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Maximizing the financial and product market values of the IPO opportunity
Maximizing the Financial and Product Market Values of the IPO Opportunity Jae H. Song, Yinsog Rhee, and Carl R. Adams
A
n initial public offering, the first selling of a company’s stock to the public, is a major milestone for a business. It provides equity capital from a broad segment of the public, as well as an opportunity to disseminate information on the company through a prospectus distributed to investors, a registration document filed with the U.S. Securities and Exchange Commission, and special presentations, called “road shows,” to potential investors or their representatives from financial institutions. The prospectus and SEC registration include information on the company’s products, management, and financial status, as well as details of the offering and various relevant risk factors. The increased transparency, broader and deeper publicity, and wider stock ownership that result for the company suggest that an IPO is more than simply a way to raise capital. Results could also include improved relationships with potential customers, employees, and possible business partners. These are generally considered side effects to the financial purpose of the IPO (raising capital) and are not currently addressed in the literature. Now, however, greater involvement of the public in equity investing-especially IPO opportunities-along with expanded access to the IPO process have made these potential side effects much more significant. Practitioners intuitively appreciate that an IPO can have side effects that enhance company awareness and reputation. In the Harvard Business School case “Amazon.com-Going Public” (1999), CEO Jeff Bezos comments that the motivation for the IPO of Amazon.com was not only to raise capital but also to enhance public awareness. His comment indicates that substantial marketing benefits may also be expected from an
IPO. Martha Stewart likely could have sustained substantial expansion of her business without the capital from an IPO. The October 1999 filing for Martha Stewart Living Omnimedia, Inc. indicates no urgent need for the capital obtained. However, the IPO was obviously orchestrated to produce tremendous publicity benefits for the firm in addition to providing an opportunity for key employees to cash in their stock holdings. Another example is Akamai, an Internet content company. According to Carr (ZOOO),its chairman and CEO George Conrades states that the main reason for the IPO was not to obtain money, but to attract the attention of customers and other business partners. The literature on IPOs is largely limited to understanding them in terms of pricing and financial motivation. While market efficiency is always a major concern, IPOs are typically “underpriced” in comparison to the first day’s closing price. This means that an offering is priced somewhat less than the expected willingness of buyers to pay in order to ensure that it is fully subscribed and that the buyers feel good about their purchase. From I960 to 1998, the first day rate of return computed from the closing and initial offer prices of IPOs averaged about 15 percent. In 1999 and early 2000, however, the rate of return was significantly higher, ranging from 63 percent to 103 percent. The proposed explanations for underpricing also include achieving broader publicity in financial markets, insuring against legal liabilities, and meeting the needs for equity financing. These greatly increased levels of underpricing have not elicited loud complaints from the 49
firms bringing IPOs. Presumably their owners are seeing value beyond the acquisition of capital. Although the literature is largely limited to understanding IPOs in investment and financial termseven research on information signaling is related in that the IPO process provides an opportunity to convey signals to participants in the financial market-it seems clear that the IPO “communication opportunity” created for the financial markets can also be used to enhance awareness and knowledge of product and service characteristics in the customer market. It can also build an appreciation for the future potential of the business and the competence of the management team. The side effects in the product market are particularly interesting. It seems the IPO can be an information event for customers of the firm’s products and services as well as for potential investors. Considering the growing importance of IPO activities in the current economy, it is valuable and useful to integrate both the financial and product market perspectives of any IPO. II’0
AS AN INFORMATION
entiating them from other products ant The description typically includes: (1) I added attributes-that is, how well the customers’ expectations in terms of pel superiority, reliability, and cost-efficient functions, especially in relation to othe or services; (3) their durability and lifestage; (4) their use of leading-edge tecl (5) their flexibility in terms of customiz scope of applications; and (6) the insta after-sale services available. Properly st information can substantially boost aw; the company’s offerings in the product A special impact on awareness res through the IPO, a larger number of p( investors become new stockholders. St ership gives a shareholder the incentivl mote the company and become a cons products and services. For example, sh of www.bn.com, an Internet bookselle likely to buy books from Barnes & Not from other online booksellers, and to s highly of the company to others.
