Going public is an exciting time for a company. It ushers in a new chapter of the
business lifecycle by providing promising enterprises with access to global markets
and more capital. But the initial public offering (IPO) is bedeviled by a host of
information asymmetries, so potential investors are cautious, potentially undervaluing
the IPO. When an IPO is undervalued, the firm absorbs all or most of the risk, which cuts against the goal of an IPO.
Many strategic decisions in business are time sensitive, so the inefficiency in IPO
valuation can hamstring a company’s ability to mobilize capital effectively. Entrepreneurs
and start-up managers must therefore understand the strategies they can use to combat
the asymmetrical nature of IPO fundraising. Investors will not necessarily interpret
withheld information generously, even when there is good reason for owners and managers to be judicious in choosing
what to share. They simply see that questions are not being answered or self-serving organizational
structures threaten the business’s longevity.
Oleg Petrenko, assistant professor of management at the University of Arkansas, investigated the
problem of IPO valuation. By studying the ambiguous signal, ownership concentration,
and IPOs, Petrenko and his coauthors found that firms need to seek more opportunities to disclose and disseminate information during
the IPO process. Petrenko, G. Tyge Payne, Lori Tribble Trudell, Curt Moore, and Nathan Hayes also found that how long the company’s been in business helped moderate the influence
of information asymmetry.
Ownership Concentration
The researchers chose to measure the influence of ownership concentration because
it does not consistently signal either positive or negative information to investors.
Prior research has equivocated what ownership concentration implies for the IPO’s
outcomes. They stress that it is not ownership concentration itself that is ambiguous
but rather what it means to investors.
Prior research has suggested the concentrated ownership of an IPO suggests optimism for the firm’s performance and a longer-term perspective
on the firm’s operation. With this perspective, dispersed ownership inversely signals
less involvement with the oversight process that will in turn increase information asymmetry.
Other research has, however, suggested the opposite case. Concentrated ownership might,
for example, signal to investors that the firm has alternative primary motives instead of economic ones. More specifically, IPOs seem to be undervalued when they
only issue small blocks of stock in order for the current owners and directors to maintain more direct control of
the firm.
For example, Porsche is currently negotiating an IPO, which has been valued as high as $100 billion, with estimates suggesting a reasonable
price might be about $75 or $80 billion. Bernstein Research, an American based market
analyst, recently downgraded Porsche’s IPO, believing it will underperform, and some analysts have suggested Porsche
may need to settle for $60 billion.
While the VW-owned luxury automaker faces a series of global challenges, investors
note that the concentrated ownership of Porsche is one stumbling block. VW cannot
dilute the German state of Lower Saxony’s ownership of the firm below 20%, constraining the amount of stock it is allowed to offer in
its IPO. Moreover, investors can reasonably expect a state owner to have significantly
different values and goals from theirs than a private owner might.
Of course, there might be ways to interpret a concentrated state owner positively
as well. Such an owner is more likely to ensure the firm maintains solvency, thus
protecting investors’ money, and it certainly has a long-term interest in the firm’s
success. Investors’ cooling excitement for Porsche’s IPO may have been induced by
the uncertain economic circumstance, and its ownership concentration is merely one way to explain investor trepidation.
This uncertainty from investors emphasizes Petrenko and his coauthors’ observation
that ownership is an ambiguous and contextual signal.
Interaction with the IPO Process
Petrenko, Payne, Tribble Trudell, Moore, and Hayes suspected that concentrated ownership
would correlate with an increase in the IPO process, which would moderate any negative interpretations potential investors might attribute to such ownership. Specifically, prior research
suggests that owners, who are involved in taking the business public, have a vested interest in decreasing information asymmetry to improve the outcomes of their firm’s IPO,
which would necessarily slow down the IPO process.
In their empirical study of 601 American IPOs, Petrenko and his coauthors found that
concentrated ownership significantly affected the length of the process time, which
in turn, decreased the likelihood the IPO would be undervalued. As the researchers note, their findings confirm earlier observations that reducing information asymmetry also reduces underpricing. Firm managers need the time to offset investor concerns, even when investors receive
ambiguous signals.
The researchers also found that firm age moderated against underpricing due to ambiguous
signals. Petrenko and his coauthors suggest that there is less information asymmetry
because established firms have more market history, even if investors suspect owners
are acting primarily out of self interest.
The researchers stress the importance of signal clarity and information asymmetry.
Specifically, managers can influence the ways investors receive and interpret ambiguous
signals by taking the opportunity to disclose and disseminate information about the
IPO. Petrenko and his coauthors argue that their investigation highlights how important
time is during the IPO process.
They suggest that concentrated owners may feel less compelled to draw out the process,
and while the tactic may seem logical, it undercuts their ability to avoid underpricing. This underpricing may be the nature of young business in hot markets, and Petrenko
and his coauthors see this phenomenon as a possible avenue of future research.
As the case may be, Petrenko, Payne, Tribble Trudell, Moore, and Hayes’s research
suggests that managers who want the best outcomes during the IPO process need to be
patient. While every IPO roadshow will come with its own difficulties and unknowns,
companies must take the time they need to properly clarify their position and business
model. Otherwise, they risk letting investors assume the worst with incomplete information.
