Structuring the IPO: Empirical evidence on the portions of primary and secondary shares
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Structuring the IPO:
Empirical evidence on the portions of primary and secondary shares
by
Nancy Huyghebaert
Cynthia Van Hulle
Katholieke Universiteit Leuven, Belgium*
*
The authors are, respectively, Assistant Professor, and Full Professor of Finance, Department of Applied Economics,
Katholieke Universiteit Leuven, Belgium. The authors thank Vladimir Atanasov, Piet Sercu, Linda Van de Gucht,
participants at EFA 2002, Berlin and FMA European Conference 2002, Copenhagen and seminar participants at K.U.
Leuven for useful comments on an earlier draft of this paper.
Corresponding author:
Nancy Huyghebaert, Department of Applied Economics, Katholieke Universiteit Leuven, Naamsestraat 69, 3000
Leuven, Belgium; tel.: 32-16-32 67 37, fax: 32-16-32 67 32, e-mail: nancy.huyghebaert@econ.kuleuven.ac.beStructuring the IPO:
Empirical evidence on the portions of primary and secondary shares
Abstract
We empirically study the determinants of the portions of primary and secondary shares offered in
IPOs. The data show that young growth firms tend to issue primary shares. Limited internal cash
generation and a debt mix that largely consists of bank loans significantly positively affect the size of
the primary portion. The data are also consistent with the notion that if financing needs warrant a
relatively small primary portion, companies may add secondary shares to the offering to increase the
offering size, which enhances post-IPO market liquidity. Furthermore, these growth firms are also
more likely to issue seasoned equity in the aftermarket. Mature firms tend to issue only secondary
shares. The diversification motive does not drive the size of the secondary portion but adverse
selection costs have an impact. Also, firms including only secondary shares show relatively higher
control turnover ex post.
JEL classification: G32, G24
Keywords: IPO structure; primary and secondary shares; motives for going public; liquidity; turnover1. Introduction
The source of the shares sold in an initial public offering is an important but little studied feature in
the IPO literature. Nevertheless, this decision has important implications, both for the company and
for the initial shareholders, and hence is likely to contain information on the motives for going
public. Specifically, when primary (i.e. newly created) shares are offered, the IPO selling proceeds
accrue to the firm. Conversely, original owners are entitled to the proceeds from selling secondary
shares (i.e. shares existing before the IPO). While Jegadeesh et al. (1993), Spiess and Pettway
(1997) and others use the nature of the shares that are sold in the IPO as an explanatory variable in
their research, we are not aware of any study that explicitly examines the portions of primary and
secondary shares in IPOs. A potential explanation could be that in the U.S., IPOs traditionally
include a notable primary portion whereas pure secondary offerings are scarcely observed. In
contrast, in Continental Europe purely primary and secondary offerings have been popular over time,
as well as offerings that combine primary and secondary shares.
In this paper, we examine what factors determine the size of the portions of primary and
secondary shares relative to the number of shares outstanding pre-IPO. We also study the nature of
trade-off between these two fractions and link it to the motives for going public. Finally, we
complement our results with ex post information on firm behavior.
Pagano et al. (1998) consider the question of why firms go public using data on Italian
companies. From comparing publicly listed and privately held firms during 1982-1992, they
conclude that the likelihood of an IPO is positively related to the firm’s size and the market-to-book
ratio prevailing in the industry. Also, they find that the limited amount of new equity raised is used
to reduce leverage rather than to finance growth. Furthermore, once introduced on the exchange,
IPO firms show an abnormal reduction in profitability and a high turnover of the controlling
shareholder(s). Similar results are obtained by Rydqvist and Högholm (1995) using Swedish data for
the period 1970-1991, and by Goergen (1998) using data on UK and German firms that went public
during 1970-1988. Overall, these findings offer a rather pessimistic view on the role played by
3European stock exchanges; they suggest that the stock market is not used as a mechanism to finance
growth, but rather as a way for owners to reduce their firm’s risk – what Pagano et al. (1998) have
called a rebalancing of financial structure – and to cut back on their involvement in the company.
However, in Continental Europe several changes have taken place since the sample period(s)
covered by these earlier studies. Cornelli and Goldreich (1999) and Sherman (2000), for instance,
document the global trend towards using the bookbuilding method for selling shares in IPOs, which
reduces asymmetric information problems. Also, in the second half of the nineties, new markets,
such as EASDAQ and the alliance of European growth markets Euro.NM, were set up to meet the
needs of an increasing number of young and high-growth companies. Simultaneously, consolidation
in more traditional sectors enlarged the financing needs of the more established firms. From these
observations, it is clear that other motives for going public may have become important.
Using a sample of 95 Belgian IPOs over the period 1984-2000, we find that younger and
smaller firms with substantial growth opportunities and limited internal cash generation issue a larger
fraction of primary shares. Whereas the overall debt ratio is not significantly related to the size of
the primary portion, the fraction of bank debt has a positive impact. Given the decision to go public,
market conditions, as measured by the stock market return and issue activity in the pre-IPO year, do
not seem to affect the portion of primary shares. Overall, these results indicate that the need for
additional financing is the main force determining the size of the primary portion. Furthermore, the
evidence suggests that the creation of a liquid market – which is an important concern when the firm
wants to tap the stock market in the future –induces firms with growth opportunities and eminent
internal cash generation to add secondary shares to a relatively small primary portion to achieve a
sufficiently large free float. By contrast, mature firms with high internal cash generation tend to
offering only secondary shares. In determining the size of the secondary portion, the worry to avoid
adverse selection costs under the form of underpricing proves to be important. Simultaneously,
given the decision to go public, the evidence indicates that windows of opportunity may also have an
impact. By contrast, diversification does not seem to be an important motive when owners fix the
4size of the secondary portion. Furthermore, post-IPO data on market liquidity and seasoned equity
offerings support the notion that at IPO-time, growth firms wish to establish a liquid market with a
view to realizing seasoned offerings in the future. Data on control turnover indicate that firms
issuing only secondary shares in their IPO are more likely to be taken over in the years following
their going public operation. Overall, while the relative importance of different offering types varies
over time, we find that the underlying relations between firm characteristics and deal structure are
largely stable during the sampling period.