EVENT
Company Reputation he IPO registration statement, which includes the prospectus for investors, T contains abundant information: a description of the business; biographical material on the officers and directors; the amount of shares owned by each insider (officers, directors, and shareholders owning more than 10 percent of the securities); complete financial statements, including existing debts and equity securities and how they are capitalized; uses of proceeds; and any legal proceeding involving the firm, including strikes, lawsuits, antitrust actions, and copyright/ patent infringement suits. Prior to the effective date (the first date the IPO will be on sale to the public), the management team holds a series of meetings in several different cities over a short time period. In these “road shows,” potential investors, including brokers and analysts, question the management team, whose members explain and answer questions about the business, its products, and its competition. In other words, the quality of management is introduced to participants and the company gains an opportunity to establish a name for itself and increase sales. Company and Product Awareness Prospectuses and road shows, then, enhance the general awareness of a business, which in turn influences public perception of its products and services. The “business” section of a prospectus describes the IPO company’s products and services in terms of their uniqueness, superiority, cost effectiveness, and essentiality, thereby differ-
In addition to publicizing information ; firm’s products and services, the IPO p SEC approval of the IPO registration er information disclosure, the involvemen and well-known investment banks, ant erally positive recommendations from ’ brokers--can help build corporate rep1 which in turn promotes sales. Five invt banks, including Morgan Stanley Dean Goldman Sachs, Merrill Lynch, Solomo Barney, and C.S. First Boston, dominate market. According to Mullaney (ZOOO), banks had a combined share of 72.8 p< the IPO market in the period from Jam March 7, 2000. In the same period, buy mendations outnumbered sells by 72 tc Fombrun and Shanley (1990) demo that involvement by respected investor, tional owners) also contributes to carp tation. Moreover, IPO underpricing can plained partly as an effort to create a fi impression of the firm on the financial An important effect of enhanced corpo tation is increased sales. As Fombrun ( ports, corporate reputation does influe] sumer interest in purchasing. Ohanian notes the same result in cases wherein reputation is credited to celebrity endo Increased Sales Thus, the general awareness and reput; company can influence customers’ pun sions. While the potential for these pro Business
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/ Jui
ket effects has always been present in the IPO process, advanced information and communication technologies as well as the incentive of investors magnify the effects of product/service information, general awareness, and company reputation on potential customers. Most investors, especially long-term ones who make their investment decisions based on a firm’s future potential performance, have a strong incentive to know more about products. This is clear from the studies on stock price gain following the announcement of new products and services as reported by Chaney and Devinney (1992) and on the association between product quality and stock price reported by Aaker and Jacobson (1994). It seems, then, that the IPO as an information event can affect product markets as well as capital markets. By studying sales trends and the relationship between sales and sales expenses, the existence of the marketing effect of an IPO can be demonstrated.
o
IF0 MARKETING EFFECTS
T
investigate their impact on marketing, we selected a simple random sample of 50 high-tech IPOs that occurred in the period from January 1997 to June 1998. When the sample is viewed as two sub-samples-27 IPOs from 1997 and 23 from 1998-both show an insignificant difference in analysis results, indicating that 50 IPOs is an adequate sample size. Two measures were used to indicate the hypothesized marketing effect: total revenues and the ratio of total revenues to sales expenses. In considering the impact of the IPOs, we chose to review both measures directly, as well as the trend in each. In some cases the overall measure could be declining while the trend showed a favorable impact. To balance out the potential impact of general market conditions on sales, half of the sample IPOs were from the periods when the NASDAQ Composite Index was in a decreasing trend; the other half were sampled from increasing periods. During the study period, there were 170 IPOs from the high-tech group, which includes computer and communication hardware, software, and service companies. The source of the data was IPO Data Systems, a commercial data provider on the Internet. Eight or more quarters of data were collected (four or more quarters before and after the IPO effective quarter). Data on total revenues and corresponding sales and marketing expense data were collected from EDGAR (Electronic Data Gathering, Analysis, and Retrieval), which performs automated collection, validation, indexing, acceptance, and forwarding of submissions by companies and others who are required by law to file forms with the SEC.
