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Initial Public Offering Allocations Initial Public Offering Allocations by Sturla Lyngnes Fjesme A dissertation submitted to BI Norwegian Business School for the degree of PhD PhD specialization: Financial Economics Series of Dissertations 9/2011 BI Norwegian Business School Sturla Lyngnes Fjesme Initial Public Offering Allocations © Sturla Lyngnes Fjesme 2011 Series of Dissertations 9/2011 ISBN: 978-82-8247-029-2 ISSN: 1502-2099 BI Norwegian Business School N-0442 Oslo Phone: +47 4641 0000 www.bi.no Printing: Nordberg Trykk The dissertation may be downloaded or ordered from our website www.bi.no/en/Research/Research-Publications/ Abstract Stock exchanges have rules on the minimum equity level and the minimum number of shareholders that are required to list publicly. Most private companies that want to list publicly must issue equity to be able to meet these minimum requirements. Most companies that list on the Oslo stock exchange (OSE) are restricted to selling shares in an IPO to a large group of dispersed investors or in a negotiated private placement to a small group of specialized investors. Initial equity offerings have high expected returns and this makes them very popular investments. Ritter (2003) and Jenkinson and Jones (2004) argue that there are three views on how shares are allocated in the IPO setting. First, is the academic view based on Benveniste and Spindt (1989). In this view investment banks allocate IPO shares to informed investors in return for true valuation and demand information. Informed investors are allocated shares because they help to price the issue. Second, is the pitchbook view where investment banks allocate shares to institutional investors that are likely to hold shares in the long run. It is argued, by investment banks, that buy-and-hold investors will create price stability that is good for the issuing companies. Finally, is the rent seeking view, or profit sharing view, where investment banks allocate shares to investors in return for kickbacks. There are four types of IPO rent seeking that have been investigated by U.S. regulators (the SEC and the NASD), see Liu and Ritter (2010). IPO allocations can be tied to future corporate business for the banks (IPO spinning), after-listing purchases of the IPO shares (IPO laddering) and stock-trading commissions. Investment banks and companies can also agree on high underpricing in return for after-listing company share coverage from a star analysts provided by the bank (analyst conflict of interest). Underpriced shares are then allocated to bank clients that generate high stock-trading commission for the investment bank. In the paper 'Laddering in Initial Public Offering Allocations' it is investigated if IPO allocations are tied to after-listing purchases of the IPO shares (IPO laddering). In the paper 'Using Stock-trading Commissions to Secure IPO Allocations' it is investigated if IPO allocations are tied to investor stock-trading commission. Private companies that want to list publicly can, as an alternative to the IPO allocation, issue shares in a negotiated private placement to a small group of specialized investors. Most theoretical papers on equity offerings, however, show that IPOs will almost always be preferred to the negotiated private placement by the seller, see Bulow and Klemperer (1996), Bulow and Klemperer (2009) and French and McCormick (1984). Why some companies use private placements has therefore been the focus of many empirical studies in finance, see Wruck (1989), Hertzel and Smith (1993), Barclay et al. (2007), Anshuman et al. (2010) and Cronqvist and Nilsson (2005). The research question addressed in the paper 'Initial Public Offering or Initial Private Placement?' is whether private placements are used, instead of IPOs, to transfer private benefits of control from sellers to buyers. A common contribution of all papers is that we introduce new and unique data on private company share ownership. This data allow us to investigate share allocations questions it has previously been difficult to investigate. Acknowledgements I am deeply indebted to Professor Øyvind Norli, my supervisor, for all the continued support, guidance and encouragement throughout my time as a PhD student. I would also like to thank Professor Roni Michaely for help and guidance, and for making my stay at Cornell University such a great experience. I am very grateful to François Derrien and Øyvind Bøhren, who gave me many helpful and detailed suggestions on my pre-doctoral defense and who helped me with the job market process. I am grateful to Bruno Gerard for supervising my master degree thesis and for helping me with the job market process and my PhD thesis. I would also like to thank Karin Thorburn, Diane Denis, William Megginson, Paul Ehling, Christopher Vincent, David