The remainder of the paper is organized as follows. Section 2 surveys the main reasons of
why companies go public, and the ensuing preference for issuing primary and/or secondary shares.
Section 3 describes the sample of 95 Belgian IPOs over the period 1984-2000. Section 4 analyzes
the determinants of the portions of primary and secondary shares and investigates the nature of trade-
off between primary and secondary shares. Section 5 provides a link between deal structure and
post-IPO market liquidity, seasoned equity offerings and control turnover. Section 6 concludes the
paper.
2. Theory and predictions
As indicated by Pagano et al. (1998), the decision to go public is too complex to be captured by a
single model. Therefore, likewise that paper, we start from the main theories on why companies go
public and infer their predictions for the portions of primary (= new shares offered relative to the
number of shares outstanding pre-IPO) and secondary shares (= fraction of existing shares divested).
The predictions from these models, as summarized in table 1 and discussed below, will allow us to
derive empirically what forces drive the size of the primary and secondary portion. This will give us
additional insight in the interaction between motives for going public and observed choices regarding
deal structure.
52.1. The costs of going public
2.1.1. Adverse selection costs
Adverse selection costs, which occur when (some) investors are less informed than the issuers about
the true value of the firms going public, induce underpricing. Not surprisingly, several authors (e.g.,
Ritter, 1984; Megginson and Weiss, 1991; Chemmanur and Fulghieri, 1999) find these costs to be
more serious for young (AGE = logarithm of the firm’s age at IPO-time) and small (SIZE =
logarithm of total assets) companies as the latter typically have a limited track record and low
visibility.
Considering the case of primary shares first, we expect adverse selection problems to induce
firms to offer a smaller portion of primary shares. For within the firm’s set of investment
opportunities, fewer projects become attractive as the price at which shares can be marketed
decreases. As this effect holds particularly true for young and small companies, adverse selection is
likely to induce a positive relation between the age and size of the firm and the primary portion.
Furthermore, ownership structure may interact with adverse selection. Specifically, if high adverse
selection costs are to be borne by a few shareholders, one could argue that these owners may prefer
to limit the primary portion at IPO-time and issue less than needed. Then, the firm could issue
seasoned equity later on, when more information has become publicly available and adverse
selection costs have decreased. However, next to the direct costs of an extra capital increase later on,
such action may result in forgone investment opportunities for the company and/or waiting costs. If
these costs are important, ownership structure is not likely to affect the size of the primary portion.
Nevertheless, to take the possible impact of ownership concentration into account, we add a variable
measuring the ownership percentage of block holders owning at least 5% of the shares (= CONC).
Furthermore, to control for the fact that the absolute amount of adverse selection costs may increase
with the size of the firm, we also include an interaction term between ownership concentration and
firm size.
6Conditional upon listing, adverse selection costs may also induce a positive relation between
firm age and size and the size of the secondary portion: if adverse selection decreases the price at
which securities can be marketed, old owners will be less inclined to part from their shares, ceteris
paribus. Likewise the primary portion, ownership structure and adverse selection may also interact.
Specifically, Gomes (2000), Habib and Ljungqvist (2001) and others argue that when underpricing
imposes considerable costs, large owners may try to maximize their overall proceeds from divesting
by limiting the secondary portion at the IPO; afterwards, as more information becomes publicly
available, they may continue to sell shares gradually. As this policy does not hamper the firm’s
investment opportunities, we expect this reduction in the size of the secondary portion to be less
costly as compared to the reduction in the size of the primary portion. To measure the impact of
ownership structure, the same variables as defined above for the primary portion are used.
2.1.2. Other costs
Other costs of going public – such as the administrative expenses and fees and the loss of
confidentiality – may affect the likelihood of going public, but these are not directly related to the
size of the primary or secondary portion. For example, the existence of fixed listing costs reduces
the attractiveness of an IPO for small firms (e.g., Ritter, 1987), but, given the decision to go public,
we expect no relation with the portions of primary or secondary shares. Similarly, the information
that has to be disclosed upon listing does not depend upon the fractions of primary or secondary
shares that are offered to the public. Given the diversity of these costs and the difficulty of
measuring them, we do not define variables to test this hypothesis.
72.2. The benefits of going public
2.2.1. Overcoming financing constraints
When firms go public, they obtain access to an additional source of financing (e.g., Pagano et al.,
1998; Allen and Gale, 1999; among others). Especially companies with sizeable financing needs and
a largely used debt capacity may value this benefit.
Financing needs will be important when firms have valuable growth prospects. High-growth
firms often are financially constrained as entrepreneurs have limited personal wealth or dislike
investing more of their own resources in the firm. Simultaneously, when there is a sizeable time lag
between investments in new projects and cash generation, debt may not be the most suited source of
financing. For these reasons, we expect growth opportunities to be positively related to the size of
the primary portion. The firm’s market-to-book ratio (= MARKET/BOOK) is an often-used
indicator of growth opportunities. Although it has the advantage that it includes market values and
therefore is forward looking, it has the disadvantage that it may also reflect windows of opportunity
embedded in too optimistic perceptions by the market. Therefore, in accordance with the literature,
we use AGE and SIZE as additional indicators of growth prospects. We expect AGE and SIZE to be
negatively related to the size of the primary portion.
Highly levered firms may have fully used their borrowing capacity. According to Myers and
Majluf’s (1984) pecking order theory, these firms will raise equity to meet their financing needs.
