Journal of Financial and Strategic Decisions Volume 13 Number 3 Fall 2000 23 ACCOUNTING BETAS – AN EX ANTI PROXY FOR RISK WITHIN THE IPO MARKET Mohamad A. Almisher * and Richard J. Kish ** Abstract Several studies in the past established an association between market and accounting betas. Most of the previous studies are performed using a sample of large established firms for which both accounting and market betas can be computed. In our study, market betas cannot be computed due to the data limitations associated with private firms. Thus, a direct measure of the association between the two betas is impossible. However by relying on the relationship that exists between market betas and the underpricing of the IPOs, we are able to establish the linkage between market and accounting betas. Through this linkage, our results confirm that accounting betas are associated with market betas within the IPO market. Therefore, accounting betas can be used as an ex anti measure for the riskiness of firms entering into the IPO market. INTRODUCTION There is an ongoing analysis of the association between market and accounting betas as measures of risk. In 1969, Ball and Brown produced one of the earliest research papers examining the degree of association between market and accounting measures of risk is similar to later studies in that it focuses on large established firms. Ball and Brown (1969), evaluating the ability of accounting numbers to convey information about the risk of the firm to market participants, concluded that 35 to 40 percent of the cross-sectional variability in systematic risk can be explained by the co-movement in the accounting income of firms. Since Ball and Brown’s study, researchers continue to validate this linkage. Even though the subsequent studies differ with regard to the degree of association between accounting and market betas, they all agree that such an association does exists. In a research report justifying the use of accounting betas as proxies for market betas when market data is unattainable, Kulkarni, Powers, and Shanon (1991) establish a technique for establishing a linkage of accounting betas and the divisional hurdle rate of a multi-product firm. This linkage lays the foundation for our analysis within the IPO market. Therefore as a continuation of this line of research, we undertake this study to answer the following question: Can market (systematic) risk within the field of initial public offerings (IPOs) be proxied with accounting data that reflects only the historical performance of the firm? To the best of our knowledge, this study is the first to examine whether the accounting beta is useful for assessing the risk of firms going public for the first time (i.e., when evaluating initial public offerings). One of the shortcomings of this line of IPO research is that we cannot compute a market beta for privately held firms. 1 Therefore, it is impossible to directly test the association between market and accounting beta for the privately held firms within our analysis. However, we do test whether the accounting beta conveys any ex anti information about the risk of the privately held firm to investors within the IPO market and find that an association does in fact exist. Our study documents this statistically significant association between accounting betas and the underpricing of IPOs implying that there is an association between market and accounting betas for the privately held firms. Extrapolating on this linkage, we offer support that accounting betas can be considered a good proxy for the systematic risk of firms involved in the IPO process. Therefore, this study is very important for several reasons. As mentioned previously, it is the first paper to our knowledge that employs accounting betas to assess the risk of firms undergoing initial public offerings (IPOs). Second, the number of firms in our sample is quite high compared with *King Saud University - Saudi Arabia **Lehigh University