Influence of venture capital, retained ownership and

Int. J. Business Excellence, Vol. 10, No. 1, 2016

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Influence of venture capital, retained ownership and board structure on initial public offering firms – case of France Djerbi Chiraz* and Anis Jarboui Department of Financial and Accounting, The University of Sfax Higher Institute of Business Administration (ISAAS), Tunisia Email: [email protected] Email: [email protected] *Corresponding author Abstract: This study investigates the impact of venture capital (VC), retained ownership and board structure on initial public offering (IPO) in France. Based on a sample of 177 French IPOs over the period 2001–2007, our results show that board independence and VC are negatively and significantly related to the level of underpricing, indicating that these two factors play important roles in mitigating asymmetry information between the issuer and potential investors. Further, this study provides evidence that the level of underpricing is positively associated with board size. However, the CEO duality and retained ownership by insiders are found to be insignificant in explaining the first day returns. Keywords: initial public offerings; venture capital; VC; retained ownership; board structure; IPO underpricing; France. Reference to this paper should be made as follows: Chiraz, D. and Jarboui, A. (2016) ‘Influence of venture capital, retained ownership and board structure on initial public offering firms – case of France’, Int. J. Business Excellence, Vol. 10, No. 1, pp.55–77. Biographical notes: Chiraz Djerbi is a Doctor Assistant in Finance and Accounting Methods in Higher Institute of Business Administration, Sfax-Tunisia. Her main research interests are related to corporate governance and finance. Anis Jarboui holds a PhD in Finance. He is currently a Professor of Finance at the University of Sfax-Tunisia. His main research interests are related to corporate governance, finance, and new problems of the value as well.

1

Introduction

Existing empirical literature provides evidence that initial public offerings exhibit, on the first day of trading on almost every stock exchange of the world, a high level of underpricing which varies to a great extent ranging from 3% to 14% in France to 127% to 950% in China (Engelen and Essen, 2010; Afza et al., 2013). IPO underpricing is considered as costly to the issuing firm because the firm gets IPO proceeds much lower

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D. Chiraz and A. Jarboui

than the expectations (Lin and Chuang, 2011). Consequently, firms tend to mitigate the causes of this loss before going public. Several theoretical models have been developed to explain IPO underpricing. The asymmetric information models seem to attract most attention. According to these models, IPO firms that are subject to more asymmetric information and uncertainties will need a greater degree of underpricing to attract investors (Rock, 1986; Beatty and Ritter, 1986; Johnston and Madura, 2009). To overcome the problem associated with information asymmetries and adverse selection problems (Akerlof, 1970), IPO firms employ various aspects in signalling the quality of the issue to potential investors; including underwriter reputation (Carter et al., 1998a; Paudyal et al., 1998), auditor reputation (Titman and Trueman, 1986; Balvers et al., 1988; Beatty, 1989; Holland and Horton, 1993; Michaely and Shaw, 1995; Broye, 2001), VCs and their certification role (Megginson and Weiss, 1991; Lin and Smith, 1998), financial performance and the equity retention by insiders (Leland and Pyle, 1977; Keasey and McGuiness, 1992). The theory suggests that privatisation1 produces marginal performance gains when states retain majority control or even sizable minority stakes in the privatised banks (Ahmet Menteş, 2013). Despite the growing body of literature that applies signalling theory, few studies have recently examined the role of corporate governance in reducing the level of informational asymmetry and IPO underpricing (e.g., USA: Certo et al., 2001; Howton et al., 2001; UK: Filatotchev and Bishop, 2002; Malaysia: Yatim, 2011; Sub-Saharan African: Hearn, 2012; Pakistan: Afza et al., 2013; Indonesia: Darmadi and Gunawan, 2013). Board structure and composition is a key feature in ensuring the mitigation of asymmetric information costs between principals (owners and investors) and agent (incumbent management) through optimal monitoring and surveillance of management and the alignment of interests with those of shareholders (Filatotchev and Bishop, 2002; Hearn, 2012). Therefore, firms that are appropriately structured should be evaluated more favourably, leading to lower levels of underpricing (Finkle, 1998). This study provides empirical evidence to address the information asymmetry-based explanation for IPO underpricing, focusing on ownership structure through venture capital backing of the firm and the equity retention by insiders, and corporate governance through board characteristics. The French context is interesting for examining underpricing theories because IPO market is less developed compared with that in the USA and UK (Chahine et al., 2007). Furthermore, the information asymmetry and the agency conflict seem to be severe in France because it is a civil law country characterised by a low index of investor protection (La Porta et al., 2000). Corruption in construction contracts is becoming widespread due to lack of transparency in procurement and project delivery process (Oyegoke, 2012). Additionally, most listed firms in France are familycontrolled firms (Faccio and Lang, 2002),2 either through ownership concentration or the presence of family members on corporate boards. Based on a sample of 177 French IPOs over the period 2001–2007, the results show that board independence and VC are negatively and significantly related to the level of underpricing, indicating that these two factors play important roles in mitigating asymmetry information between the issuer and potential investors. Further, this study provides evidence that the level of underpricing is positively associated with board size. However, the CEO duality and retained ownership by insiders are found to be insignificant in explaining the first day returns.

Influence of venture capital, retained ownership and board structure on IPO

57

The remainder of this paper proceeds as follows. Section 2 reviews previous literature and develops the hypotheses. Section 3 describes the methodology used. Section 4 evaluates the empirical results and finally, Section 5 concludes.