For some companies, sales and marketing expenses were combined with general and administrative expenses in the income statement in the EDGAR database. Sales and marketing expenses include the cost of storing and preparing goods for sale, displaying, advertising, promoting sales, making sales, and delivering the goods to the buyers if the seller pays the cost of delivery. General and administrative expenses include expenses for accounting, personnel, credit and collection, and any other material expenses that apply. General occupancy expenses, such as rent, insurance, and utilities, are classified as general and administrative expenses, but could be allocated between selling and general/administrative expenses. Using all of these data, we investigated IPO market impacts by (1) time series analysis and (2) relationship analysis. Time Series Analysis For the two variables analyzed, revenue and ratio of revenue to sales expenses, Table 1 shows the combined results of trend and quantity change in the IPO quarter. “Both Increasing” (or “Both Decreasing”) in the change column means that both the trend and the quantity of the variable are increasing (or decreasing). “Inconclusive” means that the trend and quantity changes show opposite directions. For both variables, the quantity change in the IPO quarter from the previous quarter and the trend change were considered. For the total revenues, 31 firms out of 50 showed that both total revenue quantity and the trend increased at the IPO quarter. For the total revenues to sales expense ratio, which shows revenue per $1 of sales expense, 33 firms out of 50 showed that both the ratio and its trend increased after the IPO. These results support the view that an IPO has a positive impact on a company’s revenue. A test assuming that the movements were a random
Table 1 Changes in Revenue and Revenue-to-Sales-Expense Ratio
Variables Total Revenues
Ratio of Revenues to Sales Expenses
Change in Trend and Quantity
Number of Firms
Both Increasing Inconclusive Both Decreasing
31 10
Both Increasing Inconclusive Both Decreasing
33
9 1
16
Percent of Firms
62%’ 20% 18%
66%+ 2%
32%
p< .I
fpc.05
Maximizing the Financial and Product Market Values of the IPO Opportunity
51
Figure 1 Regression Lines Between Revenues
andSalesExpenses
if;
s 3
4
*\ 4
phenomenon would be rejected. Because the effects occur too soon to be the result of using the capital raised in the IPO, the IPO event itself is considered causal. Relationship Analysis
To further support the positive market impact results, we investiB gated more specifically the relationship between revenues and Sales Expenses sales expenses. As a result of regression analysis, Figure 1 indicates this relationship over the entire period observed in comparison to viewing the pre-IPO and post-IPO periods separately. The slope of the line indicates the amount of revenue change due to a one-unit increase of sales expenses. Two slopes, one @l> from the regression line using the data for the whole period and the other 432) from the line using data in the period before and including the IPO quarter, were compared. Line A indicates the regression line for the whole period, whereas Line B is for pre-IPO, including the IPO period. The differences in the slopes indicate the impact of the IPO on revenues. For this analysis, only the 35 firms whose data show reasonably clear relationships were included. For 22 firms out of 35, the slope of the whole period is greater than the slope of the pre-IPO period @I > p2); this indicates that their revenue growth per unit sales expense in the post-IPO period is higher than the same growth in the pre-IPO period. Only 13 out of 35 firms experienced revenue growth per unit sales expense that decreased in the post-IPO period @l I p2). This again indicates the validity of the anticipated market effects. Comparing the changes in slope may also serve to measure the magnitude of the effects.
\
IPO Quarter
he results of this study indicate that an IPO does have a significant impact on T marketing. The growing number of IPOs and the publicity accorded them enhance the practical significance of these effects. Awareness of this impact has implications for several groups. Managers conducting IPOs need to act to take full advantage of the marketing effects. The SEC needs to review current information disclosure rules to balance the quality of information disclosed in the IPO process with the desire for fair disclosure to the public. Academics need to study 52
these marketing impacts further to include their effects on alliance partners and employees as well as investors, their ability to attract high-quality employees, and the encouragement for potential business partners to associate with the IPO company. The effects in various types of companies conducting IPOs and different categories of customers also need to be understood. Some managers have already recognized a few of the nonfinancial aspects of the IPO. Broad recognition of these aspects should encourage a more comprehensive development of specific marketing and financial plans for most IPOs. Companies can take advantage of the promotional benefits available from an IPO by engaging marketing managers in the information review and dissemination process. Inclusion of appropriate marketing information should enhance the firm’s marketing and sales performance as well as create positive financial and image side effects. Managers should: l ensure that the IPO information contents and formats are effective in encouraging customer purchases; l broaden the investor road show groups beyond traditional financial analysts and create general news coverage; l develop complementary documentation for communication to a broader set of potential investors; and l encourage broad interest in security ownership through pricing and promotion (pre-IPO stock option distribution could expand general IPO interest). By broadening the current IPO process, managers can enhance the market side effects of the process by: l using the IPO event to help gain access to news media with a message aimed at the product market-such an effort would fit nicely with the recently approved SEC rule banning selective disclosure and requiring the public company to disclose information to the general public; l coordinating an advertising campaign to create synergy with financial market and general media coverage, as well as Internet resources; and l coordinating a sales campaign to use the awareness created with other coverage and the possible advertising campaign. Financial managers need to reconsider the net cost of IPO capital. If IPOs have a significant marketing impact, a part of their cost should be considered a marketing cost, thereby lowering their real capital cost. This line of study warrants further investigation. A lower cost of capital that takes into account both improved sales and other positive side effects might move the timing of the IPO forward. In attempting to measure the financial value that can be attributed to the marketing effects, it should be possible to estimate, based Business