Pagano et al. (1998) indeed find that firms go public to rebalance their financial structure. We
therefore expect a positive relation between leverage (LEVERAGE = debt to total assets) and the
size of the primary portion.
Conversely, firms that generate substantial cash internally have a smaller demand for external
financing at IPO-time, ceteris paribus. As a result, we expect a negative relation between internal
cash generation (ROA = EBITDA to total assets) and the size of the primary issue.
The wish to overcome financing constraints is unlikely to influence the size of the secondary
portion.
82.2.2. Greater bargaining power vis-a-vis banks
Rajan (1992) argues that banks with private information about borrowers can extract rents at the time
loans have to be extended or rolled over. By going public and disseminating information to the
public, a company elicits outside competition to its bank and ensures a lower cost of credit and/or a
larger supply of external finance. Pagano et al. (1998) indeed document that firms experience a
decrease in the cost of credit after their IPO. We therefore expect that firms whose debt largely
consists of bank loans (DEBT MIX = bank debt to total debt) will include a larger primary portion in
their offering to reduce bank bargaining power.
The wish to reduce bank bargaining power, however, is unlikely to impact on the size of the
secondary portion.
2.2.3. Monitoring
Another benefit of being publicly quoted is the managerial disciplining provided by the stock market
(Homström and Tirole, 1993; Stoughton et al., 2001). While the danger of a hostile takeover
frequently is absent in Belgium – since firms usually introduce less than half of their shares on the
stock market – it is still possible to expose managerial decisions to the market’s assessment. This
information could then be used to develop managerial compensation schemes. Again, this motive
may affect the likelihood of going public, but we expect no direct relation with the size of the
portions of primary and secondary shares.
2.2.4. Windows of opportunity
The decision to go public may be affected by perceived windows of opportunity. Specifically, in
addition to filling true financing or divestment needs, firms may also try to capitalize on the
optimistic perceptions in the market at IPO-time (e.g., De Long et al., 1990; Ritter, 1991; Rajan and
Servaes, 1997).
9During periods of high pre-IPO market returns (MARKET RETURN = the return on the
Belgian All Shares Index (BASI) in the year preceding the IPO), firms may increase the size of the
primary portion beyond their financing needs. However this action also entails costs. Next to
increasing problems of adverse selection, free cash flow theory shows that building financial slack
negatively affects the stock price. Models by Easterbrook (1984) and Jensen (1986), for instance,
stress that the need to regularly tap the stock market imposes discipline on firms and improves stock
prices. This argument likely holds true especially for young and small firms without a proven record
and, in general, for firms that have accumulated substantial financial slack. Another aspect of the use
of windows of opportunity is the feedback effect. In particular, because of the positive market
assessment, companies may revise their investment plans upward and correspondingly increase the
size of the primary portion. This market feedback effect, however, may also be captured by the
firm’s MARKET/BOOK ratio, since, as indicated before, this measure includes company specific
expectations. Simultaneously, the clustering of IPOs (VOLUME = the number of IPOs in the
preceding year scaled by the total number of IPOs in the sample) may induce information spillovers
and hence lower information problems (e.g., Booth and Chua, 1996; Bayless and Chaplinsky, 1996;
Hoffmann, 2001). Reduced information asymmetries allow to market shares at a lower cost and
hence may increase the number of attractive projects within the investment opportunity set. As a
result, VOLUME is likely to affect positively the size of the primary portion.
If capturing windows of opportunity is important in shaping the size of the secondary portion,
we expect this variable to be positively related to MARKET RETURN, and to the extent it also
reflects windows of opportunity, the firm’s MARKET/BOOK ratio. Also, the reduced information
asymmetries during periods of high IPO activity (VOLUME) would allow firms to market more
secondary shares at lower cost.
102.2.5. Investor recognition/liquidity
In a capital asset pricing model with incomplete information, Merton (1987) shows that stock prices
are higher the larger the number of investors aware of the company’s securities. Kadlec and
McConnell (1994) find support for this argument: when companies listed elsewhere announce their
decision to also list in New York, their stock on average yields a positive abnormal return. This
motive mainly affects the likelihood of going public. In the same way, one could also argue that
having a sufficiently large number of quoted shares is important, because then more investors (e.g.,
institutional investors) become interested in the firm’s securities. This latter argument is closely
related to the notion that market liquidity may reduce the cost of capital (e.g., Benveniste and
Wilhelm, 1990; Szewczyk et al., 1992; Booth and Chua, 1996; Maug, 1998; Sherman, 2000).
Furthermore, this idea has also been supported empirically (e.g., Eckbo and Norli, 2000).
Young and small growth firms are likely to benefit most from investor recognition. The
reason is that because of their growth prospects, these firms presumably will use the stock exchange
for financing their investment projects not only at IPO-time, but also at later dates. It is clear that
increasing the size of the primary portion could add to investor recognition. However, as discussed
in section 2.2.4. above, issuing primary shares beyond financing needs entails additional costs of
adverse selection and creates free cash flow problems, especially for young and small firms.
Alternatively, these companies could add secondary shares to the primary portion to increase
liquidity. As the latter action avoids free cash flow problems, it may be a better solution. This is
likely to hold true especially if at IPO-time financing requirements are too small to create a
sufficiently liquid market, for instance when the company benefits from internal cash generation.
Preceding arguments imply that if investor recognition is important, one would likely observe it in ex
post data. Specifically, if it can be achieved by increasing the total size of the offering, we should
observe that a measure for the total size of the issue at IPO-time is positively related to liquidity in
the aftermarket. Also, firms that go public because of financing needs should be more likely to
return to the market with a seasoned equity offering.
11The positive price impact of investor recognition may also benefit old owners who wish to
cash in on their shares. However, increasing the secondary portion at IPO-time implies incurring the
cost of underpricing. As discussed in section 2.1.1., a better policy may be to limit the size of the
secondary portion and sell afterwards additional shares as more information has become publicly
available. Overall, we do not expect any clear-cut relation between this motive and the size of the
secondary portion.
