opinions (GCOs and
Year2 GCOs) tend to go public at the peak of their operating performance and profita-
bility, whereas all operating measures demonstrate a declining trend in subsequent years
post-flotation. This finding is in line with the “performance timing” hypothesis (Jain
and Kini 1994), which has been tested for various subsets of IPOs. While some stud-
ies (Degeorge and Zeckhauser 1993; Holthausen and Larcker 1996) present evidence
of operating performance declines for reverse leveraged buyouts (RLBOs), others do
not support this finding (Cao 2011). In this paper, we present evidence that the “perfor-
mance timing” argument applies to firms with GCOs.
Overall, we find that firms with GCOs tend to strategically choose the time to go
public based on their operating and profitability performance. Further, auditors’ GCOs
identify IPO firms which are likely to experience some short-term problems (GCO
IPOs), as well as IPO firms with more persistent, long-term problems (Year2 GCOs).
Table 8 compares post-IPO stock returns of GCO IPOs and Non-GCO IPOs. We
calculate portfolio-matched buy-and-hold abnormal returns (BHARs) and cumulative
abnormal returns (CARs) for 3, 6, 12, 24 and 36 months after the IPO date. We also use
the calendar-time regression approach advocated by Fama (1998). Both equal-weighted
(EW) and value-weighted (VW) results are presented in Table 8. Panel A shows that
GCO IPO firms do not significantly underperform Non-GCO IPO firms in the 3- and
6-month short-run after the IPO. However, we find that GCO IPOs tend to underper-
form in the long-run. For example, the 1- and 2-year BHARs of GCO IPOs are both
significantly lower than those of Non-GCO IPOs on the EW basis.
Presented results in Panel B show that the 1-, 2- and 3-year CARs of GCO IPOs are
significantly lower than those of Non-GCO IPOs on the EW basis. Consistent with prior
studies, results on VW become less significant. Our results supplement findings by Wil-
lenborg and McKeown (2000), who show that small GCO IPOs have worse long-run
stock return performance than small Non-GCO IPOs.
26
Except for ROA in the third year post-flotation.
13
Table 6 Illiquidity
Variables (1) (2) (3) (4) (5) (6) (7)
Illiquidity Illiquidity Illiquidity Illiquidity Illiquidity Illiquidity Illiquidity
GCO IPO 1.59*** − 0.37 − 0.40 − 1.02 − 0.15 − 1.78 − 1.55