2

Literature review and hypotheses development

2.1 Board characteristics and underpricing The IPO process is characterised by a high level of information asymmetry between managers and investors (Leland and Pyle, 1977) and between informed and uninformed investors (Rock, 1986; Beatty and Ritter, 1986). Adverse selection and moral hazard problems arise as there are incentives for the incumbent managers (agents) to mislead or even worse expropriate new owners (investors) (Boulton et al., 2009; Bruton et al., 2009). Given this condition, various corporate governance mechanisms, such as the board of directors, play crucial roles in mitigating agency conflicts and in aligning incentives of various principals and agents. Indeed, the board of directors, as a control mechanism, facilitates communication and information disclosure thereby reducing asymmetric information (Jensen and Meckling, 1976). Researchers generally consider three characteristics of the board, namely board independence, board size, and role duality. The empirical literature generally supports that independent directors are more likely to protect shareholder interests from managerial opportunism (Fama and Jensen, 1983; Mangena and Pike, 2005) and to improve the quality of managerial decisions and corporate performance (Beasley, 1996; Dehaene et al., 2001; Klein, 2002; Raheja, 2005). Thus, a higher proportion of independent directors would contribute to effective monitoring which in turn mitigates informational asymmetry and reduces underpricing (Chahine and Goergen, 2009). Mnif (2010), Darmadi and Gunawan (2013), Hearn (2012), Lin and Chuang (2011) and Filatotchev and Bishop (2002) indicate that the proportion of independent outside directors is negatively and significantly related to the underpricing of IPO firms in France, Indonesia, Sub-Saharan African, Taiwan and the UK, respectively. However, Afza et al. (2013) and Yatim (2011) fail to find any significant association in Pakistan and Malaysia respectively. We hypothesise the following: H1 There is a negative relationship between board independence and IPO firm underpricing. Jensen (1993), Yermack (1996), Eisenberg et al. (1998) and Mak and Kusnadi (2005) find an inverse relation between board size and firm value; they argue that large boards may be less cohesive, less effective in carrying out their duties, more difficult to coordinate. Thus, there will be less control and supervision of managers who will have more latitude to take opportunistic decisions and to rise agency costs. Hermalin and Weisbach (2003) found evidence suggesting that smaller boards are more effective than large boards as agency costs increase owing to a greater number of board members adopting the role of free-riders. They found that a too large board will be more symbolic and is less likely to be part of actual decision-making process. Hearn (2011) and Mnif (2010) show that board size is positively related to underpricing in West African and French IPO firms, respectively, reflecting asymmetric information and agency costs arising from coordination, communication and decision-making problems. But, Carter

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et al. (1998b), Certo et al. (2001) and Darmadi and Gunawan (2013) find that board size is negatively associated with IPO-firm underpricing. Indeed, it is argued that larger boards with greater breadth of knowledge and expertise bring advantages for the firm, especially complex firms that have greater advising requirements (Dalton et al., 1999; Coles et al., 2008). Furthermore, large boards are more effective in monitoring the actions of management (Beasley, 1996; Karamanou and Vafeas, 2005; Haniffa and Hudaib, 2006), thereby discouraging any attempt to extract private benefits (Boone et al., 2007). Other studies, however, fail to find any significant relationship between board size and IPO firm underpricing, including Howton et al. (2001), Lin and Chuang (2011), Yatim (2011) and Afza et al. (2013). Thus, the relationship between board size and underpricing is ambiguous. These countervailing arguments lead to this hypothesis. H2 There is a significant relationship between board size and IPO firm underpricing. A CEO who also holds the position of Chairman of the board has strong individual power and therefore more latitude in taking decisions, which could impedes the effectiveness and the independent monitoring capacity of the board (Fama, 1980; Fama and Jensen, 1983). In addition, the absence of duality functions ensures that the decisions taken by the board reflect the opinion of the majority and not the dominant personality (Ghazali, 2010). Thus, role duality can exacerbate potential conflicts of interest between future shareholders and managers of IPO firms and limit the board’s oversight and governance role (Yatim, 2011). Furthermore, role duality is more likely in smaller lower value firms and will be more likely associated with higher levels of underpricing and cost of equity (Hearn, 2011). Afza et al. (2013) find a significant positive relationship between duality and IPO underpricing. However, inconsistently with his prediction, Yatim (2011) find that role duality negatively and significantly influences IPO underpricing. He argue that investors view the separation of the roles of board chair and CEO as a negative signal of firm value, especially in the IPO context because newly-listed or growth-oriented firm is generally more risky and it will be better served by incumbent directors and managers who are familiar with the firm and its growth opportunities than by a more independent board leadership structure. Other studies fail to find any significant relationship between role duality and IPO firm underpricing, including Hearn (2011) and Mnif (2010). In this study, it is predicted that having different individuals hold the positions of CEO and board chair may reduce uncertainties due to more effective monitoring (Jensen, 1993). This prediction leads to the formulation of the following hypothesis: H3 There is significant positive relationship between role duality and IPO firm underpricing.

2.2 Venture capital and underpricing Venture capitalists not only provide the necessary capital but their presence also signals the firm’s quality as they are better monitors of the firm and they tend to reduce information asymmetry. Then this will be recognised by capital markets through lower IPO underpricing (Barry et al., 1990). Megginson and Weiss (1991) and Lin and Smith (1998) find that venture capital backed IPOs suffer less underpricing than no venture capital backed IPOs, supporting the certification role played by VCs. Focusing on issue of VC reputations, the ‘grandstanding hypothesis’ was proposed by Gompers (1996). According to this hypothesis, VCs will grandstand by taking younger


59

companies public and allowing greater underpricing. This implies that VCs are willing to bear the cost of underpricing because taking a company public signals firm quality and establishing a good reputation is critical to future fund raising (Elston and Yang, 2010). Francis and Hasan (2001) and Lee and Wahal (2004) find that VC-backed IPOs are more underpriced than non-VC-backed IPOs, supporting the grandstanding hypothesis. Using data from Germany’s Neuer Markt, Elston and Yang (2010) find that VCs do not have significant impact on IPO underpricing. According to them, German VCs played a more limited role in the firm’s corporate governance given the universal banking system. Concerning France, Chahine et al. (2007) find that French VC-backed IPOs show higher underpricing than IPOs without VC backing. However, Chahine and Filatotchev (2008) find that when VCs are affiliated to the lead underwriters, the level of underpricing was lower than that for IPOs backed by non-affiliated VCs. These contradictory arguments suggest that the expected directional relationship between IPO underpricing and the VC industry are indeterminate. We hypothesise the following: H4 VCs have a significant impact on IPO underpricing.

