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MSc in Finance & International Business Author: Aleksandra Jargot Academic Advisor: Jan Bartholdy WHY POLISH COMPANIES GO PUBLIC: AN ANALYSIS OF DETERMINANTS AND CONSEQUENCES OF THE INITIAL PUBLIC OFFERING. Aarhus School of Business August 2006 Abstract Initial public offering (IPO) is one of the most important moments in a firm’s lifecycle in that it has serious consequences on the company’s ownership structure, capital structure and the size of its operations. Such a serious decision should be made based on an in-depth investigation of the company’s needs and anticipated effects of an IPO because advantages of being a public company come at substantial cost. The purpose of this thesis is to discover the determinants that influence the decision of Polish companies to go public and the consequences that an IPO may have on the company’s performance in the long-run. The study examines the IPOs that took place in Poland during the period of 1997 2004. The research combines the analysis of ex ante (probit model) and ex post characteristics (fixed-effects model) of IPO companies to cast more light on the still clearly unaddressed question of what drives the companies to issue equity. Access to the AMADEUS database allows conducting a study of Polish public companies as compared to a sample of private companies. Some of the findings are consistent with prior empirical studies in other counties. The likelihood of an IPO increases as the company’s size and market-to-book ratio increase. However, contrary to the results obtained on other European markets, this analysis found that increasing leverage of a Polish firm has a positive effect on the probability to go public while increasing profitability negatively influences the likelihood of going public. The results of ex post analysis revealed, in accordance with prior evidence of various international markets, that financing needs are not the major motivation influencing the decision to issue equity. Moreover, this study reveals that in the long run the level of investments in fixed and intangible assets decreases, as does the profitability of a company. Polish companies appear to go public in order to diversify risk and obtain financing to reduce the level of leverage in the short term, and time the issue in order to take advantage of “windows of opportunity” created by investors who are overoptimistic about the company’s development opportunities. 2 Table of contents Introduction ..................................................................................................................4 Chapter 1 Literature Overview ..................................................................................9 1.1 Theory ...........................................................................................................9 1.1.1 Motives for going public ...........................................................................10 1.1.2 Motives for staying private.......................................................................15 1.2 Empirical evidence ...........................................................................................18 Chapter 2 Characteristics of the Polish IPO market ..............................................27 2.1 Initial Public Offerings at the Warsaw Stock Exchange ..............................27 2.2 The Warsaw Stock Exchange vs. other European stock markets ...............34 2.3 Polish IPOs survey results ...............................................................................36 2.3.1 Polish issuers’ motivation for going public .............................................36 2.3.2 Concerns about going public....................................................................38 2.3.3 Motives for staying private.......................................................................40 Chapter 3 Methodology and data description .........................................................43 3.1 Ex ante analysis ................................................................................................43 3.1.1 Binomial choice models.............................................................................44 3.1.2 Probit model and the explanatory variables...........................................49 3.2 Ex post analysis.................................................................................................55 3.3 Data sources and sample characteristics........................................................58 3.3.1. Data sources ..............................................................................................58 3.3.2. The sample ................................................................................................59 3.3.3 Summary statistics ....................................................................................63 Chapter 4 Results and Discussion.............................................................................69 4.1. Results of the ex ante analysis ........................................................................69 5.2. Results of the ex post analysis ........................................................................77 Chapter 5.....................................................................................................................81 Conclusions, limitations and suggestions for further research ..............................81 Appendices ..................................................................................................................84 List of tables................................................................................................................97 List of graphs ..............................................................................................................97 References ...................................................................................................................98 3 Introduction The Polish capital market is now witnessing the second biggest wave of IPOs since the reopening of the Warsaw Stack Exchange (WSE) in April 1991. Over the past two years the number of new issues increased dramatically as compared to the “cold market” period of 2000-2003. The recent IPOs boom attracts a lot of media attention not only in Poland but also abroad as WSE is currently among the leading European stock markets in terms of the number of new listings. However, not much attention is devoted to the question of why the number of IPOs differs so much in different periods, what makes companies go public and what influences the decision of the majority of Polish companies to stay private. Most empirical studies dedicated to IPO issues focus on three puzzling regularities: “hot markets” characterised by both high initial returns and the number of IPOs coming to the market at some periods (Ibbotson and Jaffe, 1975; Ritter, 1984), shortterm underpricing which is a systematic increase from the offer price to the first day closing price (Ibbotson, 1975; Ritter, 1991; Brav, Geczy and Gompers, 2000) and the stock price underperformance of IPO firms in the years after the offering (Ritter 1991; Loughran and Ritter, 1995; Gompers, and Lerner, 2003) accompanied by poor postIPO financial and operating performance relative to pre-IPO performance (Jain and Kini, 1994; Mikkelson, Partch, and Shah, 1997). Surprisingly, the empirical evidence on the motives to go public and the determinants that influence the decision to seek for external financing is still very scarce. In theory there are many determinants that may have an impact on a firm’s decision to go public. A lot of articles discuss theoretical aspects of the decision to go public. IPO is often perceived as a natural stage in the growth of a company. Fast growing companies search for capital to finance their investments and further development (Loughran, Ritter and Rydqvist, 1994; Subramanyam and Titman, 1999). However, the company’s growth is not the only reason that influences the decision to go public but is one of possible strategic choices that a company may consider. IPO may be a method of selling a firm (Zingales, 1995; Black and Gilson, 1998), increasing a company’s value and its credibility, especially in the eyes of clients and banks 4 (Maksimovic and Pichler, 2001). What is more, IPO may serve as a process of disclosing the true value of a company (Mello and Parsons, 1998) and a signal instrument where informed insiders sell uninformed investors a small fraction of shares as a signal for firms’ good prospects and high value (Leland and Pyle, 1977). However, IPO is also associated with costs: administrative costs (e.g. listing and registration fees), costs related to separation of ownership and control, as well as costs of disclosure of inside information that may reduce the competitive advantage of a company (Benninga, Helmantel and Sarig, 2005). Thus, the decision to go public is always associated with multiple trade-offs between costs and benefits. Despite the increasing interest in the decision to go public, the empirical evidence has been quite scarce, especially regarding companies from the Central Eastern European (CEE) region. The major reason for why empirical literature on this decision is underdeveloped is the difficulty in obtaining financial information about private companies as they are not required to disclose their financial reports. There are only a few empirical papers that investigate the factors influencing the decision to go public at the Western European markets and they include a database of public and private companies. Pagano, Paleta and Zingales (1998) were first to empirically test various hypotheses using a large set of IPO and private companies in Italy. In Europe their study was partially replicated by Fisher (2000), who investigated determinants of going public of companies that had gone public in Germany; Boehmar and Ljungqvist (2004) have analyzed German firms which had announced their intention to go public to see the pattern of subsequent sale of equity to outside investors; Pannemans (2002) took a closer look at Belgian IPOs and Gill de Albornoz and Pope (2004) empirically tested various hypotheses about the motives to go public on the UK market. While there are few studies that investigate the non-European markets, such as those of Helvege and Packer (2003) and Chemmanur, He and Nandy (2005), who focused on the US market, and Chun and Smith (2002), who have replicated the Pagano et al. (1998) study on the Korean market, I am not aware of any study conducted at a Central Eastern European (CEE) market that would compare private and public companies to discover the determinants of the decision to go public. However, not only motives for going public but also effects of an IPO are worth investigating. Since the decision to go public is made taking account of the firm’s 5 aims and anticipated effects, the motives for going public should correspond to the effects of the IPO in the long-run. However, several researchers document a significant decline in operating performance subsequent to the initial offering (Jain and Kini, 1994; Mikkelson et al., 1997; Teoh, Welch, and Wong 1998; Wang, 2005) that cast doubt on the ability of IPO firms to achieve their pre-IPO goals. For example, Pagano et al. (1998) find evidence that Italian companies who are financed mainly by bank credits before an IPO substantially decrease the level of leverage after an IPO and at the same time decrease investments. This indicates that funds gathered at the IPO are not spent in compliance with the initial intentions, which is to finance future growth and development. The significant cross-country differences in the companies’ propensity to seek external financing and IPO firms’ characteristics have been found by Roell (1996) and Pagano et al. (1998). Therefore, whether the prior evidence on the determinants of the decisions to go public can be generalized to include CEE countries is still an open question. Thus, the aim of this study is to test the existing theories by conducting an empirical analysis of a single, CEE country in order to discover the motives of Polish companies to go public and the consequences of such a decision on their operating performance in the long-run. The Polish capital market is interesting for several reasons. Firstly, WSE is now witnessing the second biggest wave of IPOs in its history. The first “hot period” dates back to 1997-1998 when 102 companies went public (that is over 50 percent of the total number of companies traded at that time). In 2005 and 2004 there were 36 and 35 IPOs, respectively. Bearing in mind that the period 2000 – 2003 was very poor with the total number of 32 IPOs, the question arises why and when companies make a decision to go public. Secondly, the Polish stock market is definitely the most developed stock market among other CEE markets. Moreover, the WSE is ranked on one of top positions among the biggest European stock exchanges in terms of the number and the value of IPOs. Finally, the empirical literature that tests hypotheses about the motives of Polish companies to go public is still underdeveloped. So far, studies of the Polish stock market have investigated short and long-run stock performance of IPO with a special focus on companies that went public as part of privatization programme (Aussenegg, 1999; Aussenegg, 2001; Jelic, Briston, and 6 Aussenegg, 2003; Jelic and Briston 2003) and on the long-run operating performance, and differences in performance between private and privatization IPOs (PIPOs). The only direct research that focuses on the determinants that influence the Polish companies’ decision to go public is found in Dudko-Kopczewska (2004), who investigates Polish private companies that went public during the period of 19922001. Unfortunately, her sample of investigated firms consists only of IPO companies and is not compared with a reference sample of privately held companies. The analysis is conducted in such a way that firms before the IPO are used as a control for themselves after the IPO. Although such an approach eliminates the problem of unavailable information about private companies, it makes a serious sample selection bias. Since there is no data on private firms that did not go public it is not possible to draw clear inferences about the determinants that encourage Polish firms to issue stock. One may rather investigate at what stage of its lifecycle a company decided to go public. The data on private firms obtained from the AMADEUS database allows me to contribute to the Dudko-Kopczewska (2004) study on Polish IPOs and enables me to compare the results with international literature on this topic. To my knowledge, it is the first study that tests the determinants and the consequences of decision to go public and that compares the characteristics of the Polish firms that chose to go public with the firms that remained private. Firstly, the existing theories of going public decision are tested. It is expected that the going public decision is influenced by a firm’s financing needs, its profitability and size as well as the market mood per industry. Additionally, I test the hypothesis that macroeconomic conditions of the country have an impact on the IPO decisions in Poland. Next, I conduct an ex post analysis to find out if IPO firms’ motivations to go public are consistent with the actual effects in the long-run. The rest of the paper is organised as follows. Chapter 1 reviews the existing theories on the benefits and costs of the going public decision, as well as the related empirical evidence found in prior studies. Chapter 2 characterises the Warsaw Stock Exchange and companies that decided to issue stock there with a summary of surveys conducted among these companies that reveals the stated motives for an IPO, perceived effects, concerns before an IPO and motives for staying private. Chapter 3 describes the 7 methodology used in the analysis, sources of data as well as construction and characteristics of IPO and non-IPO firms’ samples that are used in the empirical analyses. Chapter 4 discusses the results of the ex post and ex ante analysis using a probit estimation and a fixed-effects model. Section 5 contains the conclusions, limitations and suggestions for further research. 8 Chapter 1 Literature Overview Literature Overview This chapter presents various theories about the possible reasons for going public, multiple trade-offs that an entrepreneur has to face when making a decision about an IPO, results of prior studies that empirically test some of the theories, and international findings about the characteristics of IPO firms after an issue. 1.1 Theory The decision about going public is one of the most important choices that a company faces in its lifecycle. First of all, this decision defines a new capital structure of the firm. According to the pecking order theory of Myers (1984) and Myers and Majluf (1984), a firm, whenever possible, would choose internal rather than external financing of its projects. This results from (1) the information asymmetries between the original owner and the investors as insiders know more about their firm than investors, and (2) the adverse selection problem (Ackerlof, 1970) that arises form the inability of traders to assess the true quality of the firm. Thus, when a firm is making a decision about the source of financing it will first make use of the retained earnings which is perceived as the cheapest source, not associated with the adverse selection problem. When external funds are necessary, a firm will choose debt and only when the cheapest sources are exhausted it will decide to issue equity. This is again due to lower information costs associated with debt issues. Scott (1976) and Modigliani and Miller (1963) argue that firms go public when external equity helps them minimize their cost of capital and in this way maximize the value of the company. Thus, managers conduct an IPO when the firm has reached the point in the life cycle where external equity helps obtain an optimal capital structure. IPO also defines a new ownership structure of the company. The large volume of new shares sold to new owners shapes the firm’s ownership structure and thereby influences the firm’s value (Mello and Parsons, 1998). According to the life cycle theory of the firm, at some stages of the firm’s development it is optimal to keep the 9 company private, but as the firm goes through different stages of its life cycle, the optimal ownership structure also changes (Maug, 2001). Bearing in mind the serious consequences for a company and its initial owners to go public, in order to address the fundamental question “to go or not to go public”, the entrepreneur has to carefully consider all costs and benefits associated with an issue and all alternatives to the initial public offering. 1.1.1 Motives for going public “To obtain financing for future growth” One of the most frequent reasons declared by firms’ original owners in prospectuses is to obtain financing for further development and growth (Rindqvist and Hogholm, 1995; Roell, 1996). The large group of investors reached thorough the equity market helps a firm to raise capital needed to finance its various projects. It is a very important advantage of stock financing as money obtained at the bank has to be spent in accordance with its allocation defined in the credit application. Thus, raising external equity offers an opportunity to obtain low cost direct financing without the intervention of financial intermediaries, such as banks or venture capitalists (Holmstrom and Tirole, 1993). Of course, selling shares to a large group of small investors as opposed to financing through bank credit or private equity is not free of costs. I will refer to this later in the chapter. IPO also facilitates rising of new finance also in the long term. Firstly, after an IPO the equity base is strengthened and leverage is reduced, mitigating the problem of debt overhang in the future (Roell, 1996). It is possible because the sale of the company’s stock increases its net worth and decreases its debt-to-equity ratio enabling the company to increase its borrowings and obtain terms more favourable than before the offering. Secondly, as Rajan (1992) argues, an increase in dissemination of information to investors through an IPO helps a company diversify its sources of financing, increases its bargaining power with banks and decreases the cost of credit. Finally, if the company and its stock have performed well, the company can return to the market at a later time and make subsequent public offerings of equity and other corporate securities. 