Descriptive data and the differences between unit IPOs and share-only IPOs

According to both the Agency Cost and Signalling hypotheses, we expect that unit IPOs are preferred by younger (H3.1), smaller (H3.2), riskier (H3.3) firms with lower insider ownership (H3.5), less income (H3.6), higher agency costs (H3.7), and smaller offering size (H3.8). To test the hypotheses set up in section 3.3, descriptive data to indicate firm characteristics is identified and calculated from the information collected for both the unit sample and the matching share-only IPO sample. The definitions of variables are summarised in TABLE 3.1 and descriptive results are illustrated in TABLE 3.5. The age of the firm (AGE), is defined as the number of calendar days between the firm incorporation date and the date of listing; in a few cases when the listing date is not available, the date when the trading of new shares commences is applied. The riskiness of the issuing firm (RISK) is measured by the standard deviations of after-market returns19 _{spanning 200 days after the IPO, excluding the initial returns. The size of} the firm is designated with both total asset (TTLASSET) and the market capitalisation (MKTCAP) at offering price immediately following the IPO. The total asset is collected from the balance sheet by the end of the fiscal year prior to the IPO and the market capitalisation is computed as the product of number of shares immediately after the IPO and the offer price. The size of the offering (PROCEEDS) is reported as the gross proceeds from the offering calculated by multiplying the number of new shares in the issue with the offer price. Insider ownership (INSIDER) is calculated as the percentage of the number of shares directors and senior management hold in the company to the enlarged share capital immediately following the listing. The number of shares under any executive option schemes is also taken into consideration in insider subscription. However, holdings of the company shares by common employees or any other companies are not identified as insider ownership. The profitability measure is the gross revenue (REVENUE) of IPO firms collected from the prospectus by the

90 end of the fiscal year prior to the IPOs. (LEVERAGE) is the ratio of total debt to total assets, both collected from the prospectus as well.

In TABLE 3.5, the mean and median, minimum and maximum values of the descriptive statistics for both unit IPOs and matching share-only IPOs are compared. Student’s t-tests and the non-parametric Mann-Whitney (MW) tests are undertaken to examine the significance level of difference in means and medians. The Pearson moment correlation coefficients between each pair of variables are calculated to measure degree of linear relationship between the two variables. The p-value of a two tailed hypothesis test of the correlation coefficient being zero is also presented in TABLE 3.5. Contrary to the Hypothesis 3.1 from Section 3.3 regarding firm age, the unit firms in the UK are in fact significantly older in both the mean (8.8 years) and median(1.1 years) age, comparing to the mean (3.4 years) and median (0.7 years) age of matching share-only IPO firms. (Hypothesis 3.1 is rejected).

Measured by the market capitalisation at offer price immediately following the IPO, unit firms are significantly smaller in firm size than share-only firms in both mean and median terms. The average market capitalisation of unit firms after IPO is £23.617 million, which is much lower than the average market capitalisation of share-only IPOs (£31.578 million). The difference is highly significant at 1% level. Another firm size measurement is the total asset by end of the fiscal year prior to the listing. The average total asset of unit firms is £5.325 million comparing to £9.772 million for share-only firms and the difference is marginally significant at 15%, which can be expected due to limited sample size. Nonetheless, by median values, unit firms are significantly smaller than share-only counterparts at 1% level indicated by the p-value from Mann-Whitney test. As a result, Hypothesis 3.2 cannot be rejected.

Firm RISK is estimated as the residual standard deviations of the sample firms using daily discrete returns for 200 days following the listing of the IPO (excluding initial returns). As

Hypothesis 3.3 predicted, unit IPO firms present significantly higher average standard deviations (Mean 0.045, Median 0.039) than share-only IPO firms (Mean 0.036, Median 0.033). The differences in both means and medians are highly significant at 1%. Thus, unit firms are indeed riskier than share-only IPO firms, which confirm both the Agency Cost and the Signalling hypothesis. Contrarily to the Agency Cost prediction, although unit firms appear to have lower insider ownership (mean 35.43%, median 33.57%) than that of share-only firms (mean 38.88%, median 38.83%), the difference in means and medians are not significant. As a result, Hypothesis 3.5 is not statistically supported by the UK data.

