BF&IPO

ACCA Research Report No.
82
A Behavioural Finance Perspective on IPOs and SEOs

by Bruce Burton Lecturer in Finance Department of Accountancy and Business Finance University of Dundee Christine Helliar Senior Lecturer in Finance Department of Accountancy and Business Finance University of Dundee David Power Professor of Business Finance Department of Accountancy and Business Finance University of Dundee.
Certified Accountants Educational Trust, London, 2003
The Council of the Association of Chartered Certified Accountants and the members of the Research Committee consider this study to be a worthwhile contribution to discussion but do not necessarily share the views expressed, which are those of the authors alone. No responsibility for loss occasioned to any person acting or refraining from acting as a result of any material in this publication can be accepted by the authors or publisher. Published by Certified Accountants Educational Trust for the Association of Chartered Certified Accountants, 29 Lincolns Inn Fields, London WC2A 3EE.
ACKNOWLEDGEMENTS We would like to thank the Association of Chartered Certified Accountants for supporting this project; in particular, we would like to express our gratitude to Andrea Jeffries and John Jones, both of whom provided helpful advice to the research team at various stages throughout the project. We would also like to thank all those who took part in the study, both as interviewees and respondents to the questionnaires. Thanks are also due to participants at the Alternative Perspectives on Accounting and Finance Conference held in Dundee in July 2000 and the British Accounting Association Area Group Conference in Stirling in September 2000.
The Association of Chartered Certified Accountants, 2003 ISBN: 1 85908 392 7
Contents
PAGE 5
Executive summary 1 Introduction to the study 2 Literature review 3 Research methods 4 Empirical evidence on the IPO process 5 Empirical evidence on the SEO process 6 Conclusions Appendix: Responses to the SEO questionnaire Endnotes References
PAGE 9
PAGE 13
PAGE 31
PAGE 41
PAGE 67
PAGE 105
PAGE 113
PAGE 119
PAGE 129
PAGE 4
Executive summary
OVERVIEW This report details the findings of an extensive investigation into how and why UK firms raise equity capital. The project was divided into two parts: first, an analysis of the decision to issue shares for the first time as part of the flotation process (i.e. initial public offerings, or IPOs) and second, an examination of the decision by listed firms to raise further equity capital (i.e. seasoned equity offerings, or SEOs). For both IPOs and SEOs the findings are based on: (i) interviews with senior executives, accountants, fund managers and investment bankers, to enable a range of perspectives and viewpoints on the process to be compared and (ii) a detailed questionnaire survey of firms with recent experience of the equity-issuing process. IPO RESEARCH METHOD The study of IPOs involved a series of interviews with seven company managers and three advisers. Following on from these interviews, a questionnaire was posted to corporate treasurers of 450 companies that had undertaken an IPO in the previous six years to ascertain their views on the process; 102 replies were received. REASONS FOR UNDERTAKING AN IPO The findings of this study highlight a number of reasons why companies seek a listing on either the Official List or the Alternative Investment Market (AIM). These reasons include: (i) increasing the visibility of the firm and getting its name known to future investors, customers and suppliers raising funds allowing an exit route to existing shareholders
(ii) (iii)
PAGE 5
Executive summary (continued)
(iv) (v)
widening the shareholder base facilitating a strategy whereby share options and bonus schemes can be offered to employees and taking advantage of a window of opportunity where the stock market seems to have an appetite for shares of companies in a particular sector.
(vi)
The timing of an issue was decided predominantly by the need for cash for investment and expansion purposes. The views of major investors and advisers were also important in deciding upon the timing of the IPO. For AIM companies, market trends were often crucial. The choice of market on which to list also depended on the views of advisers and major investors. Smaller companies tended to list on AIM because it was cheaper to do so. The geographical location of the customer base and the location of the companys operations, as well as the liquidity and regulatory regime of the stock exchange, all influenced the decision on where to list, especially for larger companies. Tax considerations also featured among the views of the questionnaire respondents, as AIM companies qualified for the Enterprise Investment scheme. ALTERNATIVES TO IPOS Most companies did not consider alternatives to the IPO, often because these alternatives had been exhausted. Thus private equity, trade sales or venture capital were not normally viewed as options. Also, most of the companies were too small to be able to raise the funds needed through debt financing. A listing was often seen as a last resort, therefore, by firms seeking to raise cash. The cost of an issue normally ranged from 10% to 20% of the proceeds and depended upon the company size as well as on the amount raised. The opportunity cost of management time was a major concern to all those who had obtained a listing; the scale of this cost had often not been factored into decisions made before the IPO. Legal fees were seen as exorbitant by AIM companies and many of those interviewed questioned whether the costs of some advisers outweighed their benefits. Advisers were often selected on the basis of a beauty parade where
PAGE 6
research ability and distribution channels for selling the equity were important considerations. Smaller companies, however, sometimes had difficulty in finding anyone to sponsor them. CHANGES AS A RESULT OF THE IPO The main changes that took place in a company both before and after the flotation tended to involve corporate governance issues. Audit and remuneration committees had to be established and non-executive directors appointed. Executive directors were also changed in the run up to an IPO if the existing management team was thought to need strengthening. Overall, those surveyed highlighted the difficulties of undertaking an IPO and the new mind set needed to manage relations with investors once a listing was obtained. IMPLICATIONS OF THE IPO FINDINGS In the light of recent declines in market capitalisations across the globe, governments and market regulators may need to address these concerns on an urgent basis, if a steady stream of new listed companies is to be found to replace those departing voluntarily or otherwise from the market. Many of the views reported in this study demonstrate that a negative interpretation of poor share price performance is seen as having the potential to harm a firms business as well as its market prospects. The increased visibility offered by a market quotation no longer appears to be a one-way bet. SEO RESEARCH METHOD For the SEO part of the study, a series of 11 interviews were conducted with different stakeholders in the process. Eight of these were with firms that had had recent experience of issuing equity and were spread across a range of sectors, while two organisations were involved in an advising role (one of the Big Four global accounting firms and a major multinational investment bank) and one was a major UK fund management firm. Following the completion of the interviews, a questionnaire was sent to 452 firms that had undertaken an SEO in the years leading up to the study; 63 replies were received.
PAGE 7
THE SEO FINDINGS The results of the SEO part of the study indicated a number of important findings. First, the choice of issue method was contingent upon a number of factors, but primarily the ability to bear costs, the influence of advisers, the urgency with which the funds were needed and the extent to which a widening of the shareholder base is desired. Second, there was little evidence of what the behavioural finance literature might term firm irrationality; firms appeared to take a great deal of care over the decision to issue equity, and their views generally concurred with those of the advisers and investors. Third, the findings of the current investigation indicated that it would be very difficult to use conventional large-scale analyses of firm behaviour to model accurately a firms choice of equity issue method. Not only did the circumstances of each issue differ across time and sector, but the impact of some of the most important influences on SEO method choice, in particular the role of external advisers, would be near impossible to gauge and proxy for in practice. Fourth, firms continued to perceive the SEO process as costly and overly time-consuming, and some relaxation of the pre-emption guidelines would be welcomed. POLICY IMPLICATIONS OF THE SEO FINDINGS The SEO section of the report concludes with a renewed call for some relaxation (but not removal) of pre-emptive rights. In particular, a move to increase the maximum size of an external placing to 10% is recommended, in line with the UK listing rules governing minimum issue size possible without production of a detailed prospectus. Such moves have drawn resistance from shareholder groups in the past, but the findings presented in this part of the report suggest that, while firms continue to see real benefits in the flexibility provided by a relaxation of the guidelines, they have no desire to seek the gradual erosion of UK shareholders long-standing right to first refusal on new equity issues.
PAGE 8
1. Introduction to the study
1.1 INTRODUCTION The main aim of this project was to identify the important influences on equityissuing practices. Views regarding two specific types of share-issuing process were investigated: (i) when equity is issued for the first time as part of the listing process (i.e. IPOs) and (ii) when further shares are issued once a firm has achieved a listing on a major exchange (commonly referred to as seasoned equity offerings or SEOs). In both cases, the research concentrated on firms and other parties that had recent experience of share issues. This focus was adopted in order to investigate how decision-making processes operate in practice, and also to examine whether conventional academic studies of the kind undertaken in the past are appropriate for investigating share issues. The key topics examined, for both IPOs and SEOs, include: (i) the influence of external advisers in the equity-issuing process (by speaking to advisers and comparing their views with firms perceptions) differences in views between firms listed on the largest market on the London Stock Exchange (the Official List) and those listed on the Alternative Investment Market (AIM) whether the factors affecting the decision-making process surrounding share issues differ over time, i.e. whether or not influences on the decision about whether to use a rights or placing issue are time-dependent, and the influence that costs (or perceptions thereof) have on the decision about where, when and how to issue shares.
(ii)
(iii)
(iv)
1.2 MOTIVATION FOR THE STUDY Recent years have seen extensive use being made of behavioural research methods in the study of corporate finance and financial markets (DeBondt & Thaler, 1995; Schleifer, 1999; Statman, 1999; Olsen, 2000); this research has
PAGE 9
Introduction to the study (continued)
involved both qualitative as well as quantitative analysis. Central to the behavioural approach is the use of psychological insights into the nature of human behaviour when attempting to explain and predict how investors, company managers and other individuals operate. In many cases this approach has provided more comprehensive explanations of market and institutional behaviour than the conventional aggregate analysis of the average individual or typical organisation which has dominated mainstream finance literature for many years (Taffler, 2001). Examples of areas where behavioural research in finance has proved useful include: (i) analyses of why firms and individuals become overcommitted to poorlyperforming investment projects (Simonson & Staw, 1992; Wilson & Zhang, 1997) explanations of the way in which investors and managers assess and react to risk (Helliar et al., 2001; Kahneman & Tversky, 1979; March & Shapira, 1988) and investigations into the reasons why movements in share prices are prone to exhibit seemingly irrational patterns such as bubbles, crashes and price herding (Bannerjee, 1992; Olsen, 2000; Eguiluz & Zimmerman, 2000).
(ii)
(iii)
The important advance provided by behavioural research in these areas is to indicate that such phenomena should not be considered as unsurprising; psychology has established that irrational behaviour is sometimes quite normal when the actions of human beings are involved (Slovic, 1972; Heath & Tversky, 1991; Statman, 1999; Frankfurter & McGoun, 2000). In particular, individuals are prone to biases whereby loss aversion, stereotyping, over-confidence and a tendency to adjust to new information very slowly are common. (Tversky & Kahneman, 1981; De Bondt & Thaler, 1985). Of particular relevance to the present study is the fact that as early as 1989, a study of firms views by Pinegar & Wilbricht established that corporate fund raising behaviour was more strongly influenced by the existence of a pecking order of
PAGE 10
alternative financing sources than by a desire to balance the tax benefits of debt with the danger of financial distress costs at high gearing levels. Only in 1999, following the publication of a large sample regression-based study by ShyamSunder & Myers did work based around this latter research method unequivocally reach the same conclusion. The authors pointed out that the large number of aggregate analyses conducted in the 1980s and early 1990s that were claimed to provide support for the trade-off theory were not in fact conducted in such a way as to allow the researchers to reject a pecking order explanation. This suggests in turn that accountants and managers attitudes towards fund raising in practice were not properly identified in these studies. The reasons underlying firms choices between equity and debt are becoming clearer, but a new puzzle has emerged about the processes involved once equity has been chosen as the appropriate financing vehicle. In particular, empirical evidence suggests (i) that firms make extensive use of relatively expensive (both in terms of direct and indirect costs) equity-issue methods and (ii) that in both the UK and US, firms make extensive use of the issue methods that cause the greatest reduction in shareholders wealth at the time when the equity offer is announced. Early large sample evidence on what determines equity-issue methods (Burton & Power, 2003) suggests, however, that conventional aggregate analysis is unlikely to lead to a clear understanding of why firms behave in such an apparently perverse fashion. A survey is therefore needed of the views of individual firms and other parties to the share-issuing process. The same is true of the factors that influence firms behaviour at the time of first flotation. It is now well documented that initial public offerings of equity (IPOs) tend to be underpriced in the short term and yet overpriced in the long run; the reasons why these patterns exist are not fully understood. 1.3 METHODS For both IPOs and SEOs the research took two forms. First, a series of semistructured interviews were conducted with various parties involved in the shareissuing process; in both cases these included issuing firms (from AIM, the Official List and the US market), fund managers and various advisers including the UK
PAGE 11
representatives of one of the four major global accounting firms. Discussions with parties other than the equity-issuing companies themselves were undertaken to facilitate a broader perspective of the realities of undertaking share issues and to allow the alternative viewpoints to be compared. Second, following the interviews, a questionnaire was sent out to more than 900 UK-listed firms with recent experience of issuing shares. A number of practical issues not addressed in the mainstream finance literature arose from the interviews and the questionnaire was drafted to reflect these points as well as to include the conventionally-assumed determinants of corporate behaviour such as issue cost and company size. The structure of this report is as follows: chapter 2 provides a review of the literature from which the questions addressed in this study arose while chapter 3 details the research methods adopted. Chapter 4 then outlines the results regarding the decision to undertake an IPO before chapter 5 discusses the evidence obtained regarding SEOs. Chapter 6 concludes the report by summarising the main implications of the findings.
PAGE 12
2. Literature review
2.1 INTRODUCTION2 The design of the initial public offering (IPO) and seasoned equity offering (SEO) interviews and questionnaires used in chapters 4 and 5 was strongly influenced by prior academic investigations into equity issues. The present chapter therefore provides a review of the relevant aspects of this literature to inform the reader of why certain issues were included in the interview discussions and postal questionnaires. The review also provides a backdrop against which the implications of the current work can be assessed and its contribution evaluated. 2.2 IPOS 2.2.1 The IPO process in the UK
IPOs in the UK typically involve a number of experts who help the company in raising funds. Perhaps the most important of these is the sponsor usually a merchant bank or a stockbroker. The sponsor analyses all aspects of the company and advises on matters such as the composition of the board of directors, the method of share issue and the contents of the prospectus. As the issue draws near, the sponsor helps the company set the issue price, decides on the time of the flotation and insures against the risk that all the shares will not be taken up by the public or by the institutional investors; this underwriting role usually costs about 2% of the issue proceeds.3 If the sponsor is a merchant bank, then the United Kingdom Listing Authority (UKLA) requires that a broker be appointed. Brokers advise the firm on the likely demand from investors for the companys shares. They also market the company to investors to generate interest in the prospective issue; they hold road shows where the senior company executives give talks about their firm to potential (mainly institutional) investors. More recently, they have become involved in book-building exercises whereby they contact major institutional investors and obtain tentative bids for the new shares in order to help determine a possible flotation price for the issue.4 Finally, a new accountant has to be employed for the flotation5 while the companys solicitors must be involved to advise on legal matters and verify
PAGE 13
Literature review (continued)
statements contained in the share prospectus. A registrar is also required to maintain the register of share ownership and issue share certificates. Figure 2.1 outlines the typical timetable for an IPO in the UK. Information on the cost and relative importance of the different advisers is not readily available. One of the few sources of evidence is provided by the Wilson Committee (1977) on the financing of trade and industry which attempted to quantify the typical cost of an issue; the figure arrived at was 7.6% of the gross proceeds. More recently, Benoit (1999) has suggested that the total annual costs of maintaining a UK listing for firms with a market capitalisation of around 100m range between 0.25% and 0.35% of the funds raised.6 This topic is one issue that is addressed in the current study. Between 4.4 billion and 12.8 billion has been raised by new companies joining either the Official List or the AIM between 1998 and 2002, indicating that IPOs are an important source of funding for UK firms. Over these five years, all the IPOs have occurred either via: (i) (ii) (iii) a public offer where shares are offered for sale to ordinary investors a placing where shares are sold directly to institutions or a public offer with a placing, which involves a combination of the two. Tenders, whereby equity is auctioned with the shares going to those who bid the most at a price which clears the market, have not been used.
PAGE 14
FIGURE 2.1: AN OVERVIEW OF THE IPO PROCESS In relation to impact day 12 years before Several weeks before A few days before Impact Day A few days after A few weeks after Several weeks after Event Publicity about the firm; sponsor and other advisers appointed Details about price and method of issue decided Underwriting obtained and book-building begins Pathfinder prospectus issued to press without any price Prospectus published and price announced if offer for sale or placing Investors apply Offer closes and shares allocated or placed Admission to the exchange and dealing begins
Source: Adapted from Arnold (2002)
Table 2.1 (on the next page) highlights both the number of issues and the amount raised by issue type from January 1998 to July 2002. A number of points emerge from an inspection of this table. First, in any one year, placings are the most popular vehicle for listing on an exchange; the number of placings is the largest among the three issue methods shown. These results are similar to the Bank of Englands (1990) findings about new equity issues for the Official List during the second half of the 1980s. The main differences between the two are that placings were relatively less common between 198589 while a small number of tenders (11) took place during that period.
PAGE 15
TABLE 2.1: IPOS BY UK FIRMS LISTING ON THE LONDON STOCK EXCHANGE 19982002 Year Public offers No. Amount raised (m) 1998 1999 2000 2001 2002 (JanJuly) Source: The London Stock Exchange 11 13 37 24 12 475 1533 5586 1485 3413 89 101 242 118 61 Placings No. Amount raised (m) 3332 3117 5938 1736 1005 24 23 66 45 22 Public offers with placings No. Amount raised (m) 555 547 1275 3667 555 124 137 345 187 95 No. Amount raised (m) 4362 5197 12799 6888 4973 Total
Second, when the amounts raised are analysed, it is clear that the average size of the public offer is quite large. Although the number of such offers is smaller than the number of placings, the mean amount of cash raised is much bigger (128.8m versus 24.8m). This finding is hardly surprising since a sizeable proportion of the public offers relate to firms listing on the main market, where companies are typically larger. For example, in 1999, 2000 and 2001, no company joined the AIM via a public offer. A third notable feature of the results is the big increase in the number of new issues during 2000 when the dot.com euphoria was at its peak.7 The amount of funds raised by new issues in 2000 and the number of such issues was nearly three times the comparable figure for 1998. By far the largest component of this increase related to new AIM companies placing shares with institutional investors; the number of such placings was 170 (raising 1.4 billion) in 2000 compared with 30 placings (raising 0.1 billion) in 1998. This euphoria quickly died down, however, and the data for the first seven months of 2002 are much more in line with pre-2000 issues.
PAGE 16
2.2.2
The short-run performance of IPOs
One of the earliest puzzles in the new issue market is that companies seem to underprice their shares when going public. Academic studies from 25 countries, summarised in Jenkinson & Ljungqvist (1996), indicate that investors make positive gains on the first day of trading in all but one instance. These gains range from a low of 4.7% for the UK (Jenkinson & Mayer, 1988) to a high of 166.6% for Malaysia (Dawson, 1987); a majority of studies report initial gains of around 15% for developed countries and over 60% for emerging stock markets.8 The question that academics have sought to answer is: why do firms choose to issue shares too cheaply, thereby imposing an opportunity cost on existing investors? Three main theories have been proposed by researchers when attempting to answer this question. First, academics have suggested that the underpricing is a rational response by managers to the fact that outside investors may have imperfect information about the value of the firm which is to be listed; an information asymmetry exists. Therefore, some academics have argued that the sizeable returns that shareholders earn on the day of the issue are provided to compensate investors for the risks that are associated with a company that has no track record on the market (Rock, 1986; Michaely & Shaw, 1994). Second, researchers have argued that institutional factors may explain why IPOs are underpriced when coming to the market. As far back as the early 1970s, Logue (1973) and Ibbotson (1975) suggested that companies deliberately sell their shares at a discount to avoid lawsuits by new investors if the share price subsequently declines.9 Alternatively, managers may want to guarantee the success of the IPO so that any subsequent SEO will be well subscribed by the market. Another strand of the literature argues that underwriters encourage companies to issue equity below their intrinsic value in order to ensure an over-subscription and reduce the possibility that they may be left holding some of the shares (Ruud, 1991 and 1993; Schultz & Zaman, 1994). A lower issue price therefore reduces the risk that the underwriter bears.
PAGE 17
A third line of reasoning suggests that the initial underpricing is a ploy by management to spread the shares among a large group of investors and thereby avoid the possibility that one individual or group will receive a sizeable enough allocation of equity to threaten the control of the existing owners (Brennan & Franks, 1997). If a higher price is charged for the shares, the risk of a block of shares being acquired by one individual or group might be greater as fewer applications for shares would be received. 2.2.3 The long-run performance of IPOs
The second major puzzle in the literature about the new issue market concerns the long-run performance of IPO firms. Several researchers across many countries have documented that companies which obtain a stock market listing subsequently underperform by a significant amount after the initial days trading. For example, in a UK study of 712 IPOs which took place over the period from 1980 to 1988, Levis (1993) discovered that his sample firms underperformed a market index by between 8.31% and 22.96% over a subsequent three-year span. This underperformance was more pronounced for companies who listed on the AIM raising large amounts of funds, in certain years. Leviss findings confirmed the earlier US results of Ritter (1991) who detected underperformance of up to 29% over the first three years after the IPO. A subsequent US investigation by Loughran & Ritter (1995), using a sample of 4,753 IPOs over the period from 1970 to 1990, reached the conclusion that this underperformance of about 30.0% continued for up to five years after the flotation date. Academics have sought to investigate why shares of newly quoted companies perform so poorly after the initial flotation date. More importantly, they have examined why investors might wish to purchase such shares if, according to empirical research, they continually underperform a broadly-based market index. One suggestion for solving this puzzle posits that the apparent underperformance is simply a reflection of the fact that the underwriters withdraw from supporting an issue shortly after the flotation; the withdrawal of support causes the share price to fall after the initial rise (Ljungqvist, 1996). Another line of argument proposes that
PAGE 18
investors overreact to the euphoria surrounding the IPO listing and the subsequent underperformance of the new issue reflects the gradual realisation that the initial price following the IPO rose too high (Loughran et al., 1994; Loughran & Ritter, 1995). Evidence from Levis (1993) that the scale of the long-run underperformance of the IPO is proportional to the size of the initial day-one gain for a new issue would tend to support this view. Finally, a number of commentators have agreed that this long-run underperformance is spurious and arises mainly as a result of risk measurement problems (Espenlaub et al., 2000). Once the risk of the securities is properly measured, any underperformance is relatively small or disappears altogether especially after a period of years.10 2.2.4 Transaction costs
Existing literature on IPOs has traditionally focused on one further issue; that is, the costs associated with secondary trading once the shares have been issued. For example, the National Association of Security Dealers (NASD) and their automated quotation market (NASDAQ) have been subject to Department of Justice investigations and fined in excess of $1billion because of the large transaction costs charged to clients. As far back as 1994, Christie & Schultz reported that NASDAQ market-makers appeared never to make odd-eighth quotes and wondered if there was collusion between the dealers that facilitated excessive dealing profits at the expense of investors. More recently, Barclay et al. (1999) commented on the changes to the NASDAQ market since 1994. The Securities and Exchange Commission (SEC) introduced reforms, effective from January 1997, whereby the public could submit limit orders and compete against the market makers. The Department of Justice investigation required three changes to market practices: (i) (ii) the ending of the convention of odd-eighth quotes the separation of NASDs regulatory responsibility from its operational control and a mandatory display of customer limit orders and the dissemination of prices in proprietary trading systems to impart some auction
(iii)
PAGE 19
characteristics to the market. The scandal and investigations resulted in those spreads that were reported in January 1997 being generally half those that existed in 1994. Chung et al. (1999) discussed the difference between (i) conventional order-driven and quote-driven markets and (ii) markets where there is a specialist who provides liquidity for stocks when there are few limit order trades in the system. The authors found that spreads were widest at the beginning and end of the day, when there were relatively few limit order flows, and that during the middle part of the day spreads narrowed considerably. They therefore concluded that limit order trades provided liquidity and immediacy to the market, with the activities of specialists playing an important part in ensuring an order flow throughout the day. These studies seem to suggest that significant scope exists for cost reductions in markets where there is competition and a transparent pricing structure. When companies raise finance through rights issues, placings, open offers and bond issues, there may be very little competition and no price transparency. Therefore, considerable scope may exist for cost reduction if the issue processes are documented, and the reasons why companies prefer one form of issue from another are investigated; establishing market participants views about these issues was one of the key objectives of the study. 2.2.5 Conclusions about IPO research
A great deal of research effort has been invested in trying to examine the share price performance of newly listed companies: (i) on the day of the issue and (ii) over a longer period. This research has documented that two puzzles appear to exist which suggest that the price behaviour of IPOs is predictable both in the short run and the long run. Attempts to explain these anomalies have been much less successful, however, with no unambiguous conclusion emerging from the aggregate market-based investigations. What is even more surprising is that academics know very little about the IPO process itself. Questions about the factors that influence a companys decision to seek a listing, the influences on the issue method and choice of stock exchange
PAGE 20
have not been asked by academics. More importantly, views have not been sought about the role of issue costs in the IPO decisions or the part played by advisers in the listing process. This report attempts to bridge such a gap in our knowledge. Therefore, rather than focus on the behaviour of share prices after the IPO, the researchers made a conscious decision to target the views of participants in the IPO process about how the listing took place. 2.3 SEASONED EQUITY OFFERINGS 2.3.1 The SEO process in the UK Virtually all equity fund raising by UK-listed firms takes place via one of three forms of share issue: (i) (ii) a rights offer made on a pro-rata basis to existing shareholders a placing directly with institutions combined with an open offer to existing shareholders; the open offer usually takes the form of a clawback whereby the shares are placed provisionally on existing shareholders not taking up their rights11 and an institutional placing without clawback.
(iii)
Table 2.2 details the use of each method on the London Stock Exchange over the period January 1998July 2002. As the table shows, the number of rights issues in each year is small relative to the number of placings; in 2001 only 30 out of 485 (or 6.2%) of SEOs took the form of a rights offer.12 The table also indicates, however, that the average size of a rights issue is typically much greater than that of a placing. For example, despite the relatively small numbers involved, the total funds raised through rights issues in 2001 (6.55 billion) were almost identical to the combined total for the two types of placing. The dominance of placings in terms of numbers of issues is partly driven by issues on the AIM. For example, table 2.2 shows that only 20 out of 285 share offers by London-listed firms (or 7%) took the form of rights issues in the first seven months of 2002 but, when
PAGE 21
AIM data are excluded, the proportion rises to 19 out of 127 (15%). Overall, the data appear to indicate that although the popularity of rights issues fell after alterations, in 1996, to the market regulations governing large issues,13 rights offers continue to be used extensively by UK-listed firms and form the vehicle for a large proportion of equity fund raising. The main differences between rights and placing offers are that (i) a placing should normally lead to relatively greater dispersion in post-issue equity holdings and (ii) that the discount to market price is typically in the range of 10%20% for a rights issue but rarely more than 5% for a placing. The difference between a rights issue and an open offer is that rights issues are made via renounceable allotment letters, and for a three-week period shareholders can trade the rights independently from the underlying capital (Armitage, 1998).
TABLE 2.2: SEOS BY UK FIRMS QUOTED ON THE LONDON STOCK EXCHANGE 19982002 Year Rights No. Amount raised (m) 1998 1999 2000 2001 2002 (Jan-July) Source: The London Stock Exchange 44 44 36 30 20 1117 2353 3645 6550 5208 228 328 449 399 230 Placings No. Amount raised (m) 3242 5168 5659 5387 3153 64 77 81 56 35 Placings with open offer No. Amount raised (m) 1138 1839 1606 1197 636 336 449 566 485 285 No. Amount raised (m) 5497 9360 10910 13134 8997 Total
PAGE 22