2.3 Retained ownership and underpricing Ahmet Menteş (2013) analyses the case of HalkBank in which the state retained majority control after the privatisation. In this context, the study hypotheses that improvements in the post-privatisation financial performance of HalkBank will be marginal. The study employs four performance measures to compare the pre- and post-privatisation performance of HalkBank to its privately owned competitors. However, the findings reveal that HalkBank achieved significant improvements in performance compared to it is privately owned competitors. Leland and Pyle (1977) show that retained ownership can signal issue quality. In other words, insiders may retain a large stake of the firm to send out a positive signal to the market that they are confident about the future prospects of the company. Empirical support for this theory is provided by Keloharju and Kulp (1996). According to Hughes (1986), insider ownership and IPO underpricing will have a substitution signal effect, the greater is the fractional insider ownership, the less is the information asymmetry, and the lower the need to underprice a new issue. In another perspective based on the signalling models of Allen and Faulhaber (1999), Grinblatt and Hwang (1989) and Welch (1989), insider ownership and IPO underpricing constitute a pair of reinforcing signals. Therefore, underpricing and insider ownership are positively related to each other (higher quality firms underprice more than do those of lower quality) (Su, 2004). The present study concerns the IPOs in France and we cannot overlook the fact that companies in France are mostly family-controlled firms (Faccio and Lang, 2002) and they are characterised by a relatively concentrated ownership structure. That is why, it is predicted that pre-IPO owners generally tend to maintain control of their company. One way to alleviate the potential loss of control following the partial transfer of ownership, is to allocate shares to many small investors (oversubscription) through underpricing, thereby reducing both the threat of takeover and the monitoring by large block holders (Brennan and Franks, 1997; Pham et al., 2003; Alavi et al., 2008; Darmadi and Gunawan, 2013). This interpretation leads us to expect a positive association between retained ownership and IPO underpricing in France.

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Hearn (2011) finds a small positive but highly significant impact of retained director ownership on underpricing of West African IPO firms. Based on Jensen and Meckling (1976) and Fama (1980), he argue that enhanced ownership and control by directors is potentially detrimental to firm value and increases moral hazard and asymmetric information especially in civil code markets and those markets with weaker legal regimes, as the case of France. Broye (2001) shows, on a sample of 394 French IPOs between 1983 and 1998, that the shares retained by the CEO increase significantly the level of underpricing. However, Boulton et al. (2009) cite that a concentrated ownership mitigates agency problems and managerial slack in poorly protected and enforced legal regimes because insiders have a better incentive and ability to become effective monitors of management. That is why they pretend that a higher level of ownership by insiders should lead to a lower IPO underpricing. Elston and Yang (2010) and Mnif (2010) fail to detect any significant association in Germany and in France, respectively. We conclude that the relationship between IPO underpricing and retained ownership is ambiguous. Thus, the expected directional relationship is indeterminate. We hypothesise the following: H5 There is significant relationship between retained insider ownership and IPO firm underpricing.

2.4 Control variables: other factors influencing IPO underpricing Five factors are investigated, all identified in prior literature as potentially influencing the level of IPO underpricing. According to the signalling assumptions advanced by Titman and Trueman (1986) and Beatty (1989), higher quality auditors play a significant role in signalling the quality of IPO firm value. This suggests a significant negative relationship between auditor quality and underpricing approved by several empirical findings (Beatty, 1989; Balvers et al., 1988; Michaely and Shaw, 1995; Holland and Horton, 1993; Broye, 2001). IPO firms making larger issues are generally less risky and better established than those making smaller issues. Thus issue size has been used as a proxy for ex-ante uncertainty and it was found to be negatively associated with IPO underpricing (Beatty and Ritter, 1986; Ljungqvist, 1997; Kiymaz, 2000; Amihud et al., 2002; Samarakoon, 2010). Turning to the firm age, this variable is supposed to be negatively associated to the level of underpricing because the longer the operating history of the firm, the more likely it has more information available to the public and a lower level of information asymmetry and ex-ante uncertainty. Chao et al. (2010) find that information transparency is positively correlated with firm value, indicating that the more transparent a firm’s information, the higher the firm value. This is empirically confirmed by Su and Fleisher (1999), Loughran and Ritter (2004), Chahine (2008) and Engelen and Essen (2010), who all find a negative relationship between firm age and the level of underpricing. However, Ritter (2011) does not believe that underpricing is largely driven by adverse selection and asymmetric information, especially in some periods, such as the dotcom bubble or hot periods. When the market is ‘hot’, the average level of underpricing rises and the amount of firms going public increases. Subsequently, the number of IPOs continues to grow, but the level of underpricing decreases. Thus, the market becomes ‘cold’ with fewer firms going public and very low underpricing (Lowry and Schwert,


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2002). To summarise, ‘hot’ and ‘cold’ IPO markets represent one explanation for the fluctuation of underpricing between different years (Ibbotson and Jaffe, 1975; Ibbotson et al., 2001). Finally, the extent of underpricing for pure primary offerings is lower than the extent of underpricing in the case of mixed offerings. According to Prasad (1994), investors may be viewing mixed offerings as more risky investment than pure primary offerings.3

3

Data and methodology

3.1 Dataset explanation The initial obtained sample consists of 272 new companies listed on Euronext Paris during the period 2001 to 2007.4 We have eliminated foreign companies as well as those belonging to sectors presenting a particular functioning (banks, leasing and insurance companies), companies without the necessary data (prospectus missing, incomplete) and delisted companies (delisted involuntary, mergers, acquisitions and transfers). The final sample is 177 IPO companies. Table 1 describes the distribution of the sample across industries. Table 1

Procedure for sample constitution

Sample

Number of firms

Initial sample of initial public offerings on Euronext Paris during 2001–2007 period (54 in 2001; 29 in 2002; 12 in 2003; 31 in 2004; 36 in 2005; 74 in 2006 and 36 in 2007)

272

Delisted firms (delisted involuntary, mergers and acquisitions and transfers)

62

Foreign firms

9

Firms belonging to financial industry

6

Firms without the necessary data (prospectus missing, incomplete)

18

Final sample

177

The closing price of the first day of public trading for each IPO stock is obtained from the DataStream database. Data related to IPO deal characteristics, corporate governance at the time of the IPO, pre- and immediately post-IPO ownership structure (pre-IPO venture capital and shares retained by insiders after the IPO) and auditing are hand-collected from prospectuses and post-IPO published annual reports which are collected from Corporatefocus Premium and Thomson one Banker databases.

