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The role of lockup agreements on IPO survival: A study of UK IPOs from 2011-2017
BACKGROUND INFORMATION:
An Initial Public Offering (IPO), initially a private company offering shares to public, has received considerable attention from academics and practitioners in terms of how shares are priced and their performance after sale. IPOs are initiated by the owner(s) to exit the business wholly, partially or the business may seek larger capital (Brav and Gompers, 2003).latest references? To provide confidence to investors, owner(s) often retain percentage of company’s shares that is referred as ‘lockup’ agreement, which restricts the owners’ ability to sell the assigned shares to ensure investors’ confidence is retained and to avoid abnormal fluctuations of stock price, especially, in the early stage of post- IPO (Bradley et al., 2001)refs?. Lock-up agreement ensures the existing shareholders of the issuing firm (managers, directors, employees, venture capitalist and other individual) retain some percentage of shares for a specified length of time, normally longer a year.
The UK IPO market consists of two segments, which is the Main Market - London Stock Exchange (LSE) – and Alternative Investment Market (AIM). The Main Market is a market for larger companies, and AIM is for young companies. Both markets use the same trading technology. However, the entry requirements for the AIM are much more lenient than the LSE. This study will focus on the relationship between lockups length and the survival of LSE Official List IPOs; and examine the survival rates and delisting reasons for sample IPOs by tracking them for chosen companies whose data is available.
AIM AND OBJECTIVES
Aim(s):
This research investigates lockup length affect, the survival rates, information asymmetry for the IPO firms in UK.
Objective(s):
1. To examine the literature relating to IPO lockup length, information asymmetry and delisting for IPO firms
2. To examine the mythological approaches generally and specifically used to investigate IPOs and select the most appropriate method to study the survival of firms after their IPOs.
3. To analyses empirical findings, conclude and provide recommendation on how lockup length affect the survival rates.
LITERATURE REVIEW
Lock-up has gained traction over the recent period, as evidenced from the empirical studies (Brav and Gompers 2003; Jain and Kini, 2008; Yung and Zender 2010; Ahmed 2014). Lock-up includes the aspects such as the derivation of IPO lockups, the IPO size, the functionalities of lockups; the purpose of the lock-up is to demonstrate owners’ confidence in the business and commitment; essentially it is a signalling mechanism. It serves to mitigate information asymmetry of IPOs. Since managers/ owners have greater information about the firm’s prospect, potential future earnings potential and weaknesses. However, shareholders rely on information provided by the owner to value the firm and if the owner withholds information that could lead shareholders to lose confidence and wealth. Within this context, lock-ups bridges this information gap and lock-ups provides confidence to equity holders.
Brav and Gompers (2003) set out three hypotheses for the existence and length of lockup agreements. One is that lockups alleviate the problem of moral hazard by preventing founders and owners from trading in their shares and creating an increase in supply that might depress the firm’s value (Bartlett, 1995). Owners of these firms need to demonstrate a commitment to their business with similar long lockup. Second hypothesis is that owners of the high-quality firms hold large fraction of shares and longer lockup period to signal their confidence in the business. The third hypothesis concerns the market power of underwriters; high-quality underwriters can demand longer lockups, holding out the possibility of generating additional fee income from a block trade or underwriting a seasoned equity offering.
Goergen et al. (2006) suggest that the lockup agreements function as a commitment device which signals the quality of the firm that has gone public and regulate the actions of owners. Ahmed et al. (2014) examine that good quality of IPO firm with better future growth prospects and will not suffer with longer periods because no liquidity issues. It also to some extent reduce the probability for the original shareholders to take advantages of new investors as more information concerning the quality of the IPO could be revealed by the investors during the lockup period (Jensen and Meckling, 1976). Arthurs et al. (2009) indicated that both the length of lockup period or the proportion of shares that will be locked are signals of IPO quality as they function as a bonding mechanism between investors and owners against the future success of the venture. The liquidity of owner’s shares will be reduced and the bonding effect motivate the owners to take the future performance over short-term benefits from cash out activities. With long lockup period, high- quality IPOs could better distinguish themselves from those with poor prospects with assurance on business performance proven by the time.