10 Clementi (2002) notices that the decision to go public may be triggered by the productivity shock. In his model based on the life cycle theory of the firm, a firm operates at a suboptimal level of its production scale because of the borrowing constrains that it faces. However, at some stage of a firm’s life cycle it experiences a sudden and persistent increase in the firm’s total factor productivity that results in a new set of positive NPV projects available to the firm. This makes the difference between the actual and the most efficient level of operations more visible and facilitates the decision to go public despite the costs of going public. The money obtained through the IPO facilitates the company’s growth. “To sell a company” Another motivation for going public is to facilitate the sale of a company by its original owners. Zingales (1995) has developed a model in which the decision of a firm to go public is made in the context of the optimal method of selling the company. The decision to go public is driven by the original owner’s desire to sell the company’s shares to dispersed shareholders in such a way that enables the owner to capture the surplus associated with the buyer’s increased cash flow. Moreover, Zingales (1995) argues that IPO is the first step, fully conscious, and the entrepreneur’s value maximizing oriented, for a company to be acquired. The initial owner is able to sell a publicly quoted company for a higher price than he/she would bet in a direct sale. Likewise, Mello and Parsons (1998) argue that the IPO market allows a series of steps that eventually lead to the sale of the firm, and that an active secondary market maximizes the price received by an owner. According to Black and Gilson (1998), IPO is also an attractive and common exit strategy for venture capitalists. “To buy a company” However, firms may also go public not only to become targets of a takeover but also to become acquirers (Gleason, Madura and Wiggenhorn, 2006). Newly listed companies are able to use equity gained at the IPO to pay for acquisitions of other companies of a similar profile. The economies of scale achieved by the acquisition allow the newly public firms to grow and become more competitive. 11 Liquidity and diversification The diversification of risk is another benefit of going public that is frequently brought up (Pagano, 1993; Zingales, 1995; Stoughton and Zechner, 1998; and Chemmanur and Fulghieri, 1999). Increased liquidity of shares and dispersed ownership achieved by an IPO means that risk is shared among a large number of diversified investors. Moreover, Fischer (2000) points out that the diversification incentive to go public is higher for firms from riskier industries. As Pagano et al. (1998) suggest, diversification can be achieved directly by divesting from the company and reinvesting in other assets, or indirectly, when a company raises new capital after the IPO and acquires stakes in other already well diversified companies. The dispersed ownership achieved by an IPO brings with it also liquidity benefits for investors as liquidity facilitates trading and lowers the cost of capital (Bhide, 1993; Coffee 1991). The common stock of a privately held corporation is generally an asset without a readily available market or an easily determinable value. Thus, in general, the stock in a private firm is less liquid than the stock in a private company. By going public, a company creates a market for its stock. Liquidity gains are created not only for owners but also for the various types of investors who are able to buy and sell stocks more readily. Valuation of the company Undoubtedly, stock prices incorporate information about a firm and signal its market value. Thus, by going public the firm’s owner receives valuable information from dispersed investors and uses share prices to infer investor valuations of his firm (Dow and Gorton 1997; Mello and Parsons, 1998; Maug 2001). Thanks to an external assessment, managers of a firm are able to benchmark the company against its competitors and based on the comparison they may draw appropriate conclusions. Also reports prepared by brokerage houses and investment banks may be helpful as they allow insiders to look at the company from the market perspective. In this line Subramanyam and Titman (1999) argue that stakeholders have an ability to make discoveries about a firm by accident, which means that they may acquire information about a public firm that insiders do not have (e.g. information about the demand for a 12 firm’s products can be obtained in this way). The investors’ ability to uncover “serendipitous information” at low costs leads to a more precise valuation of the firm’s shares. What is more, as Leland and Pyle (1977) argue, entrepreneurs gain by going public because diversified investors value the firm’s shares more than undiversified entrepreneurs do. Stoughton, Wong and Zechner (2001) suggest that the decision to go public is also a signal of the firm’s quality as the firm opens itself to the scrutiny of outside analysts who have incentives to investigate the firm properly and critically. Motivating and monitoring According to Jensen and Meckling (1976), as managers' stakes decrease and ownership becomes more dispersed after an IPO, interests of managers and other stockholders become less closely aligned and this may have a negative impact on the company’s performance. Yet, as Holmstrom and Tirole (1993) and Bolton and Thadden (1998) point out, since stock prices reflect investor valuations of the firm, the stock value may serve as a monitor of managerial performance and may help, to some extent, align the interests of the managers and the owners. The mechanism is quite simple as a poorly performing firm becomes a target of a takeover and the threat of losing a job in the case of a takeover is believed to be an effective way to control the managers’ behaviour (Laffont and Tirole, 1988; Stein, 1989). What is more, the managers’ behaviour may also be managed by incentive contracts, such as linking the managers’ salaries to the firm’s stock prices or giving them stock options (Jensen and Murphy, 1990). Sometimes this may cause the problem of over-monitoring, but, as, Panago and Roel (1998) suggest, companies may be overmonitored also when they are private. It is because shareholders with a large stake in the company have a greater incentive to play an active role in corporate decisions because they also benefit from their monitoring effort. Thus, going public may in some cases reduce the interest of large shareholders to overmonitor the company. But companies go public not only to motivate managers but also other employees. IPO companies often admit that it may be easier to recruit qualified personnel once the firm is publicly traded and when employees may become shareholders (Rydqvist and Hogholm, 1995). 13 Marketing and publicity The Warsaw Stock Exchange guide “On the way to go public” stresses that the process of going public is a perfect occasion to promote the company and obtain every day mass media attention as being public is perceived as almost costless advertising. Many companies indeed perceive an IPO as an advertisement for the company and a way to gain publicity and promotion (Rindqvist and Hogholm, 1995). Public companies are also considered more attractive for employees. However, Roell (1996) doubts that the publicity surrounding an IPO really has a significant lasting benefit in raising the visibility of a company and its products. “To be the first firm to go public in the industry or follow competitors” According to Stoughton et al. (2001), being the first firm in the industry to go public may convey strategic advantages above rival firms. IPO enables a firm to expand early in the product market by using the capital raised at the public market. However, being the pioneering firm comes at a cost of revealing confidential information about the company (Bhattacharya and Ritter, 1983). Because of these costs some companies consciously decide to stay private or observe firms which have already gone public and only then do they make a decision to issue stock as well. Although companies hardly ever admit that they have gone public because their competitors are already present on the stock market, it is not surprising. According to Maksimovic and Pichler’s (1998) theory in industries that are undergoing technological changes, new entrants make inferences from the pioneering firms’ experience and theirs financing decisions. Benveniste, Busaba and Wilhelm (1997) suggest that firms which go public later are able to free ride on the costly information generated by those companies in the industry that have gone public before them. Moreover, announcing an IPO is bad news for competitors since this signals a higher product quality to consumers (Stoughton et al., 2001) and this may have a negative impact on competitors’ product prices and revenues. 14 Windows of opportunity There is a growing literature that suggests that entrepreneurs time their decision to go public, depending on the state of the market. The “windows of opportunity” theory developed by Ritter (1991) predicts a low equity issuance when stock prices are low. Companies time their issues and go public in periods when other companies in the industry are overvalued, meaning that overoptimistic investors price shares higher than the fundamental value would indicate. The “hot issue” markets observed by Ibbotson and Jaffe (1975) and Ritter (1984) characterized by unusually high volume of offerings, severe underpricing, frequent oversubscription of offerings and clusters of firms in particular industries result from the companies’ tactic to take advantage of the windows of opportunity. Ritter and Welch (2002) argue that a high IPO activity may follow high underpricing because underwriters encourage more firms to go public when public valuations turn out to be higher than expected and because underwriters discourage firms from filing or proceeding with an offering when public valuations turn out to be lower than expected. This is in line with Lucas and McDonald’s (1990) asymmetric information model where firms postpone their decision to go public if they know that they are currently undervalued. Pastor and Veronesi (2003) also study the timing of IPOs but they highlight the importance of changes in valuations captured by returns rather than valuation levels (a high marketto-book ratio in the industry). They argue that the number of firms going public changes over time in response to variations in market conditions. According to their model of an optimal IPO timing, IPO waves are caused by declines in the expected market return, increases in expected aggregate profitability, or increases in prior uncertainty about the average future profitability of IPOs. Likewise, a recent first-day stock performance of firms going public encourages other firms to go public (Lowry and Schwert, 2002). It is also believed that firms prefer to go public when other good firms are currently issuing (Choe, Masulis, and Nanda, 1993). 1.1.2 Motives for staying private Benninga, Hermantel and Saring (2005) stress that being private entails “private benefits of control”. These benefits are any costs saved by a firm that is not traded 15 publicly, such as administrative costs, costs of separating ownership from control, a lost autonomy when making decisions about a company, and costs of increased disclosure of confidential information that might reduce the competitive advantages of the company. Thus, the owner of a company who considers public financing is always facing a trade-off between benefits that he hopes to achieve by an IPO and inevitable costs that she/he will bear. Fixed administrative costs IPO is related to initial, rather fixed and high administrative costs, such as listing and registration fees, legal and auditing fees, the costs of preparing the registration statement, as well as ongoing costs of reporting to the government regulators and the public about the financial condition of a company and about any important events (Ritter, 1987). When the company is convinced that going public is the best possible step, it has no choice but to bear all these costs and hope that expected benefits of being a public company will outbalance the costs. However, before the decision is made, other, indirect costs of going public have to be considered as well. Ritter (1998) points out that indirect costs include the management time and effort devoted to conducting the offering, and the dilution of ownership associated with selling shares at an offering price that is, on average, below the first day aftermarket price. Moreover, a risk of an unsuccessful IPO must be also taken into account, as any delay or IPO failure have an impact on the growth plans of the company. If unsuccessful, all IPO costs could jeopardize the company and, in the extreme case, lead to the bankruptcy.1 Adverse selection costs One of the trade-offs that the owner of a company has to make when deciding whether to raise external financing by selling shares to a small number of large investors (e.g. venture capitalists) or to many small investors has been modelled by Chemmanur and Fulghieri (1999). The key element when considering a public issue is the cost of information dispersion about the real value of a company. In general, investors are 1 For example, the Polish company Arena.pl has suspended its operations after an unsuccessful IPO. Source: Polish Press Agency PAP, 30 August 2001: www.dziennik.pap.pl. 16 less informed about the true value of a company than the company owners, and this information asymmetry adversely affects the average quality of companies that go public and also negatively affects the price at which their shares can be sold (Leland and Pyle, 1997). This is why obtaining capital by selling shares to a small number of venture capitalists is connected with lower costs of information production. However, in such a case venture capitalists obtain a significant bargaining power against the owner and require higher rates of return in exchange for reduced diversification. On the other hand, selling shares to a large number of small investors means that investors are fully diversified and have almost no bargaining power. However, this means that now managers of a firm have to convince a much larger group of investors that the company’s projects are worth investing in. Thus, financing by an IPO is associated with the investor’s duplicative costs of learning about a company. These costs are actually born by a firm as in order to attract investors it has to lower the offer price at the IPO. Chemmanur and Fulghieri (1999) argue that firms decide to go public when information gathering costs are low or when the appropriate amount of information has accumulated in the public domain. Thus, firms with a longer track record will clearly have lower costs information acquisition for outsiders. Likewise, Subramanyam and Titman (1999) conclude that a firm decides to go public when outsiders can at low costs uncover useful information about a company, but they also notice that consumers, suppliers and workers are able to obtain costless information when dealing with the firm. That information becomes incorporated in the stock price and makes it an efficient source of firm valuation. Lost autonomy and control According to Boot, Gopalan and Tharkor (2005), the entrepreneur choice of ownership structure is a matter of a trade-off between the cost of capital and the degree of autonomy he/she has when making decisions that are in his/her opinion the firm’s value maximizing. Private ownership gives an entrepreneur a greater “elbow room” but at the expense of higher cost of capital. On the other hand, the manager of a public company gains from greater liquidity and lower costs of capital but faces the risks of investors’ disagreements about the decision the entrepreneur makes. The loss of control over the company is also a very serious concern of managers who consider an IPO. According to Brennan and Franks (1997), IPO firms’ managers 17 opportunistically implement anti-takeover defence because they want to maintain their private benefits of control after taking the company public. Disclosure of confidential information Bhattacharya and Ritter (1983) and Maksimovic and Pichler (1998) point out one more trade-off that the company is facing when considering an IPO. Public financing is related with the disclosure of a firm’s confidential information, such as inside technological information that is very important to uninformed market participants, especially to competitors. On the other hand, early financing and investment decisions help the company to gain an advantage over its competitors in the product market. Thus, a firm faces a trade-off between raising financing at better terms in the public equity market and disclosing confidential information to competitors. In the fast changing technology industries where there is a constant race for new patents and fear of being replaced by more technologically advanced patents or rivals, any unconsidered leak of information should not happen. Yosha (1995) notes that firms for which it is crucial to conceal information from competitors eventually choose to stay private. He concludes that high-tech firms consciously reject the stock market and choose private sources of financing, such as bank loans or private equity investors. 1.2 Empirical evidence The going public decision has generated considerable theoretical attention in recent years, however it is still one of the least empirically studied issues in corporate finance. The main reason is that it is difficult to obtain information about privately held firms as they are not required to report their financial results. Do firms go public to finance their future growth? Pagano et al. (1998) are one of the first researchers who have managed to empirically test various hypotheses using a large set of IPO and private companies that went public in Italy during the period of 1982 – 1992. Their results indicate that obtaining 18 financing is not the main motivation for companies to go public. It turned out that companies go public not to finance future investments as it is commonly believed but rather to rebalance accounts after a period of rapid growth and high investments preceding the IPO. Similarly the results of Fischer’s (2000) analysis suggest that variables that measure firms’ financing needs are not the primary factors influencing the decision to issue equity in Germany. What is more, the decision to go public turned out to have a negative impact on the post IPO investment growth rate of Korean companies (Chun and Smith, 2002). Pannemans’ (2002) study of Belgian companies that went public during 1996-2000 has also revealed that the need for funds is not a primary motivation for going public but, contrary to Pagano et al. (1998), money raised at the IPO is indeed used to finance future investment projects of the company. Gill de Albornoz and Pope (2004) also argue that on average financing needs are not a major factor for UK companies to go public but raising external funds to finance large investments underlies the going public decision for firms that survive IPOs ex post. Still, Mikkelson et al. (1997) find evidence that US IPOs are generally followed by a large growth in assets and this may support the view that firms go public to raise public equity capital that is used to finance growth. Thus, international evidence does not find support for the view that the main motivation for firms to go public is to finance their future growth. Do firms go public to overcome borrowing constraints? It is generally believed that firms go public because other sources of financing are exhausted and when further increases of leverage increase also a bankruptcy risk. Contrary to Myers’ (1977) view that highly leveraged firms with investment opportunities should be more likely to go public, Pagano et al. (1998) find that leverage has a negative impact on the likelihood of an IPO, although this effect is not statistically significant. Also Fischer’s (2000) study of German firms that went public on other than the Neuer Markt stock exchange segments, shows that increasing leverage reduces the probability of an IPO. Pagano et al. (1998) suggest that companies that face higher interest rates and have more concentrated credit sources are more likely to go public. However, neither the cost nor the availability of credit turns out to have a statistically significant impact on the decision to go public. Helwege and Packer (2001) observe similar levels of leverage in US private bond 19 issuers attempting an IPO and in those that did not want to go public concluding that leverage is neither a deterrent nor an incentive to go public. Do firms go public to diversify risk? The diversification incentive to go public was a special focus of Fisher’s (2000) study. His aim was to identify determinants that had an impact on the decision to go public by comparing privately held German firms with companies that went public on the Neuer Markt and in other stock market segments of the Frankfurt Stock Exchange during the period of 1997 – 1999. Firms belonging to riskier industries were expected to have a strong diversification incentive to go public. It is worth noting that the Neuer Markt was created with the intention to serve as the German equivalent to the technology-laden NASDAQ market in the United States. The Neuer Markt, opened in 1997, was designed for the initial public offerings of nascent German technology companies. The empirical analysis revealed that for the IPOs on the Neuer Markt the likelihood of going public increased with a company’s risk measured by intangible assets and R&D intensity. These findings are not surprising and confirm that Neuer Markt has indeed attracted high-risk technology firms. The huge importance of current investments measured by CAPEX indicate that companies that have gone public may have been in financial need, however it does not explain why German technology firms have chosen to finance themselves publicly instead of establishing bilateral financing agreements with banks or venture capitalists that, according to Yosha (1995), guarantee private information safety, so crucial for all high-tech companies. Do firms go public to become targets or acquirers? Rydqvist and Hogholm (1995) report that 35 percent of