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THE RELATIOSNHIP BETWEEN THE BOARD COMPOSITION AND THE LEVEL OF IPO UNDERPRICING IN RUSSIAN COMPANIES
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Introduction 6
Chapter 1. The problem of IPO underpricing 8
1.1. The definition of the IPO process 8
1.2. Peculiarities of the Russia equity market 10
1.3. The problem of valuing an IPO company 13
1.4. IPO underpricing theories 16
1.4.1 Asymmetric information theories 17
1.4.2 Control theories and theories of deliberate underpricing 19
1.4.3. The influence of different specifications of the IPO and the parties participating in the IPO process 21
1.4.4. Behavioral theories 23
Chapter 2. Board composition and IPO practices 25
2.1. Mechanisms of Corporate Governance 25
2.2. The composition of board of directors as an effective corporate governance mechanism 28
2.3. Corporate governance mechanisms in Russia 32
2.4. Relationship between board composition and IPO underpricing 38
Chapter 3. Empirical research 40
3.1 Model and variables 40
3.2. Data sample 43
3.3 Descriptive statistics 46
3.4. Regression analysis results 50
3.5. Discussion 53
Conclusions 55
Bibliography 57
Appendix
Chapter 1. The problem of IPO underpricing 8
1.1. The definition of the IPO process 8
1.2. Peculiarities of the Russia equity market 10
1.3. The problem of valuing an IPO company 13
1.4. IPO underpricing theories 16
1.4.1 Asymmetric information theories 17
1.4.2 Control theories and theories of deliberate underpricing 19
1.4.3. The influence of different specifications of the IPO and the parties participating in the IPO process 21
1.4.4. Behavioral theories 23
Chapter 2. Board composition and IPO practices 25
2.1. Mechanisms of Corporate Governance 25
2.2. The composition of board of directors as an effective corporate governance mechanism 28
2.3. Corporate governance mechanisms in Russia 32
2.4. Relationship between board composition and IPO underpricing 38
Chapter 3. Empirical research 40
3.1 Model and variables 40
3.2. Data sample 43
3.3 Descriptive statistics 46
3.4. Regression analysis results 50
3.5. Discussion 53
Conclusions 55
Bibliography 57
Appendix
In the context of current economic conditions and geopolitical tension, companies are in need of fund-raising opportunities to ensure sustainable growth. One of the ways to raise money is Initial Public Offering (IPO). As a financing method, IPO offers benefits such as improvement of company reputation and visibility and as a consequence increase of the liquidity.
Analysts believe that the Global IPO market is expected to climb due to a number of factors including robust monetary policy of U.S. and Europe, normalization of business conditions and fundamental reforms (Ernst & Young (EY), 2016).
At the same time experts including the Central Bank of Russia researchers are convinced that the next step in development of the Russian economy is bound to equity financing. According the forecast by (Baker, McKenzie, & Oxford Economics, 2015) the Russian IPO market is expected to increase (Appendix2) despite the current economic challenges. Indeed, the holistic overview of the market from 2002-2015 demonstrates that 105 Russian companies went public, 55 of which were listed in Russia. In 2015 a number of companies have undergone an IPO process in Russia. "Novorossiksi kombinat hleboproduktov " and the leasing company “Europlan”, which is the part of the BIN group joined the Moscow Stock Exchange. Moreover, 8 IPOs are planned for 2016-2017.
However, in the process of IPO companies face a phenomenon known as IPO underpricing. IPO underpricing is usually measured as the percentage difference between the closing price on the first day of trading on the secondary market and the offer price. In other words, this means that the issuing company loses money, by receiving less funding it could potentially obtain if the issued shared were priced more fairly.
A considerable number of experts have increasingly admitted the significant role of non- financial determinants in the success of fund-raising activities. At the same time expert consensus is that the quality of corporate governance has become a considerable obstacle for attracting investment primarily for Russia given the current economic conditions. Notably, the global ratings agencies have embedded a methodology to assess the corporate governance practices of companies coming from emerging markets as part of improving the rating models. For example, Standard & Poor’s global rating agency pays attention on the ownership structure, shareholder rights’ protection, company’s affiliation history, company disclosure and, moreover, the efficiency of the board of directors. It follows that companies have to consider their corporate governance mechanisms along with traditional corporate performance to maximize the IPO proceeds.
