The going public decision: evidence from the IPOs in Italy and in the UK

International Journal of Applied Decision Sciences

Volumn 1, Issue 2, 2008, Pages 131-152

  Paleari, Stefano ^a   Pellizzoni, Enrico ^b   Vismara, Silvio ^a  

^a UNIVERSITY OF BERGAMO   (Italy)

^b Borsa Italiana SpA   (Italy)

Author keywords

going public; Initial Public Offerings; investments; IPOs; Italy; leverage; operating performance; UK

Indexed keywords

EID: 84969452358     PISSN: 17558077     EISSN: 17558085     Source Type: Journal    
DOI: 10.1504/IJADS.2008.020321     Document Type: Article

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47. The window-dressing hypothesis goes as follows. To induce optimistic valuations, managers may window-dress their accounting numbers to make the firms look better before public offering. Given the relatively limited amount of information about the issuing firms prior to go public, IPO-investors rely on information contained in the offering prospectuses. This unusually high dependence on (accounting) disclosures, together with the firm’s desire to go public at the highest possible price, creates incentive to follow aggressive reporting policies (Chaney and Lewis, 1998). Teoh et al. (1998) show indeed that earnings management prior to going public is related to long-run underperformance. There are several ways in which managers can ‘window dress’ the firm’s pre-IPO performance. They can ‘borrow’ earnings from other periods (e.g., deferring R&D expenditures), capitalise rather than expense current costs, allocate costs over longer periods (e.g., straight-line rather than accelerated depreciation) or slow down earnings growth in the years before the IPO.
48. Think for instance to LIFFE (London International Financial Futures and Options Exchange), one of the world’s most important market for derivatives; to LME (London Metal Exchange), the world’s premier non-ferrous metals market; or to the importance of LIBOR (London Inter-Bank Offered Rate), the rate that the most creditworthy international banks dealing in Eurodollars charge each other for large loans. With reference to stocks, the London Stock Exchange is Europe’s largest and, according to the LSE website, it is “the most international of all stock exchanges, with more than 470 companies from over 60 countries admitted to trading”.
49. From 1997, tax reforms (DIT and super-DIT) aimed to reduce the differences in the marginal cost of equity and debt financing, but in 2003 these tax rules were abandoned.
50. From 1992 for large IPOs (coinciding with the first large privatisation program) and from 1994 for almost all IPOs, investment banks are used to start gathering indications of interest from institutional investors, which are not binding orders at different price levels, usually falling inside a not binding price interval indicated by the bank. This collection helps the underwriter to determine the final offer price and a list of potential buyers. While these indications of interest are collected, a prospectus addressed to retail investors is published (subject to Authorities’ approval), that specifies only (usually) the non-binding price range. After communicating a maximum price for the offer within two days before the beginning of the offer to the public, bids are solicited from retail investors and shares are finally assigned at the price that is fixed at the end of the process. For a thorough review of the IPO process in Italy and on its evolution through time, refer to Vedove et al. (2005).
51. As compulsorily reported on the front page of the Admission Document of companies listing on the AIM: “The rules of AIM are less demanding that those of the Official List of the UK Listing Authority. It is emphasised that no application is being made for admission of these securities to the Official List of the UK Listing Authority. Further, the London Stock Exchange has not itself approved the contents of this document”.
52. It is worthwhile considering that a hypothetical ‘AIM-like’ Italian unregulated market could not in any case benefit from the lessening of regulation that applies to the AIM. In fact, pursuant to Italian law, all Italian issuers of financial instruments widely distributed among the public (including issuers whose shares are traded on an alternative trading system) have to comply with several disclosure requirements and are subject to a market abuse regime, making the situation very close to that of a regulated market.
53. In the UK, the information on ownership interests contained in the prospectuses (and in the annual reports) is determined by the Companies Act 1985 Part VI. In particular, details of directors’ interests and external interests, which amounted to 3% or more of issued share capital, are required to be disclosed. The cut-off ownership level for mandatory disclosure is lower in Italy (2%) as stated in Art. 5 and 117 reg 11971 Consob.
54. Board variables are defined as in Morck et al. (1998) since ownership data in the UK and in Italy are only available for individuals who legally hold the position of director of the firm, and not for other officer managers of the firm. In contrast to the case of external shareholders, members of the board of directors must disclose the total holdings of their shares, regardless of the size of their shareholdings. Hence, in the case of directors’ shareholdings, there is no cut-off ownership level at which ownership is reported; that is, every ownership stake is disclosed.
55. The fixed effects specification is preferred to the random effects since the high values of Hausman’s Chi-Square indicated inconsistency with the random-effect models for each proxy used. For the estimation, we use OLS analysis with dummy variables and with firm-specific fixed effect. It can indeed be shown that the fixed-effects model is equivalent to applying OLS regression to the data transformed by subtracting the firm-specific means from the original data.
56. The coefficients are statistically negative for all the years on the LSE, and for only for two years in Italy. Moreover, we compare the leverage in the year prior to the IPO to that of three years later. The test on equal medians shows that the level of debt in Italy is not statistically different, while on the LSE it is significantly lower three years after the IPO.