12 Initial Public Offerings An Analysis of Theory

AmericanFinanceAssociationInitialPublicOfferings:AnAnalysisofTheoryandPracticeAuthor(s):JamesC.BrauandStanleyE.FawcettSource:TheJournalofFinance,Vol.61,No.1(Feb.,2006),pp.399-436Publishedby:BlackwellPublishingfortheAmericanFinanceAssociationStableURL::26/09/201110:39YouruseoftheJSTORarchiveindicatesyouracceptanceoftheTerms&ConditionsofUse,[e-mail]ericanFinanceAssociationarecollaboratingwithJSTORtodigitize,preserveandextendaccesstoTheJournalofFinance.*VOL.LXI,NO.1*FEBRUARY2006InitialPublicOfferings:AnAnalysisofTheoryandPracticeJAMESC.BRAUandSTANLEYE.FAWCETT*ABSTRACTWesurvey336chieffinancialofficers(CFOs)tocomparepracticetotheoryintheareasofinitialpublicoffering(IPO)motivation,timing,underwriterselection,underpricing,signaling,andthedecisiontoremainprivate.Wefindtheprimarymotivationforgoingpublicistofacilitateacquisitions.CFOsbaseIPOtimingonoverallmarketconditions,arewellinformedregardingexpectedunderpricing,andfeelunderpricingcompen-satesinvestorsfortakingrisk.Themostimportantpositivesignalispasthistoricalearnings,followedbyunderwritercertification.CFOshavedivergentopinionsabouttheIPOprocessdependingonfirm-specificcharacteristics.Finally,wefindthemainreasonforremainingprivateistopreservedecision-makingcontrolandownership.GREATEFFORT,THEORETICALANDEMPIRICAL,hasbeenmadetounderstandmanage-rialdecision-makingintheinitialpublicoffering(IPO)process.MostempiricalIPOresearchreliesonpubliclyavailablestockreturndataordatacontainedinSecuritiesandExchangeCommission(SEC)filings.InthisstudyweextendtheIPOliteraturebyanalyzinguniquedatafromsurveysofchieffinancialofficers(CFOs)tocompareCFOperspectivestoprevailingacademictheory.Specifically,weexaminethefollowingsevenissues:motivationsforgoingpublic,timingoftheIPO,underwriterselection,underpricing,signaling,IPOprocessissues,andthedecisiontostayprivate.Wesurveythreesubsamplesoffirms,namely,thosethatsuccessfullycompletedanIPO,thosethatbegantheprocessbutchosetowithdrawtheissue,andthosethatarelargeenoughtogopublic,buthavenotattemptedanIPO.*JamesC.Brau,GoldmanSachsFacultyFellow,FinanceDepartment,MarriottSchool,BrighamYoungUniversity,Provo,Utah.StanleyE.Fawcett,BusinessManagementDepartment,MarriottSchool,BrighamYoungUniversity,Provo,Utah.TheauthorsthankVaughnArmstrong,HalHeaton,AndyHolmes,GrantMcQueen,CraigMerrill,ToddMitton,MikePinegar,JayRitter,KeithVorkink,ananonymousreferee,theeditor(RobStambaugh),andparticipantsofBrighamYoungUniversity,UniversityofPuertoRico,andUniversityofUtahseminarsforhelpfulcomments.WeexpressappreciationtoGregAdams,RockAdams,TylerBrough,WillGross,BretRasmussen,andRichWoodforexcellentresearchassistanceandtoChristineRoundyforoutstandingadmin-istrativework.JimBraurecognizesfundingfromtheGoldmanSachsFacultyFellowshipandaMarriottSchoolresearchgrant.StanFawcettrecognizesfundingfromtheStaheliProfessorship.BothauthorsacknowledgetheBYUSilverFundwhichpaidfordatabasesandresearchsupport.AlsoweacknowledgeIntelfortheirgiftoftworesearchcomputerservers.Finally,wethankalltheCFOswhosharedtheirinsightsandmadethisstudypossible.Allerrorsremainours.JimBrauisthecontactauthor.399400TheJournalofFinanceHistorically,empiricistshavehaddifficultystudyingwhyfirmsgopublicduetodataconstraints.OursurveydataallowustoovercomethisconstraintanddirectlyaskCFOswhytheyconductanIPO.WefindthatCFOsidentifythecreationofpublicsharesforacquisitionsasthemostimportantmotivationforgoingpublic.TraditionaltextbookexplanationssuchasloweringthecostofcapitalandthepeckingorderoffinancingarenotamongthemostimportantreasonsforconductinganIPO.Additionally,high-techfirmsviewanIPOmoreasastrategicreputation-enhancingmovethanasafinancingdecision.PreviousliteraturehasdocumentedthatIPOstendtocomeinwaves,char-acterizedbyperiodsofhotandcoldmarkets.Tounderstandthisphenomenonbetter,weanalyzethetimingofIPOs.WefindthatCFOstakeintoaccountmarketandindustrystockreturns,andplacelessemphasisonthestrengthoftheIPOmarketwhenconsideringthetimingoftheirissue.Venturecapital(VC)-backedfirmsandfirmswithsmallinsiderownershipdecreasesintheIPOtendtoviewmarkettimingissuesasmoreimportantthantheircounterparts.ExaminingCFOsentimenttowardunderwriterselectioncriteria,wefindthatCFOsselectunderwritersbasedonoverallreputation,qualityofthere-searchdepartment,andindustryexpertise.BycomparingourresultstoKrig-man,Shaw,andWomack(2001),wefindthatCFOs'criteriaforchoosingun-derwritershaveremainedstableinthepre-andpost-bubbleperiod.Large-firmCFOsfeelthatIPOspinning(allocatingsharestopotentialclient-firminsiders)ismoreofaconcerninunderwriterselectionthansmall-firmCFOs.CFOsinfirmswithhigh-prestigeunderwritersselect