Same bank, same company, different peers:
changes in the selection of comparable firms before and after the IPO
Silvio Vismara a,, Stefano Paleari a, Andrea Signori a
Abstract
The most common method for valuing firms going public is the use of comparable multiples. Differently
from the United States, the peers chosen by underwriters are frequently published in European IPO
prospectuses. We compare this selection with that done shortly after the IPO by the same investment bank
providing aftermarket analyst coverage. We find that 5.9 out of 6.7 peers, on average, change, with peers
reported in IPO prospectuses having higher valuation multiples than those selected as post-IPO analyst. This
upward bias in the selection of peers is larger for underwriters with greater bargaining power, and lower for
those that take companies public more often. The presence of venture capitalists in an IPO provides
underwriters with increased bargaining power, but VCs that take more companies public and repeatedness in
the matching between an underwriter and a VC are associated with lower bias. We also find that more biased
selections of peers by underwriters result in poorer long run performance.
Key words: Initial Public Offerings, valuation, underwriters, analyst, comparables.
JEL Code: G30.
a
University of Bergamo, Department of Economics and Technology Management, via Pasubio 7b, 24044 Dalmine
(BG), Italy.
* Contact author: Silvio Vismara, via Pasubio 7b, 24044 Dalmine (BG), Italy. E-mail: [email protected], tel.:
(+39) 035.205.2352. Other authors’ e-mail addresses: [email protected], [email protected].
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1. Introduction
Information asymmetry in financial markets is one of the necessary conditions for misconduct to arise
(Allen and Gale, 1992). In presence of heterogeneous information, market participants at an informational
advantage can extract benefits by driving transaction prices, at the expense of less informed counterparts. A
setting where information asymmetry is particularly severe is the IPO market (Rock, 1986). While insiders
possess extensive information regarding firm quality, public market investors typically face limited
knowledge of the securities offered (Leland and Pyle, 1977). Issuers therefore hire a financial intermediary
that is in charge of mitigating the effects of information asymmetry and is required to price and sell the
shares. This paper focuses on the conduct pursued by these intermediaries when valuing IPOs.
Comparable firm multiples is the most common approach used by underwriters to value IPOs (Ritter and
Welch, 2002). In the IPO setting, where shares are offered to a diversified range of investors, this
methodology has the advantage of being intuitive and simple to justify, as it does not require to share the
assumptions about the firm’s future cash flows. Its main limitation lies instead in the discretion left to
underwriters in the selection of peers, as they may be tempted to choose comparable firms that make the
offer price look conservative. Previous studies on IPO valuation, such as Kim and Ritter (1999) and
Purnanandam and Swaminathan (2004), typically use matching algorithms to estimate the peers of firms
going public, as those actually used by the underwriters are not publicly available in the United States. In
Europe, this information is frequently disclosed in offering prospectuses, as recommended by the EU
Prospectus Directive. We take advantage of this to compare the peers selected by the underwriter at the time
of the IPO with those selected by the same investment bank shortly after the IPO, when providing analyst
coverage to the firm taken public. By comparing how the selection of peers is carried out by the same
investment bank at two different (but not distant) points in time, we are able to detect potential misconducts.
Underwriters face a trade-off when valuing IPOs. On one hand, they have a short-term incentive to raise
the valuation and increase the profit from underwriting fees, leaving issuers satisfied with a larger amount of
capital available for future investments. On the other hand, creating the reputation of systematically
overpricing shares may be dangerous in the long-term, as investors would become reluctant to subscribe
future equity issues underwritten by the same investment bank. The need to preserve reputational capital,
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stronger for intermediaries that act more repeatedly in the IPO market, is therefore expected to discourage
misconduct. This threat on the reputational capital, however, may not always be effective. A large bargaining
power vis-à-vis investors provides underwriters with a leeway and reduces the expected long-term losses
associated with opportunistic behaviors. We therefore argue that the valuation conduct of banks that take
only few, large companies public from time to time, is less affected by long-term reputational concerns. This
is particularly true for US banks, whose reputation only marginally depends from their behavior in the
European IPO market.