2.2.6. Portfolio diversification
Owners may use the IPO as a mechanism to divest shares and diversify their portfolio (Pagano, 1993;
Stoughton and Zechner, 1998). If so, one would expect the IPO to include a secondary portion.
Although selling shares to value enhancing block holders in a private sale rather than an IPO could
drive up the transaction price, the remaining owners may dislike the monitoring by these new owners
(e.g., Brennan and Franks, 1997). Also, Pagano and Roëll (1998) argue that large block holders may
even over-monitor the firm, which is not the case when selling to more dispersed shareholders in an
IPO. Simultaneously, the liquidity discount applicable to the equity of a private company can be
avoided when selling secondary shares in an IPO (e.g., Brau et al., 2000).
If diversification of owner wealth is an important motive in the decision to go public, owners
of high-risk firms are likely to divest a sizeable secondary portion. Meulbroek (2000), for instance,
finds that in highly volatile Internet-based firms, many owner-managers sell a portion of their shares,
or even exercise their stock options with the objective to sell the acquired shares and diversify their
portfolio. For young, small firms with considerable growth opportunities, high leverage or limited
internal cash generation, the owners will feel the need to diversify to a larger extent, ceteris paribus.
The diversification motive does not imply a need for primary shares and therefore is unlikely
to impact on the size of the primary portion.
122.2.7. Change of control
Preparing for a turnover in corporate control may be another motivation for selling secondary shares
at IPO-time. Zingales (1995) points out that going public can maximize the proceeds from a later
sale of the firm. By selling off a minority stake to a widely dispersed shareholder base, owners may
be able to increase the surplus they can extract from the future buyer. Mello and Parsons (1998),
Pagano and Roëll (1998) and Roëll (1996) similarly argue that an IPO can be used to improve the
efficiency of the ownership structure. Empirical evidence for other European countries indeed
indicates increased control turnover activity in the years following the IPO (e.g., Pagano et al. (1998)
for Italy, Högholm and Rydqvist (1997) for Sweden). If the transfer of control – whether immediate
or remote – is an important motive in the decision to go public, we expect the more established (i.e.
larger, older) firms to go public through selling secondary shares, as in these companies the firm-
specific investment of the initial owners is less essential. Although this motive has a positive impact
on the probability of an IPO through a secondary offering, the impact on the size of the secondary
portion is not a priori clear, other than that the original owners are likely to limit its size to keep
control and to reduce the loss in pocketing the takeover premium on the portion placed in public.
However, if this motive is important, one would likely observe it in ex post data. Particularly, we
expect a higher incidence of control transfers post-IPO when the IPO includes a secondary portion.
The change in control motive does not offer a rationale for a positive primary portion.
*************
Insert Table 1
*************
3. Sample
Our sample covers the period 1984-2000 and includes all new listings of Belgian firms on the three
main exchanges of the country, i.e. the main market of the Brussels Stock Exchange (now Euronext
Brussels), Euro.NM Belgium, and EASDAQ (NASDAQ Europe).1 Our sample does not include unit
offerings nor reverse LBOs. For all companies, we obtained the issue prospectus and the
13consolidated financial statements over the window two years before until one, two or three years
after the introduction, depending on the year of the IPO. For the post-IPO analysis, we collected
additional data as indicated in Section 5.
Figure 1 reveals a concentration of new listings in the periods 1986-1987 and 1996-2000.
Other studies (e.g., Pagano et al., 1998; Arosio et al., 2001) show that in other European countries
the issue volume is also peaking during these time periods. As expected, increased IPO activity
coincides with periods in which the stock market index BASI is booming. Figure 2 shows that deal
structure varies over time, with offerings including a positive primary portion occurring more
frequently in the later sampling years.2
*******************
Insert Figures 1 and 2
*******************
Table 2 shows the industry distribution of the 95 sample firms.3 Similar to Arosio et al.
(2001) for Italy, financial IPOs are concentrated in the earlier years of the sampling period, while
high-tech flotations mainly occurred during the later years. Despite the creation of new markets, an
important fraction of the high-tech firms continued to opt for the main market of Euronext. In
particular, of the 29 high-tech IPOs since 1996, 14 firms (48.28%) listed on the main market, while 9
and 6 firms listed on EASDAQ, respectively Euro-NM Belgium.
*************
Insert Table 2
*************
Table 3 contains some summary statistics on the IPO firms. Given the length of the sampling
period and the high inflation rates during the late eighties and early nineties, all absolute statistics are
corrected for inflation. The number of new shares offered in the IPO relative to the number of shares
1
This approach seems justified as firms can choose where to list and as the listing requirements are not very different.
2
In contrast to some other countries in Continental Europe, where reporting and marketing requirements are more
stringent for IPOs that include primary shares, the Belgian regulation does not distinguish between primary and
secondary shares.
3
As in Pagano et al. (1998), holding companies that concentrate 75% of their assets in a single industrial company are
reclassified as belonging to the corresponding industrial sector. Financial firms are kept in the sample as in Belgium, and
many other European countries, these firms represent a relatively important subgroup. However, as financial firms may
differ from the other sample firms, we have tested the robustness of our results by removing them from the sample.
These results, which show that our conclusions are unaffected, can be obtained upon request.
14pre-IPO (i.e. the primary portion) in the median firm is 10.50%. The median of the ratio of
secondary shares to the number of shares pre-IPO (i.e. the secondary portion) amounts to 15%. The
average amount collected as primary funds equals €31,609,018, which is very similar to the average
amount of secondary funds collected (€31,924,896). In total, the free float amounts to 25.79% of the
shares outstanding post-IPO. Median underpricing, after correcting for the market return, amounts to
5.31%. This figure is rather low compared to the underpricing reported for many other countries
(e.g., Ritter, 1991; Leleux, 1993; Arosio et al., 2001), but may reflect the fact that a large majority of
the sample IPOs are firm-commitment offerings (see, e.g., Jegadeesh et al., 1993).