(3.25) (− 0.43) (− 0.50) (− 0.58) (− 0.08) (− 0.70) (− 0.48)
Year2 GCO 6.50** 4.36** 4.29* 4.44** 4.21** 4.22** 4.08**
(2.88) (2.24) (2.22) (2.35) (2.26) (2.27) (2.70)
Log (IPO valuation) − 1.59*** − 1.55*** − 1.58*** − 1.55*** − 1.57*** − 1.59***
(− 4.56) (− 3.38) (− 3.33) (− 3.39) (− 3.35) (− 3.34)
Partial − 0.02 − 0.02 − 0.02 − 0.02 − 0.02 − 0.02
(− 1.07) (− 1.01) (− 1.01) (− 1.01) (− 0.97) (− 0.99)
Shares overhang − 0.02 − 0.02 − 0.01 − 0.01 − 0.01 − 0.01
(− 0.48) (− 0.42) (− 0.36) (− 0.40) (− 0.35) (− 0.28)
Initial return − 0.02** − 0.02* − 0.02* − 0.02* − 0.02* − 0.02*
(− 2.34) (− 2.12) (− 2.21) (− 2.06) (− 2.15) (− 2.13)
Multi_class 0.39 0.37 0.41 0.37 0.38 0.40
(0.42) (0.43) (0.51) (0.43) (0.46) (0.49)
Market return − 0.02 − 0.02 − 0.02 − 0.02 − 0.02 − 0.03
(− 1.15) (− 1.10) (− 1.08) (− 1.16) (− 1.06) (− 1.18)
High tech 0.07 0.07 0.08 0.08 0.07 0.08
(0.13) (0.13) (0.14) (0.14) (0.12) (0.14)
Internet IPO 0.20 0.21 0.21 0.21 0.21 0.22
(0.49) (0.50) (0.53) (0.50) (0.53) (0.54)
Earnings nve 1.03** 1.03** 1.04** 1.03** 1.03** 1.04**
(2.59) (2.60) (2.56) (2.59) (2.58) (2.53)
Insti. ownership − 0.05*** − 0.05*** − 0.05*** − 0.05*** − 0.05*** − 0.05***
(− 5.00) (− 5.00) (− 5.01) (− 4.88) (− 5.10) (− 4.92)
VC-backing − 0.06 − 0.17 − 0.07 − 0.12 − 0.18
(− 0.35) (− 0.61) (− 0.38) (− 0.58) (− 0.70)
Top tier − 0.35 − 0.30 − 0.30 − 0.33 − 0.19
(− 0.62) (− 0.45) (− 0.62) (− 0.55) (− 0.32)
Big5 audit 0.18 0.14 0.18 − 0.05 − 0.08
(0.41) (0.36) (0.43) (− 0.19) (− 0.31)
GCO*VC-backing 0.99 0.39
(0.63) (0.29)
GCO*Top tier − 0.40 − 0.97
(− 0.23) (− 0.59)
(0.80) (1.03)
Constant 4.35*** 12.17*** 11.86*** 12.11*** 11.85*** 12.25*** 12.36***
(9.24e+12) (10.97) (7.71) (7.43) (7.73) (7.21) (7.07)
Observations 784 720 720 720 720 720 720
The dependent variable is Illiquid, which indicates the spread implied by the daily high and low prices and
is calculated using the formula from Corwin and Schultz (2012). Other variables are defined in the Table 11
in “Appendix”. Heteroskedasticity-robust and industry-clustered z-statistics are in parentheses. ***, **, and
* indicate statistical significance levels 1, 5, and 10%, respectively
13
N. Matanova et al.
Table 7 Operating performance IPO Year IPO + 1 IPO + 2 IPO + 3
CFO/TA
Non-GCO (a) 0.02 − 0.01 0.31 2.62
GCO IPO (b) − 0.31 − 1.55 − 2.24 − 0.84
Year2 GCO (c) − 0.41 − 1.79 − 3.74 − 1.58
Mean (a–b) 0.33*** 1.54*** 2.55*** 3.46*
Mean (a–c) 0.43*** 1.78*** 4.05*** 4.20
Mean (b–c) 0.10 0.24 1.50* 0.74
EBITDA/TA
Non-GCO (d) 0.04 0.00 0.45 4.37
GCO IPO (e) − 0.37 − 1.88 − 2.02 0.60
Year2 GCO (f) − 0.64 − 2.36 − 4.86 − 1.84
Mean (d–e) 0.41*** 1.88*** 2.47*** 3.77
Mean (d–f) 0.41*** 1.88*** 2.47*** 3.77
Mean (e–f) 0.27* 0.48 2.84** 2.44
ROA
Non-GCO (g) − 0.05 − 0.16 − 0.41 − 0.01
GCO IPO (h) − 0.53 − 2.49 − 3.65 − 3.28
Year2 GCO (i) − 0.85 − 3.13 − 8.89 − 2.11
Mean (g–h) 0.48*** 2.33*** 3.24*** 3.27***
Mean (g–i) 0.81*** 2.97*** 8.48*** 2.10
Mean (h–i) 0.32 0.64 5.24*** − 1.17
This table presents descriptive statistics of operating performance var-

iables for Non-GCO IPOs, GCO IPOs, and Year2 GCO IPOs. CFO/
TA is defined as cash flow from operations, divided by beginning-
of-period total assets. EBITDA/TA is defined as operating income
before depreciation, divided by beginning-of-period total assets. ROA
is defined as the income before extraordinary items scaled by total
assets. IPO Year refers to the value of the performance measurement
at the IPO year; IPO + 1 corresponds to the first year post-IPO, IPO + 2
is the second year post-IPO, and IPO + 3 is the third year post-IPO.
All operating performance variables are winsorized at the 1% level in
order to reduce variance. ***, **, and * indicate statistical significance
levels 1, 5, and 10%, respectively
Panel C and Panel D report post-IPO returns in a calendar time setting. Specifically,
for every month in our sample period, we form portfolios containing all GCO and Non-
GCO IPOs, respectively, from the most recent 36 months. We also calculate the returns
on a hedge portfolio that is short on GCO IPOs and long on Non-GCO IPOs (Mitchell
and Stafford 2000; Boehme and Sorescu 2002). We regress the time-series of portfolio
returns on the three Fama–French (1993) factors and the Carhart (1997) momentum fac-
tor, focusing on the intercept or “alpha”.
Panel C reports the results for short-term calendar time regressions (months 1
through 6). EW results reveal that the alpha of the Non-GCO IPOs is not significantly
different from zero. In contrast, the GCO IPO sample has an alpha of -278 basis points
per month, which is economically large and statistically significant at the 10% level.
However, the alpha of the hedge portfolio is not statistically different from zero, sug-
gesting that after controlling for the common factors affecting stock returns, GCO IPOs
13
Table 8 Long-run stock performance

