Evidence on What CFOs Think About the IPO Process: Practice,Theory, and Managerial Implications

Many privately held companies aspire to go public through an initial public offering. But the IPO process is time‐consuming, expensive, and fraught with uncertainty. With the aim of shedding light on the process and reducing at least some of the uncertainty, the authors asked several hundred CFOs to share their experiences and perceptions with regard to six specific aspects of the IPO process: (1) motives for going public; (2) the timing of IPOs; (3) criteria for choosing an underwriter; (4) cause of IPO underpricing; (5) IPO signaling; and (6) reasons to stay private. The main findings from the survey are summarized below:

• ? The primary motive for going public is to create a currency‐publicly traded shares‐that can be used to fund acquisitions.
• ? CFOs strongly base the timing of their IPOs on overall stock market conditions, while paying relatively little attention to IPO market conditions.
• ? CFOs choose underwriters based on their overall reputation and industry expertise. Somewhat surprisingly, issuers did not express much concern about the underwriter fee structure.
• ? CFOs view underpricing mainly as a means of compensating investors for taking on the risk of IPOs in the after‐market.
• ? The two strongest perceived positive signals for issuer quality are a history of strong earnings and the use of a reputable investment bank. The strongest negative signal is the sale of insider shares in the IPO.
• ? The primary reason for staying private cited by the CFOs of private companies is the desire to maintain decision‐making control.

     

Growth Capital‐Backed IPOs

Growth capital investing is the financing of growing businesses that are investing in tangible assets and the acquisition of other companies. Growth capital is common in retailing, restaurant chains, and health care management, and represents 12% of all venture capital (VC)‐backed initial public offerings (IPOs). Since 1980, investing in growth capital‐backed IPOs has produced mean three‐year style‐adjusted buy‐and‐hold returns of +25.2%, in contrast to style‐adjusted returns of approximately zero for other VC‐backed and buyout‐backed IPOs. One‐third of growth capital‐backed IPOs are rollups and these have produced much higher returns for investors than rollups without a financial sponsor.     

IPO first‐day returns: Skewness preference,investor sentiment and uncertainty underlying factors

In this paper, we investigate the initial public offering (IPO) first-day returns. Our focus is to examine the irrational component of the agent behavior towards IPO lotteries. Based on 234 French IPOs performed between 2002 and 2012, we find that IPOs with high initial returns have higher idiosyncratic skewness, turnover and momentum. This finding provides empirical evidence for investors' preference for stocks with lottery-like features and investor sentiment. In addition, we show that the skewness preference and the investor sentiment effect are stronger during periods of favorable market conditions. Our results are robust to the integration of uncertainty underlying factors.     

Why Do European Firms Go Public?

We survey chief financial officers (CFOs) from 12 European countries regarding the determinants of going public and exchange listing decisions. Most CFOs identify enhanced visibility and financing for growth as the most important benefits of an IPO, but other motivations for IPOs differ significantly across firms, countries, and legal systems. We find strong support for the IPO theories that emphasise financial and strategic considerations, such as enhanced reputation and credibility, and financial flexibility as a major advantage of an IPO. At the same time, we find moderate support for theories that focus on exit strategy, balance of power with creditors, external monitoring, and merger and acquisition motivations. European CFOs' views on the major benefits of an IPO are generally similar to those of US managers as reported in Brau and Fawcett (2006) , but differ significantly on outside monitoring; outside monitoring is considered a major benefit by European CFOs but a major cost by US CFOs. Our evidence suggests that the decision to go public is a complex one, and cannot be explained by one single theory because firms seek multiple benefits in going public. These motivations are influenced by the firm's ownership structure, size and age as well as by the home country's institutional and regulatory environment.     

UNDERPRICING OF IPOS THAT FOLLOW PRIVATE PLACEMENT

In this study we examine the underpricing of initial public offerings (IPOs) by firms that have private placements of equity before their IPOs (PP IPO firms). We find that PP IPOs are associated with significantly less underpricing than their peers. Furthermore, PP IPOs are associated with lower underwriting spreads, more reputable underwriting syndicates, and greater postissue analyst coverage as compared to IPOs that are issued by their industry peers under similar market conditions. Consistent with the implications of the information asymmetry explanation for IPO underpricing, our findings suggest that companies could benefit by conveying their quality via successful pre‐IPO private placements that help reduce the cost of going public.     