3.2 Research methodology A multivariate specification is used to investigate Hypotheses 1 through 5, while controlling for additional factors that may influence underpricing of French IPO companies. Underpricing is regressed on corporate governance mechanisms relating to the board of directors, on ownership structure (Pre-IPO VC ownership and retained insider ownership) with several additional control variables. The estimated regression model is:

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D. Chiraz and A. Jarboui Underpricing = β 0 + β1 Indep + β 2 Size + β 3 Dual + β 4VC + β 5 Retown + β 6 Audit + β 7 Ln( Proceeds)

(1)

+ β 8 Hot + β 9 Mixed + β10 Market + β11 Ln(1 + Age) + ε

where Underpricing, the dependent variable, is measured using initial returns, calculated as the closing price on the first day of trading for a newly listed stock minus the offer price, divided by the offer price (Certo et al., 2001; Arthurs et al., 2008; Darmadi and Gunawan, 2013). Underpricing = ( Pc − Po) Po

Pc is the first closing price and Po is the offer price. Indep = the proportion of independent external directors5 serving on the board at the time of the IPO; Size = the size of the Board of Directors at the time of the IPO; Dual = dummy variable equal to 1 when the board chairman and CEO positions are held by one individual at the time of the IPO, and 0 otherwise; VC = dummy variable equal to 1 for an issue backed by venture capitalists,6 and 0 otherwise; Retown = the proportion of shares retained by insiders after the IPO; Audit = dummy variable equal to 1 if the IPO firm has a Big4 auditor, and 0 otherwise; Ln(Proceeds) = the natural logarithm of proceeds calculated as the offer price times the number of shares offered; Hot = dummy variable 1 is used as proxy for IPO issued during hot IPO period, and 0 is used for cold IPOs;7 Mixed = dummy variable equal to 1 if both the company and some existing shareholders offer shares to the public in the same offering, and 0 otherwise; Market = dummy variable equal to 1 if the IPO is introduced on a regulated market, 0 otherwise;8 Ln(1+Age) = the natural logarithm of one plus company age in years; ε = error term.

4

Empirical results

4.1 Descriptive statistics and univariate analysis Table 2 reports the descriptive statistics of our research variables. Panel A presents descriptive statistics for continuous variables, and panel B reports those for dichotomous variables. The mean (median) level of underpricing of firms in our sample, is 6.70% (5.00%) (significant at the 1% level), which is lower than in many other countries [e.g., Malaysia: 100% (86%) (Ahmad-Zaluki et al., 2011); China: 132% (Kimbro, 2005); USA: 18.80% (Welch and Ritter, 2002); Indonesia: 22.20% (Darmadi and Gunawan, 2013); Malaysia: 28.37% (17.50) (Yatim, 2011) but broadly similar to the results of studies on France (6.46% (3.36%) (Dufour and Molay, 2008); 5.36% (Gajewski and Gresse, 2006); 9% (Sentis, 2001)]. On average, 17.00% of directors are independents in IPO companies of our sample. This figure is lower than that reported in other studies, which was 53% and 38.9% for board of directors of IPO firms in Malaysia (Yatim, 2011) and Indonesia (Darmadi and Gunawan, 2013), respectively. This shows that the board of directors is not independent enough in the French IPO companies of our sample or the criterions of independence according to the Bouton report are too strict. The mean number of directors on corporate


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boards is 5.61. Specifically, 50% of our sample has a small board, which does not exceed five directors. Table 2

The industry classification of the sample

Industry Oil and gas Food products Paper and paper products Chemical products Manufacturing Computer hardware and software Electronic equipment Transportation Scientific instruments

Two-digit SIC codes

Freq.

%

13

1

0.56

20

4

2.25

24, 27

4

2.25

28

14

7.9

30, 31, 33

3

1.69

35, 73

58

32.76

36

16

9.03

37, 44, 45, 47

11

6.21

38

2

1.12

Communications

48

7

3.95

Electric and gas services

49

3

1.69

Durable goods

50

5

2.82

Retail

59

3

1.69

65

19

10.73

70, 78, 79

5

2.82

80

6

3.38

10, 16, 17, 51, 82, 83, 87

16

9.03

177

100

Real estate Entertainment services Health All others Total

The mean proportionate ownership retained by insiders after the IPO is 64.50%, which is lower than some countries [e.g., Malaysia: 77% (Ahmad-Zaluki et al., 2011); USA: 71% (Jain and Kini, 1994); UK: 74% (Keasey and Short, 1997)] but higher than some [e.g., Thailand: 39% (Kim et al., 2004); Australia: 51% (Balatbat et al., 2004)]. Approximately, 33.90% of the IPO firms (60 firms) separate the positions of the CEO and the board chair. Finally, 49.15% of all companies are VC-backed IPOs. The purpose of univariate analysis is to compare characteristics of two groups; the group of firms with a high initial return (initial return is above the median value 5%) and those with a low initial return. Before performing this analysis, it is important to check the normality of the independent variables so as to choose the appropriate statistical tests. We used the Kolmogorov-Smirnov test to check the normality hypothesis for independent variables in our study and we find that the variables retained ownership by insiders (Retown) and proceeds from the IPO (Ln(Proceeds)) follow a normal pattern. Therefore, for these variables we rely on the t-test of equality of means of two independent samples in the interpretation. On the other hand, the variables independence of board of directors (Indep), board size (Size) and company age (Ln(1+Age)) do not follow a normal pattern. For these cases, we used the non-parametric test of U Mann-Whitney. For discrete variables, the differences between proportions are based on the independent test of Chi-deux.

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Table 3

Descriptive statistics for variables used in the study (N = 177) Panel A: continuous variables

Variables Underpricing Indep Size Retown Ln(Proceeds) Ln (1+Age)

Mean

Quartile 1

Median

Quartile 3

Std. dev.