Over the past several years, the importance of the board as a key internal control body and as a supervisor of strategic deals has grown over the past several years (Appendix 1). Moreover, an increasing number of the directors are convinced that the improvement of the quality of the corporate governance can increase investment attractiveness of their companies. In 2015 a number of major corporations such as Gazprom, Alrosa, VTB have attracted independent agencies to assess the efficiency of their board of directors. Moreover, the new Code of Corporate Conduct 2014, a document containing a cornerstone set of principles of corporate governance for Russian companies, recommends that corporation should asses the balance of professional experience, expertise and independency of its members to boost their strategic agility stimulate growth.
The academic literature traditionally covers the topic of IPO underpricing in relation to to financial and operational performance of the company. Only few works are dedicated to the research of the relationship between underpricing and corporate governance. At the same time, it has been argued that the board structure and the characteristics of members of the board influence the perception of the investors, and thus are associated with underpricing.
The unique context of corporate governance system in Russia combined with growth prospects of the IPO market makes the research on relationship between underpricing and corporate governance a very attractive field.
Thus, the primary subject of the master thesis is IPO underpricing.
The aim of this paper is to analyze the relationship between the board composition and the level of IPO underpricing of the Russian. The paper is an empirical research paper.
To achieve the goal the research paper has the following objectives:
1. Define the phenomenon and provide background of IPO underpricing
2. Identify factors attributed to board composition, which are associated with IPO underpricing based on the academic literature review.
3. Provide evidence of the relationship between IPO underpricing and the key identified factors
4. Conduct an empirical study of the relationship between the identified factors and the level of the IPO underpricing
5. Analyze the results of the empirical study and draw conclusions
Analysts believe that the Global IPO market is expected to climb due to a number of factors including robust monetary policy of U.S. and Europe, normalization of business conditions and fundamental reforms (Ernst & Young (EY), 2016).
At the same time experts including the Central Bank of Russia researchers are convinced that the next step in development of the Russian economy is bound to equity financing. According the forecast by (Baker, McKenzie, & Oxford Economics, 2015) the Russian IPO market is expected to increase (Appendix2) despite the current economic challenges. Indeed, the holistic overview of the market from 2002-2015 demonstrates that 105 Russian companies went public, 55 of which were listed in Russia. In 2015 a number of companies have undergone an IPO process in Russia. "Novorossiksi kombinat hleboproduktov " and the leasing company “Europlan”, which is the part of the BIN group joined the Moscow Stock Exchange. Moreover, 8 IPOs are planned for 2016-2017.
However, in the process of IPO companies face a phenomenon known as IPO underpricing. IPO underpricing is usually measured as the percentage difference between the closing price on the first day of trading on the secondary market and the offer price. In other words, this means that the issuing company loses money, by receiving less funding it could potentially obtain if the issued shared were priced more fairly.
A considerable number of experts have increasingly admitted the significant role of non- financial determinants in the success of fund-raising activities. At the same time expert consensus is that the quality of corporate governance has become a considerable obstacle for attracting investment primarily for Russia given the current economic conditions. Notably, the global ratings agencies have embedded a methodology to assess the corporate governance practices of companies coming from emerging markets as part of improving the rating models. For example, Standard & Poor’s global rating agency pays attention on the ownership structure, shareholder rights’ protection, company’s affiliation history, company disclosure and, moreover, the efficiency of the board of directors. It follows that companies have to consider their corporate governance mechanisms along with traditional corporate performance to maximize the IPO proceeds.
Over the past several years, the importance of the board as a key internal control body and as a supervisor of strategic deals has grown over the past several years (Appendix 1). Moreover, an increasing number of the directors are convinced that the improvement of the quality of the corporate governance can increase investment attractiveness of their companies. In 2015 a number of major corporations such as Gazprom, Alrosa, VTB have attracted independent agencies to assess the efficiency of their board of directors. Moreover, the new Code of Corporate Conduct 2014, a document containing a cornerstone set of principles of corporate governance for Russian companies, recommends that corporation should asses the balance of professional experience, expertise and independency of its members to boost their strategic agility stimulate growth.
The academic literature traditionally covers the topic of IPO underpricing in relation to to financial and operational performance of the company. Only few works are dedicated to the research of the relationship between underpricing and corporate governance. At the same time, it has been argued that the board structure and the characteristics of members of the board influence the perception of the investors, and thus are associated with underpricing.