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2001
on historical experience, the general level of changes in revenue expected from an IPO and thus develop a general estimate of the marketing cost required to achieve that same level of revenue change. The IPO marketing impacts can help explain the growing preference among startup firms for large, well-known underwriters. They also help explain the recent phenomenon of substantial IPO underpricing, which provides a large price increase in the first few days of an offering and thus grabs media attention. Top executives can relate the possibility of all the nonfinancial effects to the resource-based view of strategy, which claims that superior performance is based on developing competitively distinct resources and deploying them in corporate strategy. This provides a managerial perspective from which to explain business performance by resources and diversification at the corporate level. In this view, the IPO could be a key vehicle for initially developing company awareness and reputation-resources that could then possibly be sustained. The first mover advantage could also be a part of this consideration. More study of these possible implications is needed. SEC regulators also need to respond to the nonfinancial impact of the IPO. The regulations regarding IPO information disclosure are designed to achieve fair disclosure and ensure the accuracy of the information. A broader concept of accuracy would encourage a broad range and depth of information. The recent approval of Regulation FD (fair disclosure) bans companies from giving important information to selected analysts and investors before disclosing it to the public. Communicating accurately to a broaderbased audience is more challenging and subject to misunderstanding. To ensure accurate information, company and underwriters inspect the registration statement, a process that is referred to as “due diligence.” The registered document is then reviewed by the SEC. Information not included in the registration statement cannot be disclosed during the quiet period, which starts with the selection of underwriters and extends for 25 days after the IPO. The quiet period rule limits the public access of potentially important information in a timely manner. Webvan, an online grocer, had its IPO delayed for three weeks due to its violation of the IPO quiet period rules. Information related to the forecast of the firm’s profitability, product technologies, and market competition are important information for potential investors, business alliance partners, customers, and employees. Such forward-looking information is inherently less accurate and more judgmental. SEC rules discourage companies from disclosing it and encourage them to provide only historical infor-
Maximizing
the Financial
and Product
mation to the public. Thus, an extreme emphasis on accuracy and fair disclosure could jeopardize the broader intent of these regulations to ensure wide public access of quality information in a timely manner. Abolishing outdated quiet period rules and easing the accuracy requirements by allowing forward-looking information with proper qualifications could promote the transparency of the business, benefiting investors as well as management. Enhancing the level of investor knowledge to interpret available information is also necessary. 0 References and Selected Bibliography D.A. Aaker and R. Jacobson, “The Financial Information Content of Perceived Quality,” Journal of Marketing Research, May lY%, pp. 191-201.
“Amazon.com
68-84.
N.G. Carr, “On the Edge: An Interview with Akamai’s George Conrades,” Harvard BusinessReview, May-June 2000, pp. 118-125. P.K. Chaney and T.M. Devinney, “New Product Innovations and Stock Price Performance,” Journal of BusinessFinance and Accounting, September 1992, pp. 677-695. T.J. Chemmanur, “The Pricing of Initial Public Offerings: A Dynamic Model with Information Production,” Journal of Finance, March 1993, pp. 285-304. D.J. Collis and C.A. Montgomery, sources:
Strategy
viezq July-August
“Competing
on Re-
199Os,”Harvard BusinessRe1995, pp. 118-128.
in the
C. Fombrun, Reputation: Realizing Valuefrom the Corporate Image (Boston: Press, 1996).
Harvard Business
School
C. Fombrun and M. Shanley, “What’s in a Name? Reputation Building and Corporate Strategy,” Academy of Management Journal, June 1990, pp. 233-258. A. Hammed and Quality in Initial apore,” Journal April-May 1998,
G.H. Lim, “Underpricing and Firm Public Offerings: Evidence from Singof BusinessFinance and Accounting,
pp. 455-468.
R. Ibbotson, J.L. Sindelar, and J. Ritter, “Initial Public Offerings,” Journal of Applied Corporate Finance, 1, 2
(1988): 37-45.
Market Values of the IPO Opportunity
53
J. Kim, I. Krinsky, and J. Lee, “Motives for Going Public and Underpricing: New Findings from Korea,” Journal of BusinessFinance and Accounting, January 1993, pp. 195-211. B. Lev, “Disclosure and Shareholder Litigation,” California Management Review, Spring 1995, pp. 8-28. B. Lev, “Information Disclosure Strategy,” California Management Review, Summer 1992, pp. 9-32.
J. Roemer, “The New Quiet Period,” Red Herring (Supplement: “Going Public”), July 2000, pp. 28-31 SM. Tinic, “Anatomy of Initial Public Offerings of Common Stock,” Journal of Finance, September l! pp. 789-822. B. Wernerfelt, “A Resource-based View of the Firm Strategic Management Journal, April-June 1984, pI 171-180.
T.J. Mullaney, “Is the Street Lowballing IPOs?” Business Week, April 3, 2000, pp. EB112, EB114. R. Ohanian, “The Impact of Celebrity Spokesperson’s Perceived Image on the Consumer’s Intention to Purchase,” Journal of Advertising Research, FebruaryMarch 1991, pp. 46-54. M. Pagano, F. Panetta, and L. Zingales, “Why Do Companies Go Public? An Empirical Analysis,” Journal of Finance, February 1998, pp. 27-64. M.A. Peteraf, “The Cornerstones of Competitive Advantage: A Resource-based View,” Strategic Management Journal, March 1993, pp. 179-191.
~
Jae H. Song is a professor of management at St. Cloud State University, St. Cloud, Minnesota, where Yinsog Rhee is an associate professor of management. Carl R. Adams is a professor and director of the Management Information Systems Research Center at the University of Minnesota in Minneapolis.