companies that have gone public in Sweden are sold within five years after the IPO. This is in line with the Zingales (1995) and Mello and Parsons (1998) theory that initial owners decide to make a firm public as the first step to sell the company in the future. Helwege and Packer (2001) have found evidence that companies are more likely to go public if they have private equity investors, which is in line with Black and Gilson’s (1998) view that IPO serves as an exit strategy for venture capitalists. Yet, Helwege and Packer’s 20 (2001) sample of private firms that file with the US Securities and Exchange Commission because they have issued public bonds is biased as it means that these private companies already made a decision regarding the financing sources some time ago and chose other than equity sources of financing including venture capital. Brau, Francis and Kohers (2003) point out that a firm may decide not only between going public and staying private, but it may also agree to be taken over by a publicly traded company. Using a sample of over 9,500 US privately held firms they examine the determinants of the decision to go public versus the decision to be acquired by a publicly traded firm. Their results indicate that the concentration of the industry, the high-tech status of the private firm, the current cost of debt, the "hotness" of the IPO market in relation to the takeover market, the percentage of insider ownership, and the size of the firm, are all positively related to the probability that a firm will conduct an IPO. In contrast, private companies in high market-to-book industries, firms in financial service sectors, firms in highly leveraged industries, and deals involving greater liquidity for selling insiders, show a stronger likelihood for takeovers. Unfortunately, Brau et al. (2003) do not investigate whether a firm’s decision to undertake an IPO may be part of a larger plan to sell the firm to an acquirer later. However, Brau et al. (2003) study indicates that public companies issue stock not only to become targets but also to finance acquisitions of other companies. For example, Mr. James Kelly, UPS’ chairman and chief executive, at the time of UPS’ IPO in 1999 said: “It really hasn’t been about the money. It’s been about positioning our company for the future and giving us the currency for acquisitions” (Isidore, 1999). The same view has been expressed recently by Mr. Konrad Kosierkiewicz, the president of a Polish IT company Unima 2000, who states that the main reason for taking the company public is to obtain financing for growth that will be achieved by an acquisition of one or two companies of similar profile2. Likewise, Brau and Fawcett (2006) have found in a sample of US firms that went public during 2000 and 2002 that IPO firms were acquirers 141 times and targets only 18 times. Moreover, it was found that IPOs are acquirers more often than benchmark private firms are acquirers and that IPOs are targets more often than benchmark private firms are 2 Interview for Polish Press Agency PAP available at: www.unima2000.com.pl 21 targets. This suggests that initial owners of IPO companies are aware of both possible results of an IPO and they consciously choose one of the scenarios. What is more, Gleason et al. (2006) find that newly public firms experience favourable valuation effects in response to announcements of their acquisitions, contrary to many studies on acquisitions that find a decline in the acquirer’s value. The findings support the hypothesis that companies go public to finance growth and development. Do firms take advantage of “windows of opportunity”? Several empirical studies find evidence that companies go public to use the opportunity to capture the investors’ high valuation of an industry. For example, Pagano et al. (1998) find that the likelihood of a company to finance through public sale of shares increases significantly with the industry market-to-book (MTB) ratio of existing public firms. What is more, the MTB ratio has been found as the most important factor influencing the decision of Italian firms to go public. This may indicate an entrepreneur’s choice to go public to benefit from a very good market mood. On the other hand, the high market-to-book ratio may be interpreted as higher investments needs and higher growth opportunities in the sector. The market-to-book ratio has turned out to be the most important determinant for going public also for Belgian (Pannemans, 2002) and Korean (Chun and Smith, 2002) companies. Likewise, Gill de Albornoz and Pope (2004) conclude that UK firms go public to take advantage of windows of opportunity. Also in Poland the MTB ratio has been found as the main factor influencing the timing of IPO (Dudko-Kopczewska, 2004). However, because the analysis was conducted without comparing the sample of IPO firms with the firms that stayed private, one cannot conclude that Polish companies go public only for opportunistic reasons. Is the firms’ going public decision driven by the product market competition? According to Maksimovic and Pichler (2001), in industries undergoing a rapid technological change, the optimal timing, pricing, and success of a securities offering depend not only on the individual firm, but also on the product market competition between innovative private firms in that industry. Chemmmanur, He and Nandy (2005) in a study of private manufacturing companies and those that went public 22 during 1972 - 2000 in the US, find evidence that private firms’ product market characteristics have a significant impact on the decision to go public. Firms with a higher market share, operating in less competitive and more capital intensive industries and characterized by riskier cash flows appeared to be more likely to go public. Do adverse selection costs matter? The adverse selection costs resulting from the information asymmetry between the insiders and the outsiders increase the cost of information dispersion about the true value of a firm. Chemmmanur et al. (2005), consistent with Chemmanur and Fulghieri (1999), find evidence that private firms that suffer less information asymmetry and those with projects that are cheaper for outsiders to evaluate are more likely to go public. The information asymmetry between the firm insiders and outsiders was measured by the averages of various proxies of information asymmetry for firms already listed in that industry, such as standard deviation of analyst forecasts and analyst forecast error. Are insiders worried about losing autonomy and control after an IPO? In the case the company goes public for other reasons than facilitating its sale in the future, a threat of a takeover is very serious. Field and Karpoff (2002) find that owners of newly public firms attempt to stop potential acquirers and try to retain control by maintaining a large ownership stake or adopt anti-takeover measures. Although Zingales (1995) and Mello and Parsons (1998) suggest that a takeover defence may increase the expected takeover premium when the firm is eventually acquired, Field and Karpoff (2002) find evidence that supports Brennan and Franks’s (1997) view that IPO firms’ managers implement defence because they want to maintain their private benefits of control after taking the company public. Do costs of confidential information disclosure matter? According to the theory of Bhattacharya and Ritter (1983) and Maksimovic and Pichler (2000), the costs of revealing important information about technological 23 developments to competitors in the IPO process discourage firms from going public. Chemmmanur et al. (2005) have tested empirically the confidential information disclosure theory. They expected that firms operating in industries where the value of confidentiality is greater, for example high technology firms, should be less likely to go public. However, the empirical results have revealed that the probability of going public is significantly higher for those firms which operate in high-tech industries. One possible explanation for such a result may be that the sample of high-tech industries includes only firms from the manufacturing sector, without the service oriented companies, such as computer software and that is why the sample of high technology firms may not be representative. Thus, there is no clear empirical evidence whether the costs of confidential information disclosure have an important on the decision to stay private. Are firms better off after the IPO in the long run? Several papers examine ex post characteristics of formerly private firms in order to check the theory and find out whether the motives that stay behind the decision to go public have their consequences in a firm’s characteristics and performance after the IPO. One of the earliest studies documenting the changes in operating performance of companies that have gone public was conducted by Jain and Kini (1994). They have discovered a puzzling decline in operation performance as the company made a transition from private to public. In their sample of 2,125 firms that went public in the US during the period of 1976 – 1988, they found that IPO firms substantially underperform in the long-run (three years post issue observations) comparing to its pre-IPO levels. This result holds when performance is based on companies’ operating return on assets and on operating cash flows. Jain and Kini (1994) findings were replicated on other markets and confirm the general post IPO operating underperformance. For example, Mikkelson et al. (1997) have investigated the operating performance of 283 initial public offerings in the US in the years 1980 -1983 up to ten years after going public. They document that the median operation performance of these firms in the year before the IPO exceeds the performance of industry matched firms; however the performance of IPO firms declines during the first ten years much more than the performance of matched firms. 24 A closer investigation revealed that the poor post-IPO performance is associated with rather small and young companies. The performance of larger and more established firms declined from high to a normal level as compared to industry matched firms. The long run operating underperformance has also been found outside the US. Khurshed, Paleari and Vismara (2003) and Coakley, Hadass and Wood (2004) have found a significant decline in the post-issue operating performance of UK IPOs. Cai and Wei (1997) and Kutsuna, Okamura and Cowling (2002) find evidence of poor aftermarket performance of Japanese IPOs while Wang (2005) documents a similar performance pattern in China. Pagano et al. (1998) who have analysed determinants of the decision to go public have also conducted an ex post analysis of IPO firms and compared the IPO firms post issue performance with the performance of private firms. They find evidence that profitability declines after the IPO and the deterioration increases starting from the first year after the IPO to the third year after an issue. Moreover they find that IPO has a negative impact on capital expenditures (except from one year after the IPO), financial investments and a poorer than expected impact on firms’ sales growth. Likewise, Chun and Smith (2002) find that profitability of Korean firms declines monotonically following the IPO and leverage decreases. Furthermore, it was found that the decision to go public has a negative impact on the investment growth rate and on the growth rate of total assets. The results support the hypothesis that after the IPO firms substitute their source of funds from debt to equity in order to deleverage. Both Panano et al. (1998), and Chun and Smith (2002) conclude that ex post characteristics of IPO firms indicate that firms go public not to fund future increases investments, but there is substantial evidence that they go public to take advantage of windows of opportunity. The analysis conducted by Chemmmanur et al. (2005) of pre- and postIPO total factor productivity also confirms the existence of an underperformance pattern subsequent to the IPO. Their research reveals that the total factor productivity increases steadily during the five years before an issue, reaches a peak in the IPO year and declines in the years after the issue. The similar inverted-U shape pattern is observed in the sales growth. The long run performance of Polish IPOs has been investigated by Aussenegg and Jelic (2002), but their analysis focused on privatization initial public offerings 25 (PIPOs), as compared to private IPOs, without comparing them to companies that stayed private. It was found that Polish PIPOs, as opposed to PIPOs in developed and other developing countries3, did not manage to increase profitability and significantly reduced efficiency and output in the post-privatization period. Moreover, it was found that private sector IPOs underperformed their privatization counterparts in terms of profitability, efficiency, capital investments, and output. In order to discover the postIPO operating performance of Polish companies, further empirical investigation is needed that would include a reference sample of companies that have decided to stay private. However, before the analysis of Polish IPO firms is conducted, a closer look at the characteristics of the Warsaw Stock Exchange and companies that decided to issue stock there is necessary to discuss market and economic conditions that accompanied Polish companies on their way to stock market and may have had an impact on the decision to go public an on the number of companies that made this important decision. 3 The analysis of post issue operation performance of PIPOs has been conducted for example by D’Souza and Megginson (1999) and Boubakri and Cosset (1998). 26 Chapter 2 Characteristics of the Polish IPO market Characteristics of the Polish IPO market This chapter characterises the market and economic conditions that accompanied Polish companies on their way to the stock market. Moreover, a summary of surveys conducted among the Polish IPOs reveals official motives for public issue, concerns before an IPO its anticipated effects, as well as motives for staying private. 2.1 Initial Public Offerings at the Warsaw Stock Exchange The Warsaw Stock Exchange has gone a long way from the nine companies traded in 1991, with the total turnover value of PLN 30 million (EUR 7.7 million)4 and market capitalization of PLN 161 thousand (EUR 41.2 thousand), to 238 companies in 2005 with the total turnover value of PLN 191 million (EUR 48.9 million) and market capitalization of PLN 308 million (EUR 78.9 million) as shown on graph 1. Graph 1 Number of companies listed at the WSE and market capitalization (PLN million) 400 300 238 350 213 205 209 199 300 182 250 213 186 200 250 200 150 83 100 65 100 50 150 127 44 9 16 50 22 0 Market capitalization 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 0 Number of companies Source: Warsaw Stock Exchange statistics 4 According to National Bank of Poland EUR 1 = PLN 3.9, as of 1 August 2006. 27 It is noticeable that during the 15 years of the Warsaw Stock Exchange’s operations, its life cycle has changed several times. Graph 2 presents the time distribution of 317 IPOs since the reopening of the Warsaw Stock Exchange in 1991 till the end of 2005, sub-sampled each year according to a company’s origin. Graph 2 Initial Public Offerings at the WSE between 1991 and 2005 60 50 40 30 20 10 State companies Mixed ownership Private companies with state origins Private from the beginning 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 0 National Investment Funds Source: Warsaw Stock Exchange Fact Book 2006 During the years 1991-1994 it was mainly state companies that entered the equity market as part of the privatization programme. The first whiff of the bull market appeared in spring 2003. Polish companies attracted the attention of foreign pension funds that become investing on the WSE. With every month the WSE was becoming more and more popular with individual investors and the stock prices soared rapidly. It turned out very soon that the demand for new shares exceeded the supply because the State Treasury did not manage to prepare more state companies to go public while private companies did not rush to go public. Since 1994, private companies have begun shyly entering the stock market. In April 1994 the bear market became visible at the WSE for the first time. The WIG index that in 1993 increased by over 1000 percent comparing to 1992, in 1994 decreased by almost 40 percent comparing to 1993 (graph 3). Investors were selling out and stock 28 prices went down by more than 10 percent. Fortunately, it did not last long and did not manage to discourage companies from entering the stock market and that year the number of IPOs reached 22. The years 1995 and 1996 were not much worse with 21 and 18 new listings respectively. Graph 3 Total turnover value and WIG changes (y-o-y) during 1991-2005. 1 100 250 000 900 200 000 700 150 000 500 100 000 300 50 000 100 WIG (% change) 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 0 1991 -100 Total turnover value (PLN million) Source: Warsaw Stock Exchange statistics The period 1997-1998 is believed to be the most dynamic ever at the WSE. In 1997, 46 firms went public, increasing the number of the traded companies from 83 to 129, which was an over 55 percent increase. 1998 was a record-breaking year for initial public offerings in Poland with the formidable number of 57 companies. The mass privatisation programme (MPP) that started in 1995 should be held partially responsible for the large number of companies that went public that year. The trading of the 15 National Investment Funds (NIF) shares began on 12 June 1997. The MPP helped raise the awareness and knowledge about the functioning of the stock exchange among Polish citizens as more than 91% of the 28 million Poles eligible for the MPP took part in it and had to make a decision whether to sell the certificate at the aftermarket or convert them into NIF shares. The investors’ interest in the stock market was increasing and so was the firms’ interest in going public. The improving economic conditions also had a positive impact on the investors’ and entrepreneurs’ valuations (table 1). 29 In comparison to previous two years, in 1999 significantly fewer companies decided to go public. Among the 28 IPOs there were 24 private companies. However, it was the privatisation of the Polish Oil Corporation (PKN) that attracted the most attention as it was the only company offered by the State Treasury that year. Three companies were delisted; two others deleted from the WSE on account of their mergers with other listed companies (graph 4). Table 1 Development of the WSE vs. GDP growth Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total Total number of IPOs 9 7 6 22 21 18 46 57 28 13 8 5 6 36 35 317 WSE capitalisation (% of GDP) 0,2 0,3 3,1 3,2 4,2 5,9 9,0 15,1 18,6 19,9 14,8 14,3 17,9 29,3 not available GDP growth (%) Lagged GDP growth (%) -7,0 2,6 3,8 5,2 7,0 6,0 6,8 4,8 4,1 4,0 4,0 1,3 3,8 5,2 3,2 -11,6 -7,0 2,6 3,8 5,2 7,0 6,0 6,8 4,8 4,1 4,0 4,0 1,3 3,8 5,2 Source: WSE Fact Book 2006, The Central Statistical Office (GUS) At the end of 1999 the fashion in dotcom investments arrived in Poland. However, at that time there was only one IT company listed at the WSE, namely Optimus. The investors were extremely interested in any IT company that traded in hardware or software. A company that would announce an interest in investments or operations in the IT sector immediately became an investment hit. As a result, the number of Internet companies or those that declared operations in this sector increased immediately. That year such IT companies went public as: ComArch, Szeptel and Ster-Projekt. Companies operating in traditional, sectors such as production or services lost on popularity. At the beginning of February 2000, as a result of the “internet bubble”, WIG index reached the record 21.224 points. 30 However the dotcom bubble blew up very soon, first in the USA and than in Europe, also affecting the WSE. In April 2000, investors’ optimism about Internet firms crashed and only at the beginning of 2001 investors’ evaluations of that sector slightly improved, allowing another IT company, Interia.pl, to complete the IPO without a loss. Graph 4 Number on new listings and delistings at the WSE during 1991-2005. 70 60 50 40 30 20 10 0 -10 -20 -30 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Number of IPOs Number of delistings Source: Warsaw Stock Exchange statistics The period between 2000 and 2003 was the worst ever at the WSE in terms of the number of new listings. The main reason was a lasting recession that discouraged investors and entrepreneurs as they would have to offer much lower offer prices at the IPO. In order to make a decision about equity financing and at least partially lose control over the company the entrepreneurs had to have an idea of how to spend the money raised at the IPO. However, during a recession it is difficult to find interesting, positive NPV projects. Moreover, during the period of a recession a lot of foreign strategic investors decided to delist their Polish subsidiaries. In 2000 nine companies were delisted, in 2001 four, while the number of delistings both in 2002 and 2003 reached nineteen. What is more, at the turn of 2000 and 2001 three companies did not manage to complete an IPO successfully. All these companies represented the IT sector. These unsuccessful IPOs made it more difficult for other companies to raise equity. As a result only five companies went public in 2002 and six in 2003. 