The main practical restriction on UK firms choice of issue method is that existing shareholders have pre-emptive rights to participate in any new issue of shares. The pre-emption principle has a long tradition in UK markets, and has been enshrined in the London Stock Exchanges Listing Rules for many years. These rights have also had statutory backing since 1977, with the legal framework currently being laid out in Sections 8996 of the Companies Act 1985. In contrast, external placings of shares with financial institutions were first allowed by the London Stock Exchange in 1975, but remained rare until the loosening of restrictions in 1986 (Slovin et al., 2000). To undertake a placing, a firm must first obtain shareholders permission at a general meeting under the provisions of Section 95 of the Companies Act 1985.14 However, the Pre-Emption Group, which represents the Investor Protection Committees (IPCs) of the two major institutional shareholder bodies in the UK (The National Association of Pension Funds and the Association of British Insurers), advises its members only to approve non-pre-emptive issues without clawbacks if the total amount placed in any given year represents less than 5% of existing share capital, with a rolling three-year limit of 7.5% also being recommended.15 The PreEmption Group also recommends to its members that they should vote against any proposed share issues which by-pass pre-emptive rights if the proposed discount is greater than 5% of the mid-market price existing immediately prior to the announcement of an issue. In contrast, a rights issue can in theory take place without any shareholder permission provided that the issue is within the limit of authorised capital. Irrespective of issue method, paragraph 5.27e of the UKLAs listing rules requires that formal listing particulars be produced for any share offer representing more than 10% of an outstanding class of capital. A great deal of research has been conducted into the effect of equity issues on share prices and yet little is known about how the process works in practice, in particular how firms decide upon a specific issue method. This is potentially an important research question; evidence suggests that, in the US and UK, firms make extensive use of the methods that cause the greatest reduction in share prices at the time of announcement. The London market is highly suitable for investigating these choices because, in contrast with North America, both rights and placings remain popular as issue methods (Eckbo & Masulis, 1992; Slovin et al., 2000).
PAGE 23
2.3.2
The market reaction to SEOs and possible rationales
Some of the most robust results to emerge from modern finance research relate to the stock market reaction to announcements about issues of new securities by quoted companies. Despite the consistency in the empirical evidence, however, the findings pose a number of interesting questions for researchers, few of which have been resolved satisfactorily on the basis of the large sample aggregate analyses which dominate in the area. The average two-day market-adjusted return following the announcement of an SEO has consistently been shown to be negative and in the region of 3%; in contrast, debt issues appear to exert no significant influence on share prices whatsoever (Asquith & Mullins, 1986; Masulis & Korwar, 1986; Healy & Palepu, 1990; Sant & Ferris, 1994). In addition, as with IPOs, there is strong evidence of price drift in the months and years following the announcement of the share issue (Affleck-Graves & Page, 1995; Loughran & Ritter, 1995; Speiss & Affleck-Graves, 1995; and Jung et al., 1996). The studies all report that equity issues are followed by long-term average price declines that persist for up to five years after the offer is made. Loughran & Ritter (1995), for example, show that the return for equity-issuing firms over a five-year period is 33%, while the return earned by a matched sample of non-issuers is 93% over the same period.17 Recent evidence has examined how the stock market reaction to share issue news varies across alternative issue methods. This work has indicated that the negative market reaction to SEO announcements only occurs when the fund raising takes the form of a rights issue. Armitage (1999), for example, examines 124 SEOs made in the UK between 1985 and 1996 and finds that the two-day average announcement period abnormal return is 3% for rights issues but +1.03% for open offers. Similar UK results are reported in Burton et al. (2000) and Slovin et al. (2000); the latter study documents that the market reaction to a sample of 296 share issues announced in the UK between 1994 and 1996 was significantly positive (two-day abnormal return 3.31%) for placings and significantly negative (3.09%) for rights issues. In contrast, in the US, research has shown that rights offers cause the least harm to shareholders wealth (Eckbo & Masulis, 1992). The puzzling implication of these findings arises because UK firms continue to make extensive use of the rights method (Barnes, 2002), whereas in the US such offers
PAGE 24
are relatively uncommon. An investigation of why firms regularly employ issue methods that reduce share prices is therefore needed. Academics have identified a number of possible rationales for the market reaction to new financing announcements and these have been usefully grouped into three categories by Barclay & Litzenberger (1988). The authors identify theories based on: (i) information/signalling issues, where the negative reaction to SEO announcements occurs because investors believe that an equity issue signifies managers belief that the shares are overpriced and/or that the proceeds provide the opportunity for wasteful investment on projects with negative net present values price pressure arguments, which suggest that the adverse response to an increase in the supply of shares occurs because of a downward sloping demand curve for corporate equity and gearing hypotheses based on the idea that the market reaction to a new financing announcement represents a response to an accompanying change in debt-equity ratios and the weighted average cost of capital.
(ii)
(iii)
A body of empirical evidence about cross-sectional variation in the market reaction to SEOs has also developed, partly as an attempt to test the predictions of the theories. The many variables studied to date include operating performance (Loughran & Ritter, 1995), company size (Kalay & Shimrat, 1987), growth prospects (Pilotte, 1992; Burton et al., 2000), issue purpose (Masulis & Korwar, 1986) and earnings management (Teoh et al., 1998). These studies, all of which involve large-sample statistical regression analysis, show that while the explanations outlined by Barclay & Litzenberger may be theoretically sound, no single model is consistent with all the evidence. For example: (i) the information hypotheses predict a straight forward positive reaction to debt issues, but this has rarely been found in practice
PAGE 25
(ii)
the theories based on the price pressure arguments are entirely consistent with the short-term market reaction to SEOs yet they provide no explanation for the long-term gains (falls) prior to (following) the announcements documented in the US and the gearing hypothesis predicts a simple positive relationship between issue size and the market response to an SEO the evidence in this area remains, at best, inconclusive (Asquith & Mullins, 1986; Dierkins, 1991).
(iii)
The studies that examine the market reaction to SEOs are, however, based almost entirely on large sample analyses, and the reasons why individual firms issue equity in practice are not fully known. This failure to incorporate heterogeneity in firms motives for issuing equity is arguably one of the main reasons why a comprehensive explanation of share price movements around new financing announcements does not yet exist. This situation arguably lends itself to a move away from aggregate analysis and towards a study of individual firms behaviour and the motives for issuing equity. 2.3.3 The puzzle over issue costs
The (non) relationship between issue costs and issue methods is another puzzle unresolved by conventional finance research. In particular, US firms are now known to favour fully underwritten offers and make little or no use of rights issues despite the existence of numerous studies which indicate that rights issues are the cheapest SEO vehicle available to quoted American companies (Smith, 1977; Hansen, 1988; Eckbo & Masulis, 1992). Although no similar differences in issue costs have yet been uncovered in the UK, this rights offer paradox appears to suggest that major companies choice of issue method is determined by something other than the cost of the issue. These costs are, however, ultimately borne by the equity holders, again suggesting that firms voluntary fund-raising behaviour causes harm to existing owners wealth.18 This apparently anomalous finding about the role of issue costs may partly be explained by the relative dearth of information about the decision-making processes that companies go through when deciding on equity issue methods. Very little work has been undertaken to establish the costs of
PAGE 26
alternative methods of issuing shares, although Armitage (2000) examines a sample of 583 rights issues and open offers in the UK and reports that the mean cost is 5.78%, of which less than a quarter is made up of underwriting fees. Less is known about the direct costs of placings, but Burton & Power (2003) suggest that in the UK these fees have historically been lower than for rights issues.19 When considered in conjunction with the evidence regarding the market reaction to share issue announcements, a picture emerges of firms making extensive use of SEO methods that are relatively expensive for shareholders, in terms of both direct costs and the impact on share values. A detailed investigation of how the choices are made is therefore required. 2.3.4 Prior evidence on choice of SEO method
Burton & Power (2003) provide the first published attempt to establish how firms decide on SEO issue methods. The authors compare the financial characteristics of UK firms that announced 193 rights issues and 329 external placings of equity in 1995 and 1996, in an attempt to build a predictive model of offer method choice. The variables used by the authors to identify differences between rights-issuers and non rights-issuers are all based on conventional finance logic and include firm size, profitability, shareholder structure, prior offering methods and liquidity. Despite the apparent logic behind the choice of the variables, the authors reported that the only significant difference between the two classes of firms is that rights issuers were larger than their placing-issuer counterparts. This finding was shown not to provide investors with the ability to predict issuing methods accurately. The modest nature of the findings in the Burton & Power study highlight the need for research into the determinants of SEO method choice that will allow variability in the behaviour of individual firms to emerge. 2.3.5 Evidence on the debt-equity choice
Attempts to derive explanations for the closely-related decision about whether to issue debt or equity have illustrated the ability of survey-based research to add useful insights into our understanding of corporate fund-raising behaviour. The two dominant explanations of the debt-equity choice in the literature are (i) static
PAGE 27
trade-off theory (Myers, 1984), which explains corporate financing activity in terms of movements towards a target capital structure, with the target itself being derived by balancing the tax benefits of debt financing with the financial distress costs incurred at high gearing levels, and (ii) pecking order theory (e.g. Myers & Majluf, 1984). This latter model predicts that firms will finance investment according to the perceived costs of alternative methods, with retained earnings being preferred, followed by debt and then, because of agency costs and thirdparty disclosures, equity. External fund raising activity is not driven by any target capital structure, according to the theory, but instead reflects gaps between internal funds and investment opportunities (net of dividends), as well as the extent of divergences between the market and intrinsic values of corporate securities. Empirical evidence exists to support these two broadly based theories; for example, the findings of both Marsh (1982), who reports the existence of long-term target gearing levels for UK firms, and Long & Malitz (1983), who discover significant negative relationships between the value of intangible assets and gearing levels in the US, support the static trade-off model. Choe et al., (1993) and Bayless & Chaplinsky (1996), however, find that firms prefer to issue equity at times when shares are relatively overpriced (i.e. when the market value of equity is higher than the intrinsic value) and thereby provide a measure of support for pecking order theory. The picture that emerges from the large sample tests of capital structure theories is complicated and only following the publication of a study by Shyam-Sunder & Myers (1999) has a consensus started to emerge in the conventional aggregate analysis-based literature. These authors point out that the static trade-off and pecking order theories overlap to a significant degree and much of the empirical evidence that has been purported to support the static trade-off model is not actually inconsistent with a pecking order explanation of gearing choice. When the complexities and overlap are controlled for, Shyam-Sunder & Myers find robust evidence to suggest that the pecking order model is significantly more descriptive of firm behaviour than is the static trade-off theory.
PAGE 28
Of direct relevance to the present study is the fact that, ten years earlier, a questionnaire survey by Pinegar & Wilbricht (1989) came to precisely the same conclusion, thus illustrating the potential for questionnaire research to yield insights into corporate decision making beyond those achieved via conventional aggregate analysis and a priori theorising. The authors employed a questionnaire survey of Fortune 500 firms in 1986 (receiving 176 usable replies) and concluded that managerial responses were consistent with the broad predictions of pecking order theory. The sample firms expressed a clear preference for internal funding over external funding and for debt financing rather than share issues. In addition, answers to a series of questions about the factors which influenced financing behaviour showed that variables that played a major part in static trade-off theory tax and bankruptcy considerations were not seen as being important by the managers of large US firms. These findings have been confirmed in a more recent survey of the views of US firms by Graham & Harvey (2001). In this recent study, the responses to a questionnaire survey by 392 Fortune 500 firms confirmed that factors such as financial flexibility and maximising credit rating are considered to be more important than the tax deductibility of interest and bankruptcy costs (which are considered to be central to the trade-off theory) when deciding between a debt and equity issue. The insights yielded about the debt-equity choice in these two survey-based studies are clearer than the picture that emerges from numerous large sample-based papers. The case for examining why large companies choose a particular equity issue method by directly surveying the views of issuing firms and other relevant parties would therefore appear to be overwhelming.20 2.4 CONCLUSION This chapter has reviewed prior literature about IPOs and SEOs; in both cases the main focus has been on the issues that are relevant to, and have influenced, the empirical work outlined in the following chapters. While much is known about both types of equity issues it appears to be clear (i) that firm behaviour does not always follow an entirely rational path in terms of the using the lowest cost method or the method that minimises harm to existing shareholders and (ii) that large sample market-based studies may not represent the best way of investigating how firms choose when and where to list or how to raise additional equity financing.
PAGE 29
PAGE 30
3. Research methods
3.1 INTRODUCTION This chapter provides details about the research methods used in the present study. In particular, the chapter details the interviews and questionnaires used to investigate perceptions of the IPO- and SEO-issuing processes. Two research methods were employed in both cases in order to gain a wide range of perspectives on the issues being investigated. In addition, the use of both techniques facilitated a two-stage process whereby interview findings were used as inputs to the questionnaires, thereby allowing the generalisability of the former results to be tested. 3.2 IPOS 3.2.1 The survey interviews
A series of ten interviews were conducted with parties involved in the IPO process. These interviews were with executives at two companies that had conducted an IPO on the Official List, four whose firms had gained admission to AIM21 and one whose firm had listed in the US (see table 3.1). Three advisers were also consulted to obtain their views about the various influences on the listing process for new firms. One adviser worked as a fund manager, another was employed in the corporate finance department of a Big four accounting firm while the final individual worked in an investment bank. All three were aware of the issues facing firms that seek a listing, and were able to supply alternative perspectives on the IPO process. The interviews were based on a semi-structured questionnaire that was similar for the different categories of interviewee. Two researchers attended each interview, and most of these were taped;22 the tapes were analysed after each interview and detailed notes taken. These notes were written up and the text analysed for common themes or important differences in the points that were made. These themes are explored in chapter 4 and illustrated with quotes where relevant.
PAGE 31
Research methods (continued)
TABLE 3.1: THE INITIAL PUBLIC OFFERING INTERVIEWEES Firms A B C D E F G Advisers H I J Notes: Sectors are based on FTSE categories. Listing refers to the firms listing at the time of the interview. NYSE is the New York Stock Exchange. Sector Support services Software and computer services Pharmaceuticals and biotech Software and computer services Business services Utility Software and computer services Organisation Fund Manager Accountant Investment Bank Listing AIM AIM Official List AIM Official List NYSE AIM Interviewee Two senior investment managers Director of corporate finance Managing director of corporate finance/advisory Interviewee Financial Director CFO Financial Director Chief Executive Investment Director Group Treasurer Financial Director
3.2.2
The postal questionnaire survey
A postal questionnaire was sent in the spring of 2002 to all those companies identified as having had an IPO in the last two years.23 Each questionnaire was addressed to the group treasurer as, according to the interviewees, the treasurer usually played a major part in the detailed decisions leading up to the IPO. To allow for comparisons, IPOs on both AIM and the Official List were included. The questionnaire design was based on the findings from the interviews and the prior literature on the topic. The questionnaire was split into five sections covering seven pages in total. Section A requested background information about the respondents such as company size and sector. Section B asked about the timing
PAGE 32
and choice of stock market for the IPO, while section C sought views about the costs of the issue and whether any alternative sources of finance were considered. Section D enquired about changes that arose before and after the flotation while Section E asked about the overall flotation process itself. A number of these questions employed Likert scales to show the extent of the respondents agreement or disagreement with certain statements (see chapter 4). The questionnaire was posted on 8 May 2002 to 450 companies and there were 72 responses. A second mailing was sent to the remaining 378 companies on 5 June and a further 30 replies were received; in total, 102 questionnaires were obtained from the 450 that had been sent, therefore a response rate of 23% was achieved. This rate is similar to the percentage replying to questionnaires in various UK studies (Wallace & Mellor, 1988). Of the respondent firms, 93% had a turnover of under 100m; this small size of the typical respondent is possibly a reflection of the fact that some 70 of the 102 companies were listed on AIM. Roughly half the IPOs were underwritten and half were not. Most of the respondents were in the 3050 age range and a majority had worked in their company for between one and five years. Most of the respondents had a professional qualification while over half of them had both a degree and a professional qualification. The majority of those replying were finance directors although some treasurers and individuals with other functional titles completed the document. Despite the fact that the questionnaires were sent to treasurers, AIM companies are presumably too small to have a separate treasury department and this function is often performed by the Finance Director (Helliar, 1997). The companies were from a wide range of sectors and covered all the major industry classifications. 3.2.3 Response bias
Prior evidence has indicated that possible response bias may be tested by examining whether identifiable differences exist between early and late responses to questionnaires (Hussey & Hussey, 1997). To try and examine whether there may have been a difference between those that replied and those that did not, tests were carried out to compare the mean responses of the first mailing with those of the second mailing.24 The results showed that out of a total of 71 questions, a difference arose in only three cases:
PAGE 33
(i)
on whether the respondent firms had considered a trade sale rather than an IPO on whether the top management team had changed in the run-up to the IPO, and on whether the investor relations function had altered in advance of the IPO.
(ii)
(iii)
As this was what one would expect from a random sample, it seems reasonable to conclude therefore that there was no significant response bias among the replies according to these test procedures. 3.3 SEASONED EQUITY OFFERINGS 3.3.1 The survey interviews
A series of 11 interviews were conducted with various parties involved in the SEO-issuing process. As table 3.2 indicates, these comprised discussions with senior representatives of a leading fund management firm, a senior manager with the corporate finance arm of one of the four major global accounting firms, a senior manager with one of the UKs largest corporate financial advisers (with experience of advising on more than 50 rights issues and placings over the past 20 years), and the finance director or group treasurer of eight non-financial UK companies.25 Five of the eight companies had conducted an SEO on the Official List of the London Stock Exchange, with three issuing on AIM; by visiting firms listed on both markets it was hoped that differences between the two would emerge. Seven of the companies visited had undertaken an SEO within the two years preceding the interviews, but to provide a longer-term perspective, a firm was also visited that had last conducted a share issue six years previously.
PAGE 34
The interviews were based around three versions of a semi-structured questionnaire; one for the fund manager interview, a second for the two meetings with advisers and a third for the discussions with the eight share-issuing companies. These semi-structured questionnaires guided the interviews but each interviewee was allowed to comment on pertinent issues as he or she saw fit. As with the IPOs, two members of the research team attended each interview; all were taped except for two of the company interviews where the interviewees asked for the conversation not to be recorded. In these cases, detailed notes were taken. After each session, the interview was written up following attempts at listening to the tapes and reading the notes. These written documents formed the basis of the analysis conducted in chapter 5 of this report. The interviews themselves focused on issues that the previous finance literature suggested might affect the method used to raise new equity, including timing, costs, issue size and recent firm and market performance. The interviews were concluded by giving the interviewees the chance to raise any issues which they felt were important in practice but that had not been covered during the discussions. 3.3.2 The postal questionnaire survey26
Following the completion of the interviews, a postal questionnaire was sent to the group treasurers of all 452 London-listed firms that undertook an SEO between December 1998 and September 2001.27 The group treasurers were targeted because in the interview sessions these individuals had displayed the most detailed knowledge of the share-issuing process. To allow the factors affecting behaviour in different markets to be compared, SEOs on both AIM and the Official List were included; the total comprises 260 firms that announced share issues on the former and 192 that raised funds on the latter.
PAGE 35
TABLE 3.2: THE SEASONED EQUITY OFFERING INTERVIEWEES Firms K L M N O P Q R Advisers S T U Notes: Sectors are based on FTSE categories. Listing refers to the firms listing at the time of the interview. Sector Pharmaceuticals and Biotech Transport Utility Beverages Leisure, Entertainment and Hotels Software and Computer Services Software and Computer Services Software and Computer Services Organisation Fund Manager Accountant Investment Bank UK Listing Official List Official List Official List Official List Official List AIM AIM AIM Interviewee Two senior investment managers Director of corporate finance Managing director of corporate finance/advisory Interviewee Finance Director Group Treasurer Group Treasurer Group Treasurer Finance Director Finance Director Chief Executive CFO
The design of the questionnaire was influenced by the questions emerging from prior studies of the nature and effect of SEOs, in particular early market-based attempts to identify how firms decide between rights issues and placings (Burton and Power, 2003). The types of questions asked were also influenced by factors emphasised as being important in the interviews. Particular examples of these include the role played by external advisers, the effective limit on placings of 5% of a firms outstanding share capital and the much wider range of issues that would become relevant if this restriction were lifted. The questionnaire was split into three main sections. Section A sought background details about the respondents and their firms, including company size and sector, as well as each respondents age, qualifications and years in position. Section B
PAGE 36
asked various questions about influences on the method used to issue new shares. The focus in this section was on: (i) (ii) (iii) the role of various professional advisers perceptions of the relative costs of each issue method, and views regarding institutional investors insistence on the maximum size of a placing being 5%.
Section C asked respondents to consider the importance of a number of issues that prior literature had suggested might influence the method used to raise equity financing. The factors included statements regarding recent firm and economic performance, liquidity concerns, pay-out ratios, asset structure and issue size. Despite UK firms having the ability to undertake large placings by using a clawback in the form of an open offer to existing shareholders, a number of interviewees had suggested that the 5% limit on placings was effectively the main factor which determined the share issue method used, with placings tending to be employed for small issues and rights for large fund raising. Views regarding all the statements in Section C were therefore sought twice, first under the current system and second, if the 5% limit was removed and firms had an unconstrained choice of issue method. 3.3.3 Respondent details
The questionnaire was initially sent out on 8 May 2002 to the 452 companies in the sample and 41 responded. On 5 June a second mailing was sent to the 411 that had not replied; a further 22 were received, the last of these arriving on 2 July 2002.28 The total response rate for the survey was therefore 14%. Of those replying, 26 were from Official List firms (a response rate of 13.5%) and 37 from AIM firms (14.2%). Although the overall response rate is modest, and below that found for the IPOs, the figure is actually higher than the 9% reported by Graham & Harvey (2001) in their study of 392 large US-listed firms. The difference between the response rate to the two questionnaires in this study may simply reflect the fact that the SEO firms surveyed were larger, on average, than those announcing IPOs
PAGE 37
and the range and complexity of the respondents demands on time might have been greater in the former case. Of the respondent firms, 46 had a turnover of less than 100m, although this included 36 out of the 37 AIM-listed respondents. Of the 26 Official List firms, 19 had a turnover of less than 500m, four indicated a figure of between 501m 1billion with the remaining three indicating that their annual turnover was greater than 1 billion. The responses came from a range of sectors: four from firms in the Resources sector;29 10 Industrials; 11 Consumer Goods firms; 18 from Services industries; six Financials; and 14 Information Technology firms. Although each questionnaire was addressed to the Group Treasurer, only nine out of the 63 replies were completed by the Treasurer, with most being dealt with by the Finance Director or Chief Financial Officer. All nine of the replies from Treasurers were from Official List firms, possibly indicating that, given their relatively small size, a separate treasury function was not in operation at the time when the questionnaire was received by the other respondents. Most of the respondents, for both Official List and AIM firms, were between 31 and 50 years of age, had worked for their current organisation for less than five years and held a degree and/or a professional qualification. Only one of the respondents reported holding an MBA. 3.3.4 Disaggregation of questionnaire responses
The responses to the questionnaire were disaggregated and compared in three ways; chapter 5 refers to significant findings emerging from each division of the data where appropriate. The first disaggregation related to the market on which a firms shares were quoted at the time of the survey. Although in theory there are no differences between the SEO methods available to firms listed on the Official List and AIM, the interviews indicated differences in perceptions across a number of areas, including the impact of shareholder structure and the role of advisers. Results for the two groups of respondents were therefore compared. Responses to the question on the importance of the decision about the equity issue method were used as the basis of a second disaggregation. This form of analysis was employed to check whether firms responses to the questionnaire differed
PAGE 38
according to the importance they placed on the decision. Given the small numbers of firms who failed to agree to some extent with the statement, the views of the 23 firms who strongly agreed were compared with the 39 who responded otherwise (25 of these agreed, 13 neither agreed nor disagreed and one disagreed). Finally, responses to the question regarding the extent to which the pre-emption guidelines represent the main determinant of SEO method choice, were used as the basis for a third disaggregation of the sample. This form of analysis was undertaken to determine whether the extent of flexibility that respondents perceived in the choice of issue method affected views about the influence of other factors in a predictable way. Specifically, the responses from the 21 firms that agreed with the statement in question were compared with those from the 23 who disagreed.30 3.3.5 Response bias
As with the IPOs, the answers from those questionnaires completed in response to the second mailing were compared with those from the first mailing to check for response bias. Specifically, the mean response from the 41 replies to the first mailing and that from the 22 responses to the second mailing were compared. In only two of the 48 cases was it possible to reject the hypothesis that the mean response from the first and second mailing was equal, on the basis of two-tailed testing and a 5% significance level. It therefore appears reasonable to assume that answers to the questionnaire were not systematically linked to the propensity or willingness to respond.
PAGE 39
PAGE 40
4. Empirical evidence on the IPO process
4.1 INTRODUCTION This chapter discusses the findings from the ten interviews and the 102 questionnaire survey replies on IPOs. A number of quotes have been selected from the interviews to highlight the issues that were raised. In addition, average responses to the postal questionnaire returns have been computed in order to provide more general information about the issuing process. 4.2 REASONS FOR LAUNCHING AN IPO During the ten interviews, both executives and advisers were asked why companies decided to raise funds via an IPO. The dominant reasons for this decision were as follows. (i) (ii) To increase the visibility of the company. To get its name known among investors and the potential customer base.
(iii) To raise the status of the company to a PLC in order to assist future growth. For the company listing in the US, this was especially important as it had big expansion plans in North America. Interviewee B, from an AIM company, stated that: We raised a significant amount of cash and have experienced significant organic growth since [the flotation]. If we hadnt done the IPO we would be a lot smaller today. Interviewee D also noted that perception was as important as size when deciding to obtain a listing: It was important for us in dealing with corporate clients they felt more secure in dealing with a PLC its mainly psychological.
PAGE 41
Empirical evidence on the IPO process (continued)
Interviewee J, an adviser, added that: it often gives the company more status which can help their business quite a lot. Raising money was also of vital importance when deciding on whether to develop the support services of a company, to pay for research and development, to improve the infrastructure of the company, to increase working capital or to build a war chest for future acquisitions. The money that was raised typically helped to fuel the companys growth and make it easier to raise funds in the future. As Interviewee J stated: As a company grows, it is far easier to raise capital as a listed company than as an unlisted company If you do an IPO now it puts a floor on your value and when it comes to negotiating your sale, you can normally negotiate from a higher base. And also the prospective purchaser is much more confident if its a listed company because he knows that its been through a listing with a prospectus and to be blunt they are more likely to pay a higher price. Interviewee E argued that another important reason why companies sought a listing was to facilitate an exit route for major shareholders, whether individuals, companies or venture capitalists. Specifically he commented: [Our] companys development had got to the stage where we wished to expand the international nature of the share register. We wished to secure sizeable additional funding for the next stage of development. The venture capitalists had been on board for a number of years. Allied to the exit route argument was the suggestion that an ability to issue options and offer incentives to employees remained at the forefront of executives minds when deciding to float, thereby motivating the employees and encouraging them to stay with the firm and help it to grow. For example, Interviewee J noted:
PAGE 42
Its often useful if you want to give out shares to your employees or to give them option schemes. The listing also enabled the company to widen its shareholder base; before a listing this was often very limited and a major factor in inhibiting the growth potential of the firm. Occasionally a listing would be on the back of industry trends or take advantage of a window of opportunity when the market had an appetite for a particular sectors shares. As Interviewee G stated: We were really quite conscious that there was a window and we had to get on and take advantage. Overall, therefore, there were several reasons put forward as to why companies sought a listing on an exchange and the importance attached to these different reasons varied from one firm to another depending upon the circumstances of the company or the profile of its owners. In addition, the general state of the macroeconomic environment was an influence. The dominant reason related to the growth potential of the firm, however; many saw the IPO as one way of facilitating company plans to increase in size. 4.3 TIMING OF THE ISSUE The questionnaire survey asked the respondents about the factors that influenced the timing of the IPO. Table 4.1 shows the mean responses to these factors, where the number 1 indicated a strong influence and 3 suggested that no influence was present. According to the results in this table, the most important reason for the timing of an IPO related to the need to obtain funds to fuel future growth and expansion. This factor had a mean score of 1.20 and the small standard deviation of 0.51 suggested that there was a great deal of agreement about this factors importance. A new injection of funds enabled the firm to progress to the next stage of its development and such funds were typically not available from existing shareholders or from internal operations.