Firm age at flotation varies between zero and 283 years, with a median of 18 years. Firm size
in the year preceding the IPO is also dispersed, independent of whether it is measured by total assets
or sales. The median firm has a return on assets of 14.52%, but profitability again differs widely
across firms. Companies are highly levered: on average, 67.16% of total assets are debt-financed,
and bank loans represent 42.53% of total debt. Despite high leverage, an average coverage ratio of
22.05 seems to indicate that firms can easily meet debt obligations. The median coverage ratio,
however, is much lower (3.09). From the observation that some firms have a debt ratio above one
and/or a negative coverage ratio, it can be concluded that not all firms are financially sound at IPO-
time. The average market-to-book ratio, calculated using the offer price, is 3.94. The median firm
experiences a 28.22% increase in total assets and a 21.43% growth in sales in the pre-IPO year.
Ownership before and after the IPO is highly concentrated. On average, there are 2.46 block
holders per firm; together, they own 93.31% of the shares before the IPO. Afterwards, their number
and stake are reduced to 1.99, respectively 64.94%. In only 16% of the cases, initial ownership
decreases below 50 percent because of the IPO, but this does not need to imply that initial block
holders lose control once listed. Similar results have been found for Italy (Pagano et al., 1998),
Germany (Ljungqvist, 1997; Goergen, 1998) and other European countries.
*************
Insert Table 3
*************
15Table 4 presents the median of each variable in Table 3 when firms are sorted according to
deal structure (i.e. when firms include only a primary portion, only a secondary portion or a
combination of both). Reporting separate statistics may give a first indication of whether the profile
of IPO-firms differs across deal structure. Table 4 also contains p-values corresponding to a non-
parametric Wilcoxon rank sum test of difference in distribution across pairwise subsamples. Table 4
shows that 24 of the IPOs have only a primary portion, 34 have only a secondary portion whereas 37
combine both portions.
The size of the primary and secondary portion is significantly different across all categories.
Interestingly, offerings that combine primary and secondary shares have both a smaller primary and
secondary portion than the corresponding pure offering category. The amount of primary and
secondary funds collected also differs across categories, except for primary funds collected by firms
issuing only a primary portion and firms combining both portions. Consequently, although the
percentage of shares placed in public is similar, the total amount of funds collected is significantly
higher for the latter type of firms. Especially as compared to offerings with only a secondary
portion, firms issuing only primary shares are younger, smaller and more levered, but they do not
differ significantly from firms issuing both types of shares with respect to age, size (when measured
by total assets) and leverage. Also, IPOs issuing only primary shares generate significantly less cash
internally (ROA) when compared to offerings including a secondary portion and have significantly
worse coverage ratios. Furthermore, offerings combining both primary and secondary shares have
internal cash generation and coverage ratios similar to those issuing only a secondary portion.
Finally, firms issuing only primary shares do not significantly differ from firms combining both
portions in terms of growth prospects; by contrast, growth opportunities of offerings including only a
secondary portion are significantly lower, especially when considering the market-to-book ratio and
the growth rate of total assets one year before the IPO.
In sum, table 4 suggests that firms issuing a primary portion are younger and smaller growth
companies with a subgroup that generates more cash internally, services debt more easily and –
16consistent with the discussion in section 2.2.5. on investor recognition – adds a secondary portion.
By contrast, firms that only issue secondary shares are mature and have limited growth opportunities.
Simultaneously, the fact that the total fraction of shares placed in public does not differ across
subsets of companies, suggests the existence of trade-offs between the size of the primary and
secondary portion. Such a trade-off is predicted by some of the motivations for going public
discussed above. It is also likely to arise, when, as may be expected, several motivations
simultaneously shape the data in the sample. From that perspective one can consider companies that
only include a primary (secondary) portion to have opted for a limit case in a continuum whereby the
secondary (primary) portion is set equal to zero.
*************
Insert Table 4
*************
4. Determinants of the flotation structure
In this section, we first try to identify the variables that explain the size of the primary, respectively
secondary portion in IPOs. Table 5, Panel A presents the results – parameter estimates and p-values
– from OLS regressions that explain the size of the portion of primary (column one) and secondary
(column two) shares. Then, a two equations system is set up to determine the nature of trade-off
between both variables; the results are presented in Panel B of Table 5. To limit the influence of
outliers, all variables are winsorized at 5-95%, i.e. extreme values are replaced by the corresponding
percentiles. Also, we have checked for multicollinearity by regressing each explanatory variable on
all the others.
4.1. OLS analysis of the determinants of the size of the primary, respectively secondary portion
On the basis of the discussion in section 2, we estimate the following OLS-model of the primary
portion in Table 5, Panel A, column one:
17PRIMARY PORTION = F (α1MARKET/BOOK + α2ROA + α3LEVERAGE + α4DEBT MIX
+ α5AGE + α6SIZE + α7CONC + α8CONC*SIZE + α9CARVEOUT
+ α10MARKET RETURN + α11VOLUME + γiINDUSTRY) (1)
Equation (1) shows that in addition to the explanatory variables discussed above, a dummy indicating
a carve-out as well as industry dummy variables are included. Earlier work (e.g., Michaely and
Shaw, 1995; Pagano et al., 1998) suggests that including the former dummy variable is useful as the
motivation of corporate owners in an IPO may be different from that of owners in stand-alone firms.
Concerning the industry dummy variables, we use the classification by Ritter (1991); their parameter
estimates are not reported.