31 The overall situation at the Warsaw Stock Exchange started to improve slightly as early as the end of 2003. After a few years of the bear market that began when the dotcom bubble had blown up in spring 2000, investors regained their optimism. The stock prices on the mature, Western stock markets began to increase and this fact was reflected at the CEE stock markets such as those in Warsaw, Budapest and Prague. Foreign investors were attracted to Warsaw by the accelerating economy. The GDP and industry production increase made investors expect that Polish companies would improve their financial and operational results very quickly. Indeed, the state of Polish companies was improving at that time, especially after the corporate income tax (CIT) was decreased to 19 percent. Graph 5 Relation between GDP growth and stock market capitalisation 35 8 30 6 25 4 2 20 0 15 -2 Capitalization (% of GDP) 2004 2003 2002 2001 2000 1999 1998 1997 1996 -8 1995 0 1994 -6 1993 5 1992 -4 1991 10 GDP growth (%) Source: Warsaw Stock Exchange statistics Furthermore, in 2003 new corporate governance rules were introduced to the WSE that improved relations between shareholders, the board of directors, and the supervisory board. Moreover, huge money transfers to pension funds (OFEs) strengthened OFEs’ position as institutional investors (by the end of 2003 the accumulated assets of OFEs reached PLN 45.4 billion, which was 27 percent of the capitalization of the WSE as of that year and 5.9 percent of the Polish GDP in 2002).5 5 Author’s calculations based on the data from the internet portal devoted to pension issues http://emerytury.wp.pl, WSE statistics www.gpw.com.pl and the Central Statistical Office www.stat.gov.pl. 32 Apart from institutional investors, also individual investors regained their interest in stocks as they were attracted by the privatization IPOs of large state companies, such as PKO BP, WSiP, PGNiG and Polmos Bialystok. Also investors who had entrusted their money to investment funds recorded gains, substantially larger than the gains from the risk free bank deposits. As shown on graph 5, the economic conditions and the overall situation at the stock market were improving and probably encouraged private companies to go public the following year. In 2004, the year when Poland joined the European Union, the bull market at the WSE gained momentum with the second biggest wave of IPOs, with 36 new companies. While the first IPO wave consisted mainly of state companies, in 2004 it was mostly private companies that decided to issue equity. The WSE, after a few years of the bear market, was witnessing again a huge interest in IPO among both private and state companies. The supply side met the demand as also investors were extremely interested in investing in new companies, encouraged by huge short term profits on newly listed companies (e.g. ATM gained 25 percent at the first trading day, Redan gained 20 percent, while Sniezka almost 30 percent). For the first time in three years, the number of IPOs surpassed the number of delisted companies. The demand for new investments in IPO companies was increasing alongside the increasing assets of pension and investment funds. The large number of newly listed companies in 2005 (35 IPOs) ought to be interpreted with caution. Although the macroeconomic conditions and the overall good market mood may explain the large number of IPOs, many companies were simply in a hurry to issue equity before 1 July 2005. That day new prospectus regulations came into force aimed at standardization of prospectuses within the European Union. Polish issuers were very concerned about these changes and were doing their best to go public or at least hand in the prospectus to the Polish Securities and Exchange Commission before the new EU regulations came into force. 33 2.2 The Warsaw Stock Exchange vs. other European stock markets The Warsaw Stock Exchange is the largest stock market in the Central Eastern European (CEE) countries in terms of the number of stocks listed. Moreover, it is also among the leading European stock exchanges in terms of the number of new listings. Only the London Stock Exchange, which is at the heart of global financial markets, Euronext and Deutsche Borse have more IPOs than WSE, where the total of 238 companies were listed in 2005, while at the Prague Stock Exchange only 38 and 43 companies at the Budapest Stock Exchange (graph 6). The number of stocks listed at the WSE continually increased since the beginning of its operations, while it has tended to stagnate or even decrease in other CEE countries (table 2). Graph 6 Number of companies listed in 2005 on various European stock markets. 300 238 200 109 113 38 43 Budapest 23 Prague 100 Bratislava Ljubljana Vienna Warsaw 0 Source: Warsaw Stock Exchange Fact Book 2006 The differences in the development between Polish, Czech and Hungarian stock markets stem from the differences in regulations of securities markets adopted in these counties. Poland has adopted legal rules highly protective of investors, has mandated extensive information disclosure by securities issuers and intermediaries, and has created an independent and highly motivated regulator to enforce the rules. Glaeser, Johnson and Shleifer (2001) argue that this approach to regulations in Poland has stimulated a rapid development of securities markets and it has enabled a number of firms to raise external funds. Negligent regulations in the Czech Republic have led to a high expropriation of minority shareholders and resulted in a failure of the stock 34 exchange as a source of investment capital. Hungary, which has adopted an intermediate regulatory attitude, has shown an intermediate level of financial development. It is also believed that the successful case-by-case privatisation had an extremely positive impact on the popularity of the security exchange in Poland as opposed to the failed Czech voucher mass privatisation, which resulted in common mistrust of stock market institutions (Aussenegg, 1999). Table 2 Development of CEE stock markets 1994-2004. 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 A. Number of domestic companies listed: Prague 1028 1716 1670 320 304 195 151 102 79 65 55 Budapest 40 42 45 49 55 66 60 56 49 53 54 Warsaw 44 65 83 143 198 221 225 230 216 203 230 B. Market capitalisation (in % of GDP): Prague 14.5 30.1 31.2 24.1 21.4 21.6 21.7 16.4 22.9 20.7 27.7 Budapest 4.2 6.0 12.9 36.6 29.9 36.0 28.3 19.4 17.3 22.8 28.8 Warsaw 3.2 4.2 5.9 9.0 15.1 18.6 19.9 14.8 14.3 17.9 29.3 Bratislava 8.0 7.1 11.6 9.4 4.7 5.4 6.4 7.6 8.0 8.7 5.9 Vienna 15.6 13.9 14.5 18.1 16.8 16.9 15.8 13.4 14.8 22.5 30.4 Frankfurt 23.9 25.6 27.7 39.2 50.9 72.1 67.8 58.1 31.2 45.0 44.2 London 106.9 121.7 146.3 155.0 171.0 198.3 184.3 152.2 111.0 137.1 132.0 Source: Warsaw Stock Exchange www.gpw.com.pl, Prague Stock Exchange www.pse.cz, Budapest Stock Exchange www.bse.hu. The recent strong performance of the WSE can be partly attributed to Poland’s membership in the EU, which has triggered a surge in IPOs. Many Polish companies have undergone restructuring in recent years in order to become more competitive and well prepared for the EU market. Table 3 below presents data on the number of IPOs and offering values in 2004 and 2005 at the leading European stock markets. Although the number of IPOs in Poland is far below that at the London or Euronext stock markets, the CEE region stock exchanges may envy WSE its performance. 35 Table 3 IPOs per exchange in 2004 and 2005. London Euronext Deutsche Borse Warsaw Stock Exchange Luxemburg Oslo Bors Borsa Italiana Swiss Stock Exchange Stockholm Wiener Borse Copenhagen Stock Exchange Ireland Madrid Exchange Athens Stock Exchange Europe Total IPOs 2004 305 48 10 36 8 2 8 4 5 1 2 2 3 2 433 Offering value (EUR million) 2004 8,309 8,486 1818 2,988 380 292 2,481 408 90 7 681 2,415 5 27,679 IPOs 2005 354 65 43 35 31 30 15 10 8 7 3 3 1 1 603 Offering value (EUR million) 2005 18,866 16,319 3,593 1,740 2,075 1391 2,400 2,137 392 1,162 766 12 157 29 50,677 Source: IPO Watch Europe Annual Review 2005, PwC 2.3 Polish IPOs survey results In an attempt to define the determinants of the Polish stock market development, Grat and Sobolewski (2005) have conducted a survey of 101 public companies, 55 private companies that had used bond financing, and 207 private companies that had financed themselves neither at the bond nor the stock market. The study investigates the motives behind a decision to go public and the motives for a company to stay private. Recently, KPMG has conducted a similar survey among Polish companies that went public during 2004-2005. The short summary of both surveys allows for an examination to what extent Polish managers’ motivations for conducting an IPO correlate with the theory and the motivation of CFOs in other countries. 2.3.1 Polish issuers’ motivation for going public The results of surveys conducted among Polish companies that went public only partially correspond to similar surveys conducted at the US (Brau, Ryan, DeGraw, 2004; Brau and Fawcett, 2006) and Swedish (Rydqvist and Hogholm, 1995) markets. Similarly to Swedish companies, Polish private firms state that they go public for financing reasons. The results of a survey conducted by Grat and Sobolewski (2005) 36 and by KPMG indicate that the desire to obtain financing for investments and growth is the main motivation for Polish companies to go public (graph 7) which is in line with the general view that firms go public to raise additional external equity to fuel its growth (Ritter and Welch, 2002). In contrast, for US companies obtaining financing is not the main reason to go public (Brau and Fawcett, 2006), although the surveyed CFOs strongly agreed that it is a benefit of an IPO (Brau et al. 2004). The main motivation for US companies to go public was to create public shares for use in future acquisitions (Brau and Fawcett, 2006), which supports Gleason’s et al. (2006) view that companies go public not only to become targets but also acquirers. Graph 7 Official motives for going public obtain financing 70% increase credibility 44% sell a company 41% company valuation by the market 26% marketing motives 26% increase prestige 22% other 7% 0% 20% 40% 60% 80% Source: KPMG, 2006: “Destination: Stock Exchange. The Process of Going Public at the Warsaw Stock Exchange between 2004 - 2006”. Polish companies view raising capital as the main but not the only reason to conduct an IPO. Mr. Wieslaw Rozlucki, former President of the Warsaw Stock Exchange, points out that because of the high regulatory standards at the WSE firms also gain credibility, trust of stakeholders and recognition for their brands.6 Managers of Polish companies seem to share this opinion as the firm’s increased credibility and reputation were indicated as the second most important motive to go public (KPMG, 2006; Grat and Sobolewski, 2005). Likewise, in the US one of the three most important motives to go public is to enhance the reputation of the company (Brau and Fawcett, 2006). 6 Samcik, M., “About the stock exchange on vacations”, attachment to the Gazeta Wyborcza daily, issue 145, 23 June 2004, p. 4. 37 The next important motive for Polish entrepreneurs to go public is to sell the company (KPMG, 2006). In contrast, managers of US companies no do not agree that a benefit of an IPO is that it allows for the sale of some of owners’ shares. Neither is IPO perceived as an exit strategy for initial owners (Brau et al., 2004). US companies go public in order to create public shares for use in future acquisitions rather than being taken over in the future (Brau and Fawcett, 2006). Company valuation by the market is an important motive for going public for both Polish and US companies. Interestingly, many Polish companies perceive IPO as a marketing move and hope that going public will increase their firm’s prestige and attract media attention (KPMG, 2006; Grat and Sobolewski, 2005). Likewise, Swedish companies believe that IPO make the company’s products better known (Rydqvist and Hogholm, 1995). In contrast, most of the US companies do not believe that an IPO attracts more media attention or increases prestige (Brau et al., 2004). It is important to note that Polish IPOs indeed receive a lot of media attention as early as they announce a desire to go public. It is possible because the yearly number of IPOs in Poland is still relatively small comparing to the UK market when tens of companies go public each month or US market where the number of companies going public from 1980 to 2001 exceeded one per business day (Welch and Ritter, 2002). In the KPMG survey only 7 percent of Polish companies admitted that there were informal motives for going public. All of them stated that it was the necessity to follow competitors who were already public. This is in line with Maksimovic and Pichler’s (1998t) theory according to which new entrants make inferences from the already public firms’ experience and may free ride on the costly information generated by companies that have gone public before them (Benveniste et al., 1997). 2.3.2 Concerns about going public One of the most serious concerns of Polish companies that considered an IPO is the necessity to disclose confidential information about a firm (KPMG, 2006; Grat and Sobolewski, 2005). This supports the Bhattacharya and Ritter (1983) and Maksimovic and Pichler (1998) view that firms considering an IPO face trade-off between raising financing at better terms in the public equity market and disclosing confidential 38 information to competitors. Also CFOs of US companies agree that a disadvantage of an IPO is that it suddenly opens the firm up to public scrutiny (Brau et al., 2004). Moreover, Polish companies also stress that when going public they encounter hurdles caused by additional informational duties (graph 8). Graph 8 Main concerns about going public other 15% confidential information disclosure 59% hurdles caused by additional informational duties 48% costs related to an issue 37% necessity to meet the stock market standards 19% lost of controll over a firm 7% 0% 20% 40% 60% 80% Source: KPMG, 2006: “Destination: Stock Exchange. The Process of Going Public at the Warsaw Stock Exchange between 2004 - 2006”. The necessity to meet the stock market standards is a concern of every fourth company. Polish companies are also concerned about the high financial costs related to an issue. Grat and Sobolewski (2005) report that small companies, with yearly revenues below EUR 7 million, were the most concerned about the fixed issue costs. This supports the general view that smaller companies are less likely to go public because of high, rather fixed administrative costs of going public that are unrelated to the company’s size (Yosha, 1995; Pagano and Roell, 1998). According to the WSE publication “Companies financing through the capital market”, the average cost of an IPO in Poland in recent 10 years was about 10.78 percent of the total offer value. An average cost of a seasoned equity offering (SEO) was much lower, at about 4.61 percent. The size of the offer is also very important as issues below PLN 10 million cost on average 13.8 percent of the total offer value, while issues between PLN 30-40 million cost on average only 4.5 percent. In comparison, issue costs in US during the 39 period of 1990-1994 were on average around 7 percent (Lee, Lochhead, Ritter, and Zhao, 1996). Only 7 percent of Polish managers were worried about losing the control over the company. Likewise, managers of US companies were rather “neutral” in the response to the question whether the reduction in control is a disadvantage of going public (Brau et al., 2004). This indicates that the trade-off between the cost of capital and the degree of autonomy is not that remarkable as Boot et al. (2005) suggests. According to KPMG, 80 percent of Polish managers after the IPO said that their concerns about going public were unjustified. Only 11 percent of companies indicated that costs of going public were indeed high and 7 percent of companies mentioned the negative effects of confidential information disclosure for competitors (KPMG, 2006). 2.3.3 Motives for staying private The main reason for Polish companies to stay private is that they do not need additional financing or because they have access to cheaper sources of financing, such as bank and merchant credits, issue of short term bonds on the non-public market, foreign credits and leasing (graph 9). This result suggests that there has to be a clear financial motivation for companies to take IPO into account. Secondly, this result supports the pecking order theory that firms will always prefer to issue the cheapest source of financing (Myers and Majluf, 1984; Myers, 1984). The second most frequent response is that the current legal form does not allow the company to go public but at the same time over 50 percent of companies stated that this is not an important factor that influenced the decision to stay private. Polish companies referred to maintaining decision-making control as the fourth issue, while in the US it is the most important in deciding whether or not to stay private (Brau and Fawcet, 2006). The second most important reasons for US companies to stay private is to avoid ownership dilution. In contrast, in Poland almost half of the surveyed companies perceive the dilution of ownership as unimportant. Other reasons for staying private in Poland, the most frequent response include: the owner’s decision, too risky a project, the company is still in the early development 40 stage, the decision to stay private was made by the capital group, the company concentrated on short-term financing. Graph 9 Factors that had an impact on the decision to stay private. other 56,1 insufficient knowledge of stock markets 3 31,1 60,3 complicated law regulations 36,8 9,7 43,7 11,8 19,4 21,4 5,55,1 16,4 6,7 complicated tax regulations 49,2 11,9 16,9 13,6 8,4 dilution of ownership 48,9 13,9 15,6 12,2 9,4 necessity to meet corporate governance standards 51,5 necessity to disclose financial information 50 cost related to an IPO 41,8 hurdles caused by additional informational duties 46 loss of control over the company 43,4 have access to cheaper sources of financing 40 current legal form does not allow 37,1 0% 2 3 20% 4 15,5 7,1 10 12,6 14,2 11,1 16,8 17,2 14,8 14,2 15,2 14,9 10,1 10,5 12,6 11,4 12,6 11,5 19,1 7,8 13,9 11,3 27 4,27,6 6,3 28,5 53,4 no needs for additional financing 1 - not important 15,9 9,2 17,9 40% 60% 7,1 28,7 80% 100% 5 - very important Source: Grat and Sobolewski (2005) Hurdles caused by additional informational duties were declared by only 12.6 percent of companies. More than a half of companies do not perceive fixed costs related to an IPO as an important motivation to stay private, which is rather surprising taking into account all direct and indirect costs indicated by Ritter (1998). 2.3.4 Effects of an IPO Polish companies’ expectations for IPO were met only partially. Although 70 percent of companies confirmed that IPO increased credibility of their company, which was the second most frequent reason for going public, only 30 percent of companies managed to achieve their primary goal, which is additional financing (graph 10). The 41 marketing effect seems to be achieved as over half of the companies state that IPO increased recognition of the firm and its products. Every fifth company indicated also a more visible management system as a benefit of an IPO. 75 percent of companies state that they managed to achieve the main aims and are satisfied with the effects of an IPO. Moreover, taking into account all advantages and disadvantages of going public, managers state that they would have made the same decision again. Graph 10 Areas where the company gained the most through IPO. 70% increased credibility increased recognition of a company and its brands 52% 30% access to new sources of financing 19% more visible management system 15% other 0% 20% 40% 60% 80% Source: KPMG, 2006: “Destination: Stock Exchange. The Process of Going Public at the Warsaw Stock Exchange between 2004 - 2006”. The above cited surveys, conducted among Polish companies, indicate that the stated motives for going public and concerns associated to the public issue correspond to the theory of the going public decision. Polish companies state that they go public to obtain financing for future development and are most concerned about the disclosure of confidential information to the public. However, as previous empirical evidence suggests the motives stated in prospectuses and cited by company’s insiders do not necessarily correspond to the true motives and effects of an IPO. Thus, the rest of the paper focuses on empirical analysis of determinants and consequences of the initial public offering in Poland allowing for comparison of theory, survey results and empirical results obtained on other markets. 