PAGE 43
The second most important factor, with a mean score of 1.39, related to the wishes of the firms major investors to realise some of their investment. This ranking was not uniform across all respondents, however; those in the consumer goods companies attached less importance to the views of major investors when deciding on the timing of an issue. In contrast, this factor was rated highly by smaller companies. Often such smaller companies had founders with sizeable equity stakes who wanted to reduce their investment and bring in new shareholders.
TABLE 4.1: INFLUENCES ON THE TIMING OF A COMPANYS DECISION TO FLOAT Indicate the extent to which the following influenced the timing of your companys flotation. Need for funds for growth Views of the firms major investors Views of the firms brokers The need to increase the companys profile Industry trends Views of the firms investment bankers Views of the firms underwriters Views of the firms accountants Views of the firms lawyers Notes: This table summarises responses to a question about influences on the timing of a companys decision to float. The responses were classified on the basis of a Likert scale where 1 = strong influence; 2 = weak influence; 3 = no influence. N 100 98 99 99 100 92 87 100 98 Mean 1.20 1.39 1.48 1.74 1.76 2.07 2.32 2.44 2.49 Std. Dev. 0.51 0.70 0.71 0.74 0.82 0.89 0.86 0.66 0.61
The firms brokers were also influential in the timing of a flotation. The firms were dependent upon the broker and sponsor to give the green light for the IPO and, in some cases, IPOs were pulled at the last moment because the sponsor was unwilling to proceed. This problem was especially pronounced in 2001 and 2002
PAGE 44
when telecommunications, media and technology (TMT) companies sought to raise money (see table 2.1). Both the need to increase the profile of the company and industry trends were rated as almost equally important by the respondents, with mean scores of 1.74 and 1.76 respectively. The standard deviations around the average scores were high, however, at 0.74 and 0.82 respectively, suggesting that there was a wide spread of opinion expressed by the respondents to the postal questionnaire. For example, respondents who worked in the Industrial sector did not view the raising of their companys profile as a strong influence on the timing of their decision to issue shares. Surprisingly, the views of advisers, such as investment bankers, underwriters, accountants and lawyers did not exert a strong influence on a firms timing of an IPO, according to the respondents. All four types of adviser elicited mean scores of more than 2.00. Again, there was some variability in the rankings awarded to these advisers influences by respondents from different sectors. For example, the views of investment bankers were given greater importance by those who worked in the consumer goods sector while lawyers were more important to the flotation of IT companies. Cross tabulations were undertaken to examine whether there was a difference in the views between respondents whose companies listed on AIM and those whose companies joined the Official List. A number of striking differences emerged from this analysis. The investment banks were not as influential for those whose firms sought AIM listings, but were for those whose companies were quoted on the main market. However, the Official List companies were less likely (i) to follow industry trends or (ii) to need to raise their profile, than their AIM counterparts. There were also differences in the responses between those who had had their issues underwritten and those that did not. Those who had chosen to have an underwritten issue rated investment bankers and underwriters as much more influential than those who had not. Those who did not have underwritten issues, however, attached greater importance to the statement about raising the profile of their company to potential customers and investors, when outlining the reasons for their issue.
PAGE 45
4.4 CHOICE OF STOCK MARKET LISTING The choice of where to obtain a listing is often crucial to the success of a companys IPO and this issue was discussed at the interviews and examined in the questionnaire survey. The survey asked respondents about the importance of a range of factors in their decision on which stock exchange to join (table 4.2). A visual inspection of the summary responses in table 4.2 reveals that the firms brokers appeared to have the greatest influence on this decision, closely followed by the views of the companies major investors; the mean scores for the influence of these factors were 1.51 and 1.56 respectively. In the interviews, the views of the brokers were mentioned by two of the four AIM-listed companies and appeared to be especially influential in the decision about where to issue shares for smaller companies.
TABLE 4.2: FACTORS WHICH AFFECT THE CHOICE OF STOCK MARKET FOR FLOTATION Indicate the extent to which each of the following influenced the choice of stock market for the flotation. Views of the firms brokers Views of the firms major investors Costs of the listing Views of the firms investment bankers Industry trends Location of customer base Previous experience Views of the firms underwriters Views of the firms accountants Views of the firms lawyers Secondary trading costs for investors Notes: This table summarises responses to a question about the choice of a stock market. The responses were classified on the basis of a Likert scale where 1 = strong influence; 2 = weak influence; 3 = no influence. N 97 96 98 94 97 95 94 87 97 96 96 Mean 1.51 1.56 1.83 2.07 2.12 2.23 2.30 2.40 2.42 2.52 2.56 Std. Dev. 0.78 0.78 0.73 0.92 0.79 0.80 0.80 0.83 0.72 0.63 0.58
PAGE 46
Interestingly, the cost of a listing was ranked as only third in order of importance by respondents to the questionnaire survey, with a mean of 1.83. A similar view emerged from the interviews where only one of the managers whose company had joined the Official List mentioned listing costs as a factor for the choice of an exchange. In contrast, the costs of a listing were seen as more important to AIMlisted companies in the cross-sectional analysis of the survey responses. Presumably, such firms had chosen AIM because of its less costly listing requirements. Also, the listing fees were probably a greater percentage of a companys market capitalisation for the small AIM firms than for Official List companies. What is surprising about the remaining factors listed in table 4.2 is the high mean score attached to them by respondents, indicating that they were not a strong influence on the decision about which exchange to list upon. All these means were greater than 2.00 and ranged from 2.07 for views of a firms investment bankers to 2.56 for the secondary trading costs for investors. There were some differences between sectors, however, when these mean scores were analysed further. For example, the IT sector respondents considered industry trends to be important in their choice of a listing location, possibly because of the TMT rally which had occurred a couple of years beforehand. In addition, some of the standard deviations were fairly large on these other factors, suggesting that there was a wide spread of opinion among those responding. This was especially notable for views about the extent to which each firms investment bankers influenced the choice of stock market for flotation. The standard deviation of 0.92 was the highest for any question analysed in this paper and suggests that while some respondents saw their bankers as key influences, others did not. A more detailed analysis of the responses revealed that those whose firm had joined the Official List and whose issue was underwritten placed greater weight on the views of these advisers when arriving at their decision. According to the questionnaire, the location of the firms customer base was not very important. In the interviews, however, the customer base, the geographic location of the business and the fact that the market was close to home were some of the most frequently cited reasons for joining a particular exchange. For example, Interviewee E noted that:
PAGE 47
NASDAQ exists and supports the US environment. If you have an edge in the US market for some reason your research products are based there, a well-known competitor is based over there, you have lab facilities based over there clearly this gives you one basis on which to enter into that market. From a regulatory point of view the US market doesnt have pre-emption rights and is significantly more accommodating. Interviewee F, whose company had undertaken a US listing agreed with this view. He stated that: Strategically we had decided that one of our next major steps would be an acquisition in the US and we entered into discussions[A US listing] is very much a sign that you are going to do something like that. A US listing was a precursor to us making a US acquisition. On choosing a full listing on the New York Stock Exchange rather than NASDAQ, he suggested that: It depends on how big you are. If you are not a particularly big company you cant justify a full US listing because it is expensive. You have a lot of additional reporting to be done which is extremely onerous. Our reason for entering is that strategically we were going to develop in the US. Interviewee J, an investment banker, also considered location to be important and noted that the primary driver is the geography of the business. Despite the emphasis on location by Interviewee F, the most cited reason for the choice of an exchange in the interviews was that of liquidity. The OFEX market was often thought to lack the liquidity needed, while the German NeuerMarkt was thought to lack the regulatory framework that UK firms viewed as necessary. An active market, with a strong reputation, was deemed to be important by a majority of those consulted, especially the advisers. However, not all the interviewees saw liquidity as a problem. For example, Interviewee G stated that:
PAGE 48
With hindsight Im still not sure what the main market would have given to us. But the one issue that we have with listed shares at the moment is complete absence of liquidity. As we dont need to raise more money, and the board still controls the company [it is not a problem]. A third reason for choosing a particular exchange, according to the interviewees, related to the size of the company; a larger company would not bother to list on AIM while a smaller company would probably not be able to get a full listing on the main market. Interviewee H argued that a small company, tightly held and only looking for a quote would list on AIM. Interviewee I went further and noted that: The smaller companies might just go onto the OFEX which isnt really an exchange. Quite a few companies go on to AIM because of its lighter regulation you can do transactions without going to the shareholders for approval, it doesnt incur the same amount of costs and time in complying with regulations. But the downside of that is a lot of institutions are not allowed to invest in it they only look at the bigger companies. And even if they go to the full list, smaller companies are still being shunned by a lot of institutions.31 Other factors that were mentioned by the interviewees who chose to join AIM were the short length of the trading history of the company, the previous experience of the management and the fact that some other exchanges took a long time before a firm finally came to the market. Obtaining the best price and the after-market performance of the shares were highlighted by those who had opted for an IPO on the Official List. The advisers noted that the risk ratings of a company were affected by where they chose to list; also, they mentioned that some directors were frightened of the US market because of its more onerous reporting requirements. In the questionnaire survey, respondents were asked to comment on the reasons for their choice of an exchange. The most frequently cited reason for their choice of a particular exchange, which was not included in the list in table 4.2, was tax and compliance costs. Companies listed on AIM qualified for the Enterprise Investment Scheme but Official List companies did not. Similarly, AIM companies were able to
PAGE 49
seek funding from Venture Capital Trusts but their full-listed counterparts could not. Ongoing compliance costs and the ease of raising money on AIM were frequently noted in respondents comments, as was the fact that the amount of senior managers time which had to be devoted to PLC issues after the IPO in the UK was far less than that required in the US. The currency of an acquisition was also noted by one respondent as being a consideration when his firm decided where to list. 4.5 ALTERNATIVES TO AN IPO Table 4.3 shows the mean answers for a question in the postal questionnaire that asked respondents about alternatives to raising funds other than an IPO. An analysis of these means reveals that none of the alternatives listed were strongly considered; all the means were greater than 2.00. Raising funds through the issue of private equity, a trade sale, a merger, an introduction, or the issue of short-term or long-term debt were not considered to any great extent. A more detailed analysis of the individual responses suggested, however, that private equity was more likely to have been considered by AIM companies than their Official List counterparts.
TABLE 4.3: ALTERNATIVES TO AN IPO Were any of the others considered as alternatives to the IPO? Private equity Trade sale Merger Introduction Long-term debt financing Short-term debt financing Notes: This table summarises responses to a question about alternatives to IPOs. The responses were classified on the basis of a Likert scale where 1 = strongly considered; 2 = weakly considered; 3 = not considered. N 95 94 94 91 93 93 Mean 2.06 2.48 2.55 2.70 2.67 2.77 Std. Dev. 0.78 0.68 0.63 0.53 0.60 0.49
PAGE 50
Therefore, the respondents considered that the IPO was the best route to obtaining finance for the amount required at a reasonable cost. An IPO gave a value to the company, allowed an exit to major shareholders and resulted in less dilution of ownership. The IPO was also seen as providing long-term gains to existing shareholders by establishing a more liquid market for their shares. Another reason why an IPO was chosen was that the existing shareholders did not want to lose control of their company, but wished to maintain flexibility. A number of the comments suggested that companies had already used private equity, debt or venture capital before and that the IPO was the only alternative left to them. Several also noted that there were no suitable candidates for a trade sale or merger at the time of the IPO. Some respondents admitted that the IPO had been undertaken because a window of opportunity had arisen and the company had taken advantage of this window, especially for cash burn start-up companies. In the interviews, venture capital had been considered by half the AIM-listed companies and borrowing had been a possibility for one of the larger firms, but most of the AIM companies were too small to be able to raise sufficient funds through an issue of debt. As Interviewee A also noted: companies with no revenue would find it impossible to raise debt. Debt was also thought to be more useful at a later date after the successful launch of the flotation. In general though, the flotation was considered to be the only option and other alternatives were not taken any further. 4.6 ISSUE COSTS The costs of raising finance are often highlighted in the academic literature (Bank of England, 1990) and the professional press (Benoit, 1999) as an important consideration for companies undertaking an IPO; indeed the MMC enquiry into issue fees and underwriting costs has added to this general perception (Gapper & Lewis, 1996). The respondents to the postal questionnaire agreed with this view (table 4.4). Some six of the seven cost items mentioned were given mean scores of less than 2.00 while four were less than the mid-point, in this range, of 1.50. The most significant cost for the respondents to the questionnaire survey was legal fees, having a mean score of 1.18 and a standard deviation of only 0.39. This ranking
PAGE 51
contrasted with the views put forward in the interviews, where the costs of lawyers and accountants were deemed to be insignificant by the larger companies. In the interviews, however, half the AIM-listed companies noted that the legal fees were very high, and as most of the questionnaire respondents were also AIM-listed, this may explain the apparent contradiction. Legal fees were also less significant for industrial companies, where it was possibly easier to identify the assets and liabilities of the company.
TABLE 4.4 THE SIGNIFICANCE OF DIFFERENT COSTS IN THE IPO PROCESS Indicate the significance of each of the following costs during the flotation process. Legal fees Management time Accountants fees Brokers fees Underwriters fees Investment bank fees Direct costs Notes: This table summarises responses to a question about IPO costs. The responses were classified on the basis of a Likert scale where 1 = highly significant; 2 = weakly significant; 3 = insignificant. N 98 100 100 97 81 85 99 Mean 1.18 1.22 1.33 1.39 1.75 1.80 2.23 Std. Dev. 0.39 0.50 0.51 0.51 0.86 0.87 0.60
The second most significant cost, according to the questionnaire respondents, was management time; many indicated that this cost should not be underestimated when companies raise finance. Management time was not really specified as a cost in the interviews although the interviewees clearly believed the management time involved in an IPO could be excessive. As Interviewee G stated:
PAGE 52
The newly acquired finance director did nothing but getting the accounts up to slate and running the [IPO] process from June right through to October. The chairman similarly was he was kind of fed up going around doing presentations. Meanwhile the rest [of the executives] just got on running the business, so we managed to limit it to two individuals [plus myself] in the business. Accountants fees and brokers fees were the next two most significant cost factors, according to the questionnaire responses, although the IT sector did not consider brokers fees to be as important. Underwriters fees and investment bankers fees were of much less concern, while the direct costs of an issue, such as the printing of a prospectus, were not rated as significant. Underwriting costs and investment bank fees were of more importance, however, to Official List companies and to those that undertook an underwritten issue, while accountants fees were rated more significant by AIM-listed companies. In the interviews, the brokers costs and underwriting costs (where applicable) were thought to be the most expensive features of an IPO, with most of the interviewees commenting on their magnitude. Interviewee I had his own views about the fee structure: From a pound point of view, the biggest cost normally is the underwriters fees. And last year it was 7% just as a sort of placement fee. And the smaller you are down the scale of fund-raising the bigger the percentage. We might be raising 10m but 1.5m might go on fees. [Among] the suite of fees, the underwriters are by far the biggest. The corporate finance advisory [fee] which is totally separate wouldnt be that big in comparison. Legal fees might be big depending on the business [such as] if youve got an IT [company] where you need lots of specialist input. You can have a number of lawyers who might have a look youd have the lawyers to the VC [venture capitalist], to the company, to the underwriter and to the sponsor so that all adds up. But by far the biggest chunk would be the distribution. Other costs mentioned by the interviewees related to the public relations consultancy fees, the distribution costs and the fact that the system in the UK had gone American and used the book-building approach. Investment bankers costs
PAGE 53
were only deemed to be expensive by the larger companies that had obtained a quote on the main market or in the US. In general, however, the benefits of the flotation were seen as outweighing the costs. A statement about this issue involving a five-point Likert scale, where a 1 indicated agreement and a 5 suggested disagreement, yielded a mean score of 1.83; this mean was significantly different from the neutral value of 3.00. Net of expenses, however, the money raised was sometimes unsatisfactory; the amount raised was about the same as planned or less than planned and a question in the survey on this issue obtained a mean score of 3.11 using a five-point Likert scale. Respondents to the survey were asked to comment on the scale of the issue costs of the IPO. A number stated that the issue costs were larger than expected and were especially high for small companies. For example, one respondent stated that the total fees absorbed of 1.5m from 10m of new money is very expensive. Another argued that from a market capitalisation of 21m they were able to raise 10m net of fees. Costs of 10% to 20% were not uncommon for some of the respondents. One respondent complained bitterly about the accountants fees being outrageous for a pointless document and that calculations such as working capital projections were not very useful for small dynamic companies. Another stated that there is too much red tape which only makes the lawyers rich. In contrast, one respondent countered that the advisory fees are just a function of being assessed and it will cost to do most things. A number of the respondents commented that AIM/small companies have an illusion about being publicly quoted. Share bargains are really only on a matched basis as there is no liquidity. In some cases it was all about managing expectations correctly. Compliance costs were of concern for small companies where the rules are aimed at large companies and the costs of operating as a quoted company were greater than envisaged. The costs of complying with the new corporate governance guidelines, and appointing new chairmen and non-executive directors all added to the expense of the flotation.
PAGE 54
4.7 SELECTION OF ADVISERS AND SECONDARY MARKET TRADING The interviewees were asked about how they selected their advisers, such as bankers, brokers, lawyers and accountants, to assist with the IPO.32 According to those interviewed, the most common approach to selecting an investment banker was to hold a beauty parade and choose an adviser with whom the managers felt that they could work closely. As Interviewee E commented: Prior to the listing we had done various roadshows and beauty parades to the main ...players in the City. Out of that we formed various relationships and worked with those relationships. This approach was only feasible for the largest companies, however, and smaller companies frequently had trouble in finding a sponsor. As Interviewee D reflected: You are obliged to have one but they dont do anything for you. You are completely off their radar. Its like extracting teeth its very difficult to get their attention. When the markets were very busy, interviewees felt that it was difficult to get any of the brokers to look at smaller companies; sometimes these smaller companies had no choice of broker at all. As Interviewee G stated: Panmures were just too busy, we couldnt get their attention we were too small for them. Therefore, his firm was left with those who could do it and who would talk to us. Interviewee J, an investment banker, confirmed this view. He admitted that his firm would not really look at any company trying to raise less than 100m. Once a broker and sponsor were appointed, they were very important to smaller companies in advising them on certain aspects of the issue. For example, Interviewee G stated that they relied on such advisers to tell them: how much is this business worth, how much can we raise and when can we raise it and who should we go and talk to, which prospective investors?The brokers job is to get enough people [interested] to get us our ten million.
PAGE 55
You know, they were doing some juggling[if a fund] comes in and they say well do it but we want say two million ..it would be allocated so they got their two million. Its not like the scaling down that you get in a tender offer. The broker decides from the offers that are made who is going to get [the shares]. The choice of a sponsor was also important in inspiring confidence among potential investors. As Interviewee J highlighted: The sponsor is going to have to lift every carpet in the business to see that things are all right underneath. The brokers also appeared to be very powerful in the IPO process. For example, Interviewee A commented that their broker had allocated the shares without talking to them. The Board had promised some shares to a fund manager and the broker had already notified investors of their allocations of the shares without consulting the company. As a result, their fund manager ended up with nothing. For some groups of advisers, the selection process was unnecessary as relationships were already in place or had been inherited from previous transactions. One of the interviewees IPO was undertaken, in part, to break away from its parent and the parents adviser was used for the listing. This was not very successful, however, as a conflict of interest arose and, with hindsight, a new adviser would have been the preferred option. Interviewee D was also unhappy with the quality of the advisers that his firm used: I came to this completely naive.. I was disappointed by the general levels of expertise of the various professionals involved. Various individuals were good, but I was expecting the whole process and standard of the level of people you meet to be jet set .. but they were just ordinary people. We are so small that we get assigned the C team each time. The track record and previous experience of an adviser were important. The company wanted to know that the adviser had all the requisite skills for the sort of
PAGE 56
listing being envisaged: whether the listing was in the UK or US and whether it involved AIM/NASDAQ or the main board. The analyst coverage, research ability, capital base and distribution channels of advisers were also vital to some listings. For example, if the issue was not fully subscribed, the bank might have to take up an allocation of the share capital itself. Interviewee J stated that: A typical investment bank will have analysts on the broking side who know the industry and sector very well and that can be extremely valuable both in terms of assisting with the flotation valuation, understanding the market, but more importantly when it comes to selling the issue. Major shareholders typically ring up the leading analysts in the sector and ask them about it, irrespective of what the management said. If the sponsor has one of the leading analysts thats of enormous value, whereas if somebody rings up the analyst and they say a load of rubbish they wouldnt touch the issue. So the ability to have research is very important The other important issue is capital. If again the market is a bit dodgy it could be the only way you get the issue away is if the bank itself takes some of the shares. A research capability was also important for ensuring that there was a liquid aftermarket in the shares once the IPO had occurred so that secondary trading would be efficient. A number of the companies, however, especially the smaller firms listed on AIM, did not consider the secondary market for their shares at all; it was mainly the US listing and Official List companies that were more concerned about the after-market. As Interviewee D commented: We didnt want liquidity in the shares, in a way, to start with just stability in the share price. This was especially so for those that wanted to raise further finance through a rights issue. One adviser thought that companies should give more thought to the secondary market, especially once the market dried up. In general, depending upon the level of activity in the market, the large companies tended to go to the pre-eminent banks and brokers and hold beauty parades for the
PAGE 57
selection process. The medium-sized companies tended to focus on the mid-tier banks and corporate finance departments of the Big Four accounting firms, while small companies had to search around to find anyone willing to sponsor them. 4.8 CHANGES IN THE PERIOD BEFORE THE FLOTATION Corporate governance has grown in importance in the last few years, with the publication of the Cadbury (Committee on the Financial Aspects of Corporate Governance, 1992), Greenbury (Greenbury, 1995) , Hampel (Committee on Corporate Governance, 1998) and Turnbull (ICAEW, 1999) reports. It is therefore no surprise that improvements in their corporate governance processes were the most dramatic changes that companies had to make before their listing was completed. According to table 4.5, this factor had the lowest mean score when the responses to the questionnaire were analysed.
TABLE 4.5 CHANGES IN THE PERIOD BEFORE THE FLOTATION Did the decision to float result in any changes to the following in the period leading up to the flotation? Corporate governance procedures Investor relations function Top management personnel Brokers Lawyers Auditors Investment bankers Accounting policies Notes: This table summarises responses to a question about changes before the flotation. The responses were classified as: 1 = changed; 2 = not changed. N 99 98 100 94 100 99 76 100 Mean 1.33 1.38 1.54 1.65 1.71 1.75 1.76 1.80 Std. Dev. 0.47 0.49 0.50 0.48 0.46 0.44 0.43 0.40
PAGE 58
Two of the interviewees also noted that audit and remuneration committees as well as other governance procedures had been introduced in their firms before the flotation. Several of the interviewees also stated that non-executive directors had been appointed to improve the accountability of the organisation. Accountability was also mentioned by Interviewee J who stated that: Theres obviously much, much more accountability being a listed company. Theres more and more every day. And this actually puts people off it really does. In addition, the investor relations function usually had to be upgraded before the listing could take place. However, this upgrade was normally only required for larger companies. For example, Interviewee J thought that companies with a potential market value of over 1 billion would possibly appoint an investor relations team about six months before the float; other companies would not have the finances to undertake such an operation. Companies sometimes had to change a number of the top management personnel, often bringing in a new finance director. A change in top management was mentioned by four of the ten interviewees. For example, Interviewee D highlighted that: I stepped down from being CEO: exactly the wrong thing because it didnt match my personality. I dont have a management background at all. Once we grew the company quite quickly, then the job of chief executive became a different animal. I was absolutely fed up with the City a complete waste of time! They are not interested in strategy, only in our numbers We cant afford a chief executive in a way, on a half a million turnover but then can you afford not to have one? The change in top management and the appointment of non-executive directors is not always easy. As Interviewee J noted:
PAGE 59
You can have typically the strong entrepreneur who has a salesman type mentality and a very successful man with a great deal of knowledge and character and you might have a weak finance director. And its often the case that you say Im sorry I cant float your business like that youve got to change finance director and that causes a lot of grief. Then obviously you want non-executives as well. Now most people I think, welcome the idea of non-executives. I think the non-executive system, when it works well, is very good and sensible. There are some head-strong chief executives who are very reluctant to appoint and appoint the local bank manager and golf pals and people that will say yes to him. And that will cause grief as well as you have to say sorry, I need strong independent people to turn up here. Changes in brokers, lawyers, auditors and investment bankers were less evident as were changes in any accounting policies that had been adopted by a company. It was much more likely that the investment bank or senior executive was changed if a company was seeking to join the Official List. Changes in auditors and lawyers were mentioned by a number of the interviewees; often they discussed the need to replace the existing accountant with a Big Four auditor. Investment bankers and brokers were more likely to have been changed by the consumer sector companies, while auditors were replaced by IT companies. From the interviews, it emerged that the group structure often needed simplifying and the accounting procedures needed to reflect these changes. Other changes noted by the interviewees concerned directors insurance for protection against risk, the need to forecast cash flows and the requirement to appoint public relations consultants. Interviewee J added that what changed most was sleeping habits.
PAGE 60
4.9 CHANGES AFTER THE FLOTATION PROCESS Table 4.6 shows the responses to a question about whether any changes had occurred in the organisation since the flotation. According to an analysis of the responses, corporate governance procedures again witnessed the greatest amount of change, although not to the same extent as before the listing. For example, Interviewee G stated: We do now have a board timetable that we did not have before.. .There is now a weekly management committee and so the board now talks a lot about strategic issues.
TABLE 4.6 CHANGES IN THE PERIOD AFTER THE FLOTATION Did the decision to float result in any changes to the following in the period since the flotation? Corporate governance procedures Top management personnel Investor relations function Brokers Lawyers Accounting policies Investment bankers Auditors Notes: This table summarises responses to the second part of a question about changes after the flotation. The responses were classified as: 1 = changed; 2 = not changed. N 98 98 99 98 99 100 79 100 Mean 1.53 1.56 1.58 1.76 1.80 1.80 1.85 1.87 Std Dev 0.50 0.50 0.50 0.43 0.40 0.40 0.36 0.34
The industrial companies and the IT companies were more likely to change their corporate governance and investor relations functions after the flotation. Brokers, lawyers, auditors, investment bankers and accounting policies were all less likely to be altered after the listing. The focus of top management was also likely to change.
PAGE 61