Month Equal-weighted Value-weighted
N BHARs P value BHARs P value
Panel A: Buy-and-hold abnormal returns (BHARs)

3
GCO 65 6.86 0.26 9.35 0.03
Non-GCO 716 1.61 0.14 0.39 0.72
Diff (GCO-Non) 5.24 0.20 8.96 0.04
6
GCO 65 − 3.53 0.61 − 4.13 0.41
Non-GCO 717 − 1.97 0.18 0.93 0.52
Diff (GCO-Non) − 1.56 0.77 − 5.06 0.33
12
GCO 65 − 18.56 0.04 − 8.00 0.16
Non-GCO 717 2.91 0.26 2.44 0.39
Diff (GCO-Non) − 21.47 0.02 − 10.41 0.10
24
GCO 65 − 29.78 0.02 9.46 0.56
Non-GCO 717 1.63 0.63 6.87 0.02
Diff (GCO-Non) − 31.41 0.01 2.60 0.87
36
GCO 65 − 6.18 0.78 1.17 0.95
Non-GCO 717 2.24 0.61 10.48 0.00
(Diff GCO-Non) − 8.42 0.60 − 9.31 0.60
N CARs P value CARs P value
Panel B: Cumulative abnormal returns (CARs)

3
GCO 65 4.91 0.38 8.25 0.03
Non-GCO 717 1.40 0.18 − 0.18 0.86
Diff (GCO-Non) 3.50 0.36 8.43 0.03
6
GCO 65 − 4.37 0.52 − 3.31 0.51
Non-GCO 717 − 1.07 0.45 1.84 0.13
Diff (GCO-Non) − 3.30 0.52 − 5.15 0.32
12
GCO 65 − 21.81 0.02 − 5.22 0.41
Non-GCO 717 0.17 0.94 − 1.41 0.48
Diff (GCO-Non) − 21.98 0.00 − 3.80 0.56
24
GCO 65 − 39.04 0.01 − 7.20 0.57
Non-GCO 717 3.89 0.19 9.81 0.00
Diff (GCO-Non) − 42.93 0.00 − 17.01 0.19
36
GCO 65 − 27.52 0.13 − 11.22 0.51
13
N. Matanova et al.
N CARs P value CARs P value
Non-GCO 717 8.49 0.03 13.79 0.00

Diff (GCO-Non) − 36.01 0.01 − 25.01 0.15
Non-GCO IPOs GCO IPOs Hedge
Estimate P value Estimate P value Estimate P value
Panel C: Short-term calendar-time regressions (Months 1 through 6)

Equal-weighted
Alpha − 0.24,857 0.6152 − 2.776 0.076 − 2.528 0.114
Mktret 1.224972 < 0.0001 1.243 0.014 0.018 0.969
Smb 0.681459 0.0057 1.125 0.162 0.444 0.559
Hml − 0.24887 0.2789 0.636 0.498 0.885 0.346
Umd 0.115815 0.3848 − 0.390 0.583 − 0.505 0.469
Value-weighted
Alpha 1.272114 0.0666 − 0.592 0.733 − 1.865 0.311
Mktret 1.11409 < 0.0001 1.118 0.026 0.004 0.994
Smb 0.524948 0.0691 1.074 0.190 0.549 0.525
Hml − 0.57065 0.0233 0.028 0.977 0.598 0.560
Umd 0.308079 0.0467 − 0.485 0.497 − 0.793 0.293
Non-GCO IPOs GCO IPOs Hedge
Estimate P value Estimate P value Estimate P value
Panel D: Long-term calendar-time regressions (Months 12 through 36)

