Is there still a Berlin Wall in the post‐issue operating performance of European IPOs?

• DOI: http://doi.org/10.1002/ijfe.1573
• Published date: 01 April 2017
• Author: Miguel Sousa,Tiago Pinho Pereira
• Date: 01 April 2017

RESEARCH ARTICLE

Is there still a Berlin Wall in the post‐issue operating performance

of European IPOs?*

†

Tiago Pinho Pereira

1,2

| Miguel Sousa

2,3

1

Statistics Department, Banco de Portugal, Porto,

Portugal

2

School of Economics and Management,

University of Porto, Porto, Portugal

3

Center of Economics and Finance, University of

Porto, Porto, Portugal

Correspondence

Tiago Pinho Pereira, Statistics Department, Banco

de Portugal, Porto, Portugal.

Email: tppereira@bportugal.pt

JEL Classification: G11; G14; G32

Abstract

This paper studies the post‐IPO operating performance of a sample of 555 European

firms that went public between 1995 and 2006. Consistent with previous findings,

we observe a decline in post‐issue operating performance of IPO firms. However,

firms located in emerging European countries perform even worse after the IPO than

firms located in developed European countries. Our results suggest that this less

successful post‐issue operating performance by firms located in emerging countr ies

can be explained by a more aggressive use of accruals and a better timing of the IPO

in order to coincide with a period of high operating performance.

KEYWORDS

earnings management, emerging markets, IPO, market timing, operating performance

1|INTRODUCTION

This paper studies the post‐issue operating performance of

European firms

1

that completed an initial public offering

(IPO). As pointed out by Jain and Kini (1994), although there

are many studies investigating post‐issue stock price perfor-

mance, studies focusing post‐IPO operating performance are

rare and even scarcer in Europe. This study serves to fill in

a gap in the literature concerning the post‐issue operating per-

formance of European IPO firms.

The current macroeconomic scenario and its borrowing

constraints have pushed several companies to the IPO market

as an alternative funding source. In the last couple of years,

several companies filed plans for IPOs with market authori-

ties and, although some afterwards withd rew or postponed

their plans, a growing number of notable IPOs occurred:

LinkedIn, Groupon, and Glencore went ahead during 2011,

Facebook in 2012, Twitter in 2013, Alibaba in 2014, and

more recently, Fitbit in 2015.

In Europe, one of the principal features of the IPO market

in the last decade has been the significant number of IPOs

occurring in Eastern European countries, especially in

Poland. Indeed, according to Ernst and Young (2010, 2011,

2012), Warsaw's NewConnect market (Poland) appeared in

the top 5 stock exchanges by number of deals in 2008

2

and,

in 2010 and 2011, Polish exchanges led European IPO mar-

kets with 95 and 123 deals, respectively.

The large number of IPOs, which occurred not only in

developed European countries but also in emerging European

countries during this period made us consider the eventual

existence of differences between both types of IPO markets

in terms of underpricing and post‐issue operating perfor-

mance of the firms involved and explore whether these poten-

tial differences can be explained by certain characteristics of

both types of financial markets. Hence, we compiled a set

of law and finance measures that try to explain the different

post‐IPO operating performance between the two groups of

countries.

Several papers have already explored the causes behind

this divergent financial behavior. For example, a different

level of market integration and liberalization in emerging

markets when compared with developed markets affects the

*

Comments welcome to tppereira@bportugal.pt (+351 96 9416213) or

msousa@fep.up.pt (+351 91 4164647). We thank the participants in the

2012 Financial Management Association Annual Meeting, 2012 Multina-

tional Finance Society Conference, and 2012 Portuguese Finance Network

Conference for useful comments and valuable suggestions. Finally,f inancial

support from the Portuguese government through the FCT ‐Fundação para a

Ciência e Tecnologia (PEst‐OE/EGE/UI4105/2014 project) is gratefully

acknowledged.

†

The views expressed are those of the authors and do not necessarily repre-

sent those of the Banco de Portugal or the Eurosystem. Any errors and omis-

sions are the sole responsibility of the authors.

Received: 20 August 2015 Revised: 4 July 2016 Accepted: 23 November 2016

DOI: 10.1002/ijfe.1573

Int J Fin Econ. 2017;22:139–158. Copyright © 2017 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/ijfe 139

equity return generating process, the capital flows, and the

cost of capital in those markets (Bekaert & Harvey, 2003).

Also, La Porta, Lopez‐de‐Silanes, Shleifer, and Vishny

(1998) concluded that “[b]oth shareholder rights and the legal

enforcement of the rights that do exist are generally lacking in

emerging markets”and that there is a “link from the legal sys-

tem to the economic development.”