42 Chapter 3 Methodology and data description Methodology and data description The analyses of motives and consequences of a decision to go public are based on the methodology previously employed by Pagano et al. (1998) and Chun and Smith (2002). Pannemans (2002) and Fisher (2000) have also investigated the subject, however they focused on determining motives of an IPO decision and did not actually check the results of an issue in the long-run. As Pagano et al. (1998) noticed, both ex ante and ex post analysis is necessary because ex post information complements the evidence on the ex ante characteristics of the IPO companies. If motives of going public declared by managers before an issue are true, the determinants identified in the ex ante analysis should correspond to effects of an IPO. For example, if management of a company states that the main reason for going public is to obtain capital for further development and investments, this should result in increases in tangible and/or intangible assets after an IPO. This paper aims at discovering both the motives of an IPO and its consequences on a company’s investment and financial policy after an issue. Therefore, the results of the research into the Polish market are comparable with other European markets and add additional insights to the IPO literature. 3.1 Ex ante analysis What is the probability that something will occur, and how is that probability altered by a change in some independent variable? It is especially interesting to discover the probability that a firm will go public in a given year and variables that have an impact on this decision. It is possible to observe only two states for a company: private or public. Since number of economic issues investigated by scientists is measured in noncontinuous ways and for this reason cannot be analyzed using a classical regression model, it is necessary to model the likelihood that an event will occur. Logit and probit are two most common techniques for estimation of models with a dichotomous dependent variable. I describe both models with a special focus on the probit model, which is employed further in the analysis. The models are described based on Greene (2003) textbook for econometrics. 43 3.1.1 Binomial choice models In multiple economic issues a dependent variable is a discrete variable, for example a company has received a credit or not, accepts payments in foreign currency or not, is bankrupt or not. In such cases the dependent variable is represented by dichotomous variable, which takes value yit = 1, if an event occurs with probability pit. In such a case the expected value of dependent variable equals: E(yit) = 1 · pit + 0 · (1 - pit) = pit (1) and is usually modelled as a function of some independent variables: pit = prob[yit = 1] = E(yit xit) = F(xit’ β ) (2) The right site of this equation has to be found. The simplest approach is to use OSL regression: F (xit’ β ) = xit’ β (3) However, Linear Probability Models (LPMs) have limitations. Firstly, stochastic disturbance is heteroscedastic, taking the value either (- xit’ β ) with probability (1- F), or (1 - xit’ β ) with probability F, and thus we have: var ( ε it xit) = xit’ β (1 - xit’ β ) (4) which shows that the variance of disturbances is not equal for all individuals. However, the most serious disadvantage of the LPM approach is that estimated probabilities can be less than 0 or greater than 1. Such a model produces both nonsense probabilities and negative variances (see the formula for variance of disturbances above). A solution to this problem might be a use of cumulative distribution function for a given distribution, as it results in limitation of F(xit’ β ) to 44 the desirable from the point of view of the probability theory range [0, 1]. Commonly used CDF functions are logistic CDF (logit model) or standard normal CDF (probit model). Binary variable might be also used, when dependent variable is continuous but unobservable. For example, a person decides to accept a job offer if the offered salary (yit*) exceeds a certain level: yit = 1 if yit* > 0 and yit = 0 if yit* ≤ 0, where: yit* = xit’ β + ε it (5) Thus, we have: prob (yit = 1) = prob (yit* > 0) = prob ( ε it > - xit’ β ) = F (xit’ β ) (6) Probit model: F (xit’ β ) = Φ (xit’ β ) = Logit model: F (xit’ β ) = Λ(xit’ β ) = ∫ xit 'β -∞ e xit 'β 1 + e xit 'β 1 2π e −u 2 /2 du (7) (8) Both the logit and the probit regression models are estimated by maximum likelihood. Consequently, goodness of fit and inferential statistics is based on the log likelihood and chi-square test statistics. The idea behind maximum likelihood parameter estimation (MLE) is to determine the parameters that maximize the probability (likelihood) of the sample data. Usually, when specifying a probability density function (e.g. a normal with unknown mean µ and unit variance), we treat the probability density function (PDF) as a function of z (the value of the random variable) with the distribution parameters Θ assumed to be known. With maximum likelihood estimation, we reverse the roles of the observed value and the distribution parameters by asking: Given a vector of observations z, what can we say about Θ ? To specify this alternative interpretation, the density function is denoted as λ ( Θ | z), the likelihood of Θ given the observed vector of data z. This defines a likelihood surface, as λ ( Θ | z) assigns a value to each possible point in the Θ -parameter space given the observed data z. The maximum likelihood estimate of the unknown parameters, Θ̂ , is the value of Θ corresponding to the 45 maximum of λ ( Θ | z), i.e., the MLE is the value of Θ that is “most likely" to have produced the data z. Probit and logit models are among the most widely used members of the family of generalized linear models in the case of binary dependent variables. The conventional wisdom is that in most cases the choice of the link function is largely a matter of taste. According to Amemiya (1981) in the univariate dichotomous model, it does not matter whether we use a probit or logit model, except in cases where data are heavily concentrated in tails. Liao (1994) states that either model gives identical substantive conclusions in most applications. Moreover, he argues that multiplying a probit estimate by a factor of π / 3 = 1.814 one will get an appropriate value of the corresponding logit estimate. Graph 11 gives an example of predicted probabilities for logit and probit. Graph 11 The predicted probabilities for logit and probit. Source: Gruszczynski (2002) Chambers and Cox (1967) discuss in detail similarities and differences between both models and conclude that it is only possible to discriminate between the two models when sample sizes are large and certain extreme patterns are observed in the data. Nevertheless, Noreen (1988) notices that probit models seem to be preferred and more frequently used than logit models in recent accounting classificatory studies. I decided to use probit model following Pagano’s et al. (1998) approach. 46 The probability model is a regression: E [y | x] = 0[1 - F (x’ β )] + 1[F (x’ β )] = F (x’ β ) (9) It is important to note that the parameters of the model, whatever distribution is used, are not marginal effects – they only show the qualitative, but not the quantitative impact of an independent variable on the probability, that the binary dependent variable will be equal to 1. Marginal effects have to be computed to measure the quantitative effect and there are two approaches for doing so: evaluate the expressions at the sample means of the data or evaluate the marginal effects at every observation and use the sample average of the individual marginal effects. As Greene (2003) notices, current practice favours averaging the individual marginal effects when it is possible to do so. The appropriate marginal effect for a binary independent variable d, would be: Marginal effect = Prob[Y=1| x(d ) , d = 1] – Prob [Y=1| x(d ) , d = 0], (10) where x(d ) , denotes the means of all the other variables in the model, excluding variable d. The main challenge with the logit and probit is the interpretation of the estimated regression function. The first step in interpretation is to test and describe the overall goodness of fit of the model. In maximum likelihood approaches, the common method is to examine the difference between the residuals of the model under the constraint that all regression coefficients are zero and the residuals where the coefficients are estimated from the sample data. The reduction in the "badness of fit" as a result of freeing parameters for each X can be tested as a chi-square statistic with as many degrees of freedom as freed parameters. 47 Likelihood ratio test Maximum likelihood provides for extremely convenient tests of hypotheses in the form of likelihood-ratio that examine whether a reduced model provides the same fit as a full model. The likelihood-ratio test statistic is given by: LR = -2 [ln L̂R - L̂U ] ~ χ 2 (r), (11) where r is the number of restrictions imposed on a full model, L̂R and L̂U are the loglikelihood functions evaluated at the restricted and unrestricted estimates, respectively. A common test, which is similar to the F test that all the slopes in a regression are zero, is the likelihood ratio (LR) test that all the slope coefficients in the probit or logit model are zero. For this test, the constant term remains unrestricted. Pseudo R-squared In contrast to OLS regression where R-squared is the common measure of goodnessof-fit, for binary choice models, such as logit and probit, there is an abundance of measures (Cameron and Windmeijer, 1997). R-squared is not an appropriate indicator of goodness-of-fit within a qualitative dependent variable model because the predicted values of the dependent variable are probabilities, while the actual values are either zero or one (for a dichotomous dependent variable). The most frequently used measure of goodness-of-fit used for binary choice models is the likelihood ratio index, commonly known as pseudo R-squared or McFadden R-squared: pseudo R-squared = 1 – ln L ln L0 (12) The pseudo R-squared measures the success of the model in explaining the variations in the data. The pseudo R-squared is calculated depending upon the likelihood ratio. The McFadden's R-squared compares the likelihood for the intercept only model to the likelihood for the model with the explanatory variables in order to assess the model goodness of fit. The pseudo R-squared indicates that the proportions of 48 variations in the outcome variable are accounted for by the explanatory variables. The larger the pseudo R-squared the better the model fitting. McFadden's R-squared can be as low as zero but can never equal one. 3.1.2 Probit model and the explanatory variables In order to analyze the determinants of the likelihood of going public in Poland, the probit model is used, following Pagano et al. (1998) methodology. The dependent variable (IPO) is a qualitative attribute and it equals 1 if the company goes public in the analyzed period, and 0 if the company remains private. F(.) is the cumulative distribution function of a standard normal variable. The sample is restricted to all company-years that satisfy the listing requirements as of that year. The decision to go public is affected by a broad range of factors described in international literature and cited in chapter 1. However, not all of the theories about factors behind an IPO decision have testable implications and it is virtually not possible to capture all of them in a single model. Thus, for the purpose of this thesis I focus on those determinants that can be tested on data available for Polish IPO and private companies. The following set of independent variables, captured in the probit model, was selected to test the hypotheses about the reasons for going public: P (IPO it =1) = F ( β 1 AGE it −1 + β 2 SIZE it −1 + β 3 GROWTH it −1 + (13) + β 4 INVEST it −1 + β 5 LEVER it −1 + β 6 INTAN it −1 + + β 7 ROA it −1 + β 8 MTB it + β 9 MTB it −1 + β 10 GDP it −1 + + β 11 INF it −1 + β 12WIG it + β 13WIG it −1 ) where: AGE – firm’s maturity measured by the number of years from incorporation till IPO. SIZE – firm’s size is measured by the logarithm of assets. GROWTH – firm’s annual growth rate in sales computed as sales in year t minus sales in year t-1 divided by sales in year t-1. INVEST – firm’s growth rate of fixed assets. 49 LEVER – firm’s leverage measured as the value of total debt over total debt plus equity. INTAN – a ratio of firm’s intangible assets over total assets. ROA – firm’s profitability measured as EBITDA (earnings before interest, taxes, depreciation, and change of provisions) over total assets. MTB - market-to-book ratio in the industry as computed by the WSE. GDP – Polish gross domestic product growth (y-o-y) as computed by the Central Statistical Office (GUS) www.stat.gov.pl. INF – Polish inflation rate as computed by the GUS. WIG – Warsaw Stock Exchange WIG INDEX, which is a total return index which includes dividends and pre-emptive rights (subscription rights). Index includes all companies listed on the main market, excluding foreign companies and investment funds. The index base value is 1000.00 as of April 16, 1991. I decided to use first lags of the year-end accounting data in order to avoid the timing problem noticed by Chun and Smith (2002). The main reason of the timing problem is that the data available for Polish IPO and private companies are presented in year-end accounting numbers but they do not measure IPO firm characteristics properly as IPO may have happened at any time during the year. The use of first lags of the year-end accounting variables would incorporate both ex ante determinants and effects of the IPO, especially when the firm goes public at the beginning of the year. The use of first lags of the year-end accounting variables as independent variables eliminates the timing problem. The hypotheses about the reasons for going public are created based on the theoretical predictions widely discussed in international literature and prior empirical findings. Hypothesis 1 Company size and maturity is positively correlated with the decision to go public. It is commonly assumed that stock market is a place for big and mature companies. Young companies, with a short track record and instable market position, remain under the influence of adverse selection (Chemmanur and Fulghieri, 1999). Mature companies are in a better position and may reduce the adverse selection problem 50 providing longer historical records (Ritter, 1991). According to Pastor and Veronesi (2003), younger firms pose a greater valuation problem, and uncertainty about their future profitability is greater than that of older companies because uncertainty declines with time. The size of a company seems to be related to the probability of going public for at least two reasons. Firstly, IPO is related with considerable and rather fixed costs unrelated to the company’s size and in the case of small companies issue costs consume a large fraction of proceeds (Yosha, 1995; Pagano and Roell, 1998). For this reason it is expected that small companies are less likely to go public. Secondly, small companies have more problems with selling their shares at the IPO as investors focus their attention rather on large companies. The main reason is that trade volumes of small firms are smaller than the trade volumes of large companies and it is more difficult to buy and sell shares of small companies. As liquidity of a company’s shares is a function of its trade volume, only sufficiently large companies may benefit from such liquidity gains (Pagano et al., 1998). For this reason one may predict that larger firms are more likely to go public. Hypothesis 2 Financing needs positively influence the likelihood of going public. The firm’s development depends on financing sources. The realization of a company’s investment plans and strategy of fast growth require substantial funds. Thus, it is not surprising that obtaining financing capital is one of the most frequent IPO reasons mentioned in prospectuses. Rydqvist and Hogholm (1995) find that 97 percent of Swedish companies stated in prospectuses that they go public because of financing reasons. In order to assess whether financing needs influence the decision to issue equity, two variables are used as a proxy for investment opportunities. The first one is investments in fixed assets (INVEST). Chun and Smith (2002) state that the growth rate of fixed assets measures the company’s needs for direct productive investments funds that enable a purchase of a plant and equipment, which increases the probability of an IPO. The second proxy is a firm’s annual growth rate in sales (GROWTH). If firms go public to finance investments and growth, these two variables should be positively related to the probability of an IPO. 51 Hypothesis 3 High leverage positively influences the decision to go public. International literature presents an ambiguous relationship between the leverage and the probability of an IPO. On the one hand, the stock market represents an important source of outside equity for companies that have already financed their investments by debt, are highly leveraged, and for whose liquidity further debt financing would be dangerous. Myers (1977) argues that highly leveraged firms with investment opportunities should be more likely to go public. Moreover, highly leveraged companies are easier and cheaper for investors’ evaluation as they have already undergone the scrutiny of bank lenders (Harris and Raviv, 1990). On the other hand, highly indebted firms bear a greater risk and this is why investors may be reluctant to inject equity in such a company (Gill de Albornoz and Pope, 2004). Helwege and Packer (2003) findings indicate that indeed highly leveraged firms are likely to be rather private than public. The summary statistics of independent variables that will be used in the analysis, presented later in the chapter (section 3.3.3), demonstrate that an average IPO company one year before going public is more leveraged than an average private company. This makes one expect that there may be a positive relation between the leverage (LEVER) and the likelihood of the IPO. Hypothesis 4 More risky companies are more likely to go public. Diversification is believed to be one of the motives influencing the decision to go public because when the ownership is dispersed, the risk is shared by the large number of well-diversified investors (Pagano, 1993; Roel, 1996; Chemmanur and Fulgheri, 1999). Thus, IPO is a perfect opportunity for initial owners to diversify as they may divest from the company and reinvest in other assets or they may raise a fresh capital after an IPO and acquire stakes in other companies (Pagano et al., 1998). Fisher (2000) was the first to test the relationship between diversification and the probability of going public using intangible assets over total assets (INTAN) as a proxy for the company risk. The high proportion of intangible assets (such as patents 52 or other usage rights) and their positive impact on the probability to go public is not surprising in the case of technological firms listed on the Neuer Markt in Germany. However, the positive relation between intangibles and probability of the IPO has also been found for companies that went public on other segments than Neuer Markt of the Frankfurt Stock Exchange (Fisher, 2000) and in the UK (Gill de Albornoz and Pope, 2004). Thus, this paper will test this relationship with regard to the Polish market. Hypothesis 5 The high market-to-book ratio of companies in the same industry increases the company’s propensity to go public. Ritter (1991) suggests that the high market-to-book ratio (MTB) in the industry indicates that securities are overpriced. It is easier for issuers to attract optimistic investors. This gives an incentive for other companies in the same industry to go public in order to take advantage of this “windows of opportunity”. However, such a myopic behaviour has a negative impact on the long-run performance. Loughran and Ritter (1995) found evidence that companies which went public during the “hot market” in order to take advantage of investors’ over-optimism usually underperform in the long-run. On the other hand, high MTB ratio may indicate that investors have high expectations about the growth opportunities in the industry (Pagano et al., 1998). If these opportunities require large investments, companies go public to gather the necessary funding. Chun and Smith (2002) argue that if indeed growth opportunities stay behind the high MTB ratio, companies should record a higher growth and profits after the IPO. If growth and profit do not increase after an issue, it seems to be the firms’ opportunistic behaviour that makes them go public and this confirms the “windows of opportunity” hypothesis. Apart from the MTB ratio which measures the market mood in the industry, the yearly WIG index is also used as a measure of the overall market mood at the Warsaw Stock Exchange. Every year, industry MTB ratios as well as WIG data are taken from the multiple issues of the Warsaw Stock Exchange Fact Book and the WSE statistics (appendix 1) respectively. 