The hypothesis that companies with more need for external financing include a larger primary
portion is confirmed. The variables indicating growth opportunities (i.e. MARKET/BOOK as well
as AGE, SIZE) are significantly positively related to the size of the primary portion. These results
suggest that firms with attractive investment prospects go public because they require additional
equity. Conversely, internal cash generation significantly lowers the primary issue, in line with the
pecking order argument of Myers and Majluf (1984). Leverage does not significantly influence the
size of the primary portion, but for a given level of leverage, firms whose debt largely consists of
bank loans issue a larger fraction of new shares at IPO-time. The latter result is supportive for the
argument of Rajan (1992) about bank information monopolies and consistent with the findings in
Pagano et al. (1998).
The data show that older and larger companies issue a lower fraction of new shares at IPO-
time; simultaneously, we also find that ownership concentration and the interaction term of
ownership concentration with firm size lack significance. Hence, the hypothesis that adverse
selection costs are important in shaping the size of the primary portion is clearly rejected.
Neither the stock market return nor IPO volume in the year preceding the IPO does influence
the size of the primary portion. These results, however, do not provide conclusive evidence that
18firms are not trying to benefit from windows of opportunity. As discussed earlier, buoyant market
conditions may also be captured by the market-to-book ratio and create an important market
feedback effect on investment. Furthermore, when market returns or IPO clustering are high, firms
may still collect a larger amount of new equity through a higher offer price. However, when using
the log of primary funds collected as the dependent variable, the historical stock market return and
preceding IPO volume are not significant either (not reported). Our results, therefore, do not support
the idea that, except possibly for the market feedback effect, firms try to exploit windows of
opportunity when raising new equity at IPO-time.
Likewise the primary portion, the size of the secondary portion is estimated on the RHS of
equation (1) above; the results are contained in Table 5, Panel A, column two.
The hypothesis that diversification is an important driver of the size of the secondary portion
is not supported by the data. For, contrary to the predictions of this hypothesis, owners of more
stable and mature firms with large cash generation sell a larger portion of their shares as compared to
owners of higher risk companies.4 In line with our findings, Pagano et al. (1998), Goergen (1998),
and others report supportive evidence for the idea that European IPOs are mainly used to reorganize
ownership structure. In larger, cash generating firms, the firm-specific investment of initial owners
is less essential, which might provide an impetus to rearrange ownership.5 In Section 5, we provide
more direct evidence on control turnover following the IPO.
4
When owners time the IPO by selling more shares when cash flows are unexpectedly high or even dress up their firm’s
financial statements before going public (e.g., Teoh et al., 1998), the same positive relation between size of the secondary
portion and ROA might be observed. To test this argument, the variable internal cash flow generation is split up into an
expected part, which is based upon the historical value of EBITDA/total assets, and an unexpected or potentially
manipulated part. We find that only the expected part of internal cash flow generation is significant. These results are not
reported, but can be obtained from the authors upon request.
5
As the nature of ownership might influence our conclusions, we have also re-estimated the model using the subsample
of firms where a venture capitalist is involved in the ownership structure (25 firms), respectively the subsample of firms
where no such investor owns shares. Our conclusion that the diversification motive does not drive the size of the
19In contrast to the primary portion, the data indicate that in determining the size of the
secondary portion, adverse selection costs matter. Specifically, although ownership concentration is
not significant, the interaction term between ownership concentration and firm size has a
significantly negative coefficient. Hence, owners worry about underpricing when selling their shares
at IPO-time, which is consistent with the earlier mentioned arguments of Gomes (2000) and Habib
and Ljungqvist (2001), among others. Also in line with adverse selection is the finding that for the
secondary portion, the carve-out dummy variable is significantly positive. For this result supports
the argument, as developed in Pagano et al. (1998), that carve-outs are subject to smaller information
asymmetries and therefore can divest a larger fraction of existing shares at IPO-time.
Market conditions, as reflected by the stock market return, and IPO clustering in the pre-IPO
year, do not seem to influence the size of the secondary portion. Also the MARKET/BOOK ratio
lacks significance. However, when using the log of the amount of secondary funds collected as the
dependent variable (not reported), the historical stock market return is significantly positively related
to the amount owners cash in from selling their shares, suggesting a window of opportunity effect
after all. Interestingly, this result is driven by the offerings with only a secondary portion.
4.2. The trade-off between the primary and secondary portion: a simultaneous equations model
To take the potential simultaneity of the IPO structuring decision into account, we present the results
from a simultaneous equations model in Table 5, Panel B. Given the explanatory variables used in
Panel A, the model is not identified. Therefore, we remove the variables CONC and CONC * SIZE
from the equation explaining the primary portion. The variable DEBT MIX is deleted in the
secondary portion equation.
The results from the equation explaining the primary portion in column one of Panel B are in
line with those from Panel A and show that taking into account the interaction with the size of the
secondary portion holds in both subsamples. This result is not surprising since the venture capitalist’s equity stake at
IPO-time is relatively small.
20secondary portion does not add information. By contrast, the significant impact of the size of the
primary portion on the secondary portion indicates that the former is an important driver of the latter.
Specifically, the data show that if the size of the primary portion is already large, owners divest only
a small fraction of their shares. Furthermore, internal cash generation and size no longer
significantly affect the secondary portion once the interaction is accounted for. That is, the primary
portion incorporates all relevant information these variables add to the explanation of the size of the
secondary portion. This change in significance levels, however, leaves our earlier conclusion that
diversification is not an important force in shaping the size of the secondary portion, unaltered.
In Panel B, column two historical IPO-volume carries a negative and significant coefficient,
which implies that in hot IPO-markets the size of the secondary portion tends to be smaller as
compared to cold markets. However, when using the log of the amount of secondary funds collected
as the dependent variable (not reported), this significance disappears. This indicates that the smaller
secondary portion likely is the result of a higher issue price during hot IPO-markets.