A similar trade-off between bargaining power and reputational concerns applies to venture capitalists,
whose presence in an IPO provides the underwriter with increased bargaining power that may lead to greater
valuation bias. On the other hand, VCs that take companies public more often are expected to care more of
their reputational capital, and therefore to be associated with lower distortion in the selection of peers at the
IPO. Similarly, the degree of repeatedness in the matching between an underwriter and a VC, as measured by
the number of firms taken public ‘together’, should be negatively associated with bias in peers selection.
We test these hypotheses on a sample of 130 IPOs occurring from 1999 to 2013 in the regulated markets
of the three main stock exchanges of continental Europe (France, Germany, and Italy), where disclosure of
valuation methods is required. We find that the average number of peers is 6.7 in both the prospectus and in
the first equity research report released after the IPO, but 5.9 peers are different. Given that the report is
released on average only 5 months after the IPO prospectus, such a drastic revision in the set of peers looks
suspicious. We compare the valuation of the two groups of peers, and find that peers in prospectus have
significantly higher multiples. This opportunistic behavior of investment banks, who revise their own choice
of peers in favor of comparable firms with lower multiples, has never been documented before. We also
show that the bias in peer selection is larger for US investment banks, for underwriters with larger market
share in terms of capital raised in IPOs, and in the presence of VCs, as predicted by the bargaining power
hypothesis. On the other hand, it decreases with the underwriter’s and the VC’s degree of repeatedness in the
IPO market, measured as the number of firms taken public, as predicted by the reputational capital
hypothesis. Finally, we find that greater bias in the selection of peers is associated with poorer long run
performance.
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The remainder of the article is organized as follows. Section 2 defines the testable hypotheses of the
paper, and Section 3 presents the sample and methodology used to test them. Section 4 shows the empirical
tests and results of the analysis, and Section 5 provides additional robustness tests. Section 6 concludes.
2. Testable hypotheses
Previous studies (e.g., Kim and Ritter, 1999; Purnanandam and Swaminathan, 2004; Chemmanur and
Krishnan, 2012) show that IPOs are significantly overvalued compared to industry peers. However, by
deliberately discounting the offer price from the valuation of the peers published in prospectus, underwriters
may present the IPO as favorably priced and stimulate investor demand. In a European setting, Paleari et al.
(2013) find that underwriters perform a biased, left-truncated selection of peers at the IPO, as they omit those
with the poorest valuations compared to peers obtained from matching algorithms. On average, comparable
firms published in prospectuses have 13% to 38% higher valuation multiples than those of alternatively
selected peers.
Investment banks are often in charge of valuing the firms they take public both at the IPO, as
underwriters, and after, as sell side analysts (Dugar and Nathan, 1995; Liu and Ritter, 2011). Like
underwriters, financial analysts play a key role in mitigating information asymmetries and their beneficial
role has been extensively documented (Hong et al., 2000; Barth and Hutton, 2004; Chang et al., 2006;
Bowen et al., 2008). There is, however, a strand of literature that points out the analysts’ tendency to produce
overoptimistic recommendations to drive prices above the level suggested by the firm’s fundamentals (Rajan
and Servaes, 1997; Hayes, 1998). A particular category of analysts that have drawn the attention of several
researchers is that of affiliated analysts, due to the potential conflict of interests to which they are exposed.
Lin and McNichols (1998), Michaely and Womack (1999), and Dechow et al. (2000) show that forecasts and
recommendations by underwriter’s analysts tend to be significantly more favorable than those made by
unaffiliated analysts.
The aim of this paper, however, is to unveil misconduct by detecting anomalous changes in the way the
same investment bank values the IPO firm before and after the shares are placed on the market. As the
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largest fraction of the compensation to the investment bank is realized at the initial valuation, underwriters
have an incentive to raise the valuation of the firm at the IPO, by making it look conservatively valued
relative to comparable firms. This monetary incentive is not driving post-IPO analysts valuations.
Based on these arguments, we formulate the following hypothesis:
Hypothesis 1: The valuation of comparable firms selected by the underwriter at the time of the IPO is
significantly higher than that of comparable firms selected by the same investment bank acting as analyst of
the same firm shortly after the IPO
2.1 Bargaining power
Information asymmetry generates the need to involve an uninterested third party in a market transaction,
in charge of mitigating adverse selection and moral hazard problems (Leland and Pyle, 1977). In the case of
IPOs, this role is primarily accomplished by underwriters. At the moment of valuing IPOs, underwriters face
a trade-off between the short-term gain from raising the valuation and the long-term cost of losing market
share due to damaged reputation. We argue that the importance assigned by underwriters to these two
conflicting incentives influences their selection of peers.