Business
Horizons
/July-August
A
n initial public offering, the first selling of a company’s stock to the public, is a major milestone for a business. It provides equity capital from a broad segment of the public, as well as an opportunity to disseminate information on the company through a prospectus distributed to investors, a registration document filed with the U.S. Securities and Exchange Commission, and special presentations, called “road shows,” to potential investors or their representatives from financial institutions. The prospectus and SEC registration include information on the company’s products, management, and financial status, as well as details of the offering and various relevant risk factors. The increased transparency, broader and deeper publicity, and wider stock ownership that result for the company suggest that an IPO is more than simply a way to raise capital. Results could also include improved relationships with potential customers, employees, and possible business partners. These are generally considered side effects to the financial purpose of the IPO (raising capital) and are not currently addressed in the literature. Now, however, greater involvement of the public in equity investing-especially IPO opportunities-along with expanded access to the IPO process have made these potential side effects much more significant. Practitioners intuitively appreciate that an IPO can have side effects that enhance company awareness and reputation. In the Harvard Business School case “Amazon.com-Going Public” (1999), CEO Jeff Bezos comments that the motivation for the IPO of Amazon.com was not only to raise capital but also to enhance public awareness. His comment indicates that substantial marketing benefits may also be expected from an
IPO. Martha Stewart likely could have sustained substantial expansion of her business without the capital from an IPO. The October 1999 filing for Martha Stewart Living Omnimedia, Inc. indicates no urgent need for the capital obtained. However, the IPO was obviously orchestrated to produce tremendous publicity benefits for the firm in addition to providing an opportunity for key employees to cash in their stock holdings. Another example is Akamai, an Internet content company. According to Carr (ZOOO),its chairman and CEO George Conrades states that the main reason for the IPO was not to obtain money, but to attract the attention of customers and other business partners. The literature on IPOs is largely limited to understanding them in terms of pricing and financial motivation. While market efficiency is always a major concern, IPOs are typically “underpriced” in comparison to the first day’s closing price. This means that an offering is priced somewhat less than the expected willingness of buyers to pay in order to ensure that it is fully subscribed and that the buyers feel good about their purchase. From I960 to 1998, the first day rate of return computed from the closing and initial offer prices of IPOs averaged about 15 percent. In 1999 and early 2000, however, the rate of return was significantly higher, ranging from 63 percent to 103 percent. The proposed explanations for underpricing also include achieving broader publicity in financial markets, insuring against legal liabilities, and meeting the needs for equity financing. These greatly increased levels of underpricing have not elicited loud complaints from the 49
firms bringing IPOs. Presumably their owners are seeing value beyond the acquisition of capital. Although the literature is largely limited to understanding IPOs in investment and financial termseven research on information signaling is related in that the IPO process provides an opportunity to convey signals to participants in the financial market-it seems clear that the IPO “communication opportunity” created for the financial markets can also be used to enhance awareness and knowledge of product and service characteristics in the customer market. It can also build an appreciation for the future potential of the business and the competence of the management team. The side effects in the product market are particularly interesting. It seems the IPO can be an information event for customers of the firm’s products and services as well as for potential investors. Considering the growing importance of IPO activities in the current economy, it is valuable and useful to integrate both the financial and product market perspectives of any IPO. II’0
AS AN INFORMATION
entiating them from other products ant The description typically includes: (1) I added attributes-that is, how well the customers’ expectations in terms of pel superiority, reliability, and cost-efficient functions, especially in relation to othe or services; (3) their durability and lifestage; (4) their use of leading-edge tecl (5) their flexibility in terms of customiz scope of applications; and (6) the insta after-sale services available. Properly st information can substantially boost aw; the company’s offerings in the product A special impact on awareness res through the IPO, a larger number of p( investors become new stockholders. St ership gives a shareholder the incentivl mote the company and become a cons products and services. For example, sh of www.bn.com, an Internet bookselle likely to buy books from Barnes & Not from other online booksellers, and to s highly of the company to others.