Hensler et al. (1997) examine the relation between the firm characteristics and survival rate of IPO firms using an Accelerated Failure Time (AFT) model; they find that IPOs’ survival time is positively related to the firm size, the firm’s age at the offering, the under-pricing, the IPO activity level in the market, and the percentage of owners’ ownership. Larger IPOs are more likely to have better survival; further more probability of delisting is negatively related to IPO size (Schultz, 1993). Consistent with Schultz, a study by (Jain and Kini, 1999) investigate the firm size at the time of the IPO are positively related to IPO survival.
Ritter (2003) summarised the differences between the IPO markets of the US and UK in terms of price setting, the IPO allocation mechanism, allocations to individual and institutional investor. The length of lockup in the US is concentrated at 180 days (Field and Hanka, 2001), whereas the length varies widely in the UK. Furthermore, the relationship between underwriters and IPO firms is closer in the UK compared US. Underwriters, as intermediaries, advice the owners of IPO on pricing the issue. UK IPO firms need to have a corporate broker to maintain stock exchange listings, such as activities of stake building in target companies, and director trading (Hoque,2014). Underwriters have more power in the UK to set the issue price, as argued by Chambers and Dimson (2009). The different types of lockups in the UK present an interesting empirical issue, as to whether lockups and IPO under-pricing emanate from information asymmetry and/or moral hazard. Ref?
IPO firms raising external capital for the first time in public markets face significant information asymmetry and moral hazard problems (Chong et al., 2007). Early papers, Leland and Pyle (1977) provided a model in which entrepreneurs signal the value of their ventures by the percentage of ownership retained; they examined that selling owner shares in the IPO served as negative signals to potential investors. In contrast, Owners in high quality firms can retain greater fraction of ownership after IPO to show confidence in their firms. However, if the owners can sell the shares immediately after the IPO, the ownership retention signal may not be credible (Gale and Stiglitz, 1989). Survey evidence has shown that directors avoid from selling shares during the lockup period for fear of sending negative signals to the market ( Brau and Fawcett, 2006).
Venture capitalists (VC) provide confidence to investors of the firm value as they have better financial expertise to value a firm. Involvement of VCs decrease information asymmetry between agents and principles as they also employ underwriters, reputed auditors (Megginson and Weiss, 1991). VCs take role in management of the firms even after IPOs ( Barry et al., 1990). The monitoring service provided by the VCs results in better post-issue operating performance and better survival profile for VS backed IPOs (Jain and Kini, 2000). VCs own the equity and server the role of lock-ups. Presence of VCs may be considered as a signal to other investors that business has good potential; hence, increasing the viability of firm as a target (Vismara et al., 2012). VCs may enhance the short-term performance of IPO firms at the cost of long term performance and survival due to agency conflict problems and short-term goals (Fischer and Pollock, 2004; Arthurs et al., 2008).
To protect shareholders’ interests, shareholders demand a mechanism that can help reduce investor moral hazard between owner(s) and shareholders. Brau et al. (2005) built a theoretical model and provide support for the information and moral hazard hypotheses; they reported that length of lockup is positively related to high potential for information asymmetry, and moral hazard. Consistence with precious study, Hoque (2014) examined that lockup agreements may mitigate the problem of moral hazard by ensuring owner(s) will not sell IPO shares before the expiration of the lockup period.
When uncertainty concerning an organization is high, greater under-pricing is an expected outcome to undervalue their issued shares at the time of the IPO to eventually issue equity at a more reasonable price (Grinblatt and Hwang, 1989; Welch, 1989). Further research (Arthurs et al., 2009) reported that higher under-pricing for those ventures with a going concern issue. Underwriters forced to under-price the stock to encourage outsiders to purchase of these shares (Jenkinson and Ljungqvist, 2002). By utilizing a longer lockup period, company owner(s) able to reduce investors’ uncertainty about the venture in general and hence reduce the amount of under-pricing. This reduction in under-pricing brings benefit to investors as it represents an increase in the wealth (Certo et al., 2001).
Research problem:
This dissertation examines the role of lockup agreements on IPOs survival and performance through the analysis of a certain number of UK IPOs for whom data is obtained from London Stock Market. The challenge in this research is to access the lockup length due firms’ data confidenaltlity issues, therefore the data is manually collect in terms of the type and length of lockups committed by the issuing firms.