The incentive to raise the valuation of an IPO exists for all underwriters because their gross spread
revenue per share is proportional to the offer price. Furthermore, successfully obtaining high IPO proceeds
would leave issuers satisfied, inducing them to remain affiliated with the same bank in case of future
corporate events. Krigman et al. (2001) show that one of the reasons pushing firms to switch underwriter in
follow-on offerings is that the IPO brought fewer proceeds than originally expected. Chemmanur and
Krishnan (2012) show that IPO firms backed by high-reputation underwriters are priced higher and further
away from the intrinsic value compared to low-reputation underwriters, because high-reputation underwriters
are able to exercise market power. A necessary condition for underwriters to exercise such power is a
sufficiently strong bargaining position vis-à-vis investors. We therefore expect underwriters who benefit
from a higher bargaining power to be more biased in the selection of peers at the IPO.
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In order to model the bargaining power effect, we need to account for some peculiarities of the European
IPO market. In Europe, the underwriting market is not as integrated as in the US (Abrahamson et al., 2011).
As documented by Migliorati and Vismara (2013), this market is characterized by essentially two types of
players. Domestic banks who take public a considerable number of companies on the national stock
exchange; and larger banks, often US-based, who tend not to interact with small companies but underwrite a
limited number of very large IPOs1. In this context, the underwriters benefiting from an increased bargaining
power vis-à-vis investors are those who raise the largest amount of capital on the IPO market. The concerns
about the possibility of losing reputation because of misvaluing IPOs in Europe are particularly low for big
US investment banks. Migliorati and Vismara (2013) show indeed that, while the value of the IPO business
in Europe is a significant fraction of the profits for most of the domestic underwriters, this is of only limited
importance for US banks, that do not take companies public repeatedly in this market.
Chemmanur and Krishnan (2012) argue that underwriters are able to increase their market power by
generating greater participation by higher quality market players. Among them, venture capitalists are able to
provide a valuable certification effect (Megginson and Weiss, 1991). Coherently, venture capital-backed
firms are found to perform better in the long-run (Alon and Gompers, 1997). When a VC-backed firm comes
to the IPO market, the affiliation with an investment bank is likely to be subject also to the venture
capitalist’s approval as existing shareholder. This raises both the profile of the firm and of the underwriter
before potential investors. We therefore expect that underwriters taking public VC-backed firms benefit from
an increased bargaining power towards investors.
Based on these arguments, we formulate the following hypotheses:
Hypothesis 2a: The bias in the selection of comparable firms before vs after the IPO is higher for
underwriters that raise more capital in the European IPO market
Hypothesis 2b: The bias in the selection of comparable firms before vs after the IPO is higher for USbased underwriters
1
Considering the population of IPOs occurred between 1995 and 2010 on four European stock markets (London,
Euronext, Frankfurt, and Milan), Migliorati and Vismara (2013) document that the largest fraction is underwritten by
domestic banks (85.2%), while foreign banks rarely take companies public. The only exception is represented by US
banks, involved in 9.7% of the IPOs.
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Hypothesis 2c: The bias in the selection of comparable firms before vs after the IPO is higher for
underwriters of venture-backed IPOs
2.2 Reputational capital
Persistently overpricing IPOs may damage the reputation of underwriters. Previous studies find that shortrun mispricing by underwriters causes a significant reduction in their market share (Beatty and Ritter, 1986)
and market value (Nanda and Yun, 1997). As a consequence, the threat of being punished by other market
participants due to misconduct being detected creates the incentive to appropriately price issues (Chemmanur
and Fulghieri, 1994). However, this threat may not have the same importance to all underwriters.