As Interviewee J argued: The pure hassle of management having to spend a lot of time dealing with the press and shareholders and what have you is quite distracting. Among the interviewees, there was no consensus on any important change that had occurred after the IPO. Some of the changes that did occur took place in order to maintain momentum, to ensure that there was adequate analyst coverage, to implement new financial controls, to announce quarterly results and to pay quarterly dividends (US listing), to deal with rapid growth, to adjust to the culture shock of being a quoted firm, and to get used to the initial publicity and then the feeling of anti-climax once the IPO was over. For example, Interviewee J noted that: Theres huge publicity at the time of the float, and the entrepreneurs picture is in every newspaper and hes a hero and all the rest of it and then it all dies down afterwards and its a terrible anti-climax. The respondents to the survey were asked for comments about any of the changes that had occurred either before or after the flotation. A number noted that their contacts at the broker or the investment bank had left; a specialist in-house analyst had departed from the brokers, and no one had been appointed to replace them; or stronger corporate advisers were required, causing them to change adviser. Sometimes the advisers professional competence was a concern with one respondent claiming that the auditors were sacked for being useless and we outgrew the brokers. Some noted that there had been changes in the Board structure; its workings had changed with new chairmen and non-executives being appointed before the flotation and with finance directors often being appointed or upgraded pre- and post-float. New appointments were made, especially in start-up situations where there may not have been any internal expertise, or where stock exchange guidelines had not been met. The corporate governance issues and accounting policies, however, were often changing as new regulations came into force, such as FRS 19. Some changes had occurred after the flotation because a company had subsequently been acquired by another firm. One company had dispensed with its investor relations function as it had not been cost effective.
PAGE 62
4.10 DIFFICULTIES ENCOUNTERED DURING THE IPO PROCESS The biggest difficulty encountered by the interviewees in the IPO process was that managements attention was often distracted from running the firm. The managers often had to keep the company operating while simultaneously spending an enormous amount of time on the IPO. It was difficult to do everything and managers sometimes let the operational side of the business slip. As Interviewee D reflected, the workload was just stupid at that time. Interviewee C also noted that: It places a lot of demands on the time of the executive team and you have to be careful about how you manage that at the same time as you are managing a business in fast growth mode. To help manage the business and the IPO, Interviewee C pointed out that: We split into two halves and we had a team that was focusing solely on the IPO and IPO process off-site; we hired offices and rented accommodation. Then we had the rest of the team who were running the business. People flitted between the two on occasion, but we ran it like that. This worked well. The second most important difficulty was that of sorting out the balance sheet structure of the company, as well as the accounting policies and systems when complying with US GAAP (for the US-listed company). The next major issue was that of the cost of raising the finance, already discussed in detail above. Determining the amount to raise, the issue price and the value of the company were all difficulties that were encountered by the interviewees. With fluid, dynamic markets, getting the pricing and timing decisions right was very difficult. One problem highlighted by the interviewees concerned the importance of establishing lock in agreements so that shareholders did not sell their equity capital too quickly and deflate the share price after the IPO. The dilution of earnings was a worry to some of the executives, while the small shareholder base and the presence of large block shareholders were also seen as a problem during the flotation process. The only other issues raised by the interviewees were the need to make very quick
PAGE 63
decisions and the requirement to get the investment proposals correct. The advisers to the companies had a different list of concerns. They considered that the cultural change from being ones own boss to being accountable to outside shareholders was very difficult for some managers to deal with. As Interviewee I stated: I think the culture is a big difference particularly for an owner-manager business where they might have a dominant individual who owns 75%, say, who is used to doing what he wants to, has his car on the books, has his wife on the books, and that just doesnt work in the public arena. Its a big cultural difference. Often new executives had to be appointed and top management changed, and this also caused its own difficulties. Preparing the prospectus and undertaking a number of road shows was a problem for some companies, depending upon the strengths of the top management team. Other difficulties mentioned by the advisers involved changes in taxation, corporate governance, contracts and the distribution of the shares. According to these individuals, taxation was often understated as a reason for choosing a particular exchange or for a de-listing. As Interviewee J stated: Theres actually now quite big tax penalties for being quoted rather than unquoted. The reverse of what it used to be. For instance, you get far better capital gains conditions for an unlisted company than a listed company . There is no capital transfer tax on unlisted companies. There is on listed companies one of the huge reasons for going private is that theres no capital gains tax on trust investment and more importantly theres no capital transfer tax. Overall there were a number of difficulties to be considered before undertaking an IPO, and different problems were encountered by different companies, depending upon their strengths and weaknesses in the run-up to the flotation. In general, the flotation process was about as difficult as expected by most respondents to the
PAGE 64
survey; the compliance with stock market listing rules was not as difficult as expected and the main problem since the flotation concerned the need to satisfy the expectations of institutional shareholders. As one respondent wrote: the problem of tightly held shares is the ability to sell even small quantities and has a major influence on the share price. Brokers/companies/PR need to create a real market. When brokers sell the IPO shares to major institutions there is no liquidity. One respondent complained that: a major institution acquired a shareholder and dumped the shares because we were too small. We have never been able to recover from this. The allegiance of institutions also annoyed other respondents, one of whom claimed that even though they had hit the numbers promised the institutions either sold or were weak holds and continued that: this spinelessness has made us seriously question whether the flotation was worthwhile. The IPO had unanticipated consequences for a companys operations as well. One respondent noted that: it had a surprising affect on customers. When the company was doing well and the share price was buoyant, the customers were happy. When the company was doing poorly and the share price was down, customers were concerned for the companys future and drove harder bargains. Another respondent claimed that: there was more interest [in his firm] from other companies in the sector since [they had] floated. The CEOs of other companies now think that we are important enough to return phone calls.
PAGE 65
Another executive claimed that the IPO had increased the firms visibility and enabled employee ownership but that it was time-consuming, expensive and as proved time and again in reality gives little protection from rogues. 4.11 CONCLUSION Overall, there were a large variety of views about the process of undertaking an IPO and these were influenced to a large extent by the size of the company and the choice of exchange. There was general agreement, however, that the decision to launch an IPO was not something that should be taken light-heartedly as it is a very time-consuming process, very stressful and often very costly.
PAGE 66
5. Empirical evidence on the SEO process
5.1 INTRODUCTION This chapter discusses the findings from the interviews and questionnaires regarding SEO decisions. The chapter is divided into sections based on the key issues that arose from the research, and concludes by summarising the main implications gleaned from communicating directly with the parties involved in the process. In particular, the lessons learned from the study regarding the suitability of conventional large sample analysis when examining corporate decision making are highlighted and some possible developments suggested to the regulation of equityissuing practices in the UK, in the light of the interviewees and respondents comments. The extensive nature of the discussions with the interviewees suggested that, in practice, firms devote considerable attention to the choice of SEO method. To investigate further the importance of the decision, respondents to the questionnaire were asked to state their views on the matter. As table 5.1 shows, a clear majority of respondents (48 out of 62) agreed or strongly agreed with the view that the decision about SEO method is of major importance; the mean score of 1.87 was significantly different from the neutral response score of 3.00. This pattern in results held for both Official List-based firms and those quoted on AIM.33 These figures appear to confirm that the SEO method is seen as important by firms that have recent experience of the process. 5.2 ADVISER INFLUENCE The conventional finance literature pays little direct attention to the influence of advisers on major corporate decisions. For example, Burton & Powers (2003) study of the choice of SEO method makes no reference to such matters. In contrast, all the interviewees referred to the important influence of advisers. The views of most of the firms interviewed are summed up by Interviewee N, the group treasurer of an Official List firm, who suggested that it was common practice for firms to: go to their advisers ... and say we need to issue equity to shore up the balance sheet what should we do?
PAGE 67
Empirical evidence on the SEO process (continued)
Interviewee L gave some examples of the way in which adviser input can influence SEO decision making. He stated that: Our key institutional investors may be in a position where theyve been taking up all of these rights and theyre overweight in our stock ... Thats where your broker comes in and says your top five holders are not that keen on building up their equity any further and they may go out and bring in some new institutions. In one specific case, the firms advisers had come up with a novel proposal combining elements of a rights and placing offer. The interviewee pointed out that it was: a structure that [the investment bank] came forward with very unusual. It had never been done before. The interviewees at the fund manager (S) noted another way in which advisers could tip the balance in favour of a particular issue method; a pertinent question might be: How rich is the investment banker? If its a lightly capitalised UK merchant bank, theyll tend to push towards the market with a placing. Although external advice was generally accepted by interviewees as being part of the share-issuing process, Interviewee N pointed to the danger of a conflict of interest: The adviser should give advice and then you should seek a supplier, but that is not what tends to happen in my wider experience An adviser should be frozen out from being a supplier, but that is not how it works. Interviewee Q, from an AIM-listed firm that had made its first SEO within two years of listing, also acknowledged the influence of advisers, but pointed to problems regarding broker relations in the interim:34
PAGE 68
Since the IPO we have looked at changing our broker and thats been an interesting experience. The broker chose not to choose us. Interviewee O indicated that changing advisers at the time new equity is being raised would not necessarily be wise: I think a good finance director would not want to get to the point of wanting to raise a rights issue and then say well who should I get to do it? Interviewee R, noted that the same adviser would normally be used for the takeover activities of small firms and any shares issued to fund them, whereas for larger companies this was less likely to be the case. The comments made by the fund managers indicate that the failure to consider the advisers role may represent a significant omission from prior studies of corporate fund-raising practices. It is also clear, however, that even if this factor could be modelled by researchers, the nature and strength of the influence varies so widely from firm to firm that it would be extremely difficult to explain and predict corporate behaviour on the basis of aggregating data across large numbers of firms at different times. The fund managers also noted that merchant banks are now active participants in the market, trying to stimulate business in sectors where competitors are already proceeding with an SEO. They note that a companys decision to raise funds by issuing shares varies from one firm to another, however, according to the experience and background of the executives in charge: There are companies that listen to their Merchant Banks and there are companies that dont ... [Some companies] have a strong independent capability ... and have a view about what they are doing ... there are others ... with different objectives such as making the firm bigger ... If a company is driven by a sales man, they will listen to the bankers more but if its driven by a finance man, they will be [guided by] the numbers. The complex nature of the adviser-firm relationship was confirmed by Interviewee K who pointed out that:
PAGE 69
different houses have different expertise and to some extent that has an element of influence [on the issue method]. The comments made by the two advisers interviewed for the study appeared to confirm the views of the firms themselves. Interviewee U, the investment bank representative, pointed to the importance of the pre-existing relationship between an adviser and client, particularly with regard to predicting shareholders likely response to a call for funds: The broking adviser would be the first people they [the firm] would be most likely to go to do a share issue it would be highly unusual for them not to go to an established adviser. A corporate brokers going to know the shareholders, who they are, what theyre thinking, who wants to take up the shares, who doesnt. The interviewee from the large accountancy firm agreed with this view about the importance of advisers at all stages in the external fund raising process: The question is, I [the firm] want to raise some money. Why, how much, when? And then whats the most efficient way of doing this; is it through debt or is it through equity? If its through equity, whats the best way to structure it? This interviewee also highlighted the potential conflict of interest between brokers and corporate financial advisers: What we say to clients is, if you have them together there is a natural conflict because if your financial adviser is from the same house he has one eye on the biggest fee which is the underwriting commission, whereas what we say is if we act as your financial adviser and we get somebody else to act as broker, we can test that by going down the right route and let you know if youre being completely screwed and we can help if you want to get a different broker.
PAGE 70
The role of the broker was confirmed, however, because the ability to issue new shares ultimately depends on what the markets doing so the input from the broker is paramount. The interviewee from the investment bank suggested that the sort of adviser required might depend on market conditions: If its on a [bear] market or an average market then the actual ability to sell the shares is terribly important and thats when you must go to somebody whos dealt with these things and knows the market. Accountants ... wouldnt have the experience to deal as a broker. Finally, Interviewee T, the accountant, pointed out that in one specific instance the underwriters themselves influenced the issue method. The case involved a large issue where a placing with clawback had been employed. The underwriters had apparently suggested this route to the company as they (the underwriters) wanted to end up with some of the new shares and there was no guarantee that this would have happened with a conventional rights offer. Interviewees views about the role of advisers were tested with the postal questionnaire. A total of 55 out of 63 respondents35 agreed or strongly agreed with the notion put forward that input from advisers is a major influence on the SEO method and, as table 5.1 indicates, the average score of 1.70 was significantly different from the neutral response of 3. Inspection of table 5.1 also reveals that there was less support for the view that advisers were a major influence on equity issue timing, although the average responses did not differ significantly.
PAGE 71
TABLE 5.1: OVERALL VIEWS OF THE SEO PROCESS N The choice of method used to issue equity is a decision of major importance The timing of an equity issue is a decision of major importance Input from advisers is a major influence on whether a rights issue or placing is used to raise equity capital Input from advisers is a major influence on the timing of a share issue The 5% pre-emption limit on share issues other than rights offers is the main determinant of whether a rights or placing issue is used for equity fund raising The removal of equityholders pre-emption rights to participate in new share issues would be a positive development Notes: This table summarises responses to questions about the SEO process. The responses were classified on the basis of a Likert scale where 1 = strongly agree; 2 = agree; 3 = neither agree nor disagree; 4 = disagree; 5 = strongly disagree. * indicates that the mean was significantly different from 3 at the 5% level on the basis of a twotailed test. N = sample size. Further details about the responses are contained in the Appendix. 63 2.83 1.07 63 2.94 1.09 63 1.86* 0.74 63 1.70* 0.82 63 1.37* 0.49 62 1.87* 0.80 Mean Std. Dev.
Table 5.2 reports the results obtained when respondents were asked about the influence of a number of factors on the choice of SEO method, including that of external advisers. The findings indicate that brokers were seen as having the strongest influence on the decision, followed by major investors, investment bankers, previous experience and then underwriters. The mean score of 1.14 for a question about the influence of brokers, indicated stronger support for this factor than any other, while the most popular response to the question about the main
PAGE 72
influence on SEO method was also the advice of brokers. In contrast, lawyers (with a mean score of 2.14) and accountants (2.35) were seen as having a more limited role in the decision process.36 5.3 COSTS Although research studies have begun to analyse the costs, both direct and indirect, of alternative equity issue methods, little is known about firms perceptions of the significance of these costs and their impact on equity issue method choice. In particular, US evidence has failed to detect any relationship between the cost and popularity of alternative issue methods; rights issues have virtually disappeared despite the fact that they have been shown to be considerably cheaper than the more popular firm-commitment37 issue method (Eckbo & Masulis, 1992). The issue of costs therefore formed a key part of both the interview and questionnaire surveys. 5.3.1 Nature of costs
The interviewees saw their main direct costs as including underwriting, broking, printing, lawyers fees and accountants fees, with the first two of these usually being referred to as the most significant. There was a clear awareness of each cost element, however, including those of an indirect nature such as management time and the organising of roadshows.38 For example, Interviewee L noted: We estimate the cost before the deal effectively gets signed off and approved. I suppose that is the issue costs, the legal costs, your printing cost, all of those things. At the same time we also assess the roadshow management time. Over the last six to twelve months weve actually taken a better view of these things. Interviewee M indicated that such costs can be linked to a transaction underlying the share issue:
PAGE 73
Management time is important ... It usually involves months but it depends on the nature of the deal, whether its hostile or friendly. Interviewee R, from an AIM-listed firm, noted that for companies such as themselves: the cost of a placing depends on the work needed to drum up support ... An acquisition is an easier story to tell in terms of persuading the market of the need for funds. Interviewee K pointed out that although cost relative to issue size was always going to be of importance, it would not necessarily be the overriding factor: There may be a point in time ... when your requirement for funds is such that you have to bite the bullet and take it at that cost. This final quote concurs with the fund managers point of view that, in many cases: entrepreneurs just want the money and the costs are almost secondary. The investment bank representative agreed with the view that managerial time was significant, but suggested that it is typically only a quarter of the time of an IPO. The accountant raised the issue of the possible reduction in costs for nonunderwritten rights and placings but suggested that: The company is at risk if they dont raise the money. There was one transaction recently where it wasnt underwritten but the overall fees to advisers etc. were still significant. 5.3.2 Rights versus placings
All the interviewees reported having formally analysed the costs of the SEOs that had been undertaken, yet none appeared to have performed comparisons of the rights and placings options beforehand. Most of those interviewed tended to see
PAGE 74
the costs as being linked more closely to the size of the issue than the method used. There was some evidence, however, of a general perception that rights issues were more expensive than placings, other things begin equal. For example, Interviewee P , from an AIM-listed software firm, suggested that the cost of the formal documents required for a rights issue would have been prohibitive for the size of issue which they were contemplating. This view concurs with that of Interviewee R, also from an AIM-listed firm who, although having only ever undertaken a placing, assumed that: a rights issue would have been more expensive, although (we) dont know the exact costs. One of the AIM-listed questionnaire respondents stated that the high cost of documents for a rights issue favour a limited placing. There was some inconsistency among the views of the advisers. For example, while the investment banker stated that: [for] a relatively small issue a placing is simpler and cheaper, the accountant interviewed believed that the overall costs of rights and placings were not particularly different, even in extreme circumstances: If it was just a placing to one investor and there was no extensive paperwork required then in theory it might be cheaper [than a rights issue] but probably not much. There would still be a fee required by the broker, it might be 7%. Interviewee O pointed to the increased visibility involved with production of a prospectus, so much so that a placing was clearly his preferred option in most circumstances: One of the reasons why rights might disappear is that they are much more visible ...Youre back to the pecking order theory of finance, managers do not like to be that visible. Doing a placing is a damn sight easier than having to put a public prospectus out. Thats why I wouldnt do rights. It [the disappearance of rights] doesnt seem like a paradox in the States to me. The questionnaires indicated overwhelming support for the view that rights issues cost more than placings. The results shown in table 5.4 reflect the fact that most
PAGE 75
respondents stated that the costs of rights issues were higher than for placings; this was true for each cost element and for both Official List and AIM-listed firms. For six out of the seven cost elements, the difference between the mean response and the neutral response of 2 was significant; the one exception related to brokers fees which were not perceived to differ between the two issue methods. In terms of total costs, 46 firms believed rights issues to be more costly than placings, while 11 believed that the costs were the same for both issue methods and only four (or 6.6%) of the respondents suggested that placings were more expensive. The mean response of 1.30 was again significantly different from the neutral value of 2. In three cases (lawyers fees, investment bank fees and brokers fees), the perception that the costs for rights were higher was significantly stronger among those firms that expressed the highest level of support for the notion that choice of SEO method is a decision of major importance than among firms that did not. This may reflect variation in the extent to which costs are analysed in detail. These perceptions are potentially interesting given that: (i) much of the anecdotal evidence from the interviews suggested that the lower cost of a placing (both direct and indirect in terms of visibility) derived from the lack of a need for a prospectus for any share issue representing less than 10% of an existing class of capital,39 there was no real enthusiasm among respondents for removal of pre-emption rights and
(ii)
(iii) in the US, non-rights issues have consistently been shown to be relatively expensive. 5.3.3 Costs relative to the value of services provided
The interviewees highlighted a number of concerns about the costs of issuing equity in relation to the service obtained, particularly as regards underwriting fees. Interviewee N held strong views about the value of the underwriting services obtained, claiming that firms do perceive that they are being ripped off relative to the level of risk taken. Interviewee L put forward a similar view:
PAGE 76
The problem I have is that the big guys collude ... Its like a closed shop with equity and syndicate banking; its in nobodys interest to be competitive and get the price down and theres been a lot of overcharging. This view concurs with that of a report commissioned by the Office of Fair Trading (OFT) in 1996, which found that the cost of sub-underwriting often outweighed the risks undertaken. Following the publication of the OFTs findings, the Monopolies and Mergers Commission (MMC) undertook an investigation into the supply of underwriting services for share offers in the UK. The main conclusion of the subsequent MMC report40 was that the use of tendering for the whole of subunderwriting should be encouraged, in order to allow movement away from the fixed cost of 1.25% of gross proceeds typically associated with this part of the process.41 In practice, it seemed that firms were already resorting to tendering at various stages in the process. Interviewee N, who felt that the report itself was a damp squib, noted: We would try to go to more than one potential adviser. We decided to speak to two people about our rights issue ... It worked enormously well in getting a kind of pricing tension. If you only buy from one party youre not going to get the keenest price. This view concurs with that of the investment banks representative who stated that: costs and value are regrettably quite an important element in peoples selection of advisers. The representative of the investment bank also had strong views about the MMC enquirys recommendations, suggesting that: There was a much more efficient system in my view, but the system has been destroyed by the American banks who basically didnt like our system because it involved risk.
PAGE 77
In particular, this interviewee claimed that the move to negotiated and tendered underwriting fees had led to an increase in cost from around 0.75% to 2.5% for placings, and yet at the same time a move from true underwriting to US-style bookbuilding42 had taken place. The net result of this change was that: There are higher fees today and less risk I blame the Treasury ... they started the investigation because they thought the old system was fixed. The fund manager interviewees also pointed to the increasingly important role played by US investment banks and a more general move to American-style issuing practices. Finally, one of the Official List-based questionnaire respondents suggested that the perception of costs may partly depend on the size of the organisation, stating simply that issue costs are far too high and listing requirements too onerous for small companies.
TABLE 5.2 THE EXTENT OF INFLUENCES ON THE CHOICE OF SEO METHOD Indicate the extent of the influence of each of the following on the decision about whether to use a rights issue or a placing when issuing new equity. Industry trends Views of the firms accountants Views of the firms brokers Views of the firms investment bankers Views of the firms lawyers Views of the firms underwriters Views of the firms major investors Previous experience Notes: This table summarises responses to questions about influences on the choice of SEO method. The responses were classified on the basis of a Likert scale where 1= strong influence; 2 = weak influence; 3 = no influence. N = sample size. Further details about the responses are contained in the Appendix. N 63 63 63 61 63 60 63 62 Mean 2.21 2.35 1.14 1.48 2.14 1.78 1.24 1.71 Std. Dev. 0.74 0.70 0.43 0.72 0.59 0.83 0.47 0.66
PAGE 78
5.4 DILUTION AND DEEP-DISCOUNTED RIGHTS ISSUES It can easily be shown that the diluting effect of a discounted rights issue on earnings per share (EPS) is irrelevant in theory and should not, therefore, be seen as a cost (Bhagat & Frost, 1986; Lee et al., 1996; Arnold, 2002). Some of the interviewees pointed out, however, that the situation may not be this simple in practice because of the way in which market participants tend to view the issue. For example, Interviewee N suggested that his company: Sees [the price] as being important in terms of dilution that is what will determine perceptions of your future measured performance. Interviewee M made a similar point, saying that: you cant get analysts and brokers not to look at EPS so it is important that we do as well. Interviewee L agreed, noting that: Dilution is a big issue when the equity market focuses so much on earnings per shareDilution is the key thing that will be highlighted in our internal models, but he also explained that within his organisation some senior personnel remained fixated on the theorised impact of different security issues: Our company secretary ... is a very theoretical accountant. He takes [the view that] things like a rights issue should not impact on your total market value and price ... theoretically the dividend per share shouldnt impact on your price, but in reality, its all a perception issue. A comment made by Interviewee O perhaps sums up the complexity of the issue: I certainly see the discount as [part of] the cost of a rights issue. Do I see that as an economic cost to the shareholders, well, no.
PAGE 79
The interviewees were also aware of the particular problems regarding dilution that can arise when shares are externally placed. Interviewee N noted that: Shareholders on a rights issue should be completely neutral to the issue price with a placing [however] price is very important. You could upset existing shareholders if the placing price is unfairly low. Interviewee Ks views suggested that concerns about dilution might be sector specific and vary across investors: Investors are not so worried about dilution for a biotech company since they are investing knowing that potentially there is a very high reward or significant loss There is a difference in attitude [to dilution] between investors with a US background who are used to investing in biotech companies and a UK investor who is principally involved with older economy stocks. The interviewee from the investment bank suggested that, from their point of view, issue price was a potential influence on whether to use a rights offer or a placing with clawback43 for large equity issues: The placing with clawback was the alternative to a rights issue ... it was quite a good mechanism if you had a lot of people who couldnt take up their rights. With a placing with clawback theyre often better off because its done at a higher price. Finally, the fund manager interviewees suggested that a firm with high dividend pay-outs was likely to prefer placings, other things being equal, because dividends per share (DPS) were often maintained at the pre-rights level.44 It was pointed out that: The dividend comes into play in the UK traditionally when [a firm] has ... held the dividend while the rights issue has been done at a discount. This has made [rights issues] expensive in terms of the cost of capital.
PAGE 80
The unwillingness to adjust DPS after a discounted rights issue is often thought to be linked with concerns about maintaining a high pay-out and taxation policy. The fund managers also indicated that: The tax structure in the USA has driven [dividends lower] over the last decade or two while the tax structure in the UK undoubtedly was biased the other way. They agreed, however, that the recent abolition of Advance Corporation Tax might change this situation. The results shown in table 5.3, regarding the impact of SEOs on EPS figures, reflect the fact that most questionnaire respondents indicated that concerns about dilution would not affect the choice of equity issue method. A small majority of those expressing a preference (14 out of 20 under the current rules; 12 out of 21 if pre-emption rights were removed), actually suggested that a rights issue might be preferred in such circumstances. The above evidence is relevant to the recent renewed debate about the value of deep-discounted rights issues (DDRIs),45 which were the subject of a number of comments from the interviewees. The popularity (or otherwise) of such issues has puzzled researchers in both the US and UK (e.g. Patterson & Ursel, 1993; Armitage, 1998). In particular, their rarity remains something of a mystery, given the reduction in underwriting costs which should, in theory, be possible in such cases.46 Armitage (2000) notes that in the UK such a perception is not factually based and that in practice, underwriting costs for DDRIs are typically greater than for other issues. Armitage suggests, however, that this pattern may simply reflect the fact that DDRIs have often been employed for particularly difficult share issues where the cost is justified on the basis of the risks incurred.47 Notwithstanding this evidence, there was some consensus among interviewees that the coming years will see a significant increase in the popularity of DDRIs. For example, Interviewee N envisaged that:
PAGE 81
What will develop is a trend in that deep-discounting of rights issues is getting recognised as being very appropriate in a lot of cases. You cut out underwriting fees and your shareholders are dealt with more fairly. The interviewee from the investment bank expressed real concerns, however, about the current wave of enthusiasm for such issues, pointing out that there are: Problems in perception in terms of a falling share price, an earnings per share reduction and a reduction in dividends per share as well as practical problems, in terms of both taxation48 and the fact that rights issue entitlements tended to be traded at a theoretical discount, with the absolute sums involved becoming very significant with DDRIs. The interviewee felt so strongly about these matters that he had led the attack during the MMC enquiry and although they were not aware of these issues beforehand: They did know after wed been through it with them. The views of firms appeared to reflect some scepticism about the merits of DDRIs. For example, Interviewee R, from an AIM-listed firm that had recently undertaken a placing of shares, only saw such issues as an option if desperate, while one of the Official List respondents to the questionnaire implied that care was needed if considering a deeply-discounted offer as they involve a different cost and decision profile to a conventional rights issue or placing.
PAGE 82
TABLE 5.3: THE NATURE OF INFLUENCES ON THE CHOICE OF SEO METHOD

