IPO valuation and insider manipulation of R&D

Abstract

PurposeThe purpose of this paper is to examine the effects of R&D manipulation on stock valuation for periods around IPOs. Insider manipulation is the difference in actual R&D change minus predicted R&D change where a negative difference indicates R&D underinvestment.Design/methodology/approachThis study is designed to build on prior IPO research that has found reduced R&D expenditures when insiders lower their ownership. The paper derives an R&D manipulation variable that measures underinvestment in R&D. This variable is used in a regression methodology to test its influence on: IPO stock valuation at various points in time and post‐IPO price changes relative to the offer price.FindingsThe paper discovers that greater underinvestment in R&D is associated with greater values during the IPO stock valuation process. This association is reversed when the paper looks at short‐term valuation based on market prices. Only for bubble period IPOs do the paper finds poorer valuations for the long‐term. Larger insider ownership decreases lead to poorer valuations regardless of the period of occurrence. Greater R&D underinvestment and insider ownership decreases both lead to less underpricing.Research limitations/implicationsLike prior research, the paper assumes that knowledge about the change in R&D is known at the time of the offering. Interpretations for long‐run results can be tenuous due to unexpected changes that occur over time.Practical implicationsInvestors should note that managers are able to set higher offer prices when they inflate earnings by underinvesting in R&D. Buying at an inflated offer price with R&D manipulation leads to losses in the aftermarket with these losses associated with IPOs that occur during a bubble period.Social implicationsMisrepresentation during the IPO valuation process affects those who buy shares at inflated prices. This raises ethical questions about the behavior of those involved in the issuance process.Originality/valueThis study is unique in testing how R&D manipulation and changes in insider ownership proportions impact the: IPO valuation process, post‐IPO valuation, and changes in the stock price over time relative to the offer price.

Growth Opportunity and IPO Value: An Empirical Study of Malaysian IPOs

“…First, the underwriter's reputation (UNDREP) is positively related to both IPO price and market values during the IPO's first trading day, with a confidence level of 5 per cent. This finding is consistent with earlier studies by Aggarwal et al (2009) and Hull et al (2013) who found that investors trigger IPOs' value upwards when prestigious underwriters are involved in IPO issuance. Issuers use prestigious underwriters as signalling mechanism to investors to convey their high qualities of firms, as these underwriters obtain superior information of firms.…”

“…The positive result is further supported by prior studies (Aerts & Cheng 2012;Aggarwal et al 2009;Bédard, Coulombe & Courteau 2008;Hull et al 2013). However, the insignificant negative impact of SHARERTN on aftermarket prices possibly explains the greater shares retained by issuers, which is the cause of the agency problem between minority and majority shareholders, and in return could increase uncertainties in IPO market.…”

“…IPO proceeds which were allocated more for capital expenditures convey positive information to potential investors about the firms' high qualities. Trueman (1986)'s signalling arguments are further applied in studies by Krinsky and Rotenberg (1989), McGuinnes (1993) and Hull, Walker and Kwak (2013). As for the present study, we focus on the influence of growth opportunity on IPO pricing, which is closely linked to the signalling theory explanation by Trueman (1986).…”

The Role of Duality Managerial Ownership and Boards on Ipo Value (An Empirical Evidence of Indonesian Firms)

“…The responsibility of the old owner is shown by the TMT (top management team) not only managing the IPO process but also directing the company's growth and negotiating the IPO price. With the retention rate by the old owner, it is assumed by investors that the owner wants the success of the IPO, so that the company's value becomes the quality reference, (Hull et al, 2013). With the ownership of a large owner will have a positive effect on the value of the IPO.…”

R&D and Insider Shareholing

“…Cosh et al (2007) found that CEO shareholding positively affected innovative efficiency at low levels of shareholding, with the turning point lying between 65% and 68% of shareholding after which the effect turned negative. Hull et al(2013) discovered that larger under-spending in R&D was related with larger values during the IPO stock value assessment. Bigger insider shareholding reduces led to inferior valuations in spite of the period of occasion.…”