Dual Class IPOs ARE Underpriced Less Severely

We analyze a sample of dual and single class initial public offerings (IPOs) to investigate whether empirical estimates of underpricing determinants are consistent across alternative measures of firm size and alternative techniques intended to account for underwriter price stabilization efforts. We find that results from long‐standing methods for estimating underpricing relations are generally robust to one's choice of size proxy and are consistent with estimates obtained from censored regressions of first‐day returns and from least squares regressions of longer horizon initial returns. We also confirm an existing finding in the literature that dual class IPOs endure less underpricing than do single class firms.     

媒体关注度对新股表现的影响——来自中国股票市场的证据

新闻媒体对证券投资的影响日趋重要,它会通过影响投资者的心理和行为而影响资产价格。首次公开发行的股票（IPOs）由于倍受媒体关注,从而会在上市以后的价格表现上产生一定的影响。本文选取2006年6月至2008年6月上市的246只首次公开发行的股票作为样本,以百度新闻搜索到包含股票名称的新闻数量作为媒体关注度的衡量指标,实证检验了媒体关注度对新股表现的影响。本文得出结论：媒体关注度通过影响投资者情绪,对新股短期累积超额收益产生正的影响,而对长期累积超额收益产生负的影响。同时发现,媒体关注度高的新股,其发行价格也相对较高。     

Does favorable investor sentiment lead to costly decisions to go public?

We investigate the real effects of decisions to undertake an initial public offering of stock in periods of favorable investor sentiment. Specifically, we examine potential effects of favorable investor sentiment on investment expenditures and how effects on investment affect firm operating performance and value as well as the likelihood of survival. We find that firms going public during periods of favorable sentiment, on average, spend substantially more on investments, especially acquisitions, than firms going public in other periods. The effect of favorable investor sentiment on investment is more pronounced for younger firms. We do not find, however, that the higher investment spending in the wake of favorable sentiment leads to worse operating or stock performance. Stock returns around acquisitions announcements are also positive for firms going public in favorable sentiment periods. The preponderance of our findings indicate that decisions to go public in favorable investor sentiment periods do not lead to corporate investment decisions that harm firm performance and value.     

The Wealth Effect of Demutualization: Evidence From the U.S. Property-Liability and Life Insurance Industries

This study examines the wealth effect of demutualization initial public offerings (IPOs) by investigating underpricing and postconversion long‐run stock performance. Our results suggest that there is more “money left on the table” for demutualized insurers than for non‐demutualized insurers. We show that higher underpricing for demutualized firms can be explained by greater market demand, market sentiment, and the size of the offering. Further, contrary to previous research reporting an average underperformance of industrial IPOs, we show that demutualization IPOs outperform non‐IPO firms with comparable size and book‐to‐market ratios and non‐demutualized insurers. We present evidence that the outperformance in stock returns is mainly attributable to improvement in post‐demutualization operating performance and demand at the time of the IPOs. The combined results of underpricing and long‐term performance suggest that the wealth of policyholders who choose stock rather than cash or policy credits is not harmed by demutualization. Stockholders who purchase demutualized company shares either during or after the IPO have earned superior returns. Our findings are consistent with the efficiency improvement hypothesis.     

Characterizing the Risk of IPO Long‐Run Returns: The Impact of Momentum,Liquidity, Skewness,and Investment

We study 6,686 initial public offerings (IPOs) spanning the period 1981‐2005 and find that the new issues puzzle disappears in a Fama‐French three‐factor framework. IPOs do not underperform in the aftermarket on a risk‐adjusted basis and do not underperform a matched sample of nonissuers. IPO underperformance is concentrated in the 1980s and early 1990s, and IPOs either perform the same as the market or outperform on a risk‐adjusted basis from 1998 to 2005. We find that outperformance in the later period is driven by large firms. Factors for momentum, investment, liquidity, and skewness help to explain aftermarket returns, although size and book‐to‐market tend to proxy for skewness. IPO investors receive smaller expected returns due to negative momentum and investment exposure and in exchange for higher liquidity.     