Indicate the effect of each of the following possible influences on the choice between rights offers and placings. N Concern over EPS dilution Existence of a narrow shareholder base A relatively large issue size A relatively small issue size The funds are required for takeover activity Recent rise in the firms share price Recent rise in stock market 62 59 61 60 59 61 61 Mean 1.87 2.37* 1.64* 2.67* 1.97 2.08 2.07 1.98 1.98 2.66* 2.05 1.82* 2.02 Std. Dev. 0.56 0.79 0.86 0.68 0.74 0.76 0.65 0.74 0.50 0.68 0.59 0.50 0.34 N 61 57 60 60 59 60 60 60 60 60 60 60 60 Mean 1.95 2.46* 2.08 2.52* 2.14 2.23* 2.17* 2.10 2.00 2.63* 2.17* 1.85* 2.05 Std. Dev. 0.59 0.73 0.87 0.75 0.71 0.74 0.64 0.73 0.49 0.69 0.56 0.48 0.34 -0.08 -0.09 -0.44# 0.15# -0.17 -0.15# -0.10 -0.12 -0.02 0.03 -0.12 -0.03 -0.03 (I) Under current system (II) If pre-emption rights were removed Difference in means between (I) and (II)
Company growth prospects highly favourable 61 Macro-economic prospects highly favourable 61 Funds required relatively quickly Existing gearing ratio above target High dividend pay-out ratio High level of intangible assets 61 61 61 61
Notes: This table summarises responses to questions about influences on the choice of SEO method. The responses were classified on the basis of a Likert scale where 1= favour rights; 2 = no influence; 3 = favour placings. * indicates that the mean was significantly different from 2 at the 5% level.
#
indicates that the difference in means between (I) and (II) was significant at the 5% level on the
basis of a paired t-test. Two-tailed significance testing was used throughout. N = sample size. Further details about the responses are contained in the Appendix.
PAGE 83
5.5 TIMING AND LIQUIDITY The speed with which issues can be undertaken is frequently cited in texts as a major influence on SEO method. Here, the chief advantage of a placing is the avoidance of the 21-day period during which the rights to the new issue are tradable. The main benefit of a rights issue in terms of timing is that separate shareholder approval for the share offer is not required.49 Such matters are also complicated by the fact that many equity issues are now linked to major acquisitions. The favoured policy of interviewees in such instances was to have one extraordinary general meeting (EGM), at which both the takeover and its funding could be voted upon, and this appeared to lead to timing issues as a whole favouring rights issues. As Interviewee M stated, holding a separate EGM to allow a placing for the share issue subsequent to shareholder agreement for the bid itself: would have added an additional contingency to the quality of our bid. If you can come out [of the EGM] with agreement for an underwritten rights issue ... the quality of your bid is better than if you come out with a contingent placing. The firms were well aware of the complications arising in such cases. Interviewee L illustrated this point: I think both a rights and placing can be done fairly rapidly ... There are two [restrictions]. One is whether you need shareholder approval for the acquisition and if you do you will burn up exactly the same time as it takes to get approval for any funding through a rights issue ... After that the prospectus documentation is effectively down to how quickly you can get it drawn up and signed off by the lawyers and the accountants. A week is reasonable for that. Notwithstanding these points, the general view among interviewees was that placings were quicker than rights issues in practice; this was often linked to the perception that placings involve less uncertainty and a reduced need to explain the reasons for the new funding to the market. Interviewee O noted that a placing:
PAGE 84
Gives me certainty, its faster and I have less explaining to do, while a comment from Interviewee L was typical: I think we would always look at the placing first just because its easier. That would be my view. Its easier and its less complicated for our smaller shareholders. One of the AIM-listed respondents to the questionnaire noted that, even when accompanied by a clawback, a placing is: certain and fast. A rights issue is uncertain, expensive, takes time and creates a managerial diversion. From a managerial perspective, placings are faster, cheaper and easier. And on a related note, in terms of flexibility: If it [the placing] is not going well you abort it and nobody is the wiser. Rights issues we do not like to fail. There was some variation in how long interviewees saw the entire process taking, from identification of the need for new capital to the receipt of the funds. Interviewee Q, from an AIM-listed firm that had had recent experience of a placing, admitted to underestimating the time span, stating that: the contractual stuff put eight weeks on it ... wed expected the whole thing to last about four. Most interviewees confirmed that the time periods were not set in stone but were instead contingent on various factors related to formal administration of the issue documents. Interviewee K noted that: The biggest factor in the timing is the requirement for documentation. If the requirements require legal due diligence, working capital analysis, printed documentation, then clearly that will take at least six weeks. [With
PAGE 85
a] private placing involving only one shareholder you can rationalise that process down considerably. The fund managers agreed with this notion and argued that: Timing is important. The small placings can be completed in a matter of days while larger rights issues can take several months. This view concurs with that of Interviewee P , from one of the AIM-listed firms, who noted that: If you have a potential placee and a decent broker you should be able to just call them up and do it there and then. The fund managers also pointed out that the question of timing was becoming less of an issue in the UK: Companies very often have the staff [in place]; they are pretty well teed up to have a rights issue to the appropriate level if the right acquisition comes along ... They will have a lot of the material ready. The managing director of the investment bank pointed out that while in theory a placing without clawback could be done in 24 hours, the need for a clawback could delay the process by up to three weeks; this has led to a greater incidence of firms: Running [their] placing with clawback prior to the AGM so people take it on condition of the AGM approval. Respondents to the questionnaire were asked whether urgency in the need for funding could influence the decision about whether to use a rights issue or a placing. The relevant results in table 5.3 reflect the fact that most respondents saw placings as being faster; 47 out of 61 respondents indicated that such issues would be preferred if funds were needed quickly under current pre-emption rules,
PAGE 86
and 45 out of 60 maintained this when the same question was asked in the hypothetical situation of pre-emption rights having been removed. These responses resulted in mean scores (2.66 and 2.64 respectively) that were significantly different from the neutral response of 2. Overall, the evidence points to the fact that one of the main perceived benefits of placings continues to be the speed with which such an issue can be executed and new equity capital raised. 5.6 ISSUE PURPOSE Earlier studies have analysed the relationship between issue purpose and the nature and effect of debt and equity issues (Mikkleson & Partch, 1986; Jung et al., 1996) and section 5.13 below confirms that issue purpose was viewed by several of the interviewees in the present study as having an important bearing on whether debt or equity was used. In contrast, little is known about how the choice of equity issue method is affected by issue purpose and so this topic was explored in some detail in the present study. Interviewee N pointed to a link between issue method and purpose. His firms most recent equity issue had been a share swap linked to a takeover. This reflected the firms view that: Your first choice depending on strategic circumstances would be to swap share for share ... depending on whether you want the shareholders of your vendor business to be involved with you in the future. Few of the interviewees expressed any strong opinions on the relevance of issue purpose, although one of the Official List respondents to the questionnaire pointed to the fact that: Good positive reasons [for an issue] will boost investor confidence, whereas general reasons indicate weakness and tend to have a negative effect. If this comment reflects a widely-held viewpoint, it might suggest difficulties if attempting to persuade existing owners to commit further to the firm by
PAGE 87
subscribing for a rights issue that lacks a clearly-defined purpose. The investment bank representative saw a further reason for preferring rights issues over placings when attempting a takeover in that the higher discount available in the former case lowers the risk of the bid collapsing because of a failure to raise the capital required. The timescale of the projects for which the funds are required was flagged up by Interviewee K as being linked to issue purpose in the biotech sector: The question is whether the underlying project that you are funding its time scale, its potential and how far down the development scale it is ... will influence the [share issue] method. There is a big difference in going to a shareholder and seeking funds for the short term finalisation of a project and [saying that] we have just launched a new programme which is going to take 5 to 6 years to get to the market place. More generally, the interviewees saw the role of the issue mainly in terms of concern that investors might read something into leaked news of a share issue. As Interviewee N pointed out, if a share issue is linked to an acquisition: the fewer [that know about the share issue] the better ... a tight knit group is desirable.
PAGE 88
TABLE 5.4: VIEWS ABOUT THE RELATIVE COSTS OF RIGHTS ISSUES AND PLACINGS Indicate your views about the relative cost of each of the following for rights and placing issues of equity. Total costs Direct costs Lawyers fees Underwriters fees Investment bank fees Brokers fees Accountants fees Management time Notes: This table summarises responses to questions about relative costs. The responses were classified on the basis of a Likert scale where 1 = higher for rights issues; 2 = same for both; 3 = higher for placings. * indicates that the mean was significantly different from 2 at the 5% level on the basis of a twotailed test. N = sample size. Further details about the responses are contained in the Appendix. N 60 60 60 57 57 59 60 60 Mean 1.30* 1.42* 1.53* 1.49* 1.63* 1.85 1.57* 1.55* Std. Dev. 0.59 0.50 0.60 0.68 0.64 0.71 0.56 0.62
The limited influence of issue purpose on issue method appeared to be confirmed by answers to the questionnaire. Table 5.3 confirms that the average response to the questions that asked whether knowledge that the funds were required for takeover activity would affect issue method was insignificantly different from the neutral response of 2. The most popular response was that this factor would have no influence, irrespective of market and the existence or otherwise of pre-emption rights.
PAGE 89
5.7 TRENDS One of the most important notions in the behavioural finance literature is that individual and organisational behaviour can be strongly influenced by fashions and trends, irrespective of whether these are underpinned by a sound rationale (Statman, 1999). The interviewees were therefore asked about the influence of competitor behaviour on their SEOissuing practices. There was some variability in the views expressed. For example, Interviewee K pointed to sectoral influences: You are influenced by the receptivity of the sector rather than individual companies although he also noted that: If [a competitor] went out and did a rights issue and I then came along two days later ... within institutional eyes they would have less cash for us. Interviewee L suggested that advisers recommendations might be driven by trends in the use of new issue methods: Theres a fashion [among advisers] ... if they have pulled off a new, fancy structure they then go and sell it to somebody else ... The lead arrangers, co-arrangers, the managers are participating in all of this. Interviewee N indicated that there were trends in issue method but believed these to be for sound reasons: We would be influenced by investor appetite as demonstrated by competitor preferences. Although most of the above comments suggest that trends may be driven by rationality and logic, Interviewee O admitted that his firm had issued deferred equity in the form of convertible debt on a previous occasion:
PAGE 90
because it was in vogue and this is what people were doing at the time. The questionnaire asked about the influence of trends on issue methods. As table 5.2 indicates, the responses suggested that this factor is not generally seen as having a major impact on the decision. Only 12 out of 63 responses indicated that industry trends were a strong influence on SEO method choice, and the mean score of 2.21 reflects this view. 5.8 ISSUE SIZE Another potential influence on SEO issue method relates to the amount of capital involved. There was some evidence in the interviews of the 5% pre-emption limit strongly influencing firms to favour placings for small issues and rights for large issues, other things being equal. As Interviewee O put it: In a UK sense the preemption rules just get you ahead of all [other factors]. The interviews with the fund managers expanded on this matter and one pointed out that: In general most companies act for disapplication of pre-emption rules on up to 5% of capital; for some new growing aggressive business ... it is very easy to go out ... and place several thousand shares [which only add] up to 0.1% of capital. Because of the nature of certain businesses, it is much easier to do multiple little deals issuing capital without having to worry about pre-emption requirements at much less cost. In theory, a large issue size should not always necessitate a rights offer, because a placing can be used for any size of issue by combining it with an open offer clawback.50 Analysis of responses to the questionnaire revealed that the association of placings with small issues went beyond the pre-emption rules. For example, responses to the questions summarised in table 5.1 indicated little support for the notion that the 5% limit on pre-emptive issues was the main influence on offer method. In addition, the responses to the question which asked about the influence of a large issue size and the question that sought views about the effect of small issue size, summarised in table 5.3, appeared to confirm this finding. Under current regulations, where a 5% limit applies to non pre-emptive issues, 37 out of
PAGE 91
61 respondents suggested that a large issue would favour a rights issue, with 47 out of 60 suggesting that a small issue would favour a placing. When respondents answered the same questions, but under the hypothetical assumption that preemption rights were no longer in existence, the answers were very different. In both cases, placings were now favoured by more firms than rights issues for both large and small issues, although the mean response was only significant for the small issues. In addition, for both these questions the average response had changed significantly in the direction of the neutral response of 2. This finding appears to conflict somewhat with the findings that indicated that pre-emption rules played only a small part in a firms decision processes. There were some clues in the interviews as to why the association of placings with smaller issues reflects more than the effect of the pre-emption guidelines. Several of the interviewees appeared to see the main benefit of placing small issues being the relative speed with which funds could be accessed. Provided the rolling threeyear limit on non pre-emptive issues of 7.5% is in place, shares can be placed and the funds received within a few days, whereas even a small rights issue requires adherence to the 21-day open period.51 In addition, the interviewee from the investment bank noted: If you want to raise a relatively small amount of money its more likely to be by way of a placing; theres more [readily available] money with a placing than a rights issue. 5.9 SHAREHOLDER STRUCTURE One of the main practical differences between a rights issue and a placing relates to the effect on shareholder dispersion. A placing will normally lead to a broader post-issue shareholder structure than a rights issue and this difference may affect a firms choice of equity offer method. Although the large sample evidence in Burton & Power (2003) suggests that any such effect is weak, there was a feeling amongst the interviewees that one of the main benefits of a placing is indeed the broadening of the shareholder base which can result. Interviewee M noted that:
PAGE 92
If you have a few tens of investors you have a completely different outlook from if you have hundreds of thousands of shareholders ...We genuinely wish to avoid too much complexity ... and we would prefer to go down the placing route. Interviewee O mentioned that their most recent rights issue had incorporated a placing element because of a relatively narrow equity base: Our shareholder base was quite chunky. [There was] 70% of the company in half a dozen investors and we knew some of them did not want to take up their rights. The AIM-listed firms all referred to the relevance of their shareholder base, particularly because founder shareholders were often still involved and their predicted response to a rights issue would be crucial. For example, Interviewee R noted that: A rights issue would have been a consideration, but 80% of our stock is held by 5 or 6 people ...65% of the current shareholder base would be unlikely to take it up. He also referred to the important role in the whole process of the companys founders. Interviewee Q, also from an AIM-listed IT firm stated that: We saw it [the placing] as an opportunity to get different investors on board. While in one case, according to Interviewee L, the need to broaden the overseas shareholder base persuaded the firm to use a combination rights and placing offer: The idea was really that the existing holders would take up the rights issue and the placing would attract overseas investors ... We had a fairly low overseas investor base at the time. The interviewee from the investment bank pointed out that: the shareholder base
PAGE 93
is a very important reason [for choosing] a placing or a rights issue and explained that large shareholders tend not to view rights issues favourably because, if selling the entitlement on: They would inevitably have to sell it at a very big discount and get no value at all. The accountant suggested that the make-up of the shareholder base, and not just the level of dispersion, was the important factor: It depends what your shareholder base is. If youve got an excellent blue chip base then youll just go back to them and if they support you then great. He also noted that there may be sectoral (and sentimental) issues at work: For tech stocks ... a high retail following makes them more volatile and for very sentimental reasons they might want to move to a more institutional spread, which would put placings above a rights issue. This view concurred with that of those fund managers who indicated that an external placing was likely: if the company were to be able to expand the range of names on its share register in a useful way. Recipients of the questionnaire were asked how the existence of a narrow shareholder base might affect decisions about SEO method. As expected, a clear majority (33 out of 59) of those who answered this question indicated that under current arrangements such a structure would favour a placing. When the data were broken down into Official List and AIM-listed firms, however, it became clear that it had been the views of the latter group that drove the main results, with the average response of Official List firms proving not to be significantly different from the neutral value of 2. Overall, the evidence suggests that shareholder structure is seen as a significant influence on SEO issue methods, but that the influence is greatest among young small firms. This finding makes sense in that, for these firms, a steady widening in share ownership may help create the flexibility required for future growth.
PAGE 94
5.10 FIRM, MARKET AND MACRO-ECONOMIC PROSPECTS Previous studies have shown that equity issues in general are more likely to occur at times when firm, stock market and macro-economic conditions are favourable (Choe et al., 1993; Bayless & Chaplinsky, 1996). Burton & Power (2003) suggest that rights issues might be favoured more than placings at such times given (i) the greater ease with which existing shareholders might be persuaded to deepen their commitment to the firm, and (ii) the likely reduction in concerns about EPS dilution. The interviewees and questionnaire respondents were therefore asked about the effect of firm and market performance on the decision to undertake an SEO. The fund manager interviewees had clear views on these issues, suggesting that the availability of investment opportunities and the existence of growth prospects were important determinants in deciding how to raise funds. In order to convince institutions such as themselves to take up the shares, companies had to know what they planned to do with any share issue proceeds and roadshows were seen as playing a key role in this process. They also indicated that convincing the relatively small number of investors associated with a placing about the future potential of a poorly-performing firm might be less difficult: If you are in a weak position, the placing route would be the safer option [to take] because you might be able to convince the bankers that it is not as bad as it seems ...You might be able to give them more ... information. The firms themselves also indicated that good financial performance increased the likelihood of using rights issues. Interviewee O suggested that in a poor financial situation the greater visibility of a rights issue might cause problems: If [in a] rescue rights situation with profit downgrades and the business not doing desperately well ..., I might prefer to place it rather than rights it. I dont want to expose the business too much. He also suggested that not the level of the market but its volatility might be a factor, with greater variability in pricing favouring a rights issue because of the
PAGE 95
relatively high discount involved. This view was consistent with the opinion of the investment banker who indicated that: If a companys about to produce some price volatile transaction ... and they dont know whats going to happen to the share price, it could be very difficult to underwrite a straight placing at a narrow discount. The accountancy firms representative also recognised the problems associated with attempts to undertake rights issues at times of major uncertainty, noting that since 11 September people are just not prepared to put the cash in rescue rights issues. Interviewee K, from the biotech firm, again noted that sectoral influences were relevant: When we did a rights issue ... we had some good clinical results, the market was in a bullish state in terms of biotech stocks, the flagship company for the whole sector was rearing ahead and everything was a glossy picture ... There were two windows in 2000 when biotech issues were well received. The market [conditions] doesnt mean that you cant do an issue, but it alters the size and the price. This interviewee also noted that the time period over which future potential might be judged could vary across investor groups: We have some very long term shareholders who have taken a long-term view. We also have in our share register both institutions and private individuals who take a short-term view. Although there was general agreement with the idea that good financial and market performance tipped the balance in favour of a rights issue, the investment banker suggested that the influence could in theory work both ways:
PAGE 96
You could say that if the shares are very fashionable lets suck in new shareholders with a placing. Or, you could say the shares are very high, the [outside] investors are nervous of taking it so wed better do it by way of a rights issue. The interviewees talked about the relevance of a wide range of aspects of firm and market performance. The questionnaire therefore asked about the influence of four related factors: (i) (ii) a recent rise in the firms share price recent growth in the stock market as a whole
(iii) the existence of highly favourable growth prospects for the firm, and (iv) the presence of an extremely promising macro-economic outlook. As table 5.3 indicates, in none of the four cases was the average response significant when set in the context of the current guidelines on non pre-emptive issues. When asked to respond again assuming that pre-emption rights did not exist, however, the answers indicated that both a rise in individual share price and the market as a whole would favour placings. Although this evidence appears to contradict the main argument in Burton & Power (2003), the authors of that article note that high growth is often associated with significant agency costs (Long & Malitz, 1983; Myers, 1984)52 and attempting to persuade existing shareholders to increase their financial exposure might be difficult in such a situation. This argument is also consistent with the evidence from question 27, where respondents linked high dividend pay-out policies which can alleviate normal agency problems (Keane, 1985) to a preference for rights issues. Such a finding was particularly strong among AIM-listed firms; such firms tend to be smaller, receiving less press attention than bigger firms, and might therefore be characterised as having relatively high levels of information asymmetry.
PAGE 97
5.11 OTHER INFLUENCES ON THE SEO METHOD DECISION A number of other factors mentioned in prior literature as possible influences on corporate financing behaviour were investigated but appeared to have only a limited effect on the choice between a placing and a rights issue. These included company size, gearing, asset tangibility and taxation. Company size is the only factor that Burton & Power (2003) report as having a significant effect on issue method, documenting a positive relationship between firm size and the propensity to use rights issues. The interviews failed, however, to identify any reason why the size of a firm in itself might affect issue method, although there was some evidence of a link between company size and other explanatory variables, in particular shareholder structure and issue costs. The fund managers suggested that a rights issue would not be popular: if a small company was trying to get a wider [group] of people following them and to get its recognition up. All three of the AIM-listed firms had used placings for their SEOs since flotation. They indicated that this partly reflected the prohibitive nature of the up-front costs of rights issues for firms of their size. Interviewee Qs views were typical in this regard: It comes down to the absolute cost. We dont want to use half of the money raised to pay for it ... [therefore] we are too small to be thinking about rights issues. The interviewees suggested that the other factors were unlikely to have even an indirect role. For example, the investment banker stated that: I honestly dont think that things like gearing have any influence on whether you do a placing or a rights issue. [The choice] is confined to whats your shareholder base, are your existing shareholders likely to take up the new issue and the speed of the issue relative to size. The questionnaire asked about the influence of a high level of intangible assets and high gearing ratios on the choice between rights and placings, but in both cases
PAGE 98
approximately two-thirds of respondents suggested that the equity issue method would not be affected. As table 5.3 shows, the mean response to this question provided some evidence that a gearing ratio above target tends to favour a placing, but the difference from the neutral response of 2 was only significant in the hypothetical situation where pre-emption rights no longer existed. Even then, only 15 of the 60 responses suggested that high gearing would work in such a way.53 5.12 PRE-EMPTION RIGHTS IMPORTANCE AND NEED FOR REFORM One of the recommendations in the MMC inquiry report in 1999 was that the maximum size of non pre-emptive share issues could rise from 5% to 15%.54 It was clear from the interviews that a number of firms do indeed see the existing guidelines as somewhat restrictive. For example, Interviewee K stated that: The regulatory environment is the biggest hurdle for us as a UK company because of pre-emption rights. Several of the interviewees, however, were keen to point out the importance that they attach to the notion of existing shareholders having the rights to participate in new issues. The views of Interviewee N are representative of this in pointing out that: Placings will not please your existing shareholders ... my inclination would always be to go to our existing shareholders. A placing would be circumstances driven ... Your shareholders are your shareholders and youd have to have a pretty good reason for not going to them. One of the Official List-based respondents to the questionnaire took a similar view, noting that: One of the few controls shareholders have is over who else can become shareholders. Pre-emption limits are therefore a vital protection. We have been limited in the use of convertible debt by the pre-emption limit probably rightly.
