Equity Issues and Stock Repurchases of Initial Public Offerings

Date01 January 2016
DOIhttp://doi.org/10.1111/eufm.12053
Published date01 January 2016
Equity Issues and Stock Repurchases
of Initial Public Offerings
Wolfgang Bessler
Center for Financeand Banking, JustusLiebigUniversity Giessen, LicherStrasse 74, Giessen, Germany
E-mail: Wolfgang.Bessler@wirtschaft.uni-giessen.de
Wolfgang Drobetz
School of Business, University of Hamburg, Germany
E-mail: wolfgang.drobetz@wiso.uni-hamburg.de
Martin Seim and Jan Zimmermann
Center for Finance and Banking, JustusLiebigUniversity Giessen, Germany
E-mails: martin.seim@wirtschaft.uni-giessen.de; jan.zimmermann@wirtschaft.uni-giessen.de
Abstract
We investigate the nancing strategies and valuation effects of 247 IPO rms at the
Neuer Marktin Germany that either issued additional equity (SEO) or
repurchased shares (SRP) within ve years after going public. IPOs issuing
additional equity exhibit a temporary outperformance before the event, but negative
announcement returns and a longrun underperformance. In contrast, repurchas-
ing IPOs experience positive announcement returns and no longrun under-
performance. Free cash ow problem resulting from mandatory equity issuance at
the IPO explain the SRP decision. Our ndings for SEOs are consistent with a
staged nancing strategy, while we nd no evidence for market timing.
Keywords: Initial public offerings, share repurchases, seasoned equity offerings,
valuation effects
JEL classification: G32, G35
We are grateful to two anonymous referees, John Doukas (the editor), Henk von Eije, Laura
Field, Fred Kaen as well as participants at the European Financial Management (EFM)
Symposium on Entrepreneurial Finance & Venture Capital Markets in Montreal 2010, the
Financial Management Association Conference in New York 2010, the Financial
Management Association European Conference in Hamburg 2010, the Midwest Finance
Association Conference in Las Vegas 2010, the Annual Meeting of the Verein für
Socialpolitik in Kiel 2010, the Benelux Corporate Finance Day in Groningen 2010, the
Swiss Society for Financial Market Research Conference in Zurich 2011, and the Campus
for Finance Research Conference at the WHUOtto Beisheim School of Management in
Vallendar 2011 for helpful comments and suggestions. Correspondence: Wolfgang Bessler.
European Financial Management, Vol. 22, No. 1, 2016, 3162
doi: 10.1111/eufm.12053
© 2014 John Wiley & Sons Ltd
1. Introduction
Entrepreneurial rms, especially hightechnology startups, need substantial amounts of
equity to nance their research, product development, and growth opportunities. Early on,
founders, families and friends, and venture capitalists are the sole providers of equity,
whereas bank nancing is typically rare. Successful entrepreneurial rms often need more
nancial resources and may choose to raise additional equity by going public. If rms
perform well, and if they have protable growth opportunities, then these initial public
offerings (IPOs) may issue even more equity through seasoned equity offerings (SEOs)
shortly after going public (DeAngelo et al., 2010; Hertzel et al., 2012). If staged nancing
is the strategy investors favour when investing in entrepreneurial rms, then it is
surprising to observe that some IPO rms return equity to their shareholders by initiating a
share repurchase program (SRP) soon after going public. The objective of our paper is to
examine the motivation, valuation effects, and determinants for SRPs and SEOs of IPO
rms at the German Neuer Markt.
Europes stock exchanges established new market segments during the 1990s to foster
the capital market access for hightechnology startups, providing them with sufcient
equity for nancing their growth opportunities. However, most new marketsclosed
amidst legal and regulatory issues as well as dwindling investor interest by 2005.
GermanysNeuer Marktwas initially one of the more successful new marketsin terms
of number and performance of IPOs during this new economyperiod. As the French
Nouveau Marchéand ItalysNuovo Mercatoit was highly regulated, in contrast to
LondonsAlternative Investment Market(AIM) which is a private placement market
with minimal regulation (Vismara et al., 2012; Jenkinson and Ramadorai, 2013). In
comparison to the other new markets, the German Stock Exchange (Deutsche Börse)
imposed unique rules such as requiring rms to issue additional equity when going public
(Bessler et al., 2014). For many rms this resulted in high cash holdings, as at least half of
the offering proceeds had to come from issuing new shares. We analyse whether the
mandatory equity issuance rule was benecial for IPOs and investors, given that it had
substantial implications for IPO rmsnancial policies and strategies. The results add to
the current discussion among European regulators and politicians to reestablish
organised stock market segments for startup rms, this time with an improved structure
and regulation.