De Angelis, Alyssa Anderson, Maury Saslaff, Yelena Larkin, Gideon Saar, Jay Ritter, Dag Michalsen and Richard Priestley for support and for commenting on the thesis. I would like to thank my fellow PhD students, Limei Che, Christian Heyerdahl-Larsen, Morten Josefsen, Siv Staubo, Siri Valseth, Nam Huong Dau, Ignacio Garcia de Olalla Lopez, Junhua Zhong, and my friends, Per Helmer Thorkildsen, Henrik Hasner, Kjell Olav Dalen, Jan Kenneth Evanger, Dag Djurovic, Martin Jensen, Per-Eilert Vierli and Øystein Larsen, for support and many interesting economic discussions. Finally, I would like to thank my family, Sølvi Lyngnes, Torbjørn Fjesme, Arvid Lyngnes Fjesme, Sunniva Victoria Fjesme and Hanna Kristiansen, for all the help and support during my time as a PhD student. Contents 1 Introduction 3 1.1 Laddering in Initial Public Offering Allocations . 4 1.2 Using Stock-trading Commissions to Secure IPO Allocations . 4 1.3 Initial Public Offering or Initial Private Placement? . 4 2 Laddering in Initial Public Offering Allocations 7 2.1 Introduction................................... 9 2.2 Related literature . 11 2.3 Predictions and testable implications . 12 2.3.1 The IPO laddering hypothesis . 13 2.3.2 Other testable implications of IPO laddering . 14 2.4 The listing process and the incentives to engage in IPO laddering . 15 2.4.1 Why investment banks use IPO laddering ............... 15 2.4.2 Why laddering investors agree to buy more shares .......... 16 2.4.3 Why IPO laddering is a problem .................... 16 2.5 Datadescription ................................ 17 2.5.1 The IPO sample ............................ 18 2.5.2 The remaining IPOs .......................... 18 2.5.3 Aggregate laddering ........................... 18 2.5.4 Variable explanations .......................... 19 2.6 Empiricalresults ................................ 21 2.6.1 Optimal holdings ............................ 24 2.6.2 The effect of IPO laddering ...................... 24 2.6.3 Robustness and aggregate IPO laddering ............... 24 2.7 Conclusion.................................... 24 3 Using Stock-trading Commissions to Secure IPO Allocations 43 3.1 Introduction................................... 45 3.2 Related literature . 46 3.3 Theoretical predictions and testable implications . 47 3.3.1 The rent seeking view of IPO allocations ............... 48 3.3.2 The pitchbook view of IPO allocations ................. 49 3.3.3 The academic view of IPO allocations ................. 50 3.4 Data....................................... 50 3.4.1 IPO allocations ............................. 51 3.4.2 After-listing ownership ......................... 51 3.4.3 Variable description .......................... 52 3.5 Empiricalresults ................................ 53 3.5.1 The rent seeking view of IPO allocations ............... 54 3.5.2 The pitchbook view of IPO allocations ................. 55 3.5.3 The academic view of IPO allocations ................. 55 3.5.4 Robustness ............................... 56 3.6 Conclusion.................................... 56 1 4 Initial Public Offering or Initial Private Placement? 73 4.1 Introduction................................... 74 4.2 Literaturereview ................................ 75 4.3 Theroadtothelisting ............................. 77 4.3.1 The formal listing process ....................... 77 4.3.2 A public or a private offering? ..................... 78 4.4 Theoretical predictions and testable implications . 79 4.4.1 The private benefits of control hypothesis ............... 80 4.4.2 Alternative explanations ........................ 81 4.4.3 Other control measures ......................... 82 4.4.4 Private benefits of control also after the listing ............ 83 4.5 Data and descriptive statistics . 83 4.5.1 Descriptive statistics .......................... 84 4.5.2 Variable description .......................... 84 4.6 EmpiricalResults................................ 85 4.6.1 The private benefits of control hypothesis .............. 85 4.6.2 Alternative explanations ........................ 86 4.6.3 Private benefits of control also after the listing ............ 86 4.7 Conclusion.................................... 87 5 Summary 100 2 1 Introduction This dissertation consists of three papers; ’Laddering in Initial Public Offering Alloca- tions’, ’Using Stock-trading Commissions to Secure IPO Allocations’and ’Initial Public Offering or Initial Private Placement?’ The rest of this section is organized as follows. I first discuss the common feature of the papers, namely the allocations of Initial Public Offering (IPO) shares. I then briefly discuss the main results in each of the papers. Stock exchanges have rules on the minimum equity level and the minimum number of shareholders that are required to list publicly.
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