PAGE 99
A respondent from an AIM-listed firm agreed with this sentiment: I believe that shareholders do need some protection from aggressive dilution and thus I am a supporter of retaining pre-emption rights. The fund managers commented that from the point of view of an investee institution, the importance of pre-emption rights would depend on how the company was likely to perform in the future: If its a good company that we like, we would be reluctant to see them go down the private placement route. We have to stand up for our interests. Support for maintaining the status quo was not universal; an Official List respondent to the questionnaire who had strongly agreed with the notion that removing pre-emption rights would be a positive development commented that: UK companies should be able to take shareholder votes on whether share rights should include pre-emption rights or not while even Interviewee N, who had expressed some of the strongest support for the retention of pre-emption rights admitted that: some relaxation of the 5% [pre-emption limit] would help. Rather than completing the questionnaire, one Official List firm provided a detailed narrative response, expressing clear views about the administrative requirements currently imposed on firms by market regulators, and arguing that: Small [rights issues] should be able to be done with minimal paperwork if shares issued are less than 10%. It was a real pain all that paperwork for nobodys benefit. This view ties in with the comments of one of the AIM-listed questionnaire respondents, who noted that for small growing businesses such as themselves:
PAGE 100
The 5% pre-emption limit on new share issues for cash is potentially dangerous for a company and its shareholders if it prevents the company raising cash quickly when needed. The questionnaire asked for views on two statements directly related to preemption guidelines: (i) that the 5% pre-emption limit is the main influence on issue method and (ii) that the removal of pre-emption rights would be a positive development. As table 5.1 shows, in both cases the average overall response was indistinguishable from the neutral value of 3. These findings are perhaps surprising in the light of some of the interviewees comments, but they do indicate that firms concerns about the restrictive effect of pre-emption rules on SEO behaviour may not be as deep or widespread as is often assumed to be the case. To investigate further the effect that pre-emption rules have on choice of SEO method, we compared the responses made to 13 statements in section C of the questionnaire: (i) those made in the context of the existing guidelines and (ii) those made under the assumption that pre-emption rights did not exist. The differences were minimal, again suggesting that the pre-emption requirements did not dominate firms thinking in this regard. For example, in only seven out of the 13 cases did the mean response for the whole sample move further from the neutral value of 2 in the second situation. In addition, for the three questions where the mean response differed significantly between (i) and (ii), the change was actually in the direction of the neutral response. 5.13 THE DEBT-EQUITY CHOICE The main issue investigated in this chapter is how listed firms go about issuing shares once the decision to use equity financing has been made. There were several instances, however, of interviewees (i) volunteering information that although the factor in question did not affect equity issue method choice, it had affected recent debt-equity decisions or (ii) pointing out how the debt-equity choice differs from the SEO method choice. These views are discussed here because the two decisions are often assumed to be closely related (Eckbo & Masulis, 1992; Slovin et al. 2000) and yet the interviewees indicated that they differ in a number of important respects.
PAGE 101
The interviewees referred to elements of both the pecking order and static tradeoff55 models and did not see them as mutually exclusive; one interviewee specifically referred to the pioneering work of Modigliani and Miller (1958) on capital structure theory. Interviewee N indicated a preference for debt, other things being equal, stating that the debt-equity choice is driven by balance sheet strategy in particular the amount of stretch on the balance sheet. For Interviewee K, it simply came down to the fact that, at the time of the firms most recent debt issue, debt was relatively cheap compared to equity. Interviewee M indicated, as did most of the interviewees, that his firm operated a target debt level (formally linked to their desired credit rating and interest cover), but indicated that elements of pecking order were also in his thinking, noting that: Debt is a good thing to have for the company. [It conveys] no signal to the market and is most flexible. The strongest evidence that a fund-raising pecking order existed among the interviewees stems from the fact that most made reference to (i) a desire to issue equity only if the balance sheet absolutely required it or (ii) preferring debt financing unless the issue was needed to fund a major acquisition and it would have proved impossible to borrow against the entire cost of the transaction. For example, Interviewee M stated that: You dont issue shares unless you have a reason for doing it, while Interviewee N believed that: [Share] issues out of the blue tend not to be well received ... We would always try to use acquisitions or business transactions in order to address balance sheet problems without the drama [of having a separate EGM]. Interviewee L suggested that equity would normally only be issued to fund the goodwill portion of any takeover, or as a way of motivating the target companys management. Finally, the investment banker pointed out that equity is often only issued because firms have to finance the increases in working capital caused by inflation and that this might explain why share issues are less numerous in low inflation environments such as that of the UK at the time of the study.
PAGE 102
One clear difference between the interviewees perception of debt-equity and SEO method decisions relates to the role of external advisers. Interviewee Ns views were typical in suggesting that, unlike the decision regarding how to issue shares, the debt versus equity choice has to be driven by us rather than by our advisers. This view ran contrary to the perceptions of the fund managers, who believed that company decisions to issue equity were primarily driven by the exhortations of corporate finance departments in merchant banks. They suggested that staff in these departments regularly contacted companies which had not raised funds for a significant length of time, in an attempt to generate business for their institutions. In the fund managers view: There is a large element of fashion [to the decision about an SEO] and a great deal of this is driven by corporate finance departments. [Firms] will have their named corporate financiers and will have discussions with them about raising funds. Interviewee R noted that, for information technology (IT) firms such as his, debt was not yet an option because of on-going losses and insufficient cash generation at the operating level. On a similar note, Interviewee P pointed out that for small IT firms equity risk capital was the only option in the climate of 20002001 and that currently banks wouldnt touch them. Overall, the comments made by the interviewees suggested important differences between the factors that influence the debt-equity choice and those that affect the choice of SEO method. This finding in turn suggests that attempts to model equity issue decisions are unlikely to be successful if the analysis is based entirely on the mainstream literature on corporate fund raising practices. The debt-equity decision appears to be more straightforward than the SEO method decision, with firms tending to look mainly at the balance sheet and the relative costs of debt and equity before making a decision. As Interviewee R put it, there are a lot more behavioural influences on equity issue methods than on the cost of capital itself.
PAGE 103
5.14 CONCLUSION This chapter has reviewed the results of a detailed investigation into the opinions of the main parties involved in the seasoned equity issue process. The evidence suggests that the SEO method decision, which firms continue to perceive as being important, is affected by a combination of factors, principally input from advisers (particularly brokers), shareholder structure, urgency of the funding and the ability to bear costs; a rights issue is more likely to be favoured: (i) (ii) if this is the view of advisers if the funds involved are large and linked to takeover activity
(iii) if the funds are not required quickly (iv) if the firm is well-established and no desire exists to expand the shareholder base, and (v) if concern about issue costs is relatively low.
UK firms are also clearly affected by the pre-emption guidelines, but this did not appear to be the dominant influence on share issue methods. Despite the behavioural finance literature finding increasing evidence of irrational investor behaviour (e.g. Statman, 1999), there was little indication of firms themselves acting in such a manner. For example, while there was evidence of trends in offer methods, these appeared to be for sound financial reasons, reflecting changes in the cost structure of the various alternatives. In addition, there was broad consistency among the views of the firms, advisers and fund managers, although the emphasis was sometimes placed on different aspects of the SEO process. The final chapter of this study examines in detail the implications of these findings for practitioners, regulators and future academic studies in the area.
PAGE 104
6. Conclusions
6.1 INTRODUCTION This study has reported the results of an extensive investigation into how, when and why UK firms issue shares, in the context of both initial public offerings and seasoned offerings by those already listed. On the basis of 165 questionnaire responses from firms with recent experience of issuing shares, and 21 interviews with various parties to the process, including accountants, advisers and fund managers, a number of key points emerge. These findings relate to both the nature of the share-issuing process and the wider question of how research into corporate decision making is best conducted. 6.2 FINDINGS FROM THE IPO PROCESS The first finding of the IPO research is that issuing shares is a complex process that involves a great deal of management time as well as a sizeable input from external advisers. It is not a decision that is taken lightly and usually occurs either because other sources of funding have been exhausted or because the firm is too small to raise debt. Second, all the individuals who were spoken to, or who replied to the questionnaire survey, had developed a number of strategies to manage the IPO process. For example, some established a small team of executives to manage the share issue (renting a location, separate from the main corporate headquarters, for this purpose) while others ran the business. Once the share issue was completed this small team was disbanded and managers returned to their normal activities. The successful issuers also placed a great deal of emphasis on selecting advisers who could work closely with them. They paid close attention to the advice of these advisers on questions about issue method, choice of market and issue price. There was also a recognition among those interviewed that the success of an IPO depended to some extent on an element of luck with market conditions. Third, there were differences in the views expressed by share issuers on the AIM and on the Official List. AIM companies were restricted in their choice of sponsor; some highlighted that they had great difficulties in getting any broker to sponsor
PAGE 105
Conclusions (continued)
their application for a listing. In addition, AIM companies complained more about the size of the issuing costs as well as the expense of maintaining their quoted status. Also, the ratio of cost to percentage of funds raised was much higher for AIM firms since they typically issued smaller amounts of equity. Fourth, both AIM and Official List companies highlighted that a number of changes had taken place in their operations and organisational structures both before and after the IPO. Alterations required to comply with corporate governance requirements were chief among these changes. So, for example, audit and remuneration committees had to be established while additional non-executive directors had to be appointed to the board. Respondents from AIM companies also highlighted that the existing executive team was often strengthened by the appointment of an experienced financial director in order to guarantee the success of the share issue. 6.3 FINDINGS FROM THE SEO PROCESS In terms of SEOs, firms seem to appreciate the potential in the MMC recommendations regarding underwriting in the UK, but a significant gap still exists between the fees paid and perceptions of the service obtained in return. This difference is likely to widen if a move to US-style best-efforts bookbuilding continues to develop without an associated reduction in underwriting fees to reflect the lower risk involved. Perhaps surprisingly, there is no pervasive desire for the removal of pre-emption rights among listed firms that have recently undertaken a rights or placing share offer. Such issues are likely to remain a part of the equity issuing scene in the UK for some years to come, despite the increasing influence of many other aspects of US market practices. There does, however, seem to be a belief that placings carry real practical benefits (i) because they tend to be for amounts of less than 10% of existing share capital and therefore, under chapter 5 of the UKLAs Listing Rules, do not require formal listing particulars, and (ii) because they avoid the 21-day open period required for a rights offering. Market authorities, in conjunction with the major investor groups, including the investor protection committees (IPCs), could usefully re-examine whether the pre-emption limit could be raised to 10%. By bringing the pre-emption limit into line with the
PAGE 106
prospectus requirements, a new class of small share issues requiring minimal paperwork could emerge, giving firms more certainty and speed than is currently the case. The least complicated way of making this change to share issuing practices would be through securing the agreement of investors representatives rather than through the creation of a new statutory class of share issue. This approach forms the basis of current practice, whereby it is known in advance that if a placing is for less than 5% of a class of share capital, the issue is almost certain be approved; the firms surveyed did not appear to see any inherent problems with this system. Although such a move has been resisted in the past by the IPCs, two aspects of the findings presented in this study suggest that grounds for reappraising such a view may now exist. First, firms perceive real competitive benefits from the additional flexibility that such a move would bring, particularly in the current volatile market environment. The proposed change might also remove one of the reasons why many firms incur the costs of listing on a secondary market, typically in the US, where greater de facto freedom to choose share issue methods exists. Second, the results of this study indicate that concern that such a change would herald the beginning of the end of pre-emptive rights in the UK is largely unfounded. While there is evidence that some relaxation of the rules would be welcomed, most of the firms that took part in this study claim to see inherent value in the principle of current shareholders having pre-emptive rights and would be very unlikely to instigate their removal. For the full benefits of the increased flexibility to accrue, such a move might usefully be accompanied by increasing the three-year rolling limit on non preemptive issues to 15%, where no single issue is greater than 10%. Relaxing the rules on the maximum discount to market price allowed for issues which by-pass current shareholders, might also provide firms with increased flexibility. Instability in market conditions would make such a change extremely difficult in practice, however, and alterations to the number of shares which can be issued via a non pre-emptive issue is likely to achieve the desired benefits in a more stable and predictable manner.
PAGE 107
6.4 LIMITATIONS The relatively small number of firms and other organisations that took part in the interviews is clearly a limitation of this study. The final tally of 21 interviews reflects time and financial constraints to some degree, but also the fact that a number of firms declined to take part in the study. The interviewees were necessarily a self-selecting group of those prepared to discuss the issues, and this represents one of the main problems with this type of research in general. Moreover, there is no guarantee that the views expressed to academic researchers by interviewees and questionnaire respondents portray the complete picture. For example, some firms may not be keen to express their frustration with the need to honour existing shareholders pre-emptive rights, particularly during a taperecorded interview. A small number of interviewees agreed to speak only on the condition that the discussions were not recorded, and in these cases an additional level of candour about the problems encountered during the IPO and SEO processes appeared to reveal itself. Another limitation relates to the response rate to the two questionnaires that were sent out. Only 14% of the quoted companies that were sent the SEO questionnaire replied; the figure of 23% for the IPO questionnaire was only slightly better. Also, for both questionnaires, the clear majority of responses were from AIM-listed firms; relatively few of the Official List companies that were sent the questionnaire chose to reply. Perhaps further work in this area could try and focus on the views of respondents whose firms are quoted on the main market to determine whether the findings of the present report are typical among such companies. A final limitation relates to the fact that the current report is based on views of those who have been involved in past share issues. The views expressed by participants in the study are based on recollections of events and perceptions of important factors. Attempting to conduct a case study of a company which is currently issuing shares would be difficult, however, because the management of such a firm is unlikely to have the time to take part in a face-to-face interview or even respond to a questionnaire survey. Nevertheless, most of those who completed the questionnaire or took part in the interviews for the current project
PAGE 108
had been through the share issue process only recently, so recollections should be fresh in their memory. What the report has not looked at, however, is those firms that decided not to proceed with either an IPO or SEO and the views of executives in such companies might usefully complement the current research. 6.5 IMPLICATIONS FOR FUTURE STUDIES AND SUGGESTIONS FOR FURTHER WORK There are at least three possible implications of the study for future empirical investigations of corporate decision making. First, some of the factors that seem to have a major influence on firms views of the process of issuing shares, such as the input from external advisers, would be extremely hard to measure in a conventional large-sample study. Understandably, given the difficulties in modelling such a factor, most investigations of corporate behaviour make no attempt to incorporate the role of external advice. The evidence here suggests that such an omission may be of major significance when attempting to model equity-issuing behaviour, given the overriding importance that external advisers appear to play in practice. Second, there was evidence of strong links between the various explanatory factors; for example, issue costs, shareholder structure and issue size were closely linked in the minds of most interviewees. This finding suggests that attempts to examine the influence of a range of variables on major corporate decisions might benefit from a discussion of the issues with practitioners beforehand; variables which in theory should have a discrete effect on corporate behaviour may not be independent in the perception of firms. This issue may partly explain the modest success researchers have had to date in explaining and predicting why quoted firms use particular methods to issue shares. Third, it was obvious from the interviews and various comments made by questionnaire respondents that the circumstances surrounding each share issue are different, particularly the nature and effect of adviser input, trends and macroeconomic conditions. For example, in the SEO study Interviewee U pointed out that:
PAGE 109
It [the SEO method choice] varies from one time period to another ... Some [factors] may be important at one point in time while at another they may not while Interviewee O commented: Each time I came to raise a new issue of any form of capital, the method I used to raise it and the market in which I raised it would be based on a review of market practice and conditions at the time. These views concur with the investment bankers comment that: Say were planning to do a share issue next week. Today we could be planning to it by way of a placing and suddenly tomorrow morning we could decide to do it by way of a rights. It can change just like that ... Market conditions are very volatile. When these views are considered in conjunction with the points made by various interviewees regarding the importance of sectoral influences, it may be argued that aggregating a large number of companies together across time may not be the most appropriate way to investigate corporate decision making. This finding again suggests a methodologically-based explanation for the inconclusive nature of evidence regarding choice of SEO method in particular; accurate modelling of firm behaviour is unlikely to be achieved if the explanatory variables are drawn from theory rather than face-to-face discussion with the key parties involved in the process. As regards future developments of the work reported here, it would be useful to discuss the main issues raised with market regulators. The interview transcripts and questionnaire responses both revealed some dissatisfaction with the costs and general bureaucracy involved in issuing shares in the UK, and it might be useful to obtain a response to these concerns from those with the power to amend the rules governing firm behaviour. Also, all participants in the survey had had recent experience of the process. It might be useful to establish the views of both (i) firms
PAGE 110
that had never undertaken an IPO or SEO, but had instead chosen to remain private and (ii) those that had planned to undertake a major share issue but had changed their minds. These lines of enquiry should help to establish the extent to which firms views of the share-issuing process are influenced by their own experiences. All the issues discussed in this and preceding chapters have emerged from the directly-obtained views of firms and practitioners. The evidence again highlights the usefulness of interview-based and questionnaire-based research, if not to replace, then to supplement the large-sample aggregate analyses that have dominated finance research for much of the last 50 years.
PAGE 111
PAGE 112
Appendix: Responses to the SEO questionnaire
RESPONSE RATE Number sent 452 192 260 Replies 1st mailing 41 15 26 2nd mailing 22 11 11 Total 63 (=13.9%) 26 (=13.5%) 37 (=14.2%)
Whole sample Official list firms AIM firms
SECTION A THE NUMBERS OF RESPONSES IN EACH CATEGORY WERE AS FOLLOWS. QUESTION 1: TURNOVER <100m Whole sample Official list firms AIM firms QUESTION 2: SECTOR56 Whole sample Official list firms AIM firms 1 4 2 2 2 10 6 4 3 11 3 8 4 18 10 8 5 6 3 3 6 14 2 12 500m 46 10 36 100m 1 billion 9 9 0 501m 4 4 0 >1 billion 4 3 1
QUESTION 3: RESPONDENT'S AGE 2130 Whole sample 2 Official list firms 1 AIM firms 1
3140 26 10 16
4150 22 9 13
5160 11 5 6
>60 2 1 1
QUESTION 4: RESPONDENT'S YEARS WORKING FOR ORGANISATION <1 15 610 Whole sample 5 43 8 Official list firms 2 15 4 AIM firms 3 28 4 QUESTION 5: RESPONDENT'S QUALIFICATIONS57 1 2 3 Whole sample 7 1 0 Official list firms 2 1 0 AIM firms 5 0 0
1115 4 2 2
1520 3 3 0
4 17 10 7
5 1 0 1
6 30 11 19
7 4 1 3
8 2 1 1
None Stated 1 0 1
PAGE 113
Appendix: Responses to the SEO questionnaire (continued)
QUESTION 6: RESPONDENT'S POSITION Treasurer58 Whole sample Official list firms AIM firms 9 9 0
Finance Director/ Chief Financial Officer 33 12 21
Accountant/ Fin. Controller 7 2 5
Other59 14 3 11
SECTION B QUESTION 7: INFLUENCES ON THE ISSUE METHOD DECISION The responses were coded as Strong Influence = 1; Weak Influence Number of responses Total 1 2 3 7a - Industry trends Whole sample 63 12 26 25 Official list firms 26 2 11 13 AIM firms 37 10 15 12 7b - Accountants Whole sample 63 8 25 30 Official list firms 26 4 9 13 AIM firms 37 4 16 17 7c - Brokers Whole sample 63 56 5 2 Official list firms 26 24 1 1 AIM firms 37 32 4 1 7d - Investment bankers Whole sample 61 40 13 8 Official list firms 25 19 4 2 AIM firms 36 21 9 6 7e - Lawyers Whole sample 63 7 40 16 Official list firms 26 3 16 7 AIM firms 37 4 24 9 7f - Underwriters Whole sample 60 28 17 15 Official list firms 25 13 7 5 AIM firms 35 15 10 10 7g - Major investors Whole sample 63 49 13 1 Official list firms 26 19 7 0 AIM firms 37 30 6 1 7h - Previous experience Whole sample 62 25 30 7 Official list firms 25 11 11 3 AIM firms 37 14 19 4 7i - Other62 Whole sample 8 8 0 Official list firms 1 1 0 AIM firms 7 7 0
= 2; No Influence = 3. Mean60 2.21* 2.42* 2.05 2.35* 2.35* 2.35* 1.14* 1.12* 1.16* 1.48* 1.32* 1.58* 2.14 2.15 2.14 1.78* 1.68 1.86 1.24* 1.27* 1.22* 1.71* 1.68* 1.73* 0 0 0 SD 0.74 0.64 0.78 0.70 0.75 0.68 0.43 0.43 0.44 0.72 0.63 0.77 0.59 0.61 0.59 0.83 0.80 0.85 0.47 0.45 0.48 0.66 0.69 0.65 na na na p-value (OL v AIM)61
.052
.977
.678
.163
.903
.417
.660
.775 na na na
PAGE 114
QUESTION 8: MAIN INFLUENCE ON THE ISSUE METHOD DECISION Main influence 7a 7b 7c 7d 7e Whole sample 2 3 19 9 0 Official list firms 1 1 8 5 0 AIM firms 1 2 11 4 0
7f 0 0 0
7g 13 4 9
7h 4 1 3
7i 3 1 2
QUESTION 9: RELATIVE COSTS OF RIGHTS AND PLACINGS The responses were coded as higher for rights issues = 1; Same for both = 2; Higher for placings = 3. Number of responses Total 1 2 3 Mean63 SD p-value (OL v AIM)64 9a - Total cost Whole sample 60 46 10 4 1.30* 0.59 Official list firms 24 21 2 1 1.17* 0.48 AIM firms 36 25 8 3 1.39* 0.64 .155 9b - Direct costs Whole sample 60 35 25 0 1.42* 0.50 Official list firms 24 13 11 0 1.46* 0.51 AIM firms 36 22 14 0 1.39* 0.49 .600 9c - Lawyers Whole sample 60 31 26 3 1.53* 0.60 Official list firms 24 10 13 1 1.63* 0.58 AIM firms 36 21 13 2 1.47* 0.61 .335 9d - Underwriters Whole sample 57 35 16 6 1.49* 0.68 Official list firms 23 16 5 2 1.39* 0.66 AIM firms 34 19 11 4 1.56* 0.70 .369 9e - Investment bank Whole sample 57 26 26 5 1.63* 0.64 Official list firms 22 10 11 1 1.59* 0.59 AIM firms 35 16 15 4 1.66* 0.68 .709 9f - Brokers Whole sample 59 20 28 11 1.85 0.71 Official list firms 23 7 11 5 1.91 0.73 AIM firms 36 13 17 6 1.81 0.71 .578 9g - Accountants Whole sample 60 28 30 2 1.57* 0.56 Official list firms 24 11 13 0 1.54* 0.51 AIM firms 36 17 17 2 1.58* 0.60 .782 9h - Management time Whole sample 60 31 25 4 1.55* 0.62 Official list firms 24 13 10 1 1.50* 0.59 AIM firms 36 18 15 3 1.58* 0.65 .616 9i - Other65 Whole sample 1 0 0 1 Official list firms 0 0 0 0 AIM firms 1 0 0 1
PAGE 115
QUESTIONS 1015: RESPONSES TO A SELECTION OF STATEMENTS ABOUT INFLUENCES ON EQUITY-ISSUING DECISIONS. 10. The choice of method used to issue equity is a decision of major importance. 11. The timing of an equity issue is a decision of major importance. 12. Input from advisers is a major influence on whether a rights issue or placing is used to raise equity capital. 13. Input from advisers is a major influence on the timing of a share issue. 14. The 5% pre-emption limit on share issues other than rights offers is the main determinant of whether a rights or placing issue is used for equity fund raising. 15. The removal of equity-holders' pre-emption rights to participate in new share issues would be a positive development. In each case: 1=strongly agree; 2=agree; 3=neither agree nor disagree; 4=disagree; 5=strongly disagree Question 10 Whole sample Official list firms AIM firms Whole sample Official list firms AIM firms Whole sample Official list firms AIM firms Whole sample Official list firms AIM firms Whole sample Official list firms AIM firms Whole sample Official list firms AIM firms Number of responses Total 1 2 62 25 37 63 26 37 63 26 37 63 26 37 63 26 37 63 26 37 23 9 14 40 16 24 30 12 18 19 8 11 8 4 4 6 4 2 25 9 16 23 10 13 25 10 15 36 17 19 13 5 8 20 8 12 3 13 7 6 0 0 0 5 3 2 7 1 6 19 7 12 20 7 13 4 1 0 1 0 0 0 3 1 2 0 0 0 21 10 11 13 4 9 5 0 0 0 0 0 0 0 0 0 1 0 1 2 0 2 4 3 1 Mean66 1.87* 1.92* 1.84* 1.37* 1.38* 1.35* 1.70* 1.73* 1.68* 1.86* 1.73* 1.95* 2.94 2.88 2.97 2.83 2.77 2.86 SD 0.80 0.81 0.80 0.49 0.50 0.48 0.82 0.83 0.82 0.74 0.53 0.85 1.09 1.11 1.09 1.07 1.24 0.95 p-value
(OL v AIM)67
.695
11
.791
12
.794
13
.257
14
.754
15
.730
Number of firms making comments: Whole sample 9; Official list firms 4, AIM firms 5.
PAGE 116