1
Our study contributes to the research on SRPs and SEOs of IPO rms by analysing both
nancial activities in the context of the special rules and regulation of the Neuer Markt.
For established rms, undervaluation signalling and the free cash ow hypothesis are the
1
For an overview of the current state of IPO research, see the special issue on IPOsin this
journal (Vol. 15, 2009) and especially the introduction by Jenkinson (2009) as well as the
handbook of Levis and Vismara (2013). Survey evidence on motivations for going public in
Europe is provided by Bancel and Mittoo (2009). For countrystudies of IPOs during the new
marketperiod, see for Italy Caselli et al. (2009) on IPOs and VC, Meles (2011) on IPOs and
PE, and Boreiko and Lombardo (2011) on market structure. Vandemaele (2003) provides
evidence on market structure and otation choice in France, and Pownall et al. (2014) on the
integration of the Euronext markets. A comparison of IPOs during the new economy period is
offered by Ritter (2003) for IPOs in Europe and the USA, by Goergen et al. (2009) for IPOs in
France and Germany, and by Chahine et al. (2007) for IPOs in France and the UK.
© 2014 John Wiley & Sons Ltd
32 Wolfgang Bessler, Wolfgang Drobetz, Martin Seim and Jan Zimmermann
common explanations for SRPs. For IPOs, only a few studies investigate share repurchase
activities (Chen et al., 2012; Bessler et al., 2014). Our results suggest that the rules
directly relating to the mandatory equity issuance at the IPO had a signicant effect on
both the SRP and SEO likelihood. We nd that IPOs are more likely to repurchase shares
the more preIPO owners sell their equity stake at the IPO (the exit ratio), which is
consistent with the free cash ow hypothesis. The SEO likelihood increases with the
fraction of new equity issued at the IPO (the dilution factor) as well as with growth
opportunities, for which staged nancing is an explanation, i.e., rms raise only a fraction
of their required equity at the IPO. Moreover, IPOs at the Neuer Marktexperience, on
average, a high underpricing and an inferior longrun performance. However, by
returning surplus cash to shareholders, repurchasing IPOs are able to generate signi-
cantly positive abnormal returns at the announcement and to deter subsequent
underperformance. In contrast, IPOs issuing additional equity underperform the market
before and subsequent to the SEO, but experience a preannouncement runup.
We structure our paper as follows. In Section 2, we review the literature on share
repurchases and seasoned equity offerings as well as the main reasons for IPO rms to
implement these nancial activities. Section 3 describes our data and methodology. In
Section 4, we present and discuss our empirical results by structuring the discussion into
three subsections: shortterm valuation effects (4.1), longrun performance (4.2), and a
logistic regression analysis of the SRP and SEO likelihood (4.3). Finally, Section 5
concludes.
2. Review of the Literature
A large body of literature analyses the nancing strategies and valuation effects of IPO
rms. We discuss the relevant literature by rst providing the framework and perspective
for our own analysis (2.1) and by describing the issues and empirical results for share
repurchases (2.2) and seasoned equity offerings (2.3). We then review the empirical
evidence for initial public offerings in Germany, with a particular focus on the regulatory
environment of the German Neuer Markt(2.4).
2.1. Review of the issues
One of the most importantdecisions faced by young entrepreneurial rms is whetherto go
public, raise external equity, and diversify their ownershipstructure. Academic studies on
IPOs usually analyse underpricing and the determinants of shortand longrun
performance. From this research, three main phenomena have emerged: rstday under-
pricing, longrununderperformance, and hot issue periods(windows of opportunity). For
many countries, includingGermany, various factors add to comprehend these phenomena.
These are underwriter reputation and analyst behaviour (Bradley et al., 2008; Bessler and
Stanzel, 2009), venture capital backing, ownership structure, exit behaviour and lockup
periods (Lerner,1994; Brav and Gompers, 2003; Bessler and Kurth, 2007) as well as R&D
and patents (Wagner and Cockburn, 2010; Bessler and Bittelmeyer, 2008).
Following the IPO, management must ensure that sufcient funds for nancing the
rms operations and growth opportunities are accessible. Specically, rms must
generate sufcient cash ows from operations or, alternatively, raise external funds at the
IPO and/or by issuing new debt or equity subsequent to the IPO. In contrast, successful
and cash richrms have to determine their payout policy, i.e., distributing cash ows to
© 2014 John Wiley & Sons Ltd
Equity Issues and Stock Repurchases of Initial Public Offerings 33

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