0.067*** 0.170 5.610 0.645 2.276 2.399

–0.003 0.000 3.000 0.509 1.005 1.946

0.050*** 0.133 5.000 0.666 2.201 2.302

0.128 0.333 7.000 0.804 3.491 2.890

0.143 0.197 3.104 0.201 2.114 0.836

Panel B: dichotomous variables Variables

Yes

%

No

%

Dual VC Audit Hot Mixed Market

117 87 86 120 119 70

66.10% 49.15% 48.58% 67.79% 67.23% 39.54%

60 90 91 57 58 107

33.90% 50.85% 51.42% 32.21% 32.77% 60.46%

Notes: N = is the number of IPO firms; Underpricing = initial return measured by comparing the first closing price Pc with the offer price Po: Underpricing = (Pc – Po) / Po; Indep = the proportion of independent external directors serving on the board at the time of the IPO; Size = the size of the Board of Directors at the time of the IPO; Dual = dummy variable equal to 1 when the board chairman and CEO positions are held by one individual at the time of the IPO, and 0 otherwise; VC = dummy variable equal to 1 for an issue backed by venture capitalists, and 0 otherwise; Retown = the proportion of shares retained by insiders after the IPO; Audit = dummy variable equal to 1 if the IPO firm has a Big4 auditor, and 0 otherwise; Ln(Proceeds) = the natural logarithm of proceeds calculated as the offer price times the number of shares offered; Hot = dummy variable 1 is used as proxy for IPO issued during hot IPO period, and 0 is used for cold IPOs; Mixed = dummy variable equal to 1 if both the company and some existing shareholders offer shares to the public in the same offering, and 0 otherwise; Market = dummy variable equal to 1 if the IPO is introduced on a regulated market, 0 otherwise; Ln(1+Age) = the natural logarithm of one plus company age in years. *, **, ***denote significantly different from zero at the 0.10, 0.05 and 0.01 levels, respectively. The Wilcoxon signed-ranks test is used for the median and the t-test for mean.

According to Table 3, the results show important differences between the two groups with respect to the proportion of independent directors serving on the board (Mann-Whitney U-test, p-value = 0.000), the size of the board (Mann-Whitney U-test, p-value = 0.020) and the proceeds from the IPO (t-test, p-value = 0.000). On the other hand, there are no significant differences between the two groups with respect to the retained ownership by insiders (t-test, p-value = 0.117) and the age of the IPO company (Mann-Whitney U-test, p-value = 0.816). Regarding discrete variables, the VC dummy (VC) and the regulated market (Market), the Chi-deux test is significant at the 1% and 5%, respectively. This is not the case of the discrete variables, duality of the roles of CEO and board chairman (Dual), external audit quality (Audit), hot period of issuing (Hot), and mixed offer (Mixed) which manifest no significant differences in proportions between the two groups of firms.


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The results of univariate analysis support the majority of the hypotheses that we have previously developed. In other words, firms with low initial returns show the following characteristics: •

the proportion of independent directors serving on the board is significantly higher than that in firms with high initial returns

•

have a large board of directors

•

are more likely backed by venture capitalists

•

have more gross proceeds from the IPO

•

are introduced on a regulated market.

4.2 Correlation analysis The result of correlation analysis is reported in Table 4, which shows that board independence is negatively correlated with the level of underpricing at 5% significance level, suggesting that IPO firms with a higher proportion of independent directors are less likely to experience higher underpricing, which is aligned with the first hypothesis of the study. In addition, IPO underpricing is negatively and significantly correlated with the VC dummy, providing preliminary support for Hypothesis 4. This suggests that venture capitalists play an important role in mitigating information asymmetry between the issuer and potential new investors in an IPO. Also, underpricing is negatively correlated with proceeds from the IPO and regulated markets, and positively correlated with hot issuing period. Remarkably, retained ownership by insiders after the IPO is negatively and significantly correlated with board independence, suggesting boards and ownership incentives are complements in monitoring management. The most important in regression analysis is the problem of multicollinearity among the independent variables. According to Table 4, all the correlation coefficients are below 0.8 which is the limit at which we begin to have a serious problem of multicollinearity. In addition, we calculated the variance inflation factors (VIFs), which also tests for the presence of collinearity between the explanatory variables. In all cases the VIFs are below three, knowing that the critical value is 10 (Tabachnick and Fidell, 1996). Therefore, we can deduce the absence of any multicollinearity problems.

4.3 Regression analysis Table 5 provides the results of multivariate regression relied on to test research hypotheses. Empirical results indicate that the taken variables Indep, Size, Dual, VC, Retown, Audit, Ln(Proceeds), Hot, Mixed, Market and Ln(1+Age) collectively explain the initial return by 19.70% (Adj. R2 = 0.144). Furthermore, the statistics of Fisher (F) is significant at the level of 1%. Therefore, the global significance of the tested model is proved.

Prop = 0.5341 Prop = 0.4382

Low underp

High underp

Mean = 0.6696

High underp

Prop = 0.3820 Mean = 0.6220

High underp

Low underp

Prop = 0.6023

Prop = 0.6629

Low underp

Prop = 0.6591

Low underp

Mean = 5.10

High underp

High underp

Mean = 6.13

Mean = 0.1134

Low underp

High underp

N/A

N/A

0.7082

0.6387

N/A

N/A

N/A

N/A

4.00

5.00

0.000

0.2500

Median

N/A

N/A

0.2246

0.1737

N/A

N/A

N/A

N/A

2.576

3.500

0.1896

0.1895

Std. dev.

N/A

N/A

p = (0.117)

t = –1.576

N/A

N/A

N/A

N/A

p = (0.028)

t = 2.218 **

p = (0.000)

t = 4.052 ***

t-test

N/A

N/A

p = (0.029)

z = –2.178**

N/A

N/A

N/A

N/A

p = (0.020)

z = –2.322**

p = (0.000)

z = –4.618***

z-stat

Notes: This table compares firms having high initial returns (N = 89) to those having low initial returns (N = 88). A firm is defined to have a high initial return if its initial return is above the median value (5%). N = is the number of IPO firms; Underpricing = initial return measured by comparing the first closing price Pc with the offer price Po: Underpricing = (Pc – Po) / Po; Indep = the proportion of independent external directors serving on the board at the time of the IPO; Size = the size of the Board of Directors at the time of the IPO; Dual = dummy variable equal to 1 when the board chairman and CEO positions are held by one individual at the time of the IPO, and 0 otherwise; VC = dummy variable equal to 1 for an issue backed by venture capitalists, and 0 otherwise; Retown = the proportion of shares retained by insiders after the IPO; Audit = dummy variable equal to 1 if the IPO firm has a Big4 auditor, and 0 otherwise; Ln(Proceeds) = the natural logarithm of proceeds calculated as the offer price times the number of shares offered; Hot = dummy variable 1 is used as proxy for IPO issued during hot IPO period, and 0 is used for cold IPOs; Mixed = dummy variable equal to 1 if both the company and some existing shareholders offer shares to the public in the same offering, and 0 otherwise; Market = dummy variable equal to 1 if the IPO is introduced on a regulated market, 0 otherwise; Ln(1 + Age) = the natural logarithm of one plus company age in years. For continuous variables, the differences between the means and medians of firms having high initial returns and firms having low initial returns are based on the independent t-test and the Mann-Whitney U-test, respectively. For discrete variables, the differences between proportions are based on the independent test of chi-2. *, **, ***denote significantly different from zero at the 0.10, 0.05 and 0.01 levels, respectively.