Equal-weighted
Alpha 0.128 0.746 − 5.481 0.001 5.578 0.000
Mktret 1.109 < 0.0001 1.480 0.002 − 0.362 0.417
Smb 0.896 < 0.0001 0.943 0.188 − 0.049 0.941
Hml − 0.133 0.362 1.020 0.232 − 1.153 0.145
Umd − 0.016 0.878 0.057 0.838 − 0.089 0.741
Value-weighted
Alpha 0.826 0.111 − 3.593 0.042 4.366 0.010
Mktret 1.225 < 0 .0001 1.810 0.002 − 0.564 0.297
Smb 0.721 0.004 1.051 0.184 − 0.340 0.662
Hml − 0.383 0.034 0.641 0.485 − 0.990 0.242
Umd 0.215 0.078 0.283 0.398 − 0.086 0.795
This table reports the short-run and long-run stock performance based on event time (Panels A and B) and
calendar-time regressions of portfolios formed on GCO and Non-GCO IPOs (Panels C and D). The aver-
age 3 months, 6 months, 1 year, 2-year and 3-year buy-and-hold abnormal returns (BHARs) for GCO and
Non-GCO IPOs are compounded, 3, 6, 12, 24, and 36 months after the issue dates. We assign IPOs to
matching book-to-market/size portfolios using the quintile breakpoints from Kenneth French’s website. We
compute BHARs by first compounding returns for each firm and then subtracting the compounded return
on the matching BM/ME portfolio. We present both equal-weighted (EW) and value-weighted (VW) aver-
age returns. For VW returns, we construct the weights using the IPO’s first available market capitalization
(shares outstanding multiplied by closing price) from the CRSP daily data, scaled by the level of the CRSP
VW index at that date. The CARs are calculated similarly to the BHARs, except we subtract the matching
portfolio return each month and then sum returns over the event window. All returns presented in the table
13
are expressed as percentages. The IPO sample spans the years from 2001 to 2012, to ensure an unbiased
estimate of the stock returns for all IPOs 3 years after offerings. For each month in the sample period, we
form portfolios of all GCO and Non-GCO IPOs that conduct initial offerings within the last 36 months.
We also form a zero-investment hedge portfolio that goes long (short) in Non-GCO IPOs (GCO IPOs).
We calculate both EW and VW portfolio returns. We regress monthly portfolio returns on the three factors
(Mktret, Smb, and Hml) in Fama and French (1993), and a momentum factor (Umd) (Carhart 1997). To con-
trol for heteroskedasticity due to changing portfolio constituents, we report two-tailed P values using White
(1980)-adjusted standard errors. For VW returns, each IPO is given a weight proportional to its market
value of equity using the first available CRSP-listed closing price
The Italic values indicate the differences between GCO IPOs and Non-GCO IPOs in long run stock perfor-
mance
do not underperform Non-GCO IPOs in the short run. The hedge portfolio also shows
that the factor exposures for the two portfolios are not substantially different.
Panel D shows the long-term calendar time regression results (months 12 through 36).
On an EW basis, the alpha of the Non-GCO IPOs is not significantly different from zero. In
contrast, the GCO IPOs have an alpha of -548 basis points per month, which is economi-
cally large and statistically significant at the 1% level. The hedge portfolio has an alpha
of 558 basis points, which again is highly significant, both economically and statistically.
Turning to the VW returns, the story is similar economically, but statistical significance
decreases. In particular, the GCO portfolio has an alpha of -359 basis points, and the hedge
portfolio has an alpha of 437 basis points, both significant at the 5% level. The VW results
for other factor exposures are similar to the EW results. Overall, in line with Hypothesis
5a, presented results in Table 8 indicate that GCO IPOs’ stock returns underperform sig-
nificantly in the long-run compared to Non-GCO IPOs.
4.7 Delisting
Table 9 presents results of the delisting analysis. The dependent variable for the logistic
regression is a dummy variable identifying delisting within 3 years post-IPO, where delist-
ing is performance-related (CRSP delist codes 550-572 and 574-584).
Confirming Hypothesis 5b, our results suggest that GCO IPOs are substantially more
likely to delist.27 Our finding for ordinary IPOs is in line with presented results for micro-
cap IPOs by Willenborg and McKeown (2000). The interaction term GCO*VC-backing
in Model (7) indicated that VC-backed GCO IPOs are significantly more likely to be del-
isted, suggesting that VCs’ grandstanding purpose in bringing private firms to the public
market is associated with higher delisting rates. The market return variable is significantly
positively related with delisting for all model specifications, which is consistent with the
notion that IPOs that timed the markets and issued following the “hot markets” are of lower
quality and are more likely to delist post-IPO (Lowry and Schwert 2004; Loughran and
Ritter 2004; Demers and Joos 2007). High-tech firms and firms with negative earnings are
also more likely to delist. We further show that Year2 GCO IPOs are significantly (at the
5% level) positively associated with delisting rate [models (4) and (7)], while institutional
ownership is negatively related (at the 1% level).
27
Except for results in model (4).
13
N. Matanova et al.
Table 9 Delisting
Variables (1) (2) (3) (4) (5) (6) (7)
Delist Delist Delist Delist Delist Delist Delist
GCO IPO 1.90** 2.19*** 2.12** 1.05 5.22*** 4.83*** 5.36***