Methodology:
The purpose of choosing an appropriate method is to ensure the research question is examined using the most effective method. There are a range of methods used within research. Qualitative method is used to examine topics or areas that are not easily quantifiable. Issues investigated often are characterized as soft issues, feeling, perceptions or subjective views. Such topics provide meaningless results if quantitative methods are used. On the other extreme, quantitative method deals with numbers, quantifiable entities and infers relationships using regression models. Therefore, quantitative method is used to investigate finance and sciences, numerical topics.
However, there are a range of other methods, such as case studies, mixed methods and triangulations which are used to study both aspects, numerical and soft aspect of the topic. For this study, considers quantitative method suitable die to the nature of the study.
The primary method utilized in this paper is the quantitative method. Quantitative research examines relationships between variables, which are measured numerically and analysed using a range of statistical and graphical techniques. It often incorporates controls to ensure the validity of data, as in an experimental design. Both the IPO lockups and IPO survival will be specified into certain attributes for the convenience of data collection. Each attribute will be properly defined and discussed on its validity to be the factor of reflecting IPO lockup and survival of IPO before further data collection and process.
There are three types of data to use for analysis, which is time series data, cross-sectional data and panel data. The data may be quantitative-exchange rate, stock prices, number of shares- or qualitative- day of the week-. This study will be using cross- sectional data which data will be collected at a single point of time on London Stock Exchange (LSE) website. The main source of collecting relevant data will be through the LSE for few reasons. First, due to its stringent listing requirements, Official List attracts more mature companies which are significantly different from young and growing companies usually listed on the Alternative Investment Market (AIM). Second, lockups of Official List IPOs are relatively longer duration and are more diverse in terms of their characteristics. It will also be complemented by the annual report from certain IPO companies Basically, a number of slices of data between 40-50 will be collected from the LSE Official List between January 2011 and December 2014. LSE data includes firm names, issue price, market capitalization on admission, industry and admission date. This study will exclude investment trusts, venture capital trusts (VTs), re-admissions, privatizations, non- UK firms and firms with missing data and IPO prospectuses. Perfect Filings will be sued to collect IPO prospectuses. The dates and reasons of delisting of IPOs are obtained from London Share Price Database(LSPD).
After collected data, calculate the survival rate for three years of those IPO firms from January 2015 to December 2017. Survival analysis is preferred over the conventional statistical methods, which is liner regression model and binary dependent variable models. The survival rates of the sample IPOs are estimated using the Kaplan- Meier (KM) method. KM method is a non-parametric statistic which used to estimate the survival function from lifetime data. (Clark et at., 2003) The KM estimate is the simplest way of computing the survival over time in spite of all these difficulties associated with subjects or situations. Log rank test will be used to test the statistical differences in KM survival curves, and compare the median survival times across different groups and subsamples. The Median survival time is the point in time which probability is 0.5 (Kleinbaum and Klein, 2005). Besides that, the survival model is implemented in the Accelerated Failure Time (AFT) form, which assumes that the effect of predictors is multiplicative on the survival time scale. AFT model is used for this study because it measures the direct effect of covariates on survival time which make the interpretation of results easier, as the parameters measure the effect of covariates on the median survival time.
The relationships between defined and adjusted attributes will be firstly put into separated hypotheses to make it clearer for further data processing. Then it will be proceeded into tests with corresponding hypotheses. The results of data analysis will be summarized into propositions if not rejected for the hypotheses. Further discussions will be proceeded around the limitations for this research as well as the implications for future research on this thesis.
Ethical concerns:
Ethical consideration needs to be take into account when researching to comply with the university’s code of ethics; it is designed to protect the participants from any potential harm, physical, emotional or financial. This study uses secondary data that is in the public domain. Therefore, there are no confidentiality or other associated ethical issues. This dissertation has considered the university’s ethical policy and there are no emergent ethical issues.
Timescale:
1. Access to relevant information and review of selected literatures: Oct 2017
2. Collection of data from LSE website and other recognized sources: Nov 2017
3. Data processing and analysis: Nov 2017 to Dec 2017.
4. The first draft of the dissertation: Dec 2017 to Jan 2018
5. Obtaining feedback form the tutor and do the revisions on the DT: Jan 2018
6. Proofreading before final submission: Feb 2018
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