1 THESIS SUBMITTED FOR THE DEGREE OF PhD HOW WELL DID THE STOCK MARKET TREAT INDUSTRY? EVIDENCE FROM INITIAL PUBLIC OFFERINGS ON THE LONDON STOCK EXCHANGE OVER THE TWENTIETH CENTURY ALAN DAVID CHAMBERS London School of Economics and Political Science October 2005 UMI Number: U202364 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. Dissertation Publishing UMI U202364 Published by ProQuest LLC 2014. Copyright in the Dissertation held by the Author. Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code. ProQuest LLC 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 48106-1346 h 500 / o7 2..7 Q- 2 ABSTRACT The IPO market provides owners of firms and entrepreneurs wit^ an exit for their equity investments and the opportunity to raise new capital. One empirical measure of how good a job the stock market has done for issuing firms over time is IPO underpricing. Yet, nothing is known about underpricing in Britain, nor, with one exception, about underpricing anywhere else before 1959. This thesis presents a new long-run IPO data set and analyses the change in underpricing over time. Contrary to my prior expectation and despite improvements in the regulation, disclosure, investor protection and underwriting of IPOs, underpricing rises in the second half of the century compared to the interwar years. This rise cannot be explained by any composition effect in the IPO sample or change in issue method. Plausible explanations for this puzzle include the rise of issuing house monopsonistic power, provincial competition, the exacerbation of a winner’s curse and the resort to underpricing as an anti-takeover strategy in the second half of the last century. The thesis looks at the first of these possibilities and concludes that whilst reputable issuing houses appeared to neither lower nor exacerbate underpricing, they collectively failed to recommend the highly effective method of the tender offer to their corporate clients. The remaining hypotheses are to be researched in post-doctoral work. The thesis also examines how IPO underpricing and survival behaved during the two episodes of investor exuberance about technology stocks in Britain in the last century, the 1920s and 1990s. The jump in underpricing of “technology” IPOs in 1928-29 was as nothing to that witnessed in 1999-2000. On the other hand, survival of the 1999-2000 IPOs was much improved compared to the earlier period. Whilst the underpricing findings suggest that industry was not at all badly treated by the London stock market in the interwar years and was leaving small amounts of “money on the table” compared to thereafter, the survival evidence indicates the opposite to be true. A market such as that in 1928-29 where IPOs had less than a 50% chance of surviving to their fifth birthday as a quoted company was unacceptable. 3 ACKNOWLEDGEMENTS I wish to express my most sincere thanks to my supervisors, Nicholas Crafts and Elroy Dimson, for the advice, support and intellectual stimulation they have given me during the course of my doctoral research. I am grateful to friends and colleagues, in particular Tom Nicholas and Tim Leunig, who have provided me with helpful comments and suggestions at various points during the last three years. I also wish to thank the ESRC for funding my doctoral research. Above all else, I owe an enormous debt to my wife for allowing me to “give up the day job” and indulge my interest in financial history. Prior to beginning my research, I worked for twenty years in investment banking in London, Tokyo, Boston and Los Angeles. My research is motivated by a desire to consider the extent to which financiers, in their multiple guises, make a difference to the performance of their clients and, ultimately, to industrial and economic performance. In April, 2005, I presented chapter 4 of this thesis as a paper at the Economic History Society Annual Conference and was awarded a New Researcher Prize. I am grateful to the Society for the encouragement this gave me in my endeavours. 