(2.03) (3.43) (2.52) (1.08) (6.24) (7.00) (5.66)
Year2 GCO 0.71 1.02 0.94 1.48** 1.79 1.31 4.15**
(1.22) (1.21) (1.21) (2.00) (1.59) (1.33) (2.41)
Log (IPO valuation) 0.20 0.06 0.02 − 0.12 0.06 − 0.32
(0.37) (0.09) (0.03) (− 0.19) (0.09) (− 0.49)
Partial 0.01 0.01 0.01 0.00 0.01 0.00
(0.28) (0.41) (0.35) (0.20) (0.40) (0.19)
Shares overhang 0.06 0.06 0.06 0.05 0.07 0.05
(0.49) (0.57) (0.50) (0.51) (0.63) (0.40)
Initial return − 0.03** − 0.03** − 0.03* − 0.04** − 0.04* − 0.04**
(− 2.41) (− 2.02) (− 1.89) (− 2.20) (− 1.92) (− 2.06)
Multi_class 0.21 0.21 0.33 0.24 0.33 0.67
(0.22) (0.22) (0.39) (0.21) (0.35) (0.73)
Market return 0.11*** 0.11*** 0.10*** 0.12*** 0.13*** 0.10***
(2.90) (3.24) (3.54) (3.40) (4.04) (2.90)
High tech 1.86** 1.83** 1.87*** 2.38*** 2.14*** 2.66***
(2.22) (2.40) (2.64) (3.23) (2.82) (3.29)
Internet IPO 0.40 0.40 0.41 0.18 0.36 0.16
(0.38) (0.39) (0.39) (0.15) (0.35) (0.14)
Earnings nve 0.86* 0.86* 0.86* 0.93* 0.96** 1.01*
(1.82) (1.82) (1.68) (1.93) (2.25) (1.92)
Insti. ownership − 0.07*** − 0.07*** − 0.08*** − 0.07*** − 0.07*** − 0.08***
(− 3.93) (− 4.62) (− 4.31) (− 4.87) (− 4.49) (− 4.53)
VC-backing − 0.29 − 0.62 − 0.51 − 0.15 − 1.00
(− 0.31) (− 0.75) (− 0.52) (− 0.15) (− 1.04)
Top tier 0.06 0.28 0.98 − 0.07 1.26
(0.06) (0.31) (0.90) (− 0.07) (1.19)
Big5_audit 0.61 0.47 0.77 1.09 1.05
(0.58) (0.44) (0.63) (0.93) (0.74)
GCO*VC-backing 1.74 6.00***
(1.31) (3.69)
GCO*Top tier − 5.58*** − 5.63***
(− 3.79) (− 2.73)
GCO*Big5_audit − 3.47*** − 5.89***
(− 3.86) (− 3.50)
Constant − 1.72*** − 2.03 − 1.57 − 0.72 − 2.94* − 3.39 − 2.22
(− 4.70) (− 1.28) (− 0.82) (− 0.38) (− 1.68) (− 1.59) (− 1.04)
Observations 424 313 313 313 313 313 313
Pseudo R-squared 0.164 0.464 0.467 0.472 0.500 0.477 0.519
Log Lik − 148.9 − 68.05 − 67.72 − 67.11 − 63.51 − 66.40 − 61.13
13
The dependent variable Delist is equal to one if the stock is delisted within 3 years of the IPO date (CRSP
codes 550-572 and 574-584), and zero otherwise. mfx is the marginal effects at the means for each coef-
ficient. The IPO sample spans the years from 2001 to 2012, to ensure an unbiased estimate of delisting
frequencies for all IPOs 3 years after offerings. All variables are defined in the Table 11 in “Appendix”.
Heteroskedasticity-robust and industry-clustered z-statistics are in parentheses. ***, **, and * indicate sta-
tistical significance levels 1, 5, and 10%, respectively
Further, interaction terms of GCO and reputable underwriters and auditors are also sta-
tistically negatively associated with delisting rate, suggesting reputable underwriters and
auditors also have certification effect for ordinary IPOs with GCOs.
In sum, presented results in Table 9 suggest that GCO IPOs, Year2 GCOs, and GCO
IPOs with VC-backing are positively associated with IPO delisting, whereas GCO IPOs
certified by reputable underwriters and auditors are less likely to be delisted.
4.8 Withdrawal
In this section, we investigate the impact of GCOs on firms’ IPO plans. For this analysis,
we expand our sample to include firms that filed Form S-1, but subsequently withdrew. We
run logistic regressions in which the dependent variable equals one for firms that withdraw
from the going public process, and 0 otherwise. Table 10 reports the results.
In support of Hypothesis 5c, the coefficient of GCO is positive and significant at the 1%
level in all models, indicating a GCO in the initial filing strongly increases the probability
that a firm will withdraw its IPO plans. For example, the marginal effect at the means for
the GCO coefficient in model (10) is 0.75; this implies that for two hypothetical firms with
average values in other control variables, the predicted probability of withdrawal is 0.75
greater for the GCO firm than for Non-GCO firms. If the predicted possibility of a with-
drawal for a firm planning an IPO without a GCO is 0.05, given all other control variables
are at their average values, then the probability of the firm with the same control variable
values plus the GCO significantly rises to 0.80.28 The results show the likelihood to with-
draw is positively related to the proposed maximum proceeds from the IPO (a measure of
firm size), which is consistent with Dunbar and Foerster (2008). Recent market perfor-
mance has a relatively weak effect, but certifier quality enters strongly into the decision.
Firms with top tier investment banks and Big-5 auditors are much less likely to withdraw.
Finally, the interaction between GCO and Big-5 auditors shows that GCO firms with Big-5
auditors are more likely to go public than GCO firms using less prestigious auditors.
5 Conclusion
We examine the impact and implications of going concern opinions (GCOs) on 784 ordi-
nary initial public offerings (IPOs) floated on US exchanges between 2001 and 2012. Our
results shed light on the information content of GCOs. Specifically, we provide evidence
that GCOs increase pricing accuracy. Prior research suggests that GCOs lower ex-ante
uncertainty and, therefore, reduce underpricing in microcap IPOs (Willenborg and McK-
eown 2000).
28
0.05 + 0.75 = 0.80.
13