53 Hypothesis 6 Profitability positively influences the decision to go public. The relationship between the profitability and the probability of going public is not straightforward. Fisher (2000) argues that high cash flows make a company more independent from external investors and relax its financing constrains, thus profitable companies which are able to finance their investments and growth stay private. This is in line with Pagano and Roell’s (1998) view that external sources of financing are relevant for firms that are not able to generate sufficient internal cash flows. This indicates a negative relation between profitability and probability of an IPO. However, in light of the market timing hypothesis presented by Ritter (1991), an increase in profitability may be only temporary and this encourages companies to go public to capture the “window of opportunity”. The results of studies of the long-run performance demonstrating that profitability of IPO firms usually decreases after an issue (Jain and Kini, 1994; Mikkelson and Shah, 1994; Mikkelson et al., 1997) seem to confirm Ritter’s (1991) view. Profitability is measured as the return on assets (ROA). Hypothesis 7 Macroeconomic conditions have an impact on the decision to go public. According to Dzwonkowski (2006), the development of any stock exchange, which is an instrument of the financial market, is coupled with a country’s economic development. At the same time, the economic growth rate depends on the shape and the state of the financial market in that country. Periods of favourable macroeconomic conditions create new development opportunities and help companies in achieving good financial results. This results in increases of stock prices, indices and investors’ valuations, and it creates favourable conditions for companies to go public. When times are good, an average firm’s quality is higher as there are more profitable investments opportunities, so problems of adverse selection are reduced, which means that the cost of going public is lower in upturns (Choe et al. 1993). However, when times are bad there are less interesting projects to invest in and firms postpone the stock issue until the economic conditions improve. Thus, it is expected that changing macroeconomic conditions influence the economic performance of the Polish 54 companies and their propensity to go public. Macroeconomic conditions are measured by lagged inflation (INF) and lagged GDP growth (GDP), both reported in the appendix 2. The decision to use lagged, instead of current, values is intuitive as both measures of macroeconomic conditions are observable and reported only with a lag. Table 4 summarised hypothesis about the factors influencing the likelihood of an IPO, that will be tested empirically. Table 4 Summary of hypotheses about the factors that influence the likelihood of an IPO. Factor Relationship Hypothesis 3 SIZE, AGE INVEST, GROWTH LEVERAGE Hypothesis 4 INTANG Company size and maturity is positively correlated with the decision to go public. Financing needs positively influence the likelihood of going public. High leverage positively influences the decision to go public. More risky companies are more likely to go public. Hypothesis 5 MTB, lagged MTB, WIG, lagged WIG ROA High market-to-book ratio of companies in the same industry increases the company’s propensity to go public. The market mood has an influence on the decision to go public. Profitability positively influences the decision to go public. GDP, INF Improving macroeconomic conditions have a positive impact on the decision to go public. Hypothesis 1 Hypothesis 2 Hypothesis 6 Hypothesis 7 Source: Author’s analysis 3.2 Ex post analysis The ex post analysis is aimed at complementing the determinants of IPO uncovered in the ex ante analysis. By comparing the ex post performance of the companies that went public with companies that stayed private it is possible to capture the motives that are unobservable in the ex ante analysis e.g. the investment and debt policy after an IPO. Following Pagano et al. (1998), fixed-effects regressions are employed in which the consequences of an IPO are captured by dummy variables for the IPO year and the three years following the stock issue. For panel data sets, the fixed-effects model assumes that differences across units can be captured in differences in the 55 constant term and therefore a firm before the IPO is used as a control for itself after the IPO. The fixed-effects regressions are aimed at discovering the impact of the decision to go public on various accounting variables and measures of performance. However, it is important to note that changes in the accounting variables cannot be explained solely by the IPO decision. A broader set of explanatory variables is necessary, separately constructed for each accounting variables. Pagano et al. (1998) estimated the models using a larger list of explanatory variables and, although they report neither the list of those variables nor the results, concluded that in most of the cases the results were qualitatively similar to the results obtained for models capturing only IPO effects. Since the aim the ex post analysis is to compliment the ex ante analysis and discover the consequences of the IPO on firms operating performance, I made an assumption that whatever additional variable is used to explain the accounting variables, the results obtained are similar to those that capture only the decision to go public. The following specification is used in the ex post performance analysis: yit = α + 3 ∑ β IPO j j =0 t− j + β 4 IPOt −n + 3 ∑γ j QUOTt − j + ui + ε it (14) j =0 where yit is the ith accounting variable in the tth period. IPOt − j are dummy variables equal to 1 if year t-j was the IPO year, IPOt − n is a dummy variable equal to 1 of the IPO took place more than three years before and QUOTt − j are dummy variable equal to 1 if company ith satisfied the listing requirements the year t - j. Firm-specific effects are included (ui ). In general, it is expected that companies are better off after an IPO, otherwise they would not have gone public. However, results of prior empirical studies indicate that the operating performance of IPO companies decreases with time (Jain and Kini, 1994). In theory, effects of an IPO should correspond to the motives of going public. Thus, the analysis of motives of an IPO decision helps to develop a set of predictions about the effects of an IPO, which are tested with the fixed-effects model. 56 Hypothesis 8 IPO reduces the leverage of publicly traded companies. One of the main benefits of going public is obtaining an alternative to the bank credit source of financing (Pagano et al., 1998). IPO enables companies to gather necessary funds to finance their needs. This is why it is expected that one of the consequences of an IPO would be a reduction of the debt exposure. Hypothesis 9 IPO has a positive effect on a company’s investments. It is common view that companies go public to finance their growth and investments (Rindqvist and Hogholm, 1995; Roell, 1996). Thus, it is expected that after going public companies will show increases in their investments in fixed and/or intangible assets. Hypothesis 10 IPO has a positive effect on a company’s sales growth. According to Stasiuk (2004), going public is a means of publicity and promotion for a company. A firm receives a lot of public interest already at the stage of pre-IPO preparations and every day it draws mass media attention as it is quoted on a stock exchange. Moreover, as Stoughton et al. (2001) notice, consumers learn about the product quality of the firm from the stock market and therefore good firms can charge higher prices for their products. Thus, it is expected that publicity and promotion gained by a public company will result in a larger clients’ database and larger sales after an IPO. Hypothesis 11 IPO has a negative effect on a company’s profitability. According to Ritter (1991), companies that show high profitability are suspected of going public when their good performance is temporary. Moreover, entrepreneurs may engage in creative “earnings management” at the time of the IPO (DeGeorge and 57 Zeckhauser, 1993) and they go public when they know that this high profitability cannot be sustained in the future. This is what may cause a decline in the profitability in the long run. However, Pagano and Roell’s (1998) propose contrary expectations about the relation of profitability and probability of an IPO: companies go public when they are not able to generate sufficient internal funds to finance their investments. Although predictions about the influence of profitability on the IPO decision are contrary, the expectation about the result of an IPO in any case seems to be unambiguous. No matter what that the relation between profitability and a firm’s propensity to go public is, one may expect in any case the post-IPO profitability will decrease. Firms, that have recorded high profitability levels will not be able to maintain this high level in the long run while firms that were not able to finance their needs from internal sources before an IPO, after the IPO will be unlikely to succeed either. Table 5 summarises the hypothesis that will be tested in the ex ante analysis. Table 5 Summary of the expected effects of an IPO Hypothesis Expected effect Hypothesis 8 IPO reduces the leverage of publicly traded companies. Hypothesis 9 IPO has a positive effect on a company’s investments. Hypothesis 10 IPO has a positive effect on a company’s sales growth. Hypothesis 11 IPO has a negative effect on a company’s profitability. Source: Author’s analysis 3.3 Data sources and sample characteristics 3.3.1. Data sources In order to analyze the probability that a Polish company will go public, a database is built consisting of financial and accounting data. The database is constructed based on two main sources of data. Financial reports of Polish private companies come from the AMADEUS database that contains financial information on approximately 8 million public and private companies in 38 European countries. The database provides records of companies for up to 10 last years. Unfortunately, in the case of companies from the CEE countries, this database is not as comprehensive as for companies from 58 Western Europe. In many cases the continuity of year by year financial data is not sustained. Thus, the reference sample of Polish private companies is reduced substantially to 650 companies for which at least 4 years of consequent financial data is available. The maximum 10 years of data available, with a one year delay, also limits the time framework of this study to the period from 1995 to 2004. Information about Polish companies that are or used to be traded on the WSE comes from the AMADEUS and NOTORIA databases. Financial reports of publicly traded companies available at these two databases correspond to each other; however NOTORIA provides also data on companies that are no longer traded on WSE. Thus, the sample includes IPOs which were delisted before their three-year anniversary, which is especially important for the analysis of IPO consequences. The accounting and financial data has been used in absolute values and as ratios. Absolute values are in real terms, obtained by discounting nominal values by inflation to the real values as of 1994. Information about inflation and GDP growth come from the Central Statistical Office (appendix 2). The value of shareholders equity was used in nominal terms for the purpose of reference sample construction based on minimum shareholders’ equity requirement as of that year. WSE index values were gathered from the WSE (appendix 1). 3.3.2. The sample 3.3.2.1 The IPOs sample The ex ante analysis encompasses 127 Polish private companies that went public during the period of 1997 - 2004. The range of data used in the analysis contains financial and accounting information starting from 3 years before going public till the issue year. In the ex post analysis the data ranges from the IPO year till 2004, or earlier if the company has been delisted. Dudko-Kopczewska (2004) has analysed Polish IPOs during the period of 1992 2001, which covers the first ten years of the WSE's operations (in 1991 there were only privatization IPOs). This study partly overlaps Dudko-Kopczewska’s (2004) 59 sample, however it is superior in two aspects. Firstly, it includes companies that went public in 2004, during the second biggest wave of IPOs at the WSE (the first wave dates back to 1997-1998). This allows a closer look at the factors influencing the decision to go public, especially from the “windows of opportunity” hypothesis perspective. Secondly, and most importantly, the sample period of IPO companies corresponds to the sample of companies that remained private during the same period, which is lacking in the Dudko-Kopczewska’s (2004) study. Thus, I am able to complement her analysis and cast additional light on the determinants and consequences of the decision to go public in Poland. Table 6 presents summary statistics of companies listed on WSE during the period of 1997 -2004. Table 6 Summary statistics of companies listed on WSE (1997 – 2004). Year Number of listed companies 1997 1998 1999 2000 2001 2002 2003 2004 TOTAL of which foreign 127 182 205 209 213 199 186 213 0 0 0 0 0 0 1 5 Number of new Number of listings delistings 46 2 57 2 28 5 13 9 8 4 5 19 6 19 36 9 199 Source: Warsaw Stock Exchange statistical data, www.gpw.com.pl However, not all companies traded on the WSE have been included in the analysis. Out of 199 companies that went public during the period of 1997-2004, the following companies were excluded: - National Investments Funds (NFIs) (26 companies) - Financial institutions, such as banks and insurance companies (9 companies) - Privatization companies with state origins (23 companies) - Foreign companies listed on WSE (5 companies) - Companies for which the track record of pre-IPO financial data is incomplete (9 companies) 60 Financial companies were excluded due to differences in balance sheet structure that make them incomparable with non-financial companies.7 Because one of the objectives of this thesis is to find determinants that have an impact on a company’s decision to issue equity, it is required that the company’s management is allowed to make this decision without any political influences. Privatization and NFI companies do not meet this requirement as according to Perotti (1995) and Biais and Perotti (2002), share issue privatizations (SIPs) can be structured in a way to help achieve various government objectives. Jones, Megginson, Nash and Netter’s (1999) study of 59 country samples of 630 share issue privatizations revealed that governments consistently undertake various actions, such as underpricing, favouring domestic investors, imposing control restrictions on privatized firms etc., in order to achieve political and economic policy objectives. This is why one cannot expect that factors behind the decision to go public are the same for private and privatization IPOs. As a result 127 companies were included in the IPO sample. Table 7 presents distribution of the IPO sample by year and industry. A large clustering of IPOs in certain years and industries is noticeable. Out of the 127 IPOs, 81 (63 percent) occurred during 1997 and 1999. There is also a clustering of some 47 percent of IPOs (60 firms) in just thee industries: trade, IT and construction materials. Table 7 Distribution of IPOs by year and industry Metal processing Media Communal services IT Construction materials Chemical Wood Light industry Automotive Telecommunication Food Engineering and machining Construction Trade TOTAL 1997 1998 1999 2000 2001 2002 2003 2004 3 1 2 2 1 2 1 1 2 1 2 1 4 4 3 3 5 2 3 1 1 2 2 2 2 1 2 1 1 1 1 1 1 1 4 6 1 2 1 3 4 1 22 4 9 4 39 1 4 6 20 1 7 2 1 3 2 5 2 6 6 26 TOTAL 8 7 3 20 11 7 1 2 2 2 14 10 17 23 127 Source: Author’s calculations 7 The case of financial companies that decided to go public has been investigated by Rosen, Smart and Zutter (2005). 61 3.3.2.2. The reference sample The reference sample consists of private non-financial companies that were able to go public because they met all quantitative listing requirements but they decided to stay private. Pagano et al. (1998) considers a company to have at least a minimal probability of going public when it meets the requirement of minimal shareholders’ equity of 5 billion lire (USD 3.2 million). However, Fisher (2000) criticizes the use of shareholders’ equity as a selection criterion. He points out that the equity balance sheet is changeable and many issuing companies use so-called bridge financing provided by specialized financial intermediaries in order to increase their equity position in the year before an IPO. Nevertheless, I decided to form the Polish sample of private companies based on the minimal shareholders’ equity criterion, which is in line with the official WSE listing requirements. The company is considered to have a minimum probability to go public in any year at which it exceeds the required equivalent of EUR 1 million, which is approximately PLN 4 million. The main conditions that a company has to meet in order to be admitted to the main market are specified in the Warsaw Stock Exchange Charter and Regulation of the Minister of Finance dated October 14th, 2005 on Detailed Requirements for an Official Stock-Exchange Listing Market and Issuers of Securities Admitted to Trading on Such Market (Journal of Laws No. 206, item 1712). However, the Warsaw Stock Exchange's rules and regulations regarding listing requirements were changed already on 1 May 2004, when Poland joined the European Union. Since that time there are two markets on the Exchange: main and parallel. Before 1 May 2004 the free market also existed. Appendix 3 presents listing requirements that had been in force till 1 May 2004. In the sample covering the period of 1982-1992, Pagano et al. (1998) includes only the companies that met the requirement of minimal shareholders’ equity as of 1982, and the companies that had already been established that year. I will be less severe. Firstly, taking into account the changes in listing requirements I assume that a company may have gone public at any market (main, parallel or free) at any point in time at which it met the PLN 4 million shareholders’ equity requirement. Secondly, Pagano’s et al. (1998) restriction regarding the age as of 1982 means that IPO 62 companies were older than private companies as there were no age restriction for the latter. Yet, Pagano et al. (1998) do not empirically check the relation between the age and the probability of going public. This is however one of the hypotheses tested in this paper so in order to check the relation I do not make any restriction regarding a company’s age or date of its incorporation. As a result, the whole reference sample is made up of the company years from 1995 to 2004 of 573 privately held companies that met the requirement of minimum shareholders’ equity (requirement 1). The analysis of the reference sample shows a substantial size bias between the preIPO and the reference sample (table 9). Thus, to improve the comparability of samples an additional size and industry matched reference sample is constructed. The procedure for size matching is based on assets. Firstly, companies in the reference sample have to meet the PLN 4 million shareholders’ equity requirement (requirement 1). Than a private company is included in the size matched reference sample if in a given year and industry had assets equal to or higher than the minimum assets of a private company went public (requirement 2). The aim of such an approach is to find companies that apart from meeting the official listing requirements are at least as big as companies that went public. The international literature on IPOs presents various approaches to constructing size matched reference samples. For example, Pannemans (2002) used the procedure for size matching based on sales of the IPO company in the year before going public while Fisher (2000) simply cut back the 20th percentile of the smallest companies in the reference sample to make IPO and non IPO companies more comparable in size. However, it is virtually not possible to find exact matches for each IPO company and researchers are usually constrained from making more general assumptions. 