EVENT
Company Reputation he IPO registration statement, which includes the prospectus for investors, T contains abundant information: a description of the business; biographical material on the officers and directors; the amount of shares owned by each insider (officers, directors, and shareholders owning more than 10 percent of the securities); complete financial statements, including existing debts and equity securities and how they are capitalized; uses of proceeds; and any legal proceeding involving the firm, including strikes, lawsuits, antitrust actions, and copyright/ patent infringement suits. Prior to the effective date (the first date the IPO will be on sale to the public), the management team holds a series of meetings in several different cities over a short time period. In these “road shows,” potential investors, including brokers and analysts, question the management team, whose members explain and answer questions about the business, its products, and its competition. In other words, the quality of management is introduced to participants and the company gains an opportunity to establish a name for itself and increase sales. Company and Product Awareness Prospectuses and road shows, then, enhance the general awareness of a business, which in turn influences public perception of its products and services. The “business” section of a prospectus describes the IPO company’s products and services in terms of their uniqueness, superiority, cost effectiveness, and essentiality, thereby differ-
In addition to publicizing information ; firm’s products and services, the IPO p SEC approval of the IPO registration er information disclosure, the involvemen and well-known investment banks, ant erally positive recommendations from ’ brokers--can help build corporate rep1 which in turn promotes sales. Five invt banks, including Morgan Stanley Dean Goldman Sachs, Merrill Lynch, Solomo Barney, and C.S. First Boston, dominate market. According to Mullaney (ZOOO), banks had a combined share of 72.8 p< the IPO market in the period from Jam March 7, 2000. In the same period, buy mendations outnumbered sells by 72 tc Fombrun and Shanley (1990) demo that involvement by respected investor, tional owners) also contributes to carp tation. Moreover, IPO underpricing can plained partly as an effort to create a fi impression of the firm on the financial An important effect of enhanced corpo tation is increased sales. As Fombrun ( ports, corporate reputation does influe] sumer interest in purchasing. Ohanian notes the same result in cases wherein reputation is credited to celebrity endo Increased Sales Thus, the general awareness and reput; company can influence customers’ pun sions. While the potential for these pro Business
Horizons
/ Jui
ket effects has always been present in the IPO process, advanced information and communication technologies as well as the incentive of investors magnify the effects of product/service information, general awareness, and company reputation on potential customers. Most investors, especially long-term ones who make their investment decisions based on a firm’s future potential performance, have a strong incentive to know more about products. This is clear from the studies on stock price gain following the announcement of new products and services as reported by Chaney and Devinney (1992) and on the association between product quality and stock price reported by Aaker and Jacobson (1994). It seems, then, that the IPO as an information event can affect product markets as well as capital markets. By studying sales trends and the relationship between sales and sales expenses, the existence of the marketing effect of an IPO can be demonstrated.
o
IF0 MARKETING EFFECTS
T
investigate their impact on marketing, we selected a simple random sample of 50 high-tech IPOs that occurred in the period from January 1997 to June 1998. When the sample is viewed as two sub-samples-27 IPOs from 1997 and 23 from 1998-both show an insignificant difference in analysis results, indicating that 50 IPOs is an adequate sample size. Two measures were used to indicate the hypothesized marketing effect: total revenues and the ratio of total revenues to sales expenses. In considering the impact of the IPOs, we chose to review both measures directly, as well as the trend in each. In some cases the overall measure could be declining while the trend showed a favorable impact. To balance out the potential impact of general market conditions on sales, half of the sample IPOs were from the periods when the NASDAQ Composite Index was in a decreasing trend; the other half were sampled from increasing periods. During the study period, there were 170 IPOs from the high-tech group, which includes computer and communication hardware, software, and service companies. The source of the data was IPO Data Systems, a commercial data provider on the Internet. Eight or more quarters of data were collected (four or more quarters before and after the IPO effective quarter). Data on total revenues and corresponding sales and marketing expense data were collected from EDGAR (Electronic Data Gathering, Analysis, and Retrieval), which performs automated collection, validation, indexing, acceptance, and forwarding of submissions by companies and others who are required by law to file forms with the SEC.
For some companies, sales and marketing expenses were combined with general and administrative expenses in the income statement in the EDGAR database. Sales and marketing expenses include the cost of storing and preparing goods for sale, displaying, advertising, promoting sales, making sales, and delivering the goods to the buyers if the seller pays the cost of delivery. General and administrative expenses include expenses for accounting, personnel, credit and collection, and any other material expenses that apply. General occupancy expenses, such as rent, insurance, and utilities, are classified as general and administrative expenses, but could be allocated between selling and general/administrative expenses. Using all of these data, we investigated IPO market impacts by (1) time series analysis and (2) relationship analysis. Time Series Analysis For the two variables analyzed, revenue and ratio of revenue to sales expenses, Table 1 shows the combined results of trend and quantity change in the IPO quarter. “Both Increasing” (or “Both Decreasing”) in the change column means that both the trend and the quantity of the variable are increasing (or decreasing). “Inconclusive” means that the trend and quantity changes show opposite directions. For both variables, the quantity change in the IPO quarter from the previous quarter and the trend change were considered. For the total revenues, 31 firms out of 50 showed that both total revenue quantity and the trend increased at the IPO quarter. For the total revenues to sales expense ratio, which shows revenue per $1 of sales expense, 33 firms out of 50 showed that both the ratio and its trend increased after the IPO. These results support the view that an IPO has a positive impact on a company’s revenue. A test assuming that the movements were a random