Table 10 Withdrawn IPOs
13
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
IPO wd mfx IPO wd mfx IPO wd mfx IPO wd mfx IPO wd mfx
GCO 0.60*** 0.15*** 3.00*** 0.61*** 2.41*** 0.54*** 4.30*** 0.75*** 4.26*** 0.75***
(2.96) (3.00) (7.56) (12.75) (4.15) (5.41) (5.18) (16.52) (3.78) (9.10)
Log(PMP) 2.55*** 0.57*** 3.59*** 0.75*** 3.63*** 0.74*** 3.62*** 0.74***
(11.29) (8.44) (16.82) (6.60) (15.64) (6.36) (13.84) (7.88)
Market return − 4.53 − 1.02 − 5.62* − 1.18* − 6.05* − 1.23* − 5.98** − 1.22*
(− 1.58) (− 1.63) (− 1.66) (− 1.71) (− 1.77) (− 1.82) (− 2.03) (− 1.88)
Top tier − 3.68*** − 0.73*** − 3.60*** − 0.71*** − 3.55*** − 0.71***
(− 8.50) (− 13.39) (− 8.50) (− 12.25) (− 10.78) (− 16.26)
Big5_audit − 2.76*** − 0.60*** − 2.19*** − 0.49*** − 2.24*** − 0.50***
(− 5.38) (− 7.34) (− 5.08) (− 5.72) (− 5.14) (− 5.74)
GCO*Big5_audit − 3.34*** − 0.32*** − 3.30*** − 0.32***
(− 3.15) (− 3.72) (− 2.59) (− 5.90)
Constant − 0.34 − 44.79*** − 57.85*** − 59.12*** − 58.92***
(− 1.17) (− 11.36) (− 17.03) (− 15.76) (− 13.28)
N 1367 1367 1367 1367 1367 1367 1367 1367 1358 1358
Pseudo R2 0.01 0.01 0.62 0.62 0.76 0.76 0.77 0.77 0.76 0.76
Log Likelihood − 928.8 − 928.8 − 355.5 − 355.5 − 227.5 − 227.5 − 219.9 − 219.9 − 219.4 − 219.4
This table shows the results of the logistic regression of completed versus withdrawn IPOs. The dependent variable IPO wd is equal to one if the company withdraws from
the going public process, and zero if the company goes public. mfx is the marginal effects at the means (MEMs) for each coefficient. The IPO sample spans the years from
2001 to 2010, due to the data availability of withdrawn IPO sample. All variables are defined in the Table 11 in “Appendix”. Heteroskedasticity-robust and industry-clustered
z-statistics are in parentheses. ***, **, and * indicate statistical significance levels 1, 5, and 10%, respectively
N. Matanova et al.
Our results indicate that this is true only for VC-backed IPOs, and we find evidence that
this is due to lawsuit avoidance behavior by VC investors. We expand the pricing accuracy
analysis by examining the impact of GCOs on price revisions. We contribute to the lit-
erature by providing evidence that GCOs, in general, represent more informative content,
reduce price revision, and thereby increase price accuracy in IPOs. However, GCO IPOs
that employ the support of a reputable underwriter experience higher price revisions.
We further find evidence that investors are able to differentiate between IPO firms
that receive a GCO due to temporary financial constraints that will be overcome with
the additional capital raised at the IPO, and firms with systemic financial or structural
problems that will receive a second GCO post-flotation.
In addition, we find that underpricing is successful in deterring Section 11 lawsuits.
Further, GCO IPOs are more likely to be implicated with intentional omission of mate-
rial information than Non-GCO IPOs, thus are subject to greater incidence of Sec-
tion 10b lawsuits. However, GCO IPOs can reduce this likelihood if they are VC-backed
and/or hire reputable auditors and underwriters.
We show evidence that GCOs are not related to IPO firms’ post-IPO volatility and
illiquidity. Further, we find that GCO IPOs seem to time the decision to go public based
on their performance. Upon successful completion of going public, GCO IPOs are more
likely to delist due to operational reasons and exhibit inferior long-run aftermarket per-
formance. Overall, we contribute to the literature by documenting that GCOs contain
important information about the future performance of issuing ordinary IPO firms,
which is vital to potential investors and the market as a whole.
Acknowledgements We greatly appreciate the constructive suggestions from Sobhesh Kumar Agarwalla,
Daniel Bradley, Sid Bundy, Vladimir Gatchev, Bradford Jordan, Timothy Loughran, Takeshi Nishikawa,
Jay Ritter, and Dahlia Robinson. We would also like to thank participants at the EFA 2013 Annual Meet-
ing, SFA 2013 Annual Meeting, FMA 2014 Annual Meeting, MFS 2017 Annual Meeting, and WFC 2017
Annual Meeting for valuable and helpful comments.
Compliance with ethical standards

