The objective of this study is to analyse the performance of private equity-backed initial public offerings (IPOs) in the UK for the period from 1990 to 2010 in the light of asymmetric information which takes place between the IPO companies and investors. This analysis covers two complete market cycles in the stock market, and consequently two waves of IPOs and provides the information on two performance characteristics: short-term returns represented by underpricing which is the proxy of informational asymmetry by assumption, and long-term returns which are determined by the period of up to three years after the IPO.
Additional insights are gained by exploring the relevance of certain characteristics of management buyouts (MBOs) and the magnitude of underpricing. For this, the underpricing has been assessed from different angles. First, the underwriter reputation has been examined when firms are grouped according to the ranking which placed the MBOs in three sub-groups with high rank underwriters, middle rank and low rank private equity firms. Then the market capitalization has been used to evaluate the impact of this proxy on the magnitude of underpricing. Similarly, the IPO companies are grouped on the size basis and three sub-groups are organized with the small size companies, the middle size and the large size MBOs. Finally, the investment duration has been analysed in order to find out whether it influences the underpricing. For this, the MBOs are divided into three categories depending on the length of time during which the private equity investor stays invested. The IPO companies in which investments have been made for the period less than two years, between two and five years and more than five years.
The empirical findings provide significant evidence that private equity-backed IPOs generate positive initial returns in a set of 103 MBOs for the period from 1990 to 2010. In fact, the private equity firms profit first from the underpricing which is short-run returns and second from hold-and-buy returns which are considered as long-run returns. In average, for the aggregate sample of MBOs, the underpricing accounts for 6.5%. The long-term returns for the aggregate sample are around 31% for the period of three years after the IPO. This figure is not significantly different to the market index for the same period. However between the second and the third year of investment, for the sub-group of underpriced MBOs considerably outperforms the market index with the peak at 27% of abnormal returns.
Further analysis of aspects that may determine the underpricing reveals that the reputation of the underwriter is negatively correlated with the underpricing. The high ranking sub-group shows significantly less underpricing than other two sub-groups. In addition, the market capitalization has also impact on the underpricing with the negative correlation. In contrast, only the sub-group of small MBOs shows considerable difference in the results compared to other peers. Two other categories do not demonstrate remarkable differences. The third contributor to the magnitude of underpricing which is related to the duration of the investment also indicates the strong negative relationship with the underpricing. It implies that those MBOs that are stayed invested for the period up to two years will be seriously underpriced while IPO companies with duration of the investment between two and five years will be underpriced insubstantially.
Overall, this study provides empirical evidence that private equity-backed initial public offerings in the UK generate positive returns and positive performance for the 1990 to 2010 period.
There is no doubt that private equity considerably contributes to the companies’ success and long-term economic growth if those companies need external capital which is crucial to further growth of the company. Haltiwanger, Jarmin and Miranda (2010) give empirical evidence that improvement in employment coupled with following creation of new jobs are function of the growth rate in small and medium size companies. As a result, it is vital for the success of developing firms that sufficient financial resources, essential advising and monitoring services are available to exploit by those firms. In spite of the current recession have badly influenced both financial markets and real sector of the economy over the last 3 years, it seems that recovery is coming and sustainable conditions are likely to come back with new opportunities for businesses.
Taking into account the number of companies which are interested in going public, the stock markets may demonstrate sustainable recovery in the nearest few years. Amongst others there are many potential initial public offerings which are backed by private equity providers, i.e. firms that have been invested early on. This might suggest that the private equity sector has positive effect on firm value in different times, when the economy is growing and when the country faces tough times.
Meanwhile, private equity firms have a variety of choices to exit from their portfolio companies including going public with following investing in new promising ventures. Thus, it could be an interesting research question to examine performance and a number of characteristics of private to public MBOs in the UK for the period of time from 1990 to 2010. A vast amount of empirical results over the last three decades suggest that private equity professionals significantly contribute to the success of developing companies and to the growth in the economy in general. This may be the effect of superiority of private equity in terms of the ability of screening, consulting and monitoring of their portfolio companies.
On the other hand, looking at the choice of exit, it was believed that the exit by going public is the most profitable and promising way of divestment, i.e. selling shares of the firm in the stock markets via an initial public offering. However, the chance to sell a stake of equity at higher valuation does not necessarily depend on the intrinsic value of the company which goes public. It is also closely related to the size, liquidity of the shares and quality of the equity market in the given country. The recent stock market performance is also important (Bessler, Holler and Seim, 2010). Moreover, when the market conditions fluctuate from hot periods to cold times, the notable differences might be observed resulting in significant returns and performance. (...)
2. Literature review and hypotheses development
3. Data and methodology
4. Empirical results