4 TABLE OF CONTENTS CHAPTER 1: LITERATURE REVIEW 9 1.1 IPO stylised facts 13 (i) Empirical Studies 13 (ii) Underpricing theories 15 (iii) IPO Survival 23 1.2 Capital market failures 24 (i) Criticisms of the IPO Market 25 (ii) Domestic investor bias and information gaps 30 (iii) Short-termism 32 (iv) The financing of innovation 33 1.3 Summary 34 CHAPTER 2: THE INSTITUTIONAL ENVIRONMENT 1915-86 38 2.1 Issue methods 38 2.2 Institutional investors 40 2.3 IPO underwriting 43 2.4 Regulation of the IPO market 43 2.5 London and the Provincial Stock Exchanges 52 2.6 Summary 54 CHAPTER 3: A NEW IPO DATA SET 1915-79 59 3.1 Primary Data Sources 59 3.2 Secondary Data Sources 63 3.3 Data description 64 3.4 The interwar capital market 66 3.5 Annual Time-series of IPO Volume 70 3.6 Issue methods 71 3.7 IPO Certification 72 3.8 IPO characteristics 73 3.9 Summary 78 CHAPTER 4: IPO UNDERPRICING 1917-86 98 4.1 Explanations of underpricing 1917-86 99 4.2 A model of underpricing 102 4.3 Data 104 4.4 Results 106 (i) Annual Times series of underpricing 106 (ii) IPO characteristics and Underpricing 107 (iii) Multiple Regression Results 109 (iv) Robustness 111 4.5 Summary 113 CHAPTERS: THE IMPACT OF REPUTABLE UNDERWRITERS 130 5.1 The entry of reputable capital into IPO underwriting 131 5.2 Impact on underpricing 137 5.3 Tender Offers - a missed opportunity 140 5.4 Summary 150 CHAPTER 6: IPOS DURING TECHNOLOGY BUBBLES 173 6.1 Background to 1920s and 1990s 174 6.2 Data 178 6.3 Descriptive Statistics 181 6.4 Underpricing 183 6.5 IPO Survival 185 (i) Survival rates 189 (ii) Survival analysis 190 6.6 Summary and Discussion 193 CHAPTER 7: CONCLUSIONS AND FURTHER RESEARCH 216 BIBLIOGRAPHY 223 NOTE: Tables. Figures and Appendices are included at the end of each chapter. 6 Abbreviations: AHC: Accepting Houses Committee BVP: Book value to offer price IPO: initial public offering ICAEW: Institute of Chartered Accountants in England and Wales IHA: Issuing Houses Association IHYB: Issuing Houses Year Book LSE: London Stock Exchange LSE Rules: Rules and Regulations of the London Stock Exchange NASDAQ: National Association of Securities Dealers NAV: net asset value PSE: Provincial Stock Exchange SEO: Secondary Equity Offering SXYB: Stock Exchange Year Book USM: Unlisted Securities Market Glossary: Book-building: the process of managing an IPO prior to actual issue which allows the investment bank considerable discretion in deciding both the issue price and the allocation of shares to investors, in particular, to informed and regular buyers of IPOs. Book value: PosMPO pro forma net tangible assets attributable to voting shareholders. Hot IPO market a period during which IPO initial returns rise above the long­ term average. IPO cycle : the excess volatility in IPO volume after controlling for the corporate sector’s demand for equity finance as determined by the business cycle. Long-run underperformance: this is the return on an IPO from the closing price on the first day over the following 3 to 5 years having corrected for the market return and for other systematic risk factors such as firm size and book-value-to- price (BVP). Marketability, the number of shares offered at IPO as a proportion of the total number of shares outstanding post-IPO. 7 New money, money raised by the sale of primary shares issued by the company. Offer (or issue) price: the fixed price at which shares are offered to investors as published in the prospectus prior to trading. Offer for Sale: the offer of shares to the public by way of prospectus at a fixed price by an issuing house or broker who has first bought the shares from the issuing firm. Public Issues: an issue of shares by prospectus directly by the issuing company to the public at a fixed price sponsored by an issuing house or broker. The issue is usually underwritten. Placing: an issue whereby a firm first issues shares to an issuing house or broker and those shares are then placed with a restricted number of investors on condition of a listing being approved by the Stock Exchange and prior to the shares beginning trading in the market. Sometimes placings are on a “best efforts” basis in which case the issuing house or broker does not first buy the shares from the issuing firm and there is no commitment of capital to “underwriting” the IPO. Primary shares: new shares issued by the firm and sold at IPO. R&D intensity the ratio of research and development to sales Share-pushing: a small group of investors attempt to create a false market in a share by controlling its ownership and trading in order to push up its price and to realise a quick gain. Spinning: the practice of an investment bank securing the agreement of a CEO to their handling of his firm’s IPO and to their underpricing it in return for the bank offering shares in subsequent underpriced IPOs to the CEO. Stagging: the making of multiple applications for and the subscription of shares in an IPO with the sole intention of securing short-term profits by selling out as soon as the shares begin trading.