Table 1 Changes in Revenue and Revenue-to-Sales-Expense Ratio
Variables Total Revenues
Ratio of Revenues to Sales Expenses
Change in Trend and Quantity
Number of Firms
Both Increasing Inconclusive Both Decreasing
31 10
Both Increasing Inconclusive Both Decreasing
33
9 1
16
Percent of Firms
62%’ 20% 18%
66%+ 2%
32%
p< .I
fpc.05
Maximizing the Financial and Product Market Values of the IPO Opportunity
51
Figure 1 Regression Lines Between Revenues
andSalesExpenses
if;
s 3
4
*\ 4
phenomenon would be rejected. Because the effects occur too soon to be the result of using the capital raised in the IPO, the IPO event itself is considered causal. Relationship Analysis
To further support the positive market impact results, we investiB gated more specifically the relationship between revenues and Sales Expenses sales expenses. As a result of regression analysis, Figure 1 indicates this relationship over the entire period observed in comparison to viewing the pre-IPO and post-IPO periods separately. The slope of the line indicates the amount of revenue change due to a one-unit increase of sales expenses. Two slopes, one @l> from the regression line using the data for the whole period and the other 432) from the line using data in the period before and including the IPO quarter, were compared. Line A indicates the regression line for the whole period, whereas Line B is for pre-IPO, including the IPO period. The differences in the slopes indicate the impact of the IPO on revenues. For this analysis, only the 35 firms whose data show reasonably clear relationships were included. For 22 firms out of 35, the slope of the whole period is greater than the slope of the pre-IPO period @I > p2); this indicates that their revenue growth per unit sales expense in the post-IPO period is higher than the same growth in the pre-IPO period. Only 13 out of 35 firms experienced revenue growth per unit sales expense that decreased in the post-IPO period @l I p2). This again indicates the validity of the anticipated market effects. Comparing the changes in slope may also serve to measure the magnitude of the effects.
\
IPO Quarter
he results of this study indicate that an IPO does have a significant impact on T marketing. The growing number of IPOs and the publicity accorded them enhance the practical significance of these effects. Awareness of this impact has implications for several groups. Managers conducting IPOs need to act to take full advantage of the marketing effects. The SEC needs to review current information disclosure rules to balance the quality of information disclosed in the IPO process with the desire for fair disclosure to the public. Academics need to study 52
these marketing impacts further to include their effects on alliance partners and employees as well as investors, their ability to attract high-quality employees, and the encouragement for potential business partners to associate with the IPO company. The effects in various types of companies conducting IPOs and different categories of customers also need to be understood. Some managers have already recognized a few of the nonfinancial aspects of the IPO. Broad recognition of these aspects should encourage a more comprehensive development of specific marketing and financial plans for most IPOs. Companies can take advantage of the promotional benefits available from an IPO by engaging marketing managers in the information review and dissemination process. Inclusion of appropriate marketing information should enhance the firm’s marketing and sales performance as well as create positive financial and image side effects. Managers should: l ensure that the IPO information contents and formats are effective in encouraging customer purchases; l broaden the investor road show groups beyond traditional financial analysts and create general news coverage; l develop complementary documentation for communication to a broader set of potential investors; and l encourage broad interest in security ownership through pricing and promotion (pre-IPO stock option distribution could expand general IPO interest). By broadening the current IPO process, managers can enhance the market side effects of the process by: l using the IPO event to help gain access to news media with a message aimed at the product market-such an effort would fit nicely with the recently approved SEC rule banning selective disclosure and requiring the public company to disclose information to the general public; l coordinating an advertising campaign to create synergy with financial market and general media coverage, as well as Internet resources; and l coordinating a sales campaign to use the awareness created with other coverage and the possible advertising campaign. Financial managers need to reconsider the net cost of IPO capital. If IPOs have a significant marketing impact, a part of their cost should be considered a marketing cost, thereby lowering their real capital cost. This line of study warrants further investigation. A lower cost of capital that takes into account both improved sales and other positive side effects might move the timing of the IPO forward. In attempting to measure the financial value that can be attributed to the marketing effects, it should be possible to estimate, based Business
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2001