Our paper makes a synthesis of the literature and goes

beyond, regressing operating returns on a set of variables that

capture not only the issues raised by previous studies, such as

ownership, underpricing, age, and size of the firms but also

past performance, origin of the IPO market, strength of the

institutions, and level of financial development, which are

novel features added by this work.

As far as we know, this study is the first that compares

IPOs occurred in the Eastern (emerging) European countries

to those that happened in developed European countries and

the first that introduces law and finance variables to explain

the different levels of post‐IPO operating performance

between the two groups of countries. This information can

be very valuable to entrepreneurs interested in investing in

emerging markets. Moreover, it covers all the IPO activity

that occurred in all European countries during the same

period. Existing literature in this field mainly focuses on a

specific country (e.g., Burgstaller [2009] in Austria,

Huyghebaert and Van Hulle [2006] in Belgium, and Pagano,

Panetta, and Zingales [1998] in Italy), with different method-

ologies and different time periods. This fact makes the com-

parison between them difficult, if not impossible.

Using a sample of 555 European companies, which went

public between 1995 and 2006, our study shows that compa-

nies outperform matched firms before the issue but

underperform afterwards, in line with the previous studies

pointed out before. Our results also confirm that firms from

emerging European countries are smaller, more profitable

before the IPO and face a larger underpricing than firms from

developed European countries. However, they attain a worse

post‐issue operating performance than firms from developed

European countries.

Our results suggest that this inferior post‐issue operating

performance can be explained by earnings management

(through discretionary accruals) by managers from emerging

European countries and a better timing of the IPO to coincide

with a period of high operating performance. Acting this way,

managers are able to make the issue more attractive for the

investors but, as expected, those high earnings cannot be

sustained for a long time and so a decline in post‐IPO operat-

ing performance is unavoidable. We also find that legal rules

and the level of financial development of emerging European

countries impacts negatively post‐issue operating perfor-

mance of firms that go public in these countries.

The paper is organized as follows: After this 1, Section 2

presents a literature review, Section 3 describes the

data sources and exhibits the sample summary statistics,

Section 4 presents the methodology, and Section 5 reports

the empirical univariate and multivariate results for the entire

sample. Section 6 develops the earnings management

hypothesis to explain the results for the firms from emerging

European countries and, finally, Section 7 concludes.

2|LITERATURE REVIEW

We largely follow the methodology of Jain and Kini (1994)

in order to study the post‐issue operating performance of

European IPO firms

3

and then split our sample by

geographic market, more specifically between IPOs from

developed European countries and IPOs from emerging

European countries, in order to identify differences between

both groups of firms. To more clearly understand the eco-

nomic environment of emerging European countr ies and

its impact in the post‐IPO performance, we also take into

account some law and finance variables used by Brown,

Martinsson, and Petersen (2013). These variables are

derived from La Porta et al. (1998) and subsequent litera-

ture, namely Djankov, La Porta (2008a), which show that

there is a link between legal systems, economic, and finan-

cial markets development.

Earlier studies have already looked at the correlation

between stock markets development and the growth of the

economy. For instance, Choe, Masulis, and Nanda (1993)

document that the number of firms issuing common stock

is, historically, higher during expansionary phases of the

business cycle. They developed a model in which business

cycle variables have significant explanatory power in the

magnitude of stock returns and the magnitude of stock

returns is related to the volume of equity issues. Given the

fact that, according to OECD Statistics,

4

Polish real GDP

has grown 3.6% in 2005 and 6.2% in 2006, this could be an

explanation for the hot Polish IPO market.

On the other hand, Pagano (1993) argues that not all

countries in the same economic stage have the same stock

market size. He points out that the most important determi-

nants of stock market size are the institutional and regulatory

arrangements. He also discusses the differences between the

regulatory framework in Anglo‐Saxon stock markets and

Continental Europe stock markets.

Studies on IPO firms' operating performance, such as Jain

and Kini (1994), compare the performance of firms, mainly

measured by operating income, before and after the IPO, usu-

ally in a period of 5 years (from the year before the IPO to the

year +3 following the IPO completion) and explain it through

a set of regressors.

Previous studies of IPO firms' operating performance

show a decrease in the operating performance after the

IPO, including Degeorge and Zeckhauser (1993) who were

the first to introduce the “window‐dressing”hypothesis in

order to explain it. These authors suggest that there could

be a performance manipulation before the IPO, in order to

make the offering more attractive to investors. Jain and Kini

140 PEREIRA AND SOUSA