Conflict of interest None.
Appendix
See Table 11.
13
N. Matanova et al.
Table 11 Definition of variable
Variables Definitions
Abs_rev Is the absolute value of price revision, which is calculated as the percentage differ-
ence from the offer price to the midpoint of the file range. Negative percentage
differences are converted into positive values
BHAR Is the average buy-and-hold abnormal returns (BHARs) for GCO and Non-GCO IPOs
Big5_audit Is the indicator variable for companies that hire the following five auditors: KPMG,
PricewaterhouseCoopers LLP, Deloitte, Ernst & Young LLP, and Grant Thornton
LLP
CAR Is the cumulative abnormal returns are calculated by subtracting the matching portfo-
lio return each month and then summing returns over the event window
Delist Is the dummy variable with a value of one if the stock delisted within 3 years of the
IPO date for a deleterious reason (CRSP delisting codes 550-572 and 574-584), and
zero otherwise (Willenborg and McKeown 2000)
Earnings nve Is the dummy variable with a value of one if an IPO firm had negative earnings per
share (EPS) over a period of 1 year after initial public offerings, based on COM-
PUSTAT quarterly data, and zero otherwise
GCO IPO Is the dummy variable with a value of one if an IPO firm has a going concern opinion
in the final IPO prospectus (424) filed with the Securities and Exchange Commis-
sion (SEC), and zero otherwise
GCO*VC-backing Is the interaction term between GCO IPO and the VC-backing status of the IPO
GCO*Big5_audit Is the interaction term between GC opinion and Big5_audit
High tech The high technology industry classification from SDC’s new issue database
Illiquid Indicates the spread implied by the daily high and low prices and is calculated using
the formula from Corwin and Schultz (2012)
Initial return Is the percentage difference between the closing price on the first day of trading and
the offer price
Insti. ownership The mean ownership of the IPO firm stock in the first quarter after the initial public
offering as shown in institutional holding (13f) data
Internet IPO Is the dummy variable with a value of one the IPO is classified as internet IPO, and
zero otherwise
Lawsuit Is the dummy variable with a value of one if the IPO gets a class action lawsuit after
the IPO date up to 3 years after public offering, and zero otherwise. This data is
collected from the Stanford Law School’s Securities Class Action Clearinghouse
Log (IPO valuation) Is the logarithmic IPO valuation, which is offer price multiplied by the pre-IPO num-
ber of shares expected to exist after the IPO in the IPO prospectus
Market return Is the value-weighted market return 6 months before IPO offering date or withdrawal
Multi-class Is the dummy variable with a value of one for firms with more than one class of
stock, and zero otherwise
Offer price Is the offer price (USD) for an IPO firm as indicated in SDC Database
Proceeds Is the proceeds (in millions) in the final prospectus as recorded by SDC
Partial Is the percentage difference from the offer price to the midpoint of the file range
Volatility Is defined as the market model root-mean square error (multiplied by 1000) for each
firm over day + 5 to day + 64 relative to the offer day, as in Loughran and McDon-
ald (2013)
13
Variables Definitions
Section 11 Is the dummy variable with a value of one if the IPO firm gets Section 11 class action
lawsuit after the IPO date up to 3 years after public offering, and zero otherwise.
This data is collected from the Stanford Law School’s Securities Class Action
Clearinghouse. Lawsuits are brought under Section 11 and 12 of the Securities Act
of 1933, where “damages for direct purchasers in the IPO are based on the differ-
ence between the offer price and either the sale price or the security’s price at the
time of the lawsuit, depending on whether or not the share was sold” (Lowry and
Shu 2002)
Section 10b Is the dummy variable with a value of one if the IPO firm gets Section 10b class
action lawsuit after the IPO date up to 3 years after public offering, and zero
otherwise. This data is collected from the Stanford Law School’s Securities Class
Action Clearinghouse. Lawsuits are brought under Section 10b-5 of the Securities
Act of 1933, where “while under Section 10b-5, the omission must be the result of
an intent to deceive or defraud” (Hanley and Hoberg 2012)
Shares overhang Is defined as pre-IPO shares retained for all classes divided by shares filed, including
primary and secondary shares (Bradley and Jordan 2002)
Top tier Is a dummy variable with a value of one if the IPO’s investment bank has a Carter–
Manaster ranking of 8 or higher on a 1–9 point scale
VC-backing Is the dummy variable with a value of one if the firm is VC-backed, and zero other-
wise
Underwriter rank Is the average rank on a Carter–Manaster ranking on a 1–9 point scale
Year2 GCO Is the dummy variable with a value one if the GCO IPO gets a GCO in its second
year annual report post-flotation
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Review of Quantitative Finance and Accounting