The loss of significance of explanatory variables – except those linked to adverse selection –
once the information embedded in the primary portion is accounted for, highlights the importance of
the latter in shaping the size of the secondary portion. In fact, the data seem to be generally
consistent with a decision process that could be summarized as follows. In case the company has
financing needs, the size of the primary portion is chosen first and is determined by these needs. If
this portion is relatively large, no secondary shares are added. However, if financing needs can be
filled with a relatively small primary portion, particularly when internal cash generation is
substantial, owners divest some of their own shares. In case the company has no financing needs, the
primary portion is set equal to zero and a relatively large fraction of secondary shares is sold to the
public.
Except for the earlier documented result that firms issuing only secondary shares benefit from
windows of opportunity, the findings in Table 5 do not support any motive for selling secondary
shares; the data only indicate that owners try to avoid (adverse selection) costs associated with the
21operation. Consequently, what begs further investigation is the question why owners of firms with
financing needs add a secondary portion if the primary portion is small. The analysis in section 2
above, the absence of support for any other motive, the fact that firms adding a secondary portion to
the primary issue are young growth companies and the univariate statistics in section 3, all suggest
that investor recognition may play an important role. Second, the benefits associated with going
public for firms without financing requirements, need further clarification. The discussion in section
2 as well as the fact that firms issuing only secondary shares are relatively mature, indicate the need
to investigate the control turnover motive for these companies. These issues will be addressed in
section 5 below; we end this section with a discussion of the robustness checks we implemented.
4.3. Robustness checks
The introduction section mentioned that changes occurred in the IPO market during the sampling
period. To distinguish between changes in the values of the independent variables, that reflect
changes in the characteristics of the firms going public, versus changes in the underlying structure of
the IPO market, we checked for structural breaks. Specifically, we allowed the coefficient of each
variable in Table 4 to show a break at the beginning of 1996.6 In a first model, which consumes
more degrees of freedom, all variables are allowed to change at once, whereas in a second model, the
coefficient of each variable – one by one – could differ before and as of 1996. Using a Chow test,
the hypotheses of identical parameter estimates could not be rejected in the equation explaining the
primary portion. However, in the secondary portion equation, some of the parameter estimates
turned out to be significantly different across both subperiods. After including year dummy
variables, these differences disappeared without affecting the significance of the other explanatory
variables. These results indicate that the relations between firm characteristics and the primary,
respectively secondary portion have remained stable over time, although institutional features (e.g.,
6
Using 1995 as the dividing year results in the same classification, whereas using 1997 leads to fewer differences in
parameter estimates. The results of these robustness checks are not reported, but can be obtained from the authors.
22bookbuilding) and the mixture of firms engaging in an IPO have changed. Section 3, for instance,
showed that most financial companies in the sample listed in the earlier years while the high-tech
offerings mainly have taken place in the later years. As a last check, the simultaneous regression
model has been re-estimated using only the subsample of IPOs that listed in the second half of the
nineties. The earlier conclusions prove to be robust.
*************
Insert Table 5
*************
5. Post-IPO characteristics
In this section, we investigate whether post-IPO data support the hypothesis that at the IPO, investor
recognition is an important factor driving the size of the secondary portion for growth firms.
Similarly, we investigate whether post-IPO data confirm the idea that subsequent control turnover
may be a benefit owners of mature firms bear in mind at IPO-time. Specifically, we examine market
liquidity, seasoned equity offerings and control turnover following the IPO and before December
2001. A major problem we encountered is that for many firms in the sample we do not have
information that extends a long period beyond the IPO. For an examination of market liquidity, the
problem is limited though. Listings with a history shorter than one, respectively two years are simply
disregarded, depending upon the horizon under consideration. In line with the literature, we use a
window of three, respectively five years to analyze seasoned equity offerings respectively takeovers.
Therefore, we especially consider our findings with respect to takeovers as preliminary evidence.
5.1. Market liquidity
Presently, we investigate the hypothesis that securing market liquidity is an important consideration
for firms at the time of the IPO. Post-IPO market liquidity is hereby defined as the number of shares
traded during a horizon of one, respectively two years starting one month after the IPO divided by
the number of shares outstanding after the IPO (see also Eckbo and Norli, 2000). The first post-IPO
23month is disregarded to correct for the fact that early liquidity may be affected by the adopted
distribution rules.
To determine whether free float influences post-IPO market liquidity, we calculate total funds
collected as the log of the number of shares placed in public times the offer price. To control for
firm age and size, the log of firm age at the IPO, respectively the log of total assets post-IPO are
included. Following the specification of Brennan and Subrahmanyam (1995), Chordia et al. (2001)
and others, we control for additional factors that may impact on market liquidity: our earlier measure
for growth opportunities, a dummy that equals one when the firm lists on a market for innovative
growth companies (i.e. EASDAQ or Euro.NM Belgium), a dummy that equals one when at least one
market maker is appointed, the historical stock market return and our measure for IPO-activity.
Again, we include industry dummy variables using Ritter’s (1991) classification. The model of post-
IPO market liquidity thus looks as follows:
LIQUIDITY = F (α1FUNDS COLLECTED + α2MARKET/BOOK + α3AGE + α4SIZE
+ α5MARKET TYPE + α6MARKET MAKER
+ α7MARKET RETURN + α8VOLUME + γiINDUSTRY (2)
The results shown in Table 6 are in line with the empirical findings in the literature. However, the
main piece of evidence for this research is the fact that increasing free float (i.e. funds collected) at
IPO-time significantly increases market liquidity in the years following the IPO. Hence the data are
consistent with the idea that complementing a relatively small primary issue with a secondary portion
significantly helps to secure a sufficient free float and hence liquidity.
Next, we find evidence of different levels of market liquidity depending upon the exchange
on which the firm lists. Hence, as pointed out by Corwin and Harris (2001), the selection of the
appropriate stock market is an important consideration for IPO candidates. Appointing a market
maker also significantly increases market liquidity, especially over longer horizons. The latter result
is not surprising as the task of a market maker mainly consists of guaranteeing market liquidity.