on historical experience, the general level of changes in revenue expected from an IPO and thus develop a general estimate of the marketing cost required to achieve that same level of revenue change. The IPO marketing impacts can help explain the growing preference among startup firms for large, well-known underwriters. They also help explain the recent phenomenon of substantial IPO underpricing, which provides a large price increase in the first few days of an offering and thus grabs media attention. Top executives can relate the possibility of all the nonfinancial effects to the resource-based view of strategy, which claims that superior performance is based on developing competitively distinct resources and deploying them in corporate strategy. This provides a managerial perspective from which to explain business performance by resources and diversification at the corporate level. In this view, the IPO could be a key vehicle for initially developing company awareness and reputation-resources that could then possibly be sustained. The first mover advantage could also be a part of this consideration. More study of these possible implications is needed. SEC regulators also need to respond to the nonfinancial impact of the IPO. The regulations regarding IPO information disclosure are designed to achieve fair disclosure and ensure the accuracy of the information. A broader concept of accuracy would encourage a broad range and depth of information. The recent approval of Regulation FD (fair disclosure) bans companies from giving important information to selected analysts and investors before disclosing it to the public. Communicating accurately to a broaderbased audience is more challenging and subject to misunderstanding. To ensure accurate information, company and underwriters inspect the registration statement, a process that is referred to as “due diligence.” The registered document is then reviewed by the SEC. Information not included in the registration statement cannot be disclosed during the quiet period, which starts with the selection of underwriters and extends for 25 days after the IPO. The quiet period rule limits the public access of potentially important information in a timely manner. Webvan, an online grocer, had its IPO delayed for three weeks due to its violation of the IPO quiet period rules. Information related to the forecast of the firm’s profitability, product technologies, and market competition are important information for potential investors, business alliance partners, customers, and employees. Such forward-looking information is inherently less accurate and more judgmental. SEC rules discourage companies from disclosing it and encourage them to provide only historical infor-
Maximizing
the Financial
and Product
mation to the public. Thus, an extreme emphasis on accuracy and fair disclosure could jeopardize the broader intent of these regulations to ensure wide public access of quality information in a timely manner. Abolishing outdated quiet period rules and easing the accuracy requirements by allowing forward-looking information with proper qualifications could promote the transparency of the business, benefiting investors as well as management. Enhancing the level of investor knowledge to interpret available information is also necessary. 0 References and Selected Bibliography D.A. Aaker and R. Jacobson, “The Financial Information Content of Perceived Quality,” Journal of Marketing Research, May lY%, pp. 191-201.
“Amazon.com
68-84.
N.G. Carr, “On the Edge: An Interview with Akamai’s George Conrades,” Harvard BusinessReview, May-June 2000, pp. 118-125. P.K. Chaney and T.M. Devinney, “New Product Innovations and Stock Price Performance,” Journal of BusinessFinance and Accounting, September 1992, pp. 677-695. T.J. Chemmanur, “The Pricing of Initial Public Offerings: A Dynamic Model with Information Production,” Journal of Finance, March 1993, pp. 285-304. D.J. Collis and C.A. Montgomery, sources:
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on Re-
199Os,”Harvard BusinessRe1995, pp. 118-128.
in the
C. Fombrun, Reputation: Realizing Valuefrom the Corporate Image (Boston: Press, 1996).
Harvard Business
School
C. Fombrun and M. Shanley, “What’s in a Name? Reputation Building and Corporate Strategy,” Academy of Management Journal, June 1990, pp. 233-258. A. Hammed and Quality in Initial apore,” Journal April-May 1998,
G.H. Lim, “Underpricing and Firm Public Offerings: Evidence from Singof BusinessFinance and Accounting,
pp. 455-468.
R. Ibbotson, J.L. Sindelar, and J. Ritter, “Initial Public Offerings,” Journal of Applied Corporate Finance, 1, 2
(1988): 37-45.
Market Values of the IPO Opportunity
53
J. Kim, I. Krinsky, and J. Lee, “Motives for Going Public and Underpricing: New Findings from Korea,” Journal of BusinessFinance and Accounting, January 1993, pp. 195-211. B. Lev, “Disclosure and Shareholder Litigation,” California Management Review, Spring 1995, pp. 8-28. B. Lev, “Information Disclosure Strategy,” California Management Review, Summer 1992, pp. 9-32.
J. Roemer, “The New Quiet Period,” Red Herring (Supplement: “Going Public”), July 2000, pp. 28-31 SM. Tinic, “Anatomy of Initial Public Offerings of Common Stock,” Journal of Finance, September l! pp. 789-822. B. Wernerfelt, “A Resource-based View of the Firm Strategic Management Journal, April-June 1984, pI 171-180.
T.J. Mullaney, “Is the Street Lowballing IPOs?” Business Week, April 3, 2000, pp. EB112, EB114. R. Ohanian, “The Impact of Celebrity Spokesperson’s Perceived Image on the Consumer’s Intention to Purchase,” Journal of Advertising Research, FebruaryMarch 1991, pp. 46-54. M. Pagano, F. Panetta, and L. Zingales, “Why Do Companies Go Public? An Empirical Analysis,” Journal of Finance, February 1998, pp. 27-64. M.A. Peteraf, “The Cornerstones of Competitive Advantage: A Resource-based View,” Strategic Management Journal, March 1993, pp. 179-191.
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Jae H. Song is a professor of management at St. Cloud State University, St. Cloud, Minnesota, where Yinsog Rhee is an associate professor of management. Carl R. Adams is a professor and director of the Management Information Systems Research Center at the University of Minnesota in Minneapolis.
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/July-August