Going concern opinions and IPO pricing accuracy

Natalia Matanova1 · Tanja Steigner2 · Bingsheng Yi3 · Qiancheng Zheng2

© Springer Science+Business Media, LLC, part of Springer Nature 2018

Keywords Going concern opinions · Ordinary IPOs · Underpricing · Price revisions ·

JEL Classification G12 · G14 · M42 · G33 · G28 · K22

2 Prior research and hypotheses

2.1 Price accuracy: underpricing and price revisions

2.3 Post‑IPO idiosyncratic return volatility

Hypothesis 4 GCOs are not associated with post-IPO illiquidity.

2.5 Long‑run performance, delisting, and withdrawal

Hypothesis 5a Conditional on successful completion of the IPO process, GCO IPOs

3.1 Data and main variables

Panel A: Number and percentage of GCO IPOs by year

3.2.1 Multivariate regression analyses

3.2.2 Long‑run stock performance

where Rmt is the return of the corresponding value-weighted size/book-to-market portfolio

In Table 2 we summarize our multivariate analysis of underpricing, where our dependent

GCO IPO − 7.33*** − 7.09*** − 6.01** − 1.66 − 8.74 − 6.48 − 5.69

(1.84) (1.36) (1.22) (1.30) (1.35) (1.17)

(3.65) (3.81) (3.12) (3.55) (3.68)

Big5_audit 6.47*** 6.40*** 6.40*** 5.72** 5.97**

(2.65e+14) (13.40) (10.85) (12.04) (11.72) (13.05) (13.83)

Panel B: Logistic regressions on lawsuits within 3 years following IPOs

4.4 Post‑IPO idiosyncratic return volatility

GCO IPO 10.10** 3.70 4.34 − 0.57 5.10 3.47 1.54

In Table 7, we present descriptive statistics of operating and profitability performance vari-

GCO IPO 1.59*** − 0.37 − 0.40 − 1.02 − 0.15 − 1.78 − 1.55

Table 7 Operating performance IPO Year IPO + 1 IPO + 2 IPO + 3

This table presents descriptive statistics of operating performance var-

Table 8 Long-run stock performance

Panel A: Buy-and-hold abnormal returns (BHARs)

Panel B: Cumulative abnormal returns (CARs)

Non-GCO 717 8.49 0.03 13.79 0.00

Panel C: Short-term calendar-time regressions (Months 1 through 6)

Panel D: Long-term calendar-time regressions (Months 12 through 36)

GCO IPO 1.90** 2.19*** 2.12** 1.05 5.22*** 4.83*** 5.36***

Compliance with ethical standards

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2 Prior research and hypotheses

2.1 Price accuracy: underpricing and price revisions

2.3 Post‑IPO idiosyncratic return volatility

2.5 Long‑run performance, delisting, and withdrawal

3.1 Data and main variables

3.2.1 Multivariate regression analyses

3.2.2 Long‑run stock performance

GCO IPO − 7.33* − 7.09* − 6.01** − 1.66 − 8.74 − 6.48 − 5.69

Big5_audit 6.47* 6.40* 6.40* 5.72 5.97**

4.4 Post‑IPO idiosyncratic return volatility

Table 7 Operating performance IPO Year IPO + 1 IPO + 2 IPO + 3

Table 8 Long-run stock performance

GCO IPO 1.90 2.19* 2.12 1.05 5.22* 4.83* 5.36*