Measured by total revenue, the unit firms in the UK have less income prior to listing comparing to matching share-only firms, which is in line with the Agency Cost theory. The differences in means and medians are both significant at 5% level. The average revenue for unit firms is £5.462 million comparing to £10.648 million for share-only IPO firms. The less promising historical financial records reflecting higher level of uncertainty of the firm’s profitability, which is consistent with the fact that unit firms are riskier than share-only IPO firms. Therefore, Hypothesis 3.6 proposed in Section 3.3 is not rejected.

Unit firms also exhibit much smaller issue size measured by the expected IPO proceeds. An average unit IPO can only raise £6.581 million before any expenses; whilst the average gross proceeds of share-only IPOs is £12.755 million, which is nearly twice the size of a unit offer. The difference in means is significant at 5% level as indicated by a Student t-test, whereas the difference in medians is highly significant at 1% level suggested by the p-value of a Mann-Whitney test. Therefore, Hypothesis 3.8 cannot be rejected. Expectedly, the total expenses of unit IPOs is also significantly lower than that of share-only IPOs.

92 total asset (mean 47.3%, median 34.3%) than that of share-only IPO firms (mean 88.9%, median 66.2%), the differences in both means and medians are significant at 1% level. Therefore, the original Hypothesis 3.14 is supported by the UK data. The result on debt leverage before listing confirm that share-only firms are generally less risky with better historical trading records, and it is easier for them to secure cheaper debt financing with banks comparing to unit IPO firms that are not as creditable. It is therefore expected for unit firms to seek further financing after the IPO through exercise of warrants.

In conclusion, the descriptive statistics indicate that compared to share-only IPO firms, unit IPO firms in the UK are significantly smaller and riskier with less income prior to the IPOs, which confirms the common ground of both the Agency Cost and the Signalling hypotheses. Contrary to both hypotheses, my UK data does not support the common argument that unit firms are significantly younger than share-only IPOs. Unit IPOs also seemingly exhibit lower insider ownership than that of share-only IPOs but the difference is not significant and therefore unable to support the Agency Cost prediction. However, in unique support to the Agency Cost hypothesis, unit IPOs are significantly smaller offers than share-only IPOs are, which confirm the Agency Cost hypothesis that unit firms intestinally limit the size of the unit IPO proceeds so the managers will not have excessive free cash flow for careless investments. Instead, they only have enough money to start production and test the market. As a result, managers of unit firms are motivated to spend the proceeds carefully by only invest in value-generating projects so that the company’s share price will increase to allow the exercise of warrants as the second round of financing. Considering the higher risk, naturally unit firms do not stand out as the best candidate for investors’ choice. In such instance, including warrants in the IPO to form a staged financing can provide investors more open options for future involvement in the investments. If the unit firm enjoys better performance in the future, warrants will naturally be exercised and investors will be happy to be more involved with the company by holding more shares in it. If

the unit firm suffers bad performance after the IPO, warrants will expire to protect investors’ interest and no further involvement will occur.

INSERT TABLE 3.5 HERE

3.5.3 Direct tests of the Agency Cost and Signalling hypotheses

Following How and Howe (2001), the most straightforward test of the Agency Cost hypothesis is to examine whether unit IPO firms have a greater level of agency cost than share-only IPOs. The most straightforward test of the Signalling hypothesis is to see whether unit firms have higher levels of information asymmetry and therefore greater incentive to signal firm value than share-only firms do.

Following Ang et al. (2000), ‘efficiency ratios’ are employed as measures of agency cost. Three different efficiency ratios are calculated using data by end of the accounting year prior to the IPO: revenue divided by total asset (REV/TTLASSET), earnings before interest and taxes divided by total asset (EBIT/TTLASSET), and net income divided by total asset (NI/TTLASSET). The means and medians, minimum and maximum values of the three ratios with the p-values from both Student’s t-test for means and the non-parametric Mann-Whitney test for medians are presented in Panel-A of TABLE 3.6. Results indicate that the first two efficiency ratios (revenue-to-total asset and EBIT-to-total asset) are significantly lower for unit IPO firms, suggesting lower levels of profitability and asset utilisation and therefore higher level of agency cost, comparing to those of share-only IPO firms. The third ratio of net income to total asset is still lower for unit IPOs, however the differences in means and medians are not significance at conventional level. Nonetheless, this paper provides partial support for the Agency Cost hypothesis with two efficiency ratios. It is safe to reason that unit firms exhibit significantly lower profitability and asset unitisation before listing than share-only firms