The unique context of corporate governance system in Russia combined with growth prospects of the IPO market makes the research on relationship between underpricing and corporate governance a very attractive field.
Thus, the primary subject of the master thesis is IPO underpricing.
The aim of this paper is to analyze the relationship between the board composition and the level of IPO underpricing of the Russian. The paper is an empirical research paper.
To achieve the goal the research paper has the following objectives:
1. Define the phenomenon and provide background of IPO underpricing
2. Identify factors attributed to board composition, which are associated with IPO underpricing based on the academic literature review.
3. Provide evidence of the relationship between IPO underpricing and the key identified factors
4. Conduct an empirical study of the relationship between the identified factors and the level of the IPO underpricing
5. Analyze the results of the empirical study and draw conclusions
Traditionally, the phenomenon of IPO underpricing is commonly viewed in association with financial and operational performance metrics. The aim of the study was to explore the association between the level of underpricing and non-financial factors such as internal corporate governance mechanisms. Namely, we analyzed the relationship between the board composition and the level of IPO underpricing. We have chosen Russia as it represents unique context both in terms of corporate governance system and IPO market. To perform the empirical study we have employed a unique hand-collected data sample on Russian companies, listed on Russian stock exchanges for the pre-IPO period. Moreover, this paper studies board composition as a corporate governance mechanism at the pre-IPO stage of Russian corporations, which has not been covered in the contemporary academic literature before.
We have tested the following hypotheses:
• H1 The IPO’s board diversity is negatively associated with IPO underpricing of Russian IPO companies.
• H2 The share ownership of the IPO company’s non-executive directors is negatively associated with underpricing of Russian IPO companies.
• H3 The share ownership of the IPO company’s executive directors is negatively associated with underpricing of Russian IPO companies.
Our findings demonstrate that board diversity, namely the outside directorships of the board members, management experience of CEO and other executives and outside directorships positions occupied by independent directors in the relevant industry or financial sector are negatively associated with IPO underpricing.
At the same time the hypotheses about share ownership of executives and non-executives have not been empirically proved.
Based on the conducted study we believe that company should seek to appoint:
1. CEO and other executives with prior directorship and managerial (CEO) experience
2. Independent directors with experience in the industry, related to the company operations
3. Non-executives with outside directorships in the relevant industrie and or/ in financial sector
This study contributes to the existing body of corporate governance literature by offering valuable insights on the role of corporate governance mechanisms in the context of IPO performance. This paper extends the prior study of the board characteristics in Russia by taking into account more involved board composition metrics such as outside directorships, experience of executives and independent directors at the time of an IPO.
At the same time given the context of the study, it has a number of limitations. The board composition as a corporate governance mechanism is considered in isolation without taking into consideration external corporate governance mechanisms. For example, consideration of institutional context, labor market for managers and other external corporate governance mechanism, comparative study of Russia IPO on Russian and foreign stock exchanges are some of the possible directions of future research
We have tested the following hypotheses:
• H1 The IPO’s board diversity is negatively associated with IPO underpricing of Russian IPO companies.
• H2 The share ownership of the IPO company’s non-executive directors is negatively associated with underpricing of Russian IPO companies.
• H3 The share ownership of the IPO company’s executive directors is negatively associated with underpricing of Russian IPO companies.
Our findings demonstrate that board diversity, namely the outside directorships of the board members, management experience of CEO and other executives and outside directorships positions occupied by independent directors in the relevant industry or financial sector are negatively associated with IPO underpricing.
At the same time the hypotheses about share ownership of executives and non-executives have not been empirically proved.
Based on the conducted study we believe that company should seek to appoint:
1. CEO and other executives with prior directorship and managerial (CEO) experience
2. Independent directors with experience in the industry, related to the company operations
3. Non-executives with outside directorships in the relevant industrie and or/ in financial sector
This study contributes to the existing body of corporate governance literature by offering valuable insights on the role of corporate governance mechanisms in the context of IPO performance. This paper extends the prior study of the board characteristics in Russia by taking into account more involved board composition metrics such as outside directorships, experience of executives and independent directors at the time of an IPO.
At the same time given the context of the study, it has a number of limitations. The board composition as a corporate governance mechanism is considered in isolation without taking into consideration external corporate governance mechanisms. For example, consideration of institutional context, labor market for managers and other external corporate governance mechanism, comparative study of Russia IPO on Russian and foreign stock exchanges are some of the possible directions of future research