3.3.3 Summary statistics Table 8 presents summary statistics of company size measures. A median IPO company has many more people employed both in the IPO year and one year before the issuance than an average potential IPO firm. 63 Table 8 Summary Statistics of Company Size Measures Panel A consists of 127 companies that went public during 1997 – 2004 and shows the size measures as of the IPO year. Panel A1 and A2 consists of the same IPO sample and shows size measures for year 1 and 2 before floatation, respectively. Panel B consists of average size measures of the reference sample that consists of 573 privately held companies that may have gone public during the same period, which means that they meet requirement 1. Panel C presents average size measures of size and industry matched reference sample that consists of 282 private companies that meet requirement 1 and have assets at least as big as assets of IPO companies that went public. All amounts are in thousands of PLN. Panel A Employees Sales Total Solvency Net Equity Panel A1 Employees Sales Total Solvency Net Equity Panel A2 Employees Sales Total Solvency Net Equity Panel B Employees Sales Total Solvency Net Equity Panel C Employees Sales Total Solvency Net Equity Mean Median Std. Dev. Min Max Obs. 539.189 76214.72 75506.8 55.78888 1598.565 79404.6 327 45867.36 36829.46 60.3381 2183.231 41079 1004.49 93131.07 189182 50.9694 23501.27 146518.4 4 53.90411 4066.708 -470.685 -236129.1 4937 10840 547094.5 1941180 95.90089 71613.66 1219616 127 127 127 127 127 127 591.3858 65676.09 58261.08 45.45435 2091.418 47014.51 344 37364.86 25311.85 48.40356 1985.884 21583 905.6177 78958.63 159473.9 47.14183 16933.34 110840.2 7 347.9972 3080.192 -413.9235 -173186.1 -1253 9000 475575 1640887 100 49645.13 949817 127 127 127 127 127 127 567.8548 57929.67 39957.05 45.97525 2230.869 29269.3 334.5 30453.06 18595.83 43.47534 1182.305 12799.5 766.0908 69389.35 83344.45 23.22559 11126.52 92447.51 6 1016.057 2252.025 -22.5997 -90573.37 -92924 7000 337809.9 761579.5 100 48659.7 984218 124 124 124 124 124 124 339.8858 45006.94 28530.99 51.50974 1463.414 29989.69 200 27003.39 13981.29 51.19473 573.1295 13080 391.1766 90238.26 123436.1 20.92238 11710.15 124323.2 1 847.1693 0.0092443 3.075312 -30737.01 4001 4000 2400497 34135664 100 385994.7 4095213 3468 3468 3468 3468 3468 3468 437.9874 76565.82 53926.83 49.20622 3224.02 52269.69 349.5 50480.58 28717.67 49.53912 1164.919 23376 457.4102 143024.7 195421.3 21.93779 20819.44 192482.3 1 1411.42 5427.01 3.328743 -29396.73 4073 4000 2400497 3413564 100 385994.7 4095213 554 554 554 554 554 554 Source: Author’s calculations 64 However, the typical IPO company seems to reduce its employment in the year of going public, which is rather surprising and contrary to Belgian (Pannemans, 2002) and German (Fisher, 2000) companies’ employment strategy after an IPO. The typical IPO company reports large sales and assets increases when comparing to two years before going public and the IPO year. Moreover, a median IPO company one year before floatation has sales almost 1.4 times as large and assets 1.8 times as large as a median potential IPO. The solvency ratio that reflects a company's ability to meet its long-term obligations, calculated as total net worth divided by total assets, increases when consequent years before an IPO are compared. However the solvency ratio is higher for a potential IPO company than for an IPO company one year before an issue. The median net income of an IPO company almost doubles comparing to the net income in the IPO year and 2 years before. Moreover, the typical IPO company one year before an issue has the net income almost 4 times as large as the median net income of a potential IPO. Average equity of IPO companies increases after going public, which is in line with our expectations. The size and industry matching procedure employed to better match the reference sample with IPOs sample helped to tackle the issue of a size bias problem observable in the whole reference sample. The typical potential IPO matched by size and industry turned out to have comparable, but slightly higher, assets than an IPO company one year before going public. However, size and industry matched potential IPOs seem to be much bigger in terms of employees and sales than a typical IPO one year before floatation, although the latter has a higher net income. The solvency ratio is at a similar level for both samples. The investigation of IPO company size measures before and after an issue shows that in the short run these companies have become larger and better off in terms of net income, sales and solvency. They also report higher assets. In order to assess the impact of an IPO on a company’s long term performance, a further analysis is conducted with results presented in chapter 4. Table 9 presents summary statistics of some explanatory variables that will be used in the analysis of determinants and consequences of the IPO decision. 65 Table 9 Summary statistics of explanatory variables Panel A consists of 127 companies that went public during 1997 – 2004. Panel A1 and A2 consists of the same IPO sample and summary statistics of the explanatory variables for year 1 and 2 before floatation, respectively. Panel B shows average figures of the explanatory variables of the reference sample. Panel C shows summary statistics for the size and industry matched reference sample. The explanatory variables are: AGE is the firm’s maturity measured by the number of years from incorporation till IPO; SIZE is the firm’s size is measured by the logarithm of assets; GROWTH is the firm’s annual growth rate in sales; INVEST is the firm’s growth rate of fixed assets; LEVER is the firm’s leverage measured as the value of total debt over total debt plus equity; INTAN is a ratio of the firm’s intangible assets over total assets; ROA is the firm’s profitability measured as EBITDA over total assets. Mean Median Std. Dev. Min Max Obs. 22.6063 10.51131 17.39539 2.975563 44.21112 107.2047 7.680695 11 10.51405 9.622636 1.982154 39.6619 58.39211 8.16 26.48664 1.034081 39.31261 4.208231 50.9694 190.2627 13.52186 2 8.310589 -84.51019 0 4.099115 -49.26423 -75.5 162 14.47881 223.3528 30.33099 570.6849 1564.191 72.45 127 127 127 127 127 127 127 21.6063 10.17748 28.59035 2.21473 54.545665 137.2339 10.65239 10 10.13903 14.30254 0.9047644 51.59644 38.39058 9.84 26.48664 1.085713 61.40288 3.120716 47.14183 352.8649 16.23848 1 8.032747 -94.92767 0 0 -58.03786 -129.9 161 14.31075 390.2838 25.60399 513.9235 2926.069 43.87 127 127 127 127 127 127 127 21.05645 9.873526 18.41692 1.436406 53.03794 66.01058 12.63249 9 9.830693 9.898429 0.3184557 56.10343 30.96416 9.125955 26.64226 1.103757 68.44825 3.103317 22.88529 123.1165 13.29815 1 7.719585 -87.42225 0 0 -96.88151 -12.2 160 13.54315 480.2354 22.75012 106.1987 841.5674 49.46 124 124 124 124 124 124 124 27.78345 9.649333 7.860382 1.265616 48.49026 27.58012 9.668916 12 9.545475 -0.581493 0.1695148 48.80527 5.029303 6.785 33.61423 0.962233 52.52115 4.079629 20.92238 138.7931 14.172 1 -4.683749 -94.38917 0 0 -88.54094 -84.12 218 15.04327 1682.726 75.4688 96.92469 3968.756 95.08 3468 3468 3468 3468 3468 3468 3468 Panel A AGE SIZE GROWTH INTAN LEVER INVEST ROA Panel A1 AGE SIZE GROWTH INTAN LEVER INVEST ROA Panel A2 AGE SIZE GROWTH INTAN LEVER INVEST ROA Panel B AGE SIZE GROWTH INTAN LEVER INVEST ROA Continued on the next page. 66 Table 9 - continued. Panel C AGE SIZE GROWTH INTAN LEVER INVEST ROA 31.90975 10.35807 7.782643 1.363326 50.79378 34.7116 10.31587 13 10.26525 2.107899 0.2589079 50.46088 10.17727 6.64 39.21862 0.8078563 37.09945 4.011076 21.93779 78.41831 14.28021 1 8.599144 -94.38917 0 0 -76.74973 -31.48 216 15.04327 464.2884 44.05533 96.67126 748.529 80.33 554 554 554 554 554 554 554 Source: Author’s calculations The average age of a Polish company that went public during 1997 – 2004 was 22.6 years (median 11). In Italy the average age of a company that went public during 1982-1992 was 33.4 years (median 26) (Pagano et al., 1998). German companies going public on Neuer Markt during 1997-1999 were on average 13.3 years old while IPO companies on Frankfurt Stock Exchange were on average 58.8 years old (Fisher, 2000). The average age of a Belgian company that went public between 1996 - 2000 was 15 years (Pannemans, 2002). Thus, Polish IPO companies are older than Western European companies that went public about the same time but Polish results cannot be fully comparable with international findings. The main reason is that mature companies did not have a chance to go public before 1991 because no stock exchange existed in Poland. The typical sample IPO company in 1997 was 27.2 years old while in 2004 was 10 years. The typical size of an IPO company measured as logarithm of assets, increases each year comparing levels 2 and 1 year before and issue with the size in the IPO year. A median IPO company before floatation is also bigger in terms of assets than a median potential IPO, but it is comparable with a potential IPO matched by industry and size. A high sales growth of a typical IPO one year before going public is also noticeable but in the IPO year the growth rate comes back to a similar level as two years before an issue. Surprisingly, a typical potential IPO company is characterized by a negative rate of sales growth while a potential IPO firm matched by size and industry has a sales growth rate of 2.1 percent, which is still much lower than an IPO company one year before an issue. This proves that IPO companies are increasing their sales and 67 customers base extremely fast. Thus, Subramanyam and Titman’s (1999) idea that companies go public to get a more precise valuation of the company by, among others, investors who are the company’s customers able to make use of serendipitous information, seems to be reasonable in the Polish case. Both intangibles and investments of a typical IPO company increase substantially every year before the issue including the IPO year and are considerably higher than investments in fixed and intangible assets of a potential IPO company. The leverage of an IPO company decreases in the IPO year, which is rather expected as stock issue is aimed at obtaining a different form of financing than credit. It is also noticeable that the leverage of a typical IPO company decreases when comparing its level to that 2 years or 1 year before an IPO. One possible interpretation is that companies who already consider a public offering do not increase their leverage levels as they know that funds obtained through an IPO will enable them to realize their investments plans. It is also possible that companies consciously decrease the level of leverage before an issue as they are aware that a very high leverage can prevent investors from injecting equity in a company and may therefore be a deterrent for firms to go public (Gill de Albornoz and Pope, 2004). There is not much difference, however, in the level of leverage between a typical IPO company one year before an issue and a potential IPO company, whichever reference sample is considered. The profitability of an IPO company 2 years or 1 year before floatation is much better than the profitability of a potential IPO company, yet it decreases in the IPO year. 68 Chapter 4 Results and Discussion Results and Discussion 4.1. Results of the ex ante analysis The effect of the variables, described in detail in chapter 3 (see page 50) on the probability to go public is estimated by a probit model. The estimation method is maximum likelihood. The dependent variable is equal to 0 if the company was not listed and 1 if a company went public. The probit regression analyses were performed with STATA 8.0 statistical package. The data were prepared in MS Excel. The illustration how the data was organized and prepared is presented in appendix 4. The appendices 5-A to 6-B contain original outputs from the STATA. Table 10 reports the test results of the probit estimations. The complete sample consists of data about IPO companies that issued equity on the Warsaw Stock Exchange and Polish private companies that might have gone public because they met the official minimum shareholders’ equity requirement. The size and industry matched sample consists of Polish IPOs and private companies that besides meeting the requirement of minimum shareholders’ capital have assets at least as big as minimum assets of an IPO company from the same industry in the same year. Exponent ( β i ) is the factor by which the odds – i.e. the ratio of the probability to go public to the probability not to go public – change when the ith independent variable increases by one unit, so this is the marginal effect mentioned in the previous chapter. The likelihood ratio test examines the null hypothesis that the joint effect of all explanatory variables equals zero. Standard errors are in parentheses. 69 Table 10 The results of the probit model. Determinants of the IPO decision. The effect of the variables on the probability to go public is estimated by a probit model. The variables are: AGE which is the firm’s maturity measured by the number of years from incorporation till IPO; SIZE is the firm’s size measured by the logarithm of assets, GROWTH is the firm’s annual growth rate in sales computed as sales in year t minus sales in year t-1 divided by sales in year t-1; INVEST is the firm’s growth rate of fixed assets; LEVER is the firm’s leverage measured as the value of total debt over total debt plus equity; INTAN is the ratio of firm’s intangible assets over total assets; ROA is the firm’s profitability measured as EBITDA over total assets; MTB is the market-to-book ratio in the industry as computed by the WSE, GDP is gross domestic product growth (y-o-y); INF is the inflation rate; WIG is the WSE index. The estimation method is maximum likelihood. The dependent variable is 0 if the company is not listed and 1 on the year of listing. The complete sample is restricted to all company-years that meet the listing requirements as of that year (requirement 1). The size and industry matched sample is restricted to companies that meet requirement 1 and have assets at least as big as minimum assets of an IPO company from the same industry in the same year. Standard errors are in parentheses. Exponent ( β i ) is the marginal effect. Explanatory variable AGE S.E. Exp ( β ) SIZE S.E. Exp ( β ) GROWTH S.E. Exp ( β ) INTAN S.E. Exp ( β ) LEVER S.E. Exp ( β ) INVEST S.E. Exp ( β ) ROA S.E. Exp ( β ) WIG S.E. Exp ( β ) lagged WIG S.E. Exp ( β ) Complete sample -0.002955 (0.0015655) -0.0001548 0.2213296*** (0.0388935) 0.011594 -0.0002763 (0.0005461) -0.0000145 0.020638*** (0.0080273) 0.0010811 Size and industry matched sample -0.0024948 (0.0020512) -0.0006265 0.2538893*** (0.05609) 0.0637603 -0.0005612 (0.0006674) -0.0001409 0.0204681* (0.011817) 0.0051402 0.0016464* (0.0008912) 0.0000862 0.0001544 (0.000106) 8.09e-06 -0.0005489 (0.028374) -.0000288 0.0011586 (0.0012493) 0.000291 0.002417*** (0.0006766) 0.000607 -0.004922 (0.004224) -0.0012361 -0.0196408*** (0.0071171) -.0010288 0.0113916* (0.006894) 0.0005967 -0.0138371 (0.0095775) -0.003475 0.0136902 (0.008974) 0.0034381 Table continuation on the next page. 70 Table 10 – continued. lagged GDP S.E. Exp ( β ) Industry MTB S.E. Exp ( β ) Lagged industry MTB S.E. Exp ( β ) Lagged INFLATION S.E. Exp ( β ) Constant S.E. Obs. Thereof IPO = 0 Thereof IPO = 1 Log likelihood LR χ 2 (14) 0.1481969*** (0.0788286) 0.007763 0.0402216 (0.609398) 0.010101 0.2370711*** (0.0788286) 0.0124185 -0.0790256 (0.077518) -0.0041396 0.0002273 (0.8119505) 0.0000119 0.1928178** (0.0893284) 0.0484231 -0.073808 (0.087258) -0.0185357 -0.0064323 (0.0246872) -0.0016154 -4.858127*** (0.4284804) 700 573 127 -479.12851 140.28 -3.865199*** (0.6215029) 430 303 127 -293.36176 68.53 0.0000 0.0000 Prob > χ 2 *** Coefficients significantly different from zero at the 1 percent level or less. ** Coefficients significantly different from zero at the 5 percent level. * Coefficients significantly different from zero at the 10 percent level. Source: Author’s calculations In the case of the whole sample the likelihood ratio chi-square of 140.28 with a pvalue of 0.0000 indicates that the model as a whole is statistically significant, as compared to model with no predictors. In the case of the size and industry matched sample the likelihood ratio chi-square of 68.53 with a p-value of 0.0000 indicates that the model as a whole is statistically significant, as compared to model with no predictors. Hypothesis 1 Company size and maturity is positively correlated with the decision to go public. It was expected that more mature companies face lower adverse selection costs because they have longer track records and thus are easier for investors to evaluate. Based on the probit model estimations carried out on the Polish data it turned out that age of a company is not statistically significant. This result does not support the prediction that company’s maturity has a significant positive impact on the decision to 71 go public. However, it is important to notice that the sample of Polish IPO companies is age biased. This is because of the short period of the WSE operations many companies had to wait many years to be given a chance to issue equity. In such a sample, the lack of significance is not surprising although it is in contradiction with the theory. Helwege and Packer (2003) who also empirically tested the relation between a firm’s age and probability to go public in the US found no evidence that younger firms have trouble going public. The company’s size, measured by the logarithm of assets, is significant at the 1 percent level for both reference samples used. Assets increase has a positive impact on the decision to go public and, what is more, it is one of the most important determinants of the probability of issuing equity. A one percent increase in the total assets raises the probability of an IPO by 1.16 percent in a complete sample and by 6.38 percent in a size and industry matched sample. This result corresponds to the results obtained by Pagano et al. (1998) on the Italian market and by Chun and Smith (2002) on the Korean market who found that the firm size is the second most important (after MTB ratio) determinant of the probability of an IPO. Size was also one of the main factors affecting the probability of an IPO in the UK (Gill de Albornoz and Pope, 2004). The result is consistent with both prior empirical evidence found in other countries and the theory, it however contradicts Dudko-Kopczewska’s (2004) findings that the size of a company has no impact on the decision to go public in Poland. Hypothesis 2 Financing needs positively influence the likelihood of going public. It was expected that for firms that have huge financing needs to finance investment and growth the probability of an IPO would be positively related to the growth in sales (GROWTH) and investment opportunities (INVEST). Nevertheless, the results indicate that growth decreases the probability of listing for the probit analysis of both reference samples; however, the coefficients are very small and statistically not significant. This is in contrary to the Pagano et al. (1998) and Fisher (2000) findings which report a positive relationship between growth and possibility of an IPO. Yet, 72 the result that growth decreases the probability of listing is found also by Pannemans (2002) on the Belgian market. Investments increase the probability of an IPO when the probit analysis is carried out on a complete sample; however the coefficients are also not significant. On the other hand, the findings of the probit analysis on sample that includes size and industry matched private companies indicate that increases of investments have a positive and statistically significant influence of the decision to go public. A one percentage point increase in investments increases the probability of an IPO by 0.06 percent. The positive relation between investments (measured by the growth rate of fixed assets) and size (measured by the logarithm of total assets), and the decision to issue equity in the sample including size and industry matched companies indicate that Polish companies go public after a period of huge investments. The ex post analysis of the impact of IPO on the firms investments will reveal if the companies went public to finance their future investments. The empirical evidence found in Italy (Panago et al., 1998), Germany (non-Neuer Markt companies analysed by Fisher, 2000), Belgium (Pannemans, 2002), the UK (Gill de Albornoz and Pope, 2004), and Korea (Chun and Smith, 2002) suggests that on average financing needs is not the major factor in IPO decisions. Dudko-Kopczewska (2004) reported on a lack of a clear relation between financing needs and the probability to go public of Polish IPOs. Hypothesis 3 High leverage positively influences the decision to go public. The results of the probit estimations indicate that leverage has positive effect on the likelihood of going public as expected, however the coefficient is statistically significant at the 10 percent level only for the whole sample. A one percentage point increase in leverage increases the probability to go public by 0.009 percent. This corresponds to Myers’ (1977) view that highly leveraged firms with investment opportunities should be more likely to go public. The positive effect of leverage on the likelihood of IPO is in line with our expectations and prior empirical evidence found by Pannemans (2002) on Belgium market (except for the results of Nasdaq Europe listed companies). However this is in contrary to Pagano et al. (1998) results who found negative but statistically not significant impact of leverage on the 73 likelihood of going public of Italian companies. Also Fisher (2000) and Gill de Albornoz and Pope’s (2004) report that in Germany and the UK leverage is negatively related to the probability of an IPO. The findings of probit analysis of Polish companies contradict prior empirical evidence found by Dudko-Kopczewska (2004), who found negative relation between leverage and a company’s propensity to go public. The results obtained on the sample of Polish firms contradict the Gill de Albornoz and Pope’s (2004) view that highly leveraged firms may face constraint on raising additional debt financing because their creditors are aware of the increasing risk. On the contrary, it seems that insiders, aware of the fact that they have reached the level of leverage that may result in financial distress, try to mitigate the problem issuing equity. Hypothesis 4 Riskier companies are more likely to go public. It was expected that riskier companies have higher propensity to go public as public offering enables initial owners to diversify the risk. The level of intangible assets over the total assets has been used as a proxy for company risk. The results indicate that the level of intangibles is positively and significantly related to the probability of going public in the Polish sample. A one percentage point increase in intangibles increases the probability of an IPO by 0.11 percent in the whole sample. As far as the industry and size matched reference sample is concerned, the effect is even stronger indicating that a one percent increase in intangibles increases the probability of going public by 0.51 percent. The coefficients are significant at 1 and 10 percent level for complete and size matched samples respectively. This result, together with the positive signs of leverage and investments suggests that our sample period includes many risky companies that are already highly leveraged and go public to diversify the risks. The positive relation between intangibles and probability of an IPO has been also found on the German (Fisher, 2000) and the UK (Gill de Albornoz and Pope, 2004) market. 