A Comparison of Underwriting Costs of Initial Public Offerings by Investment and Commercial Banks

We examine differences in underwriting costs between commercial‐bank‐Section‐20‐underwritten initial public offerings (IPOs) and investment‐bank‐underwritten IPOs. Our results suggest that total underwriting costs (gross margin plus underpricing) are significantly lower for commercial bank IPOs. The lower cost for commercial bank IPOs is attributable to less severe underpricing for these issues. Gross margin costs generally do not differ between commercial bank and investment bank issues. Furthermore, we find that the long‐run stock price performance for commercial bank issues is superior to that of investment bank issues. That is, lower underpricing for Section 20 issues may not be a short‐run phenomenon. Rather, there appears to be a favorable outcome for investors in the long run for holding IPOs underwritten by Section 20 commercial banks. These results are inconsistent with the conflict of interest hypothesis often associated with merging commercial and investment bank functions in one organization.     

Shell games: On the value of shell companies

A reverse merger allows a private company to assume the current reporting status of another company that is public. This can be done quickly, without fundraising, road show, underwriter, substantial ownership dilution, or great expense. Private firms that go public via reverse merger are often motivated by the need to quickly secure financing through privately placed stock (PIPEs) and the desire to make acquisitions using stock as payment. In each of the last eight years reverse mergers have outnumbered traditional IPOs as a mechanism for going public, and reporting shell companies are providing fuel for much of this growth. We study 585 trading shell companies over the period 2006-2008. The purpose of most of these shell firms is to find a suitor for a reverse merger agreement. These companies have no systematic risk, operations, or assets, and their share price tends to decline over time. Yet, these firms have investors. When a takeover agreement is consummated, shell company three-month abnormal returns are 48.1%. We argue that this exceptional return is compensation to investors for shell stock illiquidity and the uncertainty of finding a reverse merger suitor. We show that shell company returns are much greater at the consummation of a merger than those of a similar entity that in dollar terms is more popular among investors — Special Purpose Acquisition Companies (SPACs).     

Cycles in the IPO market

We develop a model in which time-varying real investment opportunities lead to time-varying adverse selection in the market for IPOs. The model is consistent with several stylized facts known about the IPO market: economic expansions are associated with a dramatic increase in the number of firms going public, which is in turn positively correlated with underpricing. Adverse selection is procyclical in the sense that dispersion in unobservable quality across firms should be more pronounced during booms. Taking the premise that uncertainty is resolved (and thus private information revealed) over time, we test this hypothesis by looking at long-run abnormal returns and delisting rates. Consistent with the model, we find (a) greater cross-sectional return variance, and (b) higher incidence of delisting for hot-market IPOs.     

CFO Fiduciary Responsibilities and Annual Bonus Incentives

We examine how firms design bonus plans of their CFOs. CFOs participate in decision making much like other executives, but they also have significant fiduciary responsibilities for reporting firms' financial results. Responsibility for financial reporting raises the question of whether it is appropriate to pay CFOs annual bonuses contingent on self-reported financial performance. In this paper, we provide a framework that characterizes CFO bonuses as a tradeoff between CFOs' decision-making responsibilities and their fiduciary duties over financial reporting. This framework yields a number of implications that we examine empirically using a proprietary survey of CFO compensation practices of public and private firms. Our main finding shows that from 2003 to 2007 public entities (relative to private entities) reduced the percentage of CFO bonuses contingent on financial performance. We interpret this result as evidence that firms mitigate misreporting practices in part by deemphasizing CFO incentive compensation.     

THE EFFECT OF THE TRADING SYSTEM ON IPO UNDERPRICING: EVIDENCE FROM THE 1997 ORDER‐HANDLING RULES

We use a natural experiment resulting from the 1997 Securities and Exchange Commission rule mandating a change in the order‐handling rules (OHR) for all NASDAQ stocks to test whether secondary market structure affects initial public offering (IPO) underpricing. We find that the increase in liquidity that the OHR represent led to a decrease in underpricing for cold NASDAQ IPOs, suggesting that when liquidity is lowest, changes in market liquidity display a negative relation to initial returns.     

