Investment funds and underpricing of shares.
| Autor | Castilho, Hitalo Alberto de Souza Faria |
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Introduction
Between 2007 and 2017, the Brazilian economy underwent periods of oscillation with increase and decrease in the gross national product, thus directly affecting the basic interest rates (SELIC rate) and hampering the access to credit (Bacen, 2018a, b). In periods of crisis, one can highlight the role played by funds of venture capital (VC) and private equity (PE). These funds work as a financial alternative for ventures with high potential of growth and risk. In fact, investments made by these funds were R$13.3bn in 2014, R$18.5bn in 2015 and R$11.3bn in 2016 (ABVCAP, 2018).
Initial public offering (IPO) is among the most common forms of VC/PE investment funds and whose life cycle lasts, on average, from two to seven years. According to Cumming and Johan (2008), the presence of VC/PE investment funds in companies contributes to reducing the information asymmetry in the market. In order to do so, fund managers submit the prospective companies to due diligence processes and other analyses for assessment of risks and opportunities. Therefore, companies receiving such investments are viewed as more reliable by non-fund investors, thus creating a quality stamp to their IPO.
According to Miller and Reilly (1987), underpricing is a way for market operators to compensate for the lack of information at the moment of IPO. Also, Sonoda (2008) materialises this concept by stating that underpricing is an under-estimation of or discount in share prices in relation to the actual market price. As for IPO, specifically, this occurs when its offering price is lower than that on the first day of negotiation. Therefore, underpricing can be understood as the difference between closing price and offering price of IPO share on the first day of negotiation. For Ribeiro (2005), Gioielli (2013) and Sonoda (2008), the presence of VC/PE funds decreases the information asymmetry between owners and investors so that the effect of underpricing on IPOs can be mitigated in companies relying on the participation of these funds.
According to Belghitar and Dixon (2012), companies with prior participation of VC/PE funds are considered to be of low risk. Therefore, emitters do not need to under-price their IPO shares in order to attract investors. It is also thought that VC/PE funds regularly include IPO companies in their portfolios so that they have a strong incentive to establish a reliable reputation. This enables them to access the IPO market in the future under favourable conditions. Finally, the reputation of credibility helps these funds to establish a strong relationship with all offering participants, namely, auditors, insurers, pension fund managers and institutional investors.
In view of the above, the objective of this study is to assess whether the presence of VC/P funds in invested companies contributes to reducing the underpricing of their shares at the moment of IPO. The resulting hypotheses are:
H1. Companies with prior participation of VC/PE funds have less underpricing of IPO shares compared to those without such participation.
H2. The greater the prior participation of VC/PE funds in these companies' capital, the less the underpricing of IPO shares.
Therefore, the population of companies making IPO in the Brasil Bolsa Balcao (B3) between 2007 and 2017 were considered. The hypotheses were verified by using descriptive statistics, correlation analysis, mean difference tests and cross-sectional regression, including their assumptions. Differently from other studies, this one is concerned with capturing the sensibility regarding the participation of VC/PE funds in the companies' capital structure before their IPO. Either high or low level of property has different impacts on the underpricing of these companies. From the market's perspective, this fact suggests that the simple presence of these funds cannot have the expected effect on the mitigation of a potential asymmetry between managers and owners, in addition to other conflicts regarding the market information effectiveness. Also, the recent crisis in the country's economy might shed light on the relevance of these funds as alternative development sources in the Brazilian market.
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Literature review
Underpricing can be identified by means of abnormal positive returns from shares in the initial negotiations. This fact means that the company is evaluated for a value lower than the potential one, thus enabling profitability for investors in the first days of negotiation. Therefore, underpricing is regarded as an indirect cost for the company because part of the offer is not collected. This phenomenon is termed in the finance literature as "leaving cash on the table" and can be measured by the number of shares multiplied by the difference between closing price in the first day of negotiation and the initially offered one (Ibbotson, 1975; Miller & Reilly, 1987; Tinic, 1988; Leal & Lemgruber, 2000; Loughran & Ritter, 2002).