94 matched on firm size and industry, therefore have more incentive to limit agency cost and encourage management to make optimal investment decisions by including warrants in their IPOs. Hypothesis 3.7 stating that unit firms have higher agency costs in terms of profitability and asset utilisation ratios than share-only counterparts cannot be rejected.

Following How and Howe (2001)’s direct test on the Signalling hypothesis, information asymmetry is measured as the residual standard deviations using daily discrete returns for 200 days following the listing (which is the same measure of RISK variable). The time lag as the number of calendar days between the registration of firm prospectus (i.e. when the information of a new issue is announced) and the listing of new issues (or the first trading day), is also calculated to proxy for the level of information asymmetry in the offering (DELAY). As shown in Panel-B of TABLE 3.6, unit firms present significantly higher residual standard deviations in both mean (0.045) and median (0.039) values than those of share-only firms (Mean, 0.036; Median, 0.033), suggesting unit IPOs are associated with higher level of information asymmetry. The p-values from both the Student t-test and the non-parametric Mann-Whitney test are highly significant at 1% level. Between registration of prospectus and commence of the trading (DELAY), unit firms on average experience longer time lag (13 days) comparing to that of share-only firms (10 days), the difference in means is significant at 5% level. The median days of delay between the announcement of IPO and the first trading day are both 7 days for unit IPOs and share-only IPOs. Such an outcome can be explained by the fact that unit firms tend to prolong the time lag between Prospectus publication and the listing day intentionally to convey more information on firm value. Overall, as predicted by Hypothesis 3.11 in this study, direct tests suggest that unit firms present higher levels of information asymmetry comparing to that of share-only offerings and therefore have greater motivation to signal the true firm value to the public by including warrants.

In conclusion, the direct test on Agency Cost hypothesis using three efficiency ratios provides partial support to Schultz (1993b) that unit IPO firms present much less efficient use of their total assets to generate profits and therefore have more agency problems, comparing to share-only IPO firms which exhibit higher efficiency ratios. On the other hand, the direct tests on the Signalling hypothesis provide conclusive support. The information asymmetry measured by the residual standard deviations indicates that unit firms suffer more asymmetric information and have more motivation to include warrants to signal true firm value. Such results are consistent with the signalling explanation (Hypothesis 3.11 cannot be rejected).

INSERT TABLE 3.6 HERE

3.5.4 Initial underpricing and short-term after-market performance of unit IPOs

Early research documents that initial public offerings are on average issued at a discount (Ibbotson, 1875; Ritter, 1984; and Welch, 1989). In other words, initial underpricing has been recognised as a feature of IPO in general. The Signalling hypothesis of Chemmanur and Fulghieri (1997) only predicts that the degree of underpricing will increase with firm riskiness, which is tested in the last section. More specifically, the Agency Cost hypothesis of Schultz (1993b) predicts that unit IPO firms are more underpriced than are share-only IPO firms. Schultz (1993b) interprets that firms tend to include warrants in their IPO when they suffer more agency cost and the value of their projects cannot be easily evaluated. In order to convince the investors to purchase their shares and participate in the company’s future development, they choose to include warrants and to underprice their shares at the same time. To test whether unit IPOs are more underpriced than matching share-only IPOs, I examine both the initial returns and the short-term after-market performance of unit IPOs in comparison to share-only IPOs.