74 Hypothesis 5 High market-to-book ratio of companies in the same industry increases the company’s propensity to go public. Both the current and the lagged market-to-book ratio has been used in the probit analysis conducted on the sample. Similarly to Pagano et al. (1998), it turned out that the current industry MTB ratio is one of the most significant determinants of the probability of going public. For the whole reference sample a one percentage point increase in the current MTB ratio increases the probability of going public by 1.24 percent. For the size and industry matched reference sample the impact of the current MTB ratio is even stronger indicating that a one percentage point increase of MTB ratio increases the probability of going public by 4.84 percent. The coefficients are significant at the 1 percent level for both reference samples. However, it is also found that the lagged MTB ratio decreases the probability of listing when both reference samples are used. Yet, these results are not statistically significant. The opposite signs of the coefficients on the current and lagged MTB ratio have also been found by Chun and Smith (2002). They notice that the interpretation of the information content of the current MTB is different than that of a lagged MTB and this is why none of them should be omitted in the regression analysis. The interpretation of the negative sign of the lagged MTB ratio may be that most firms wishing to conduct an IPO would already have done it when there had been a recent hot market. According to Chun and Smith (2002), only firms whose propensity to go public has markedly increased, or which have suddenly met the minimum listing requirements, would be expected to conduct an IPO in the period immediately following a high MTB ratio. Thus, the obtained results support the windows of opportunity hypothesis under which firms go public in order to take advantage of the market’s overvaluation of firms in their industry. Surprisingly, increases in the current WIG index level have a negative impact on the probability to go public while a lagged WIG increases the probability of an IPO. However, coefficients are statistically significant only for the complete reference sample. Thus, the overall market mood has an opposite impact than the market mood per industry. It is possible that companies make a decision to go public encouraged by 75 the last year good stock exchange conditions and wait until the current MTB ratio in the industry indicates that this is the best time for a company to capture the benefits of being overvalued. Hypothesis 6 Profitability positively influences the decision to go public. The finding for Polish market regarding the relation between profitability and probability of an IPO is consistent with Dudko-Kopczewska (2004), who found a negative impact of profitability on probability of an IPO. However, the Polish results are contrary to those found in Italy (Pagano et al., 1998), Germany (Fisher, 2000) and Belgium (Pannemans, 2002). For both reference samples, the coefficients are negative. Such a result supports Fisher’s (2000) view that profitable companies should be able to finance their investments and growth by internal cash flows and that is why they are more likely to stay private. The negative sign of profitability might indicate that the Polish sample period includes many companies facing borrowing constraints that were not able to generate sufficient internal funds; however a clear interpretation is not possible as variables coefficients are not statistically significant. Hypothesis 7 Macroeconomic conditions have an impact on the number of companies deciding to go public. The hypothesis about the impact of macroeconomic conditions on a firm’s probability to go public has been verified based on the results of models for lagged GDP growth and lagged inflation. Both variables seem to have a positive impact on the probability of an IPO, however, only GDP is statistically significant and only when the size and industry matched reference sample is concerned. These results are in line with Boehmer and Ljungquist’s (2004) findings who, after investigating 330 privately-held German companies that during the period of 1984 and 1995 announced their intention to go public, concluded that macroeconomic conditions had little effect on IPO timing. Therefore, contrary to Dudko-Kopczewska (2004), I cannot conclude that macroeconomic conditions are the main factors that influence the decision to go public in Poland. 76 5.2. Results of the ex post analysis An ex post analysis has been conducted in order to estimated the consequences of an IPO and to complement the ex ante analysis so that more a precise interpretation about motives for going public can be formulated. Following Pagano et al. (1998) the fixed effect regressions are used in which the effect of the decision to go public is captured by the dummy variables for the year of the IPO and the three subsequent years. The fixed effects regressions were performed with STATA 8.0 statistical package. The appendices 7 - 11 contain original outputs from the STATA. Table 11 presents estimates of the IPOs on some operating and financial variables. Hypothesis 8 IPO reduces the leverage of publicly traded companies. The results of the analysis reveal that, contrary to the expectations, leverage of an average IPO company sharply increases in the years following an IPO although a noticeable decrease is observable in the IPO year. The decrease in leverage is statistically significant in all years except from the first year following the IPO. These results are in contrary to the findings of Panago et al. (1998) and Chun and Smith (2002), who reported a sharp decrease of leverage immediately after an IPO. Therefore, contrary to Pagano et al. (1998) it is found that Polish firms do not go public to reduce the level of leverage. A sharp decline in leverage in the IPO year may indicate that sources obtained at IPO help reduce the high leverage level that a company reached before the IPO. An increase in leverage in the years following the IPO does not support the view that after an issue firms change their source of funds from debt to equity. 77 Table 11 Effects of the decision to go public. Standard errors are in parentheses. The last column reports the p-value of an F-test of the hypothesis that all the coefficients standing next to all the post-IPO dummies are equal to zero, meaning that these dummies are jointly insignificant and that the IPO decision had no effect on the analyzed operating/financial variable. ROA which is (EBITDA) over total assets measures profitability SIZE is the logarithm of total assets; GROWTH is the firm’s annual growth rate in sales computed as sales in year t minus sales in year t-1 divided by sales in year t-1; INVEST is the firm’s growth rate of fixed assets; LEVER is the firm’s leverage measured as the value of total debt over total debt plus equity. INTAN is a ratio of the firm’s intangible assets over total assets. ROA Obs. 5620 SIZE Obs. 5621 GROWTH Obs. 5621 LEVER Obs. 5621 INVEST Obs. 5621 INTAN Year 0 -3.669188*** (1.267785) Year +1 -6.371511*** (1.586509) Year +2 -13.13934*** (1.620245) Year +3 -16.02276*** (-1.689561) Year > 3 -14.30735*** (1.417537) F-test 0.0000 0.4931998*** (0.0427796) 0.1421389*** (0.0535344) 0.1879125*** (0.0546728) 0.1774669*** (0.0570118) 0.1052739** (0.0478327) 0.0000 -6.321331 (8.477311) -3.843059 (10.60852) 12.66539 (10.83411) -2.592428 (11.2976) 11.50031 (9.478657) 0.4495 -9.668548*** (2.774089) 3.177992 (3.4715) 8.562471** (3.54532) 16.44045*** (3.696992) 32.17315*** (3.101766) 0.0000 4.353043 (25.13092) -80.45667** (31.44888) -85.38356*** (32.11763) -110.838*** (33.49165) -105.114*** (28.0994) 0.0000 1.036285*** (0.2710828) -0.0544644 (0.3392335) 0.3178848 (0.3464472) -0.0503634 (0.3612685) -0.8880524*** (0.3031033) 0.0000 Obs. 5621 *** Coefficients significantly different from zero at the 1 percent level or less. ** Coefficients significantly different from zero at the 5 percent level. * Coefficients significantly different from zero at the 10 percent level. Source: Author’s calculations 78 Hypothesis 9 IPO has a positive effect on a company’s investments. The hypothesis that The size of total the assets slightly increases after an IPO, with the increase ranging from 0.49 percent in the IPO year and between 0.14 and 0.18 percent in the next three years and all these results are statistically significant. Although the effect of an IPO on investments in total assets (SIZE) is positive it has a negative impact on the investments growth rate (INVEST). For the full sample, the investment growth rates decline sharply in the first year after an issue to -110.8 percent in the third year and -105.1 percent in the following years. The effect of an IPO on intangible assets (INTAN) is mixed and statistically significant only in the IPO year and 3 years after an issue. Hypothesis 10 IPO has a positive effect on a company’s sales growth. The effect of an IPO on a company’s growth rate is not statistically significant. This conclusion may be drawn either by considering significance of coefficients for individual post-IPO dummies or by looking at the F test statistic, which value does not allow to reject null hypothesis of joint insignificance of post-IPO dummies. By way of comparison, Chemmanur, He and Nandy (2005) find that the sales growth is increasing in the years prior to the IPO, and declining in the years subsequent to the IPO. However in all years the result is also not statistically significant. Pagano et al. (1998) report that growth of sales rises temporarily at the time of the IPO but decreases again in the second year after an issue. Hypothesis 11 IPO has a negative effect on a company’s profitability. Profitability declines after an IPO. This effect is increasing very fast during the first three years after an IPO, deteriorating from -3.7 percent in the IPO year to –16.02 percent in the third year. The fall is statistically significant at the 1 percent level in each individual year. This is consistent with prior empirical findings in other countries (Jain and Kini, 1994; Mikkelson et al., 1997; Pagano et al., 1998; Chun and Smith, 79 2002). The ex ante analysis has revealed that profitability is negatively related to the probability of an IPO. This suggests that Polish companies went public because they were not able to generate sufficient funds internally and public offering was the only way for them to obtain financing for investments and growth. Companies that are not able to generate sufficient internal funds have even more serious problems with profitability after an issue. Thus, the decline in post-IPO operating performance is not a result of a pre-IPO window dressing of accounting numbers but rather a trend that might have been expected based on the results of an ex ante analysis. In summary, the results of the ex post analysis indicate that the profitability of the IPO company sharply decreases after the issue. Moreover, the leverage of an average IPO company increases after an IPO while the rate of investments in fixed assets decrease. Thus, the expected effects of an IPO have not been achieved. One possible explanation may be that the initial public offering was too small and the money raised at the IPO helped the firm only in the short term. 80 Chapter 5 Conclusions, limitations and suggestions for further research The aim of this paper was to investigate the motives of Polish companies to go public and the consequences of such a decision on their operating performance in the longrun. The analysis concerns companies that went public during the period of 1997 2004 in Poland, by far the largest stock market in Central and Eastern Europe. Thanks to the access to the AMADEUS database that contains accounting information on a large number of privately held firms, the study has been carried out by comparing firms that went public with those that chose to remain private, in contrast to prior research conducted in Poland. The research combines the analysis of ex ante and ex post firms’ characteristics. The results of ex ante analysis have revealed that the probability of an IPO is positively affected by a company’s size, its level of intangible assets, and the stock market valuation of firms in the same industry. The results of the ex post analysis indicate that IPO firms’ profitability declines after the IPO, leverage decreases only in the short run and money raised at the IPO is not spent to finance the company’s strategy of fast growth and intensive investments. Polish firms that decided to go public in the sample period are rather large, risky, already highly leveraged, unable to generate sufficient funds internally, and they go public after periods of investments. They go public not to finance future investments, as growth of investments in fixed assets decreases after an IPO, but time the issue in order to take advantage of “windows of opportunity” created by investors who are overoptimistic about the company’s development opportunities. The analysis was limited by the time range of data available at the AMADEUS database. The maximum 10 years of data, available with a one year delay, limited the time framework of this study to the period from 1995 to 2004. This is why the interesting part of the “hot issue” market of 2004-2006 could not be investigated. Future research that encompasses the whole hot period of 2004-2006 has to account for a large number of companies that went public before 1 July 2005. The timing of these issues may have been triggered, apart from other factors, by the issuers’ attempt 81 to go public before the EU prospectus regulations came into force in Poland. Thus, it would be worth investigating whether there was actually a “hot issue” period as defined by Ibbotson and Jaffe (1975), and Ritter (1984). It was not possible to test the hypothesis that companies go public to sell the company (Zingales, 1995) as no database delivers information on the ownership structure of Polish companies on the regular basis. It would be possible to draw the information about the pre-IPO ownership structure from the company’s prospectuses and case by case investigate substantial changes in the ownership structure as announced by a firm but this means an extremely time consuming and hand collecting process of data gathering. However, when such a database is constructed it would be possible to follow changes in the structure of ownership and this way check whether one of the most frequent motives of Polish companies to go public, according to a KPMG survey, namely to sell a company, is indeed an important factor. One of the weaknesses of the ex post analysis is that, although it is clear that changes in accounting measures of performance depend not only on the decision to go public, it is assumed that any additional variable used to explain the accounting variable has the same explanation power as the IPO variable. Thus, it should be recommended for future researchers to built richer models which would include other relevant regressors. The ex post analysis has revealed that the operating performance of IPO firms declines with time. It would be interesting to investigate why the post issue operating performance of IPO firms decreases with time. There are a number of explanations proposed in international literature that may be tested in future research, for example “earnings management” before an IPO (Teoh, Welch and Wong, 1998), or increased agency problems resulting from separation of ownership and control (Jensen and Mecking, 1976). It is also frequently argued that the declining operational performance is a result of entrepreneurs’ attempt to take advantage of the “windows of opportunity” and make a decision to go public when a company demonstrates an exceptionally good performance that cannot be sustained in the long run. 82 The empirical literature on the motives that influence the company’s decision to issue equity is still scarce and further researcher in this field is recommended in other countries and over several sample periods. The results of this paper has been compared with a few researches conducted mainly on the US and Western Europe markets. The motives of companies from other Central Eastern Europe countries remain unexplored. Also in Poland several puzzling IPO issues require further analyses. 83 Appendices Appendix 1 WSE main statistics as of June 2006 Year Number of listed companies of which foreign Number of new listings Number of delistings WIG (%) 2005 255 2004 230 2003 203 2002 216 2001 230 2000 225 1999 221 1998 198 1997 143 1996 83 1995 65 1994 44 1993 22 1992 16 1991 9 7 5 1 - - - - - - - - - - - - 35 36 6 5 8 13 28 57 46 18 21 22 6 7 9 10 9 19 19 4 9 5 2 2 0 0 0 0 0 0 33.66 27.94 44.92 3.19 -21.99 - 1.30 41.30 -12.80 2.30 89.10 1.50 -39.90 13.20 - 8.09 Market capitalisation Domestic companies (PLN mil.) Foreign companies (PLN mil.) Total turnover value (PLN mil.) 308 418 214 313 140 002 110 565 103 370 130 085 1 095.30 7 450 5 845 351 161 116 77 385 27 715 482 - - - 191 096 118 79 774 63 662 80 443 518 123 72 442 43 766 24 000 11 271 411 - - - - - - - 169 88 974 62 338 52 342 29 895 13 671 23 420 096 7 873 228 30 Source: Warsaw Stock Exchange statistics: www.gpw.com.pl 84 - - Appendix 2 Inflation rate and GDP growth data year inflation rate GDP growth 1994 32,2 5,2 1995 27,8 7 1996 19,9 6 1997 14,9 6,8 1998 11,8 4,8 1999 7,3 4,1 2000 10,1 4 2001 5,5 4 Source: Central Statistical Office (GUS) 85 2002 1,9 1,3 2003 0,8 3,8 2004 3,5 5,2 Appendix 3 Selected listing requirements that had been in force till 1 May 2004. Minimum value of shares to be admitted to trading Minimum book value of company Minimum value of shares admitted to trading and held by shareholders, each of whom owns no more than 5% of the total number of votes at the general meeting Minimum percentage of shares to be admitted to trading and held by shareholders, each of whom owns no more than 5% total number of votes at the general meeting Minimum number of shareholders who hold shares to be admitted to trading Main market PLN 40 million PLN 65 million PLN 32 million Parallel market PLN 14 million PLN 22 million PLN 11 million 25% or at least 500 000 shares of value at least PLN 70 million 500 10% or at least 200 000 shares of value at least PLN 35 million 300 - Period for which company is required three to disclose audited financial reports to financial the public years two financial years Free market PLN 4 million PLN 4 million - last financial year Source: Warsaw Stock Exchange Factbook, 2003 86 Appendix 4 The illustration how the data for the analyses was organized and prepared. 87 Appendix 5 A Probit estimates – Complete sample 88 Appendix 5 - B Marginal effects 89 Appendix 6 - A Probit estimates – Size and industry matched sample 90 Appendix 6 – B Marginal effects 91 Appendix 7 92 Appendix 8 93 Appendix 9 94 Appendix 10 95 Appendix 11 96 List of tables Table 1 Development of the WSE vs. GDP growth.....................................................30 Table 2 Development of CEE stock markets 1994-2004.............................................35 Table 3 IPOs per exchange in 2004 and 2005..............................................................36 Table 4 Summary of hypotheses about the factors that influence the likelihood of an IPO success. .........................................................................................................55 Table 5 Summary of the expected effects of an IPO...................................................58 Table 6 Summary statistics of companies listed on WSE (1997 – 2004). ...................60 Table 7 Distribution of IPOs by year and industry ......................................................61 Table 8 Summary Statistics of Company Size Measures.............................................64 Table 9 Summary statistics of explanatory variables...................................................66 Table 10 The results of the probit model. Determinants of the IPO decision..............70 Table 11 Effects of the decision to go public...............................................................78 List of graphs Graph 1 Number of companies listed at the WSE and market capitalization (PLN million) .................................................................................................................27 Graph 2 Initial Public Offerings at the WSE between 1991 and 2005 ........................28 Graph 3 Total turnover value and WIG changes (y-o-y) during 1991-2005. ..............29 Graph 4 Number on new listings and delistings at the WSE during 1991-2005. ........31 Graph 5 Relation between GDP growth and stock market capitalisation ....................32 Graph 6 Number of companies listed in 2005 on various European stock markets. ...34 Graph 7 Official motives for going public ...................................................................37 Graph 8 Main concerns about going public .................................................................39 Graph 9 Factors that had an impact on the decision to stay private.............................41 Graph 10 Areas where the company gained the most through IPO. ............................42 Graph 11 The predicted probabilities for logit and probit. ..........................................46 97 References Ackerlof, G. 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