PAGE 117
SECTION C QUESTIONS 1628: INFLUENCES ON THE CHOICE BETWEEN RIGHTS AND PLACINGS Responses coded: 1= favour rights; 2 = no influence; 3 = favour placings (I) Under current system (ii) If pre-emption rights were removed Mean 3 Number of responses Total 1 2 Mean 3 Difference in means between (I) and (II)
Number of responses Total 1 2 Question 16. Concern over EPS dilution Whole sample Official list firms
62 25
14 4 10 11 6 5 37 19 18 7 1 6 17 9 8 15 5
42 19 23 15 9 6 9 4 5 6 2 4 27 10 17 26 17
6 2 4 33 9 24 15 2 13 47 21 26 15 4 11 20 3
1.87 1.92 1.84 2.37* 2.13 2.54* 1.64* 1.32* 1.86 2.67* 2.83* 2.56* 1.97 1.78 2.08 2.08 1.92
61 25 36 57 24 33 60 25 35 60 25 35 59 24 35 60 25
12 5 7 8 6 2 20 11 9 9 2 7 11 5 6 11 4
40 17 23 15 6 9 15 6 9 11 5 6 29 12 17 24 13
9 3 6 34 12 22 25 8 17 40 18 22 19 7 12 25 8
1.95 1.92 1.97 2.46* 2.25 2.61* 2.08 1.88 2.23 2.52* 2.64* 2.43* 2.14 2.08 2.17 2.23* 2.16
-0.08 0.00 -0.13 -0.9 -0.12 -0.07 -0.44# -0.56# -0.37# 0.15# 0.19 0.13 -0.17 -0.30 -0.09 -0.15# -0.24#
AIM firms 37 17. Existence of a narrow shareholder base Whole sample 59 Official list firms 24 AIM firms 35 18. A relatively large issue size Whole sample Official list firms AIM firms 19. A relatively small issue size Whole sample 61 25 36 60
Official list firms 24 AIM firms 36 20. The funds are required for takeover activity Whole sample 59 Official list firms 23 AIM firms 21. Recent rise in firm's share price Whole sample Official list firms 36 61 25
PAGE 118
AIM firms 22. Recent rise in stock market Whole sample Official list firms AIM firms
36 61 25 36
10 11 5 6
9 35 18 17 28 16 12 46 20 26 7 5 2 40 19 21 44 22 22 54 22 32
17 15 2 13 16 3 13 7 2 5 47 20 27 12 3 9 3 1 2 4 1 3
2.19 2.07 1.88 2.19 1.98 1.88 2.06 1.98 1.96 2.00 2.66* 2.80* 2.56* 2.05 2.00 2.08 1.82* 1.96 1.72* 2.02 1.96 2.06
35 60 25 35 60 25 35 60 25 35 60 25 35 60 25 35 60 25 35 60 25 35
7 8 3 5 13 4 9 7 3 4 7 0 7 5 1 4 12 3 9 2 1 1
11 34 17 17 28 17 11 46 20 26 8 5 3 40 19 21 45 21 24 53 22 31
17 18 5 13 19 4 15 7 2 5 45 20 25 15 5 10 3 1 2 5 2 3
2.29 2.17* 2.08 2.23 2.10 2.00 2.17 2.00 1.96 2.03 2.63* 2.80* 2.51* 2.17* 2.16 2.17 1.85* 1.92 1.80* 2.05 2.04 2.06
-0.10 -0.10 -0.20 -0.04 -0.12 -0.12 -0.11 -0.02 0.00 -0.03 0.03 0.00 0.05 -0.12 -0.16 -0.09 -0.03 0.04 -0.08# -0.03 -0.08 0.00
23. Company growth prospects highly favourable Whole sample 61 17 Official list firms 25 6 AIM firms 36 11 24. Macro-economic prospects highly favourable Whole sample Official list firms AIM firms 25. Funds required relatively quickly Whole sample Official list firms AIM firms 26. Existing gearing ratio above target Whole sample Official list firms AIM firms 27. High dividend pay-out ratio Whole sample Official list firms AIM firms 28. High level of intangible assets Whole sample Official list firms AIM firms 61 25 36 61 25 36 61 25 36 61 25 36 61 25 36 8 3 5 7 0 7 9 3 6 14 2 12 3 2 1
Notes: * indicates that the mean was significantly different from 2 at the 5% level on the basis of a two-tailed test. # indicates that the difference in means was significantly different from zero at the 5% level on the basis of a two-tailed test. Number of firms making overall comments: Whole sample 11; Official list firms 6, AIM firms 5.
Endnotes
Graham & Harvey (2001) provide further evidence that a pecking order model is descriptive of how large firms choose between debt and equity. This chapter is based partly on academic investigations of share issues and practitioners may choose to skip from section 2.2.2 to 2.2.4, and from section 2.3.2 to 2.3.5. The lead underwriter typically pays part of the fee (approximately 1.25%) to sub-underwriters who each agree to buy a certain number of shares if called upon to do so. This technique started in the US but is now growing in popularity throughout Europe (Arnold, 2002). This accountant must be different from the company's auditor, although they can come from the same firm. Specifically, Benoit (1999) indicates that merchant bank and solicitor fees each typically represent 20% of the total cost of an IPO whereas stockbroker, public relations consultancy and accountancy costs were each equivalent to 10%. The costs of floating on the AIM are generally lower than those for the Official List, because of the less onerous reporting and administrative requirements (Tilston 2000a and 2000b). Such a conclusion emerges from US studies about the propensity of 'Internet' and 'dot.com' companies going public. For example, Schultz & Zaman (2001) found a 300% increase in IPOs for such firms in 1999 and 2000. This sizeable underpricing in emerging stock markets has been attributable, in part, to country-specific regulations, to corruption and to the relatively thin trading which characterises such operations. For example, Korean companies once had to price their shares at book values, while legal requirements in Malaysia mandated that certain ethnic groups be allocated a minimum amount of each new share issue. Targeted allocations at senior officials in Japan led to a change in the law and the resignation of a prime minister.
PAGE 119
Endnotes (continued)
Another explanation for the initial underpricing of IPOs is that managers want the share issue to be a success so that they can subsequently return to the market for an SEO (Allen & Faulhaber, 1989; Grinblatt & Hwang, 1989; Welch, 1989 and 1996). For example, Welch (1989) reported that approximately 25% of US IPOs returned to the market within three years of listing to raise 'significant' amounts of money. Readers interested in the technical issues raised when attempting formal measurement of the long-run market performance of IPOs should consult Kothari & Warner (1997) and Lyon et al. (1999). Section 4.1 of chapter 4 of the UKLA's Listing Rules provides the formal guidelines regarding approved methods of issuing seasoned equity on the London Stock Exchange. The Financial Services Authority is now responsible for the listing rules; prior to 2000 they were issued by the Exchange itself, and known colloquially as the 'Yellow Book'. Eckbo & Masulis (1992) note that almost half of all US SEOs took the form of rights issues until the 1960s; the equivalent figure today is less than 1%. Barnes (2002) reports on the issue method used by UK firms that announced SEOs between 1989 and 1998. The study notes that rights issues were used for the majority of issues, peaking at 92.3% in 1989, until, in 1996, the London Stock Exchange relaxed rules that prevented placings being used for issues in excess of 15m. Under UK company law, at least 75% of those voting must be in favour for the pre-emption rules to be by-passed. The recommendation of a 5% limit is relaxed to 10% for shares issued as part of a vendor placing. See Smith (1986), Armitage (2000) and Burton et al. (2000) for more detailed reviews of the evidence concerning the market reaction to SEOs.
10
11
12
13
14
15
16
PAGE 120
17
Korajczyk et al. (1990) and Asquith & Mullins (1986) report that equity issues tend to follow periods of sustained abnormal price gains; the evidence as a whole therefore suggests that equity issues are made during long-term peaks in share prices. Patterson & Ursel (1993) point to another puzzling aspect of corporate shareissuing behaviour: firms' preference for paying for underwriting rather than guaranteeing the success of an issue through deep-discounting. Evidence from the Wilson Committee (1977) suggested that the direct cost of a placing (rights issue) was then 2.6% (4%). In contrast to the situation regarding fund raising behaviour, interviews and questionnaires have always played a key role in attempts to understand the motivations behind firms' dividend decisions (e.g. Lintner, 1956; Baker et al., 1985; Baker & Powell, 1999). In one of the four cases the interviewee was the Investment Director of the venture capital firm that had been involved with the flotation of an investee company. Two of the interviewees asked for the discussions not to be recorded and in these cases extensive notes were taken during the interviews. Questionnaires were not sent to those firms that had taken part in the interviews; this was also the case for the SEO survey detailed later in the chapter. Comparing responses to a first and second mailing is recommended by Wallace & Mellor (1988) as one of the most effective ways of dealing with non-response bias in questionnaire surveys. The three advisers interviewed about SEOs were the same as those interviewed about IPOs. In table 3.2, however, they are given different letters to distinguish their views about quoted companies issuing shares from their thoughts about new companies obtaining a listing.
18
19
20
21
22
23
24
25
PAGE 121
26 27
The Appendix details the responses to the questionnaire. A small number of firms announced simultaneous placings and rights issues and these were removed from the sample. Five investment trusts on the Official List announced equity offerings during this period and, as in most studies of corporate behaviour, these were removed. A further five companies responded without completing the questionnaire. One provided a number of specific comments regarding the rights versus placing decision, including detailed views on costs and the pre-emption limits. One further questionnaire was received more than two weeks after any others, but by this time the analysis had been completed. The sectors used were based on the ten main FTSE categories. Given the relatively small number of respondents, (i) cyclical and non-cyclical subgroups and (ii) basic and general industrials were combined. This means that, in this study, questionnaires were sent to firms in seven broad groups: Resources; Basic/General Industrials; Consumer Goods; Services; Utilities; Financials; and Information Technology. A comparison of responses between large and small firms was also considered, but was rejected because the Official List/AIM dichotomy closely resembles such a division and a further size-based split within the two groups of responses would have led to the creation of small sample sizes. Analysing the results across different industrial sectors was also considered, but the relatively small number of responses meant that little of significance would have been added to the overall findings. He carried on by saying: "What is a small company? Some people say less than a billion pounds is a small company and that is why you are seeing lots of private transactions". Several studies suggest that auditors played a key role in US IPOs during the late 1980s boom. For a review of this literature, see Datar et al. (1991) and Feltham et al. (1991).
28
29
30
31
32
PAGE 122
33
Perhaps surprisingly, support for the statement in question 10 ('The choice of method used to issue equity shares is a decision of major importance') was significantly higher among firms that agreed with the notion put forward in question 14 that the 5% pre-emption limit is the main determinant of equity issue method. Krigman et al. (2001) report that, in the mid-1990s, 30% of US firms that undertook an SEO within three years of their IPO changed underwriters when doing so. A detailed breakdown and analysis of the responses to each question is contained in the Appendix. The influence of investment bankers was seen as significantly stronger by those firms which agreed with the notion that the 5% pre-emption limit is the main determinant of issue method. Respondents who strongly agreed with the notion that the choice of SEO method is a decision of major importance perceived a significantly stronger (weaker) role for underwriters (accountants) than did other firms. A US firm-commitment offer is the same as a UK placing in all key respects. Roadshow is the term usually given to the meetings between firms and potential investors to talk about the need for new financing and encourage take up of the new shares. Under what is now paragraph 5.27e of the UKLA's Listing Rules. Issued on the 24 February 1999. See also Gapper & Lewis (1996). That is, where the shares are placed with an underwriter, but the commitment is only to attempt to sell them on to clients at the best possible price. These 'best-efforts' contracts have existed for many years in the US (see Eckbo & Masulis, 1992).
34
35
36
37 38
39 40 41 42
PAGE 123
43
As discussed in chapter 2, the only way to place shares for significant amounts is to link them to a clawback, i.e. where the shares are placed provisional on existing shareholders not taking up their rights to the shares. These differ from rights issues in that (i) the discount is typically lower and (ii) the rights to purchase the shares are not separately tradable. The greater discount associated with most rights issues in the UK (typically 15%) compared with placings (typically 5%) means that more shares must be issued under the rights method to raise a given sum. The associated difference in potential dilution of EPS figures is a possible explanation for the rights offer paradox discussed earlier. Definitions of DDRIs vary, but they are typically considered to be any issue offered at a discount of more than 30% (Armitage, 2000). One of the main recommendations of the 1999 MMC report on the underwriting of share issues was that firms should be made more aware of when DDRIs might be worthwhile, with the scrip element of any such issues being made clear at an early stage in the advising process. Armitage (2000) notes that, in his sample, the percentage underwritten was actually higher for deep-discounted offers; only 16 out of 174 issues with a discount of more than 30% had underwriting for less than half the shares on the offer. This evidence provides the backing for the author's suggestion that DDRIs are typically low in quality. Articles in the Financial Times on 9 July 2002 (pp. 2124), which examine Kingfisher PLC's decision to raise 2 billion through a one for one, 50% discounted issue to facilitate a share purchase, suggests that underwriting costs have now fallen to around 1%. In that gains from conventional rights issues tend to be tax exempt, whereas this would not be the case for the much larger gains likely to accrue from DDRIs. Although this may also be the case for a placing, if a three-year rolling exemption has been approved by shareholders and remains valid.
44
45
46
47
48
49
PAGE 124
50
Burton & Power (2003) report that by the mid-1990s the median placing of equity on the UK market measured 16.5% of market capitalisation and therefore most placings were accompanied by an open offer; the authors also note, however, that the median size of a rights issue was significantly higher at 21.5%. The Director of Corporate Finance from the accountancy firm pointed out that in theory there might be some reasons to favour placings for large issues, because the dilution effect of a rights issue is increased in absolute terms for large issue sizes. The association of rapid expansion with agency problems largely stems from the fact that such growth is often associated with high levels of intangible assets; the value of these assets tends to fall rapidly when firms struggle, causing outside investors to be wary of investing in such companies (Scott, 1976). Cross-analysis of the questionnaire responses also revealed that this finding was restricted to those who had failed to agree strongly with the notion that the decision on SEO method is of major importance. One of the AIM-listed respondents to the questionnaire noted that their shareholders had, at an AGM, approved issues of up to 20% of existing capital. This was the only such case found. The pecking order model assumes that firms' first choice of funds is retained earnings, followed by debt and lastly (primarily because of agency costs) equity (see for example Myers & Majluf, 1984). In contrast, the static tradeoff model assumes that an optimum capital structure level exists, whereby firms attempt to balance the tax shield benefit of debt interest against the problems that can occur when excessive gearing increases the risk of bankruptcy (Shyam-Sunder & Myers, 1999).
51
52
53
54
55
PAGE 125
56
The sectors used are based on the official FTSE categories. Given the relatively small number of respondents, (i) cyclical and non-cyclical subgroups and (ii) basic and general industrials are combined. This means that in the above table, sector 1= resources; 2 = basic/general industrials; 3 = consumer goods; 4 = services; 5 = financials; and 6 = information technology. In the table 1= degree; 2= MBA; 3= higher degree; 4= professional; 5= other; 6 = degree plus professional qualification; 7= any other two; 8 = any three. Including treasurer, group treasurer, assistant treasurer. These were, for the Official List firms, two company secretaries and one chief executive. For the AIM firms they were three chief executives, two chairmen, two deputy chairmen, one chairman/chief executive, one director, one VP finance and one executive director. A * indicates that the mean was significantly different from 2 at the 5% level on the basis of a two-tailed test. The p-value relates to a test of whether the mean response for OL firms was equal to that of AIM firms. The other factors stated were 'State of the stock market' (by the one OL firm that responded to the question) and 'Profile of current shareholders', 'Known level of interest for placing', 'News flow', 'Market appetite', 'Known potential recipient', 'Stock price' and 'Cost' for the seven AIM respondents. A * indicates that the mean was significantly different from 2 at the 5% level on the basis of a two-tailed test. The p-value relates to a test of whether the mean response for OL firms was equal to that of AIM firms.
57
58 59
60
61
62
63
64
PAGE 126
65 66
The only other factor mentioned was 'Dilution'. A * indicates that the mean was significantly different from 3 at the 5% level on the basis of a two-tailed test. The p-value relates to a test of whether the mean response for OL firms was equal to that of AIM firms.
67
PAGE 127
PAGE 128
References
Affleck-Graves, J. & Page, M.J. (1995). The timing and subsequent performance of seasoned offerings: the case of rights issues, Working Paper, University of Notre Dame, Indiana, US. Allen, F. & Faulhaber, G.R. (1989). Signalling by underpricing in the IPO market, Journal of Financial Economics, Vol. 23, pp. 30323. Armitage, S. (1998). Seasoned equity offers and rights issues: A review of the evidence, European Journal of Finance, Vol. 4, pp. 2959. Armitage, S. (1999). The proportion underwritten and the reaction to SEOs: UK tests of the Eckbo-Masulis theory, Working Paper, University of Edinburgh, UK Armitage, S. (2000). The direct costs of UK rights issues and open offers, European Financial Management, Vol. 6, pp. 5768. Arnold, G. (2002). Corporate Financial Management, FT-Prentice Hall, London. Asquith, P . & Mullins Jr. D.W., (1986). Equity issues and offering dilution, Journal of Financial Economics, Vol. 15, pp. 6189. Baker, H.K., Farrelly G.E. & Edelman, R.B. (1985). A survey of management views on dividend policy, Financial Management, Vol. 14, pp. 7884. Baker, H.K. & Powell, G.E. (1999). How corporate managers view dividend policy, Quarterly Journal of Business and Economics, Vol. 38, 1735. Bank of England (1990). New equity issues in the United Kingdom, Bank of England Quarterly Bulletin, May, pp. 24352. Bannerjee, A. (1992). A simple model of herd behavior, Quarterly Journal of Economics, Vol. 3, pp. 797817. Barclay, M., Christie, W., Harris, J., Kandel, E. & Schultz, P . (1999). The effects of market reform on trading costs and depths of Nasdaq stocks, Journal of Finance, Vol. 54, pp. 134.
PAGE 129
References (continued)
Barclay, M.J. & Litzenberger, R.H. (1988). Announcement effects of new equity issues and the use of intraday price data, Journal of Financial Economics, Vol. 21, pp. 7199. Barnes, E. (2002). Seasoned equity issues. A change in the trend, Accountancy Ireland, April, pp. 289. Bayless, M. & Chaplinsky, S. (1996). Is there a window of opportunity for seasoned equity issuance?, Journal of Finance, Vol. 51, pp. 25379. Benoit, B. (1999). Professional expenses prove a deterrent to maintaining stock market exposure, Financial Times, 31 August, p. 19. Bhagat, S. & Frost, P .A. (1986). Issuing costs to existing shareholders in competitive and negotiated underwritten public utility offerings, Journal of Financial Economics, Vol. 15, pp. 23359. Brennan, M.J. & Franks, J. (1997). Underpricing, ownership and control in initial public offering of equity securities in the UK, Journal of Financial Economics, Vol. 45, pp. 391413. Burton, B.M., Lonie A.A. & Power, D.M. (2000). The impact of corporate growth opportunities on the market response to new equity announcements, Applied Financial Economics, Vol. 10, pp. 2736. Burton, B.M. & Power, D.M. (2003). Evidence on the Determinants of Equity Issue Method in the UK. Applied Financial Economics, 13, pp. 145147. Choe, H., Masulis, R.W. & Nanda, V. (1993). Common stock offerings across the business cycle, Journal of Empirical Finance, Vol. 1, pp. 331. Christie, W.G. & Schultz, P .H. (1994). Why do Nasdaq market makers avoid oddeighth quotes? Journal of Finance Vol. 49, pp. 181340. Chung, K.H., Van Ness, D.F. & Van Ness, R.A. (1999). Limit orders and the bidask spread, Journal of Financial Economics, Vol. 53, pp. 22587.
PAGE 130
Committee on Corporate Governance (1998). The Combined Code, Committee on Corporate Governance, Gee Publishing, London. Committee on Corporate Governance (1998). Final Report: Committee on Corporate Governance (The Hampel report), Committee on Corporate Governance, Gee Publishing, London. Committee on the Financial Aspects of Corporate Governance (1992). Report on the Financial Aspects of Corporate Governance (The Cadbury Report), Gee Publishing, London. Datar, S.M., Feltham, G.A. & Hughes, J.S. (1991). The role of audits and audit quality in valuing new issues, Journal of Accounting and Economics, Vol. 14, pp. 350. Dawson, S.M. (1987). Secondary stock market performance of initial public offers in Hong Kong, Singapore and Malaysia, Journal of Business Finance and Accounting, Vol. 14, pp. 6576. DeBondt, W.F.M. & Thaler, R.E. (1985). Does the stock market overreact?, Journal of Finance, Vol. 40, pp. 793805. DeBondt, W.F.M. & Thaler, R.E. (1995). Financial decision-making and firms: A behavioral perspective, chapter 13 in R.A. Jarrow, V. Maksimovic, W.T. Ziemba, G.L. Nemhauser & A.H.G. Rinnooy Kan (eds). Handbooks in Operational Research and Managerial Science Vol. 9, pp. 385410, Amsterdam, Oxford, Elsevier Dierkins, N. (1991). Information asymmetry and equity issues, Journal of Financial and Quantitative Analysis, Vol. 26, pp. 18199. Eckbo, B.E. & Masulis, R.W. (1992). Adverse selection and the rights offer paradox, Journal of Financial Economics, Vol. 32, pp. 293332. Eguiluz V.M. & Zimmerman, M.G. (2000). Transmission of information and herd behaviour: an application to financial markets, Physical Review Letters, Vol. 85, pp. 565962.
PAGE 131
Espenlaub, S., Gregory A. & Tonks, I. (2000). Reassessing the long-run underperformance of UK initial public offerings, European Financial Management, Vol. 6, pp. 31942. Feltham, G.A., Hughes, J.S. & Simunic, D. (1991). Empirical assessment of the impact of auditor quality on the valuation of new issues, Journal of Accounting and Economics, Vol. 14, pp. 37599. Frankfurter, G.M. & McGoun, E.G. (2000). Resistance is futile: The assimilation of behavioural finance, Paper presented at the Fifth Alternative Perspectives in Finance and Accounting Conference, Dundee, UK. Gapper, J. & Lewis, W. (1996). The cost of raising equity: is it too high?, Financial Times, 11 December, p.23. Graham, J.R. & Harvey, C.R. (2001). The theory and practice of corporate finance: Evidence from the field, Journal of Financial Economics, Vol. 60, pp. 187243. Greenbury, R. (1995). Report of a study group chaired by Sir Richard Greenbury, Directors Remuneration (The Greenbury Report), Gee Publishing, London. Grinblatt, M. & Hwang, C.Y. (1989). Signalling and the pricing of new issues, Journal of Finance, Vol. 44, pp. 393420. Hansen, R.S. (1988). The demise of the rights issue, Review of Financial Studies, Vol. 1, pp. 289309. Healy, P .M. & Palepu, K.G. (1990). Earnings and risk changes surrounding primary stock offers, Journal of Accounting Research, Vol. 28, pp. 2548. Heath, C. & Tversky, A. (1991). Preference and belief: Ambiguity and competence in choice under uncertainty, Journal of Risk and Uncertainty, Vol. 4, pp. 528. Helliar, C.V. (1997). Uses of Interest Rate and Currency Swaps by Financial Managers, Research Monograph, The Chartered Institute of Management Accountants, UK.
PAGE 132
Helliar, C.V., Lonie, A.A., Power, D.M. & Sinclair, C.D. (2001). Attitudes of UK Managers to Risk and Uncertainty, Research Monograph, The Institute of Chartered Accountants in Scotland. Hussey J. & Hussey R. (1997). Business Research, Macmillan , London. Ibbotson, R.G. (1975). Price performance of common stock new issues, Journal of Financial Economics, Vol. 2, pp. 23572. ICAEW (1999). Internal Control Working Party, Internal Control: Guidance for Directors on the Combined Code (The Turnbull Report), Institute of Chartered Accountants in England and Wales, London. Jenkinson T. & Ljungqvist, A. (1996). Going Public: The Theory and Evidence on How Companies Raise Equity Finance, Clarendon Press, Oxford, pp. 1174. Jenkinson T. & Mayer, C. P . (1988). The privatisation process in France and the UK, European Economic Review, Vol. 32, pp. 48290. Jung, K., Kim Y. & Stulz, R.M (1996). Timing, investment opportunities, managerial discretion, and the security issue decision, Journal of Financial Economics, Vol. 42, pp. 15985. Kahneman, D. & Tversky, A. (1979). Prospect theory: An analysis of decisions under risk, Econometrica, Vol. 47, pp. 26891. Kalay, A. & Shimrat, A. (1987). Firm value and seasoned equity issues, Journal of Financial Economics, Vol. 19, pp. 10926. Keane, S.M. (1985). Dividend Policy. In Issues in Finance, Philip Allen, Oxford. Korajczyk, R.A., Lucas, D.J. & McDonald, R.L. (1990). Understanding stock price behaviour around the time of equity issues. In R.G. Hubbard (ed.), Asymmetric Information, Corporate Finance, and Investment, Chicago, University of Chicago Press, pp. 25778.
PAGE 133
Kothari, S.P . and Warner, J.B. (1997). Measuring long-horizon security price performance, Journal of Financial Economics, Vol. 43, pp. 30140. Krigman, L., Shaw, W.H. and Womack, K.L. (2001). Why do firms switch underwriters?, Journal of Financial Economics, Vol. 60, pp. 24584. Lee, I., Lochhead, S., Ritter, J.R. & Zhao, Q. (1996). The costs of raising equity. Journal of Financial Research, Vol. 19, pp. 6974. Levis, M. (1993). The long-run performance of initial public offerings: The UK experience 1980-1655, Financial Management, Vol. 22, pp. 2841. Lintner, J. (1956). Distribution of incomes of corporations among dividends, retained earnings and taxes, American Economic Review, Vol. 46, pp. 97113. Ljungqvist, A.P . (1996). Can firms outwit the market? Timing ability and long-run performance of IPOs, in M Levis (ed.), Empirical Issues in Raising Equity Capital, Amsterdam, North Holland. Logue, D. (1973). On the pricing of unseasoned equity issues 19651969, Journal of Financial and Quantitative Analysis, Vol. 8, pp. 91103. Long, M.S. & Malitz, E.B. (1983). Investment Patterns and Financial Leverage, National Bureau of Economic Research, US. Loughran, T. & Ritter, J.R. (1995). The new issues puzzle, Journal of Finance, Vol. 50, pp. 2351. Loughran, T., Ritter, J.R. & Rydquist, K. (1994). Initial public offerings: international insights, Pacific Business Finance Journal, Vol. 2, pp. 16599. Lyon, J.D., Barber, B.M. and Tsai, C-L. (1999). Improved methods for tests of long-run abnormal returns, Journal of Finance, Vol. 54, pp. 165201. March, J.G. and Shapira, Z. (1988). Managerial perspectives on risk and risktaking. In Decisions and Organisations, Blackwell, Oxford.
PAGE 134
Marsh, P . (1982). The choice between equity and debt: An empirical study, Journal of Finance, Vol. 37, pp. 12144. Masulis, R. & Korwar, A. (1986). Seasoned equity offerings: An empirical investigation, Journal of Financial Economics, Vol. 15, pp. 91118. Michaely, R. & Shaw, W.H. (1994). Asymmetric information, adverse selection and the pricing of initial public offers, Review of Financial Studies, Vol. 7, pp. 279 319. Mikkleson, W.H. and M.M. Partch (1986), Valuation Effects of Security Offerings and the Issuance Process, Journal of Financial Economics, Vol.15, pp. 2160. Modigliani, F. and M.H. Miller (1958), The cost of capital, corporation finance and the theory of investment, American Economic Review, Vol. 48, pp. 261297. Monopolies and Mergers Commission (1999), Underwriting services for share offers, The Stationery Office, London. Myers, S.C. (1984). The search for optimal capital structure, Midland Corporate Finance Journal, Vol. 2, pp. 616. Myers, S.C. & Majluf, N.S. (1984). Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics, Vol. 13, pp. 187222. Office Of Fair Trading (1996), Underwriting of rights issues. A study of the returns earned by sub-underwriters from UK rights issues, OFT Research Paper 6, London. Olsen, R.A. (2000). The instinctive mind on Wall Street: Evolution and investment decision-making, The Journal of Investing, Winter, pp. 4754. Patterson, C.S. & Ursel, N.D. (1993). Rights issues and perceived growth rate dilution, Journal of Business Finance and Accounting, Vol. 20, pp. 11524.
PAGE 135
Pilotte, E. (1992). Growth opportunities and the stock market response to new financing, Journal of Business, Vol. 65, pp. 37194. Pinegar, J.M. & Wilbricht, L. (1989). What managers think of capital structure theory: A survey, Financial Management, Vol. 18, pp. 8290. Ritter, J.R. (1991). The long-run performance of initial public offerings, Journal of Finance, Vol. 46, pp. 327. Rock, K. (1986). Why new issues are underpriced, Journal of Financial Economics, Vol. 15, pp. 187212. Ruud, J.S. (1991). Another view of the underpricing of initial public offerings, Federal Reserve Bank of New York Quarterly Review, Vol. 16, pp. 835. Ruud, J.S. (1993). Underwriter price support and the IPO underpricing puzzle, Journal of Financial Economics, Vol. 34, pp. 13551. Sant, R. & Ferris, S.P . (1994). Seasoned equity offerings: the case of all-equity firms, Journal of Business Finance and Accounting, Vol. 21, pp. 42944 Schleifer, A. (1999). Inefficient Markets, Oxford, Oxford University Press. Schultz, P .H. & Zaman, M.A. (1994). After market support and the underpricing of initial public offerings, Journal of Financial Economics, Vol. 35, pp. 199219. Schultz, P .H. & Zaman, M.A. (2001). Do the individuals closest to internet firms believe they are overvalued?, Journal of Financial Economics, Vol. 59, pp. 34781. Scott Jr., J.H. (1976). A theory of optimal capital structure, Bell Journal of Economics, Spring, pp. 3354. Shyam-Sunder, L. & Myers, S.C. (1999). Testing static trade-off against pecking order models of capital structure, Journal of Financial Economics, Vol. 51, pp. 21944
PAGE 136
Simonson, I. & Staw, B.M. (1992). De-escalating strategies: A comparison of techniques for reducing commitment to losing course of action, Journal of Applied Psychology, Vol. 77, pp. 41926. Slovic, P . (1972). Psychological study of human judgement: Implications for investment decision making, Journal of Finance, Vol. 27, pp. 77999. Slovin, M.B., Sushka, M.E. & Lai, K.W.L. (2000). Alternative flotation methods, adverse selection, and ownership structure: evidence from seasoned equity issuance in the UK, Journal of Financial Economics, Vol. 57, pp. 15790. Smith Jr., C.W. (1977). Alternative methods for raising capital: rights vs. underwritten offers, Journal of Financial Economics, Vol. 5, pp. 273307. Smith Jr., C.W. (1986). Investment banking and the capital acquisition process, Journal of Financial Economics, Vol. 15, pp. 329. Speiss, D.K. & Affleck-Graves, J. (1995). Underperformance in long-run stock returns following seasoned equity offerings, Journal of Financial Economics, Vol. 38, pp. 24367. Statman, M. (1999). Behavioral finance: Past battles and future engagements, Financial Analysts Journal, Vol. 55, pp. 1827. Taffler, R. (2001). Behavioural Finance and the Corporate Treasurer, The Treasurer, May, pp. 213. Teoh, S.H., Welch, I. & Wong, T.J. (1998). Earnings management and the underperformance of seasoned equity offerings, Journal of Financial Economics, Vol. 50, pp. 6399. Tilston, D. (2000a). Floating on AIM, The Treasurer, October, pp. 1721. Tilston, D. (2000b). Aim to be the best, Accountancy, December, pp. 312.
PAGE 137
Tversky, A. & Kahneman, D. (1981). The framing of decisions and the psychology of choice, Science, Vol. 211, pp. 4538. Wallace, R.S.O. & Mellor, C.J. (1988). Non-response bias in mail accounting surveys: A pedagogical note, British Accounting Review, Vol. 20, pp. 13139. Welch, I. (1989). Seasoned offerings, invitation costs and the underpricing of initial public offers, Journal of Finance, Vol. 44, pp. 42149. Welch, I. (1996). Equity offers following the IPO: Theory and Evidence, Journal of Corporate Finance, Vol. 2, pp. 22759. Wilson Committee (1977). Report of the Committee to Review the Functioning of Financial Institutions, Cmnd. 7937. Wilson, R.M.S. & Zhang, Q. (1997). Entrapment and escalating commitment in investment decision making: A review, British Accounting Review, Vol. 29, pp. 275305.
PAGE 138
RR/082/001 ISBN: 1 85908 392 7 The Association of Chartered Certified Accountants 29 Lincoln's Inn Fields London WC2A 3EE United Kingdom tel: +44 (0)20 7396 5980 fax: +44 (0)20 7396 5730 www.accaglobal.com