96 Following How and Howe (2001) and Jelic et al. (2001) I calculate the raw initial returns (IRD1), HGSC Index-adjusted initial returns (IRD2), and continuously compounded initial returns (IRD3) on the first trading day (EQUATION 3.1-3.3 in Section 3.4) for both the unit IPOs and their share-only counterparts. The Hoare Govett Smaller Companies (HGSC) Index is chosen to adjust for general market movement. Since unit IPOs tend to be issued by smaller firms, HGSC Index as benchmark can account for firm size. As alternative underpricing measure for robustness check, I also calculated the weekly initial returns for the first trading week. IRW1 in EQUATION 3.4 is the HGSC-adjusted first week initial returns, whereas IRW2 in EQUATION 3.5 is the natural logarithm of market-adjusted weekly initial returns, both of which are calculated using the closing price on the fifth trading day relative to the IPO offer price.The mean, median, minimum, and maximum values with the standard deviations of each initial return measures are illustrated in TABLE 3.7 for 92 unit IPOs and 92 share-only IPOs matched on firm size and industry.

INSERT TABLE 3.7 HERE

Panel A of TABLE 3.7 illustrates the initial underpricing for the first trading day and first trading week before dealing with outliers. By all five IR measures, the UK unit IPOs exhibit significantly higher initial returns comparing to their share-only counterparts, in both their means and medians. The average raw initial return on the first trading day (IRD1) for unit firms is 51.02% comparing to share-only IPO firms which average at only 7.55%; whereas the median raw initial return for unit IPOs is 25.00%, which is much higher than the 5.03% median for share-only IPOs. After adjusting for market movements from Hoare Govett Smaller Companies (HGSC) Index, the market-adjusted initial returns of unit IPOs (Mean 50.89%, Median 24.76%) are significantly higher than those of share-only IPOs (Mean 7.56%, Median 4.94%). As robustness check, IRW1 measures the initial share price run-up during the first trading week relative to the offer price. The HGSC-adjusted weekly initial returns remain

significantly higher for unit IPOs (Mean 47.09%, Median 21.59%) than for their matching share-only counterparts (Mean 17.58%, Median10.19). After comparing the first-day and first-week initial returns for both unit and share-only IPOs, a clear pattern can be recognised: after the first trading day the magnitude of underpricing decreased over the first week for unit IPOs whereas the initial returns of matching share-only IPOs inflated by the end of first trading week. Nonetheless, unit IPOs still remain significantly more underpriced than share-only IPOs. To correct for the high standard errors caused by extreme values of raw initial returns, I calculate the continuously compounded initial returns (EQUATION 3.3 and EQUATION 3.5). The log initial returns for both the first trading day (IRD3) and first trading week (IRW2) provide smoother results after controlling for extreme values by taking logarithm of the discrete returns.

The minimum, maximum values and the standard deviations in Panel A suggest possible outliers in the sample. The maximum raw initial return for unit IPOs is 431.25% whilst the minimum is -0.33%; and the standard deviation is 0.726. For matching share-only IPOs, raw initial returns range from -80% to 130% with standard deviation to be 0.290. To deal with possible bias from outliers, I ranked the initial returns, eliminated the top-5 and bottom-5 extreme values from the sample, and calculated the trimmed means and medians as robustness-test, the results of which are presented in Panel B of TABLE 3.7. After excluding outliers, the minimum and maximum values exhibit much smaller gaps with smaller standard deviations for both unit and matching share-only samples. The raw initial returns for unit IPOs vary between the maximum 183% and the minimum 4% with standard deviation of 0.390; whereas the raw initial returns for share-only IPOs range from the maximum of 39.76% and the minimum of -38.46% with a standard deviation of 0.143. All five underpricing measures remain highly significant with smaller magnitude in both the trimmed means and medians.

98 Overall, TABLE 3.7 strongly indicates that unit IPOs significantly outperform share-only IPOs on the first trading day and within the first trading week. The differences in both means and medians for all underpricing measures are significant at 1-5% level before and after dealing with outliers, which provide strong support to the Agency Cost hypothesis that unit IPOs are more underpriced than share-only IPOs.

To examine whether the abnormally high initial returns on the first trading day will sustain after the completion of IPOs, I also calculate the HGSC-adjusted buy-and-hold abnormal returns (BHAR) relative to the first trading day for 2, 7, 14, and 21 days in the after-market. The results of BHARs are presented in TABLE 3.8. Panel A illustrates the mean, median, minimum and maximum values of the HGSC-adjusted BHARs before dealing with outliers. Two days post-listing, the average HGSC-adjusted buy-and-hold return for unit sample is 9.2% comparing to the 3.49% for matching share-only sample. The difference in means is significant