There is still no definitive explanation on underpricing. A view on this theme supports that underpricing occurs due to market imperfections regarding the IPO process, that is, the existence of information asymmetry among investors. For Benveniste and Spindt (1989) and Spatt and Srivastava (1991), the book building acts as a mechanism for data extraction so that adverse selection among investors can be reduced. These data are useful in the pricing of shares and set accuracy to the value being determined. The book-building practice enables the underwriters to obtain more information from better-informed investors (Cornelli & Goldreich, 2003). For Drake and Vetsuypens (1993), on the other hand, underpricing occurs due to legal liability. Underwriters use the book-building process in order to avoid legal problems in case of lack of clarification on something relevant in the IPO prospects. According to Taranto (2002), in turn, underpricing occurs due to the fact that executives who possess stock options can have fiscal benefit with the reduction of share prices in the first day of negotiation.
With regard to the concept of VC/PE funds, Takahashi (2006) states that VC funds are those invested in companies operating in new markets (NM), preferably the ones with a bold and entrepreneurial stance. In addition, VC funds enable companies to position themselves in a competitive market environment despite their difficulties to obtain credit lines due to their low level of net equity (Engel, 2002; Leite & Souza, 2001). On the other hand, investments of PE funds are aimed at large-sized companies with high growth potential. This investment is directly negotiated between funds and managers by means of a private placement. The financing of companies by means of VC/PE funds is aimed at providing capital for them and aggregating value through administrative participation (Barry, 1994; Takahashi, 2006; Sonoda, 2008).
In Brazil, VC funds are regulated under the normative instruction number 209/94 (CVM, 1994), whereas PE funds are regulated under the normative instruction number 391/03 (CVM, 2003). According to Carvalho, Furtado and Ribeiro (2006), the participation of VC/PE funds in the Brazilian market began in the 1990s due to the country's economic stability resulting from the Real Plan. The second cycle of this industry occurred in the 2000s when 71 VC/PE funds invested in 306 companies. Today, there are 157 VC/PE funds in Brazil (ABVCAP, 2018).
VC/PE funds have the reputation of being involved in the control of the company's activities. Wruck (2008) states that these funds add new management methodologies to the market, which, in turn, are applied to the invested companies. The VC/VE funds make investments in target companies, that is, those with management problems or inefficiency. According to Williamson (1967) and Jensen (1986), these funds understand that excess of free cash flow and high capitalisation are signs of poor management by the company.
The market's positive perception of the presence of VC/PE funds in companies is related to the theory of agency. According to Jensen and Meckling (1976), financing decisions are affected by the fact that the companies' owners delegate the management to fund agents. In this way, it is not possible to ensure that the fund agent will always make a great financial decision under the company managers' point of view. Mechanisms of control, corporate management, variable remuneration for managers, indebtedness, among others, are established in order to conciliate the interests of managers with those of shareholders. This set of measures is termed agency costs. The theory of agency points to the existence of information asymmetry between managers and owners.
Barry, Muscarella and Peavy (1990) found that companies with VC/PE fund investment are better positioned in the financing market before IPO compared to those with no participation of these funds in their capital structure. It is believed that companies belonging to the portfolio of these funds provide superior quality in the moment of IPO as a result of the reduced agency conflicts. For Saito and Silveira (2008), this occurs because of the concentration of functions as the same person plays the roles of manager and owner, which condenses the efforts for maximisation of the shareholders' wealth.
Another positive aspect highlighted in the literature regarding the presence of VC/PE funds in the company's capital structure is the mitigation of information asymmetry. This occurs when two or more fund agents make an economic transaction in which one of the parts involved holds more information than the others. Information asymmetry is one of the main market failures occurring when it is difficult or very expensive to obtain relevant and precise data on the quality of traded goods. This fact alters the market balance and resource allocation (Akerlof, 1970; Lambert, Leuz, & Verrecchia, 2011).
Rock (1986) identified that non-informed investors are more inclined...
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