DIVERGENCE OF OPINION AND LONG‐TERM PERFORMANCE OF INITIAL PUBLIC OFFERINGS

Miller's hypothesis posits that divergence of opinion can lead to asset overvaluation and subsequent long‐term underperformance in markets (such as initial public offerings [IPOs]) with restricted short‐selling. Consistent with this hypothesis, we find that early‐market return volatility, a proxy for divergence of opinion, is negatively related to subsequent IPO long‐term abnormal returns. This relation holds after accounting for other factors that previous studies suggest affect long‐term abnormal returns for IPOs (including another proxy for divergence of opinion). Moreover, we find that this relation is stronger in IPO markets than in non‐IPO markets (where short‐selling restrictions are less stringent), again consistent with Miller's hypothesis.     

Long‐term Performance of Greek IPOs

We analyse the long‐run performance of 254 Greek IPOs that were listed during the period 1994–2002, computing buy‐and‐hold abnormal returns (BHAR) and cumulative abnormal returns (CAR) over 36 months of secondary market performance. The empirical results differ from international evidence and reveal long‐term overperformance that continues for a substantial interval after listing. Measuring these returns in calendar time, we find statistical significance with several of the benchmarks employed. We also find that long‐term overperformance is a feature of the mass of IPOs conducted during a pronounced IPO wave. Cross‐sectional regressions of long‐run performance disclose several significant factors. The study demonstrates that although Greek IPOs overperform the market for a longer period, underperformance eventually emerges, in line with much international evidence. Our interpretation is that the persistence of overperformance over a significant interval is due to excessive supply of issues during the ‘hot IPO period’. Results associated with pricing during the ‘hot IPO period’ indicate positive short‐ (1‐year), medium‐ (2‐year) and negative long‐term (3‐year) performance.     

Local corporate misconduct and local initial public offerings

This paper investigates the cost of going public through initial public offerings (IPOs) for firms located in regions with significant fraud density. We find that companies in regions with a high proportion of nearby firms that have committed corporate misconduct have more pronounced underpricing, experience higher post-IPO stock return volatility, and are more likely to withdraw their offerings. Overall, our results show that local corporate misconduct is associated with the pricing of IPOs, and the breach of trust is related to costly IPOs for newcomers.     

CFO role and CFO compensation: An empirical analysis of their implications

Given concerns over CFO pay, especially incentives, and considering the tension between a CFO’s fiduciary responsibility and being a key member of the firm’s executive team, we examine the determinants and effects of CFO compensation amount, incentive intensity, and proximity to CEO compensation in a sample of European companies (FTE 500, 2005–2009). First, we focus on the CFO role as a determinant of CFO compensation. Like prior work, we proxy for CFO roles by using hand-collected public data on education and past professional experience, but we supplement these proxies with proprietary data to more directly capture the firm-specific nature of the CFO job in term of its similarity with that of the CEO. We thus argue how CFOs can have varied roles characterized by different levels of financial expertise and CEO-likeness, and document that it is this latter aspect that is associated with CFO compensation. Second, we study the effects of CFO compensation design on outcomes in the CFO’s realm related to financial reporting. We find that CFO financial expertise is positively associated with financial reporting quality, while a CFO’s pay long-term incentive intensity and a CFO’s incentive compensation proximity with the CEO are negatively associated with financial reporting quality. Overall, then, our results suggest that CFOs get rewarded for their CEO-likeness, and particularly for their being similar to the CEO in terms of tasks and decision making authority. But it is their financial expertise that is positively related to financial reporting quality. At the same time, using compensation that is more incentive intensive and more similar to that of the CEO appears to be potentially detrimental to the quality of financial reporting. These results are relevant for boards involved in selecting highly expert CFOs, and their compensation committees charged with defining subsequently effective incentive compensation plans for those CFOs.