BF&amp;IPO

Încărcat de

Informații document

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

BF&amp;IPO

Încărcat de

Drepturi de autor:

Formate disponibile

ACCA Research Report No.

A Behavioural Finance Perspective on IPOs and SEOs

A Behavioural Finance Perspective on IPOs and SEOs

Certified Accountants Educational Trust, London, 2003

The Association of Chartered Certified Accountants, 2003 ISBN: 1 85908 392 7

A Behavioural Finance Perspective on IPOs and SEOs

A Behavioural Finance Perspective on IPOs and SEOs

Executive summary (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Executive summary (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Executive summary (continued)

A Behavioural Finance Perspective on IPOs and SEOs

1. Introduction to the study

A Behavioural Finance Perspective on IPOs and SEOs

Introduction to the study (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Introduction to the study (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Introduction to the study (continued)

A Behavioural Finance Perspective on IPOs and SEOs

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

Source: Adapted from Arnold (2002)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

The short-run performance of IPOs

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

The market reaction to SEOs and possible rationales

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

Literature review (continued)

A Behavioural Finance Perspective on IPOs and SEOs

A Behavioural Finance Perspective on IPOs and SEOs

A Behavioural Finance Perspective on IPOs and SEOs

Research methods (continued)

The postal questionnaire survey

A Behavioural Finance Perspective on IPOs and SEOs

Research methods (continued)

A Behavioural Finance Perspective on IPOs and SEOs

BF&IPO

BF&IPO