Audit

Retown

VC

Dual

Size

Mean = 0.2289

Mean/prop

Low underp

Groups

N/A

N/A p = (0.202)

X = 1.629

2

N/A

p = (0.003)

X2 = 8.588***

p = (0.957)

X = 0.003

2

N/A

N/A

N/A

X2 test

Table 4

Indep

Variables

66 D. Chiraz and A. Jarboui

Descriptive statistics and results of univarite analysis of the two groups (group with high underpricing and group with low underpricing)

Mean = 2.4072 Mean = 2.3909

Low underp

High underp

Prop = 0.3034

High underp

Prop = 0.6854 Prop = 0.4886

Low underp

High underp

Prop = 0.6741 Prop = 0.6591

High underp

Low underp

Prop = 0.6818

Low underp

Mean = 1.6786

2.1973

2.4414

N/A

N/A

N/A

N/A

N/A

N/A

1.7292

2.7080

Median

0.7697

0.9041

N/A

N/A

N/A

N/A

N/A

N/A

2.0255

2.0392

Std. dev.

p = (0.898)

t = 0.128

N/A

N/A

N/A

N/A

N/A

N/A

p = (0.000)

t = 3.933***

t-test

p = (0.816)

z = –0.232

N/A

N/A

N/A

N/A

N/A

N/A

p = (0.000)

z = –3.917***

z-stat

Notes: This table compares firms having high initial returns (N = 89) to those having low initial returns (N = 88). A firm is defined to have a high initial return if its initial return is above the median value (5%). N = is the number of IPO firms; Underpricing = initial return measured by comparing the first closing price Pc with the offer price Po: Underpricing = (Pc – Po) / Po; Indep = the proportion of independent external directors serving on the board at the time of the IPO; Size = the size of the Board of Directors at the time of the IPO; Dual = dummy variable equal to 1 when the board chairman and CEO positions are held by one individual at the time of the IPO, and 0 otherwise; VC = dummy variable equal to 1 for an issue backed by venture capitalists, and 0 otherwise; Retown = the proportion of shares retained by insiders after the IPO; Audit = dummy variable equal to 1 if the IPO firm has a Big4 auditor, and 0 otherwise; Ln(Proceeds) = the natural logarithm of proceeds calculated as the offer price times the number of shares offered; Hot = dummy variable 1 is used as proxy for IPO issued during hot IPO period, and 0 is used for cold IPOs; Mixed = dummy variable equal to 1 if both the company and some existing shareholders offer shares to the public in the same offering, and 0 otherwise; Market = dummy variable equal to 1 if the IPO is introduced on a regulated market, 0 otherwise; Ln(1+Age) = the natural logarithm of one plus company age in years. For continuous variables, the differences between the means and medians of firms having high initial returns and firms having low initial returns are based on the independent t-test and the Mann-Whitney U-test, respectively. For discrete variables, the differences between proportions are based on the independent test of chi-2. *, **, ***denote significantly different from zero at the 0.10, 0.05 and 0.01 levels, respectively.

Ln (1+Age)

Market

Mixed

Hot

Mean = 2.8802

Low underp

Mean/prop

High underp

Groups

N/A

N/A

p = (0.012)

X2 = 6.353**

p = (0.709)

X2 = 0.139

p = (0.913)

X2 = 0.012

N/A

N/A

X2 test

Table 4

Ln(Proceeds)

Variables

Influence of venture capital, retained ownership and board structure on IPO Descriptive statistics and results of univarite analysis of the two groups (group with high underpricing and group with low underpricing) (continued)

67

Indep

Size

Dual

VC

Retown

Audit

Ln(Proceeds)

Hot

Mixed

Market

Ln(1+Age)

2

3

4

5

6

7

8

9

10

11

12

0.010

–0.203***

0.090

0.143*

–0.249***

–0,077

0.071

–0.209***

–0.049

–0.065

–0.183**

1

1

–0.102

0.268***

–0.193**

0.192**

0.370***

0.283***

–0.367***

0.333***

–0.151**

0.364***

1

2

0.073

0.397***

–0.243***

0.179**

0.565***

0.323***

–0.171**

0.248***

–0.171**

1

3

0.053

–0.104

0.314***

–0.187**

–0.179**

–0.235***

0.095

–0.060

1

4

–0.131*

0.037

–0.180**

0.097

0.268***

0.265***

–0.482***

1

5

0.152**

–0.176**

0.104

–0.259***

–0.383***

–0.344***

1

6

–0.104

0.347***

–0.140*

0.235***

0.498***

1

7

0.025

0.659***

–0.172**

0.372***

1

8

0.002

0.038

–0.198***

1

9

0.081

–0.100

1

10

–0.062

1

11

Notes: This table reports Pearson correlation coefficients between research variables. Underpricing = initial return measured by comparing the first closing price Pc with the offer price Po: Underpricing = (Pc – Po) / Po; Indep = the proportion of independent external directors serving on the board at the time of the IPO; Size = the size of the Board of Directors at the time of the IPO; Dual = dummy variable equal to 1 when the board chairman and CEO positions are held by one individual at the time of the IPO, and 0 otherwise; VC = dummy variable equal to 1 for an issue backed by venture capitalists, and 0 otherwise; Retown = the proportion of shares retained by insiders after the IPO; Audit = dummy variable equal to 1 if the IPO firm has a Big4 auditor, and 0 otherwise; Ln(Proceeds) = the natural logarithm of proceeds calculated as the offer price times the number of shares offered; Hot = dummy variable 1 is used as proxy for IPO issued during hot IPO period, and 0 is used for cold IPOs; Mixed = dummy variable equal to 1 if both the company and some existing shareholders offer shares to the public in the same offering, and 0 otherwise; Market = dummy variable equal to 1 if the IPO is introduced on a regulated market, 0 otherwise; Ln(1+Age) = the natural logarithm of one plus company age in years. *, **, ***denote significantly different from zero at the 0.10, 0.05 and 0.01 levels, respectively.