24Historical stock market performance affects market liquidity positively, indicating that in a buoyant
stock market trade volume tends to be high. Also, there is some evidence of reduced liquidity
following periods of high IPO volume (during the two-year window). Finally, a comparison of the
adjusted R² of the models in Table 6 indicates that it is easier to explain market liquidity over the
longer horizon. The reason may be that the trade of shares in the first post-IPO year still is subject to
some random factors, for instance distribution rules or support activities by the investment banker.
*************
Insert Table 6
*************
5.2. Seasoned equity offering
In this section, we investigate what firms use the stock exchange to raise additional equity once
listed. Given that the latest IPOs in our sample could only be followed during a limited post-listing
period, this analysis might be subject to biases if we miss seasoned equity offerings outside the
observation window. However, Spiess and Pettway (1997) find that the firms in their sample quickly
return to the public equity market once listed: on average, this occurs after 1.3 years (median of 1.2
years). Following Jegadeesh et al. (1993), Levis (1995), and Spiess and Pettway (1997), we use a
three-year horizon to investigate the likelihood of a seasoned equity offering post-IPO. In our
sample, 31 firms raise additional equity within this three-year horizon.
In Table 7, column one, we present the results from a multivariate logit model based on
Garfinkel (1993) and Jegadeesh et al. (1993). The variables included are the market-to-book ratio,
internal cash generation, leverage post-IPO, firm age, firm size post-IPO, unexplained underpricing,7
the percentage adjustment in the offer price relative to the mid-price of the initial price range, the
cumulative return on the firm’s equity, respectively the stock market, both measured in the year
7
Unexplained underpricing is the residual of the regression of underpricing on the adjustment in the offer price, the
market-to-book ratio, firm age, firm size, a dummy variable that equals one if a high-reputation foreign investment bank
is part of the underwriting committee, and the historical stock market return and IPO volume (see Garfinkel, 1993). All
variables have the expected sign and are significant at the 10% level, except for firm age and size. The adjusted R² of the
regression amounts to 23.20%. These results can be obtained upon request.
25following the IPO,8 and the industry dummy variables. Finally, the model includes a dummy
variable that equals one when the offering contains a primary portion. The model looks as follows:
SEO DUMMY = F (α1MARKET/BOOK + α2ROA + α3LEVERAGE + α4AGE+ α5SIZE
+ α6UNEXPL.UP + α7ADJ.PRICE + α8FIRM RETURN
+ α9MARKET RETURN + α10PRIMARY DUMMY + γiINDUSTRY (3)
The main finding for the present research is that, as reflected in Table 7, column one, the primary
portion dummy is significantly positive. Firms with a positive primary portion thus are more likely
to launch a seasoned offering. Hence, in line with the results in Table 5 and 6, this finding is fully
consistent with the hypothesis that firms that include a (relatively small) primary portion in their IPO
worry about the post-IPO liquidity of their stock and therefore, may include a secondary portion. In
column two of Table 7, we present the results when the model is estimated solely on the firms that
include a primary portion and PRIMARY PORTION is replaced by a dummy variable that equals
one when the offering combines a primary and secondary portion. Since the combined offering
dummy is not significant, we are able to conclude that combined and primary offerings are as likely
to issue seasoned equity after the IPO.
Next, Table 7 shows that leverage post-IPO is positively related to the likelihood of a
seasoned equity offering. Hence, consistent with the pecking order hypothesis of Myers and Majluf
(1984), firms with a relatively high post-IPO debt ratio are more likely to subsequently tap the stock
market. Furthermore, the coefficient of the firm’s cumulative return on equity post-IPO is
significantly positive. This relation is also documented by Garfinkel (1993) and Spiess and Pettway
(1997), among others. It may support the argument that when their stock is undervalued, firms wait
to reissue until the share price increases to reflect its fair value. However, it is also consistent with
the market feedback hypothesis, which states that after a price run-up firms adjust upward their
8
If IPO firms reissue before the first year had passed, the firm and stock market return are calculated until the day before
the announcement of the seasoned offering and transformed to a one-year basis. A similar procedure is adopted by
Garfinkel (1993).
26marginal return estimates and reissue equity to finance additional projects (e.g., Jegadeesh et al.,
1993; Garfinkel, 1993).
Finally, note that the proxies for growth opportunities and internal cash generation at IPO-
time are not significant in explaining a seasoned offering. This result should not come as a surprise.
Specifically, if, as argued earlier, at IPO-time firms issuing a primary portion worry about the
liquidity of their stock in the aftermarket because they intend to return to the market with a seasoned
offering, insiders’ expectations at IPO-time about such a future event will already be reflected in the
primary portion dummy.
**************
Insert Table 7
**************
5.3. Transfer of control
Finally, we investigate which IPO firms are taken over subsequent to listing. For this purpose, we
study takeovers during a period of five years following the IPO. In view of the length of this
window, the results from this section should be considered as preliminary. Within the horizon under
study 12 sample firms are taken over.
Following Palepu (1986), we set up a multivariate logit model to explain the likelihood of an
IPO firm being taken over within five years following its initial listing. The variables included are
the market-to-book ratio, internal cash generation, leverage post-IPO, firm age, firm size post-IPO,
and the cumulative return on the firm’s equity, respectively the stock market, both measured in the
year following the IPO. To this model, we add a dummy variable that equals one when the IPO only
includes a secondary portion. The model looks as follows:
TAKEOVER DUMMY = F (α1MARKET/BOOK + α2ROA + α3LEVERAGE + α4AGE
+ α5SIZE + α6FIRM RETURN + α7MARKET RETURN
+ α8SEC. OFFERING DUMMY + γiINDUSTRY (4)
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