Underpricing

1

12

Table 5

1

68 D. Chiraz and A. Jarboui

Correlation matrix


69

As shown in Table 5, the proportion of independent directors indep is negatively and significantly (at the 0.10 level) associated with underpricing, thus accepting H1. This suggests that IPO firms with higher proportion of independent directors experience lower level of underpricing which is consistent with Mnif (2010), Darmadi and Gunawan (2013), Hearn (2012), Lin and Chuang (2011) and Filatotchev and Bishop (2002) who report a negative relationship between the fraction of independent directors serving on the board and underpricing of IPO firms in France, Indonesia, Sub-Saharan African, Taiwan and UK, respectively. Therefore, independent board plays an important role in mitigating information asymmetry between the issuer and potential new investors, facilitates the reduction of investors’ ex ante uncertainty at the time of IPO and positively affects the pricing of the issue. The hypothesis of the relationship between IPO underpricing and board size H2 was supported. The coefficient of Size is positive (0.009) and significant (at the 0.05 level), suggesting that IPO firms with smaller board experience lower level of underpricing. This result is consistent with the findings of Hearn (2011) and Mnif (2010) who show that board size is positively related to underpricing in West African and French IPO firms, respectively. Thus, larger boards act to reduce coordinative efficiency and communication between directors and hence increase the likelihood of asymmetric information and agency cost reflected in underpricing. According to Table 5, the coefficient of CEO duality Dual is not significant, and thus inconsistent with our anticipation in H3 and the result of Afza et al. (2013) who find a significant positive relationship between duality and IPO underpricing. However, this result is consistent with the finding of Hearn (2011) and Mnif (2010) who also report no significant relationship between board leadership structure and underpricing. Thus, role duality does not affect the underpricing of French IPOs firms. As expected, the OLS results reported in Table 5 shows that the coefficient on the VC dummy VC is negative (–0.051) and significant (at the 0.05 level). The Hypothesis 4 is then supported and VCs have a significant impact on IPO underpricing. This result is consistent with the finding of Megginson and Weiss (1991) and Lin and Smith (1998) who find that venture capital backed IPOs suffer less underpricing than no venture capital backed IPOs. This evidence would indicate that venture capitalists not only provide the necessary capital but their presence also signals the firm’s quality as they are better monitors of the firm and they tend to reduce the likelihood of asymmetric information and agency cost reflected in underpricing. Thus, this result supports the certification role played by VCs and rejects the ‘grandstanding hypothesis’ proposed by Gompers (1996) and supported by Francis and Hasan (2001) and Lee and Wahal (2004). Our regression results show that ownership retained has no significant effect on the level of underpricing. However, the estimated coefficient is negative (–0.077) and thus consistent with the signal theory. This theory suggests that higher percentages of ownership retained by insiders serve as a signal to potential investors that they are confident about the future prospects of the company, implying a negative relationship between retained ownership and IPO underpricing (Leland and Pyle, 1977; Keloharju and Kulp, 1996). In addition, enhanced ownership and control by directors mitigates agency problems and managerial slack in poorly protected and enforced legal regimes because insiders have a better incentive and ability to become effective monitors of management. That is why a higher level of ownership by insiders should lead to a lower IPO underpricing (Boulton et al., 2009).

70


Regarding the control variables, Table 5 shows that there is no significant relationship between auditor quality Audit and underpricing of French IPO firms. Furthermore, we notice that the estimated coefficient is positive (0.014), which is inconsistent to the signaling assumptions advanced by Titman and Trueman (1986) and Beatty (1989). In their model, these authors consider that higher quality auditors play a significant role in reducing information asymmetry between issuers and potential investors and therefore lead to a lower degree of underpricing. Previous empirical studies using French IPO firms provide mixed evidence on the impact of auditor quality on IPO underpricing. Based on a sample of 130 French IPOs over the period 2000–2004, Mnif (2010) find no evidence to suggest that the level of underpricing declines when a French IPO firm is audited by a Big 4 audit firm. In the works of Labégorre and Boubaker (2005), auditor quality does not reduce significantly IPO underpricing. However, from a sample of IPOs on the French secondary market, Broye (2001) find a negative and significant relationship between the auditor’s reputation and the level of underpricing. From Table 5, we notice that there is a pronounced statistically significant (at the 0.01 level) negative (–0.029) relationship between IPO underpricing and the offer size Ln(Proceeds). These finding are consistent with our expectation and previous empirical studies. Beatty and Ritter (1986) find that issue proceeds is one of the proxies that capture ex-ante uncertainty because better established firms often make larger issues and are generally less risky than those making smaller issues. Issue size has been used as a proxy for ex-ante uncertainty in other studies as well (e.g., Ljungqvist, 1997; Kiymaz, 2000; Amihud et al., 2002; Samarakoon, 2010) and it was found to be negatively associated with IPO underpricing. Turning to the timing of IPO activity Hot, this variable has a positive (0.084) and significant influence (at the 0.01 level) on the level of underpricing. Put it differently, IPOs issued during the period when IPO activity is more, the initial return is reported more. These results are found to be consistent with Ibbotson et al. (2001), Lowry and Schwert (2002) and Ritter (2011) who find that underpricing is largely driven by the timing of IPO activity. Our model findings show that mixed offerings Mixed have no significant effect on the level of underpricing. However, the estimated coefficient is positive (0.032) and thus consistent with the findings of Prasad (1994). This author suggests that the extent of underpricing for pure primary offerings is lower than the extent of underpricing in the case of mixed offerings because investors may be viewing mixed offerings as more risky investment than pure primary offerings. Similarly, the variable Market has no significant impact on underpricing of French IPO firms. In others words, the level of underpricing of firms introduced on a regulated market does not differ significantly to the level of underpricing of firms introduced on an unregulated market. In respect of the relationship between firm age Ln(1+Age) and underpricing of French IPO firms, there is no significant connection found in this study. However, the estimated coefficient is negative (–0.003) and thus consistent with our expectation and the results obtained by Su and Fleisher (1999), Loughran and Ritter (2004), Chahine (2008) and Engelen and Essen (2010) who find a negative relationship between firm age and the level of underpricing. In fact, the longer the operating history of the firm, the more likely it has more information available to the public and a lower level of information asymmetry and ex-ante uncertainty.

Influence of venture capital, retained ownership and board structure on IPO Table 6

71

Determinants of IPO underpricing Expected sign

Coeff.

t-stat.

Indep

–

–0.100

–1.685*

Size

+/–

0.009

2.246**

Dual

+

–0.025

–1.079

Experimental variables

VC

+/–

–0.051

–2.100**

Retown

+/–

–0.077

–1.230

–

0.014

0.600

Ln(Proceeds)

–

–0.029

–3.414***

Hot

+

0.084

3.378***

Control variables Audit

Mixed

+

0.032

1.386

Market

+/–

–0.001

–0.049

–

–0.003

–0.204

0.110

1.644

Ln (1+Age) Constant N

177

R-square

19.70%

Adj R-square

14.40%

F

3.691***

Notes: This table reports an OLS regression with the level of Underpricing as the dependent variable. N = is the number of IPO firms; Underpricing = initial return measured by comparing the first closing price Pc with the offer price Po: Underpricing = (Pc – Po) / Po; Indep = the proportion of independent external directors serving on the board at the time of the IPO; Size = the size of the Board of Directors at the time of the IPO; Dual = dummy variable equal to 1 when the board chairman and CEO positions are held by one individual at the time of the IPO, and 0 otherwise; VC = dummy variable equal to 1 for an issue backed by venture capitalists, and 0 otherwise; Retown = the proportion of shares retained by insiders after the IPO; Audit = dummy variable equal to 1 if the IPO firm has a Big4 auditor, and 0 otherwise; Ln(Proceeds) = the natural logarithm of proceeds calculated as the offer price times the number of shares offered; Hot = dummy variable 1 is used as proxy for IPO issued during hot IPO period, and 0 is used for cold IPOs; Mixed = dummy variable equal to 1 if both the company and some existing shareholders offer shares to the public in the same offering, and 0 otherwise; Market = dummy variable equal to 1 if the IPO is introduced on a regulated market, 0 otherwise; Ln(1+Age) = the natural logarithm of one plus company age in years. *, **, ***denote significantly different from zero at the 0.10, 0.05 and 0.01 levels, respectively.

5

Conclusions

Researchers proposed different theories to explain IPO underpricing based on asymmetric information models, institutional explanations, ownership and control models, and behavioural explanations (Ljungqvist, 2006). Current study investigates the impact of

72


board structure and corporate ownership on the level of IPO underpricing by using a sample of 177 French IPOs over the period 2001–2007. While the French context is characterised by low levels of property rights protection, a less developed IPO market compared with that in the UK and USA, concentrated ownership and large private benefits of control the evidence suggests that some of the globally standard best practice governance mechanisms are beneficial. Empirical findings supported significant negative impact of independent board on the level of underpricing which implies that independent board plays an important role in mitigating information asymmetry between the issuer and potential new investors, facilitates the reduction of investors’ ex ante uncertainty at the time of IPO and positively affects the pricing of the issue. In addition, board size is positively related to underpricing in French IPO firms because larger boards act to reduce coordinative efficiency and communication between directors and hence increase the likelihood of asymmetric information and agency cost reflected in underpricing. However, the results do not provide any clear evidence about the relationship between dual leadership structure and level of underpricing. The findings regarding the role of ownership structure in deriving firm’s level of underpricing demonstrate that VCs play an important role in signalling firm value and reduce IPO underpricing which results in a decrease of agency problem. Nevertheless, retained ownership does not significantly link to underpricing which might be because the benefits of a high insider ownership providing effective monitoring are offset by the detrimental effect of entrenchment. The results of the study are expected to help academicians, policy makers, investors, managers and particularly firms that plan to go public, in identifying how board characteristics and corporate ownership can influence the value of IPO firm. However, despite the important contribution to the IPO signalling and governance research, this study neglects the behavioural approaches which would help to explain how corporate governance and ownership variables influence investors and managers in IPO process.

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Notes 1 2

3

4 5

6

7

8

IPO is called ‘opening of the capital’ if the company has not issued any shares, or ‘privatisation’ for a company whose capital was held by the State. A study by Faccio and Lang (2002) showed that 86% of French companies have a shareholder holding at least 20% of capital, knowing that block holders are either founders and members of their immediate family or societies (usually holdings) controlling the company. Faccio and Lang (2002) added that in 60% of cases of block holding, the controlling shareholder is a family. Pure primary offerings – where only the company offers shares to the public. Mixed offerings – where both the company and some existing shareholders offer shares to the public in the same offering (Prasad, 1994) The initial sample is identified from Boursier.com (http://www.boursier.com). A member of a company’s board of directors who was brought in from outside the company. Because an independent outside director has not worked with the company for a period of time (typically for at least the previous year), he or she is not an existing manager and is generally not tied to the company’s existing way of doing business. Money provided by investors to startup firms and small businesses with perceived long-term growth potential. This is a very important source of funding for startups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns. Venture capital can also include managerial and technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. Specifically, we want to investigate whether the timing of issue has an effect on underpricing. The IPO issue period 2001–2007 has been divided into 28 quarters. By ranking all quarters in terms of frequency of issues in France, we classify quarters with more than 12 IPOs as high IPO activity period. In other words, a quarter with less than 12 issues is treated as cold period. We find quarters 1, 4–19 are categorised as low activity period, and quarters 2–3, 20–28 are categorised as high activity period. Our methodology of categorising quarters as high/low activity period is consistent with Helwege and Liang (2004), Hoechle and Schmid (2007) and Sahoo end Rajib (2010). Le Premier Marché, le Second Marché, le Nouveau Marché, or Euronext-Paris since February 2005, is regulated markets. However, le Marché Libre and Alternext are not regulated markets.