Underwriters are indeed able to credibly act as certifying agents towards investors because they take part to
several transactions in the IPO market over time, which allows them to develop a reputational capital (Beatty
and Ritter, 1986). The same argument applies to venture capitalists, who tend to bring companies in their
portfolio to the market on an ongoing basis, as well as to take part in a series of equity investments in various
firms over time. The more they seek to be active players in the financial markets, the more they are
concerned about their reputation. This increases their willingness to discourage misconduct by IPO
underwriters of their portfolio companies. We therefore expect that the higher is the frequency with which
both underwriters and venture capitalists act in the IPO market, the stronger is the need to preserve
reputational capital due to larger expected loss arising from short-run opportunistic behavior, and the lower
is the bias in the selection of peers.
Organizations need to collaborate to be able to survive against competitors, and the likelihood to keep
their business alive depends on one another’s resources for survival (Cyert and March, 1963). In our
framework, underwriters and venture capitalists repeatedly interact, and the success of the deals depends also
on their interaction. For instance, when a venture capitalist owns a significant fraction of equity in the firm, it
takes part to the negotiation for the definition of the price at which the issuer’s shares are placed by the
underwriter. Bradley et al. (2012) argue that, given that VCs cannot sell all their shares at the time of the
IPO, they care about the aftermarket price at the time they are allowed to sell shares, after lock-up expiration.
7
As a consequence, VCs may engage in quid-pro-quos with underwriters, accepting lower initial valuations in
exchange for post-IPO marketing support and all-star analyst coverage (Hoberg and Seyhun, 2006; Liu and
Ritter, 2011). Cooperating underwriters, in turn, receive repeat business. If both parties are aware that, by
negotiating over repeated sequence of future IPOs, a substantial fraction of their future revenues depends on
one another’s market share, they are less likely to engage in opportunistic behavior. This suggests that the
higher is the degree of interaction between an underwriter and a venture capitalist, the lower is their common
incentive to excessively raise the firm’s valuation at the IPO.
Based on these arguments, we formulate the following hypotheses concerning the reputational capital
effect in the underwriter’s trade-off associated with the valuation of IPOs:
Hypothesis 3a: The bias in the selection of comparable firms before vs after the IPO is lower for
underwriters that take companies public more frequently in European markets
Hypothesis 3b: The bias in the selection of comparable firms before vs after the IPO is lower for
underwriters of IPOs backed by venture capitalists that take companies public more frequently
Hypothesis 3c: The bias in the selection of comparable firms before vs after the IPO is lower when the
underwriter and the venture capitalist have already matched in past IPOs
2.3 Long-run performance
Ritter (1991) documents that IPOs underperform in the long run. When investors are over optimistic
about the future potential of certain industries, firms may take advantage from such a window of opportunity
by timing their IPO and benefiting from very high valuations (Loughran and Ritter, 1995). This inevitably
causes poor performance in the long-run, as market enthusiasm starts to fade and stock prices are
progressively adjusted. In addition to this market timing effect, underwriters who select an upwardly biased
set of peers contribute to the overvaluation of IPO firms. If the underwriter’s selection is appropriate due to
the superior quality of the issuer, we should detect no influence of the bias in peer selection on the long run
returns of IPOs. If, instead, the selection is biased with the purpose of obtaining higher valuations that still
8
look conservative, as we argue, then we should observe poorer long run returns for IPOs with larger bias. We
therefore formulate the following hypothesis:
Hypothesis 4: Long run performance. Long run performance is poorer for IPOs with larger bias in the
selection of comparable firms
3. Sample and methodology
3.1 Sample and data
The sample is composed of 130 IPOs taking place between 1999 and 2013 on the three largest stock
markets of Continental Europe, namely France (Euronext), Germany (Deutsche Börse), and Italy (Borsa
Italiana). Our sources of information are the Euripo database, for data on IPOs and official prospectuses, and
Investext Investment Research and stock exchanges websites, for post-IPO equity research reports published
by underwriters. The focus on the European context is motivated by the fact that in the US there is no
publicly available information about the valuation methodologies used by underwriters in setting IPO prices.
Therefore, we would have been unable to compare the two selections of peers made by the same bank in US
IPOs.
In Europe, the Prospectus Directive (2003/71/EC) established a harmonized format for IPO prospectuses
of companies going public on regulated markets, although disclosure policies vary by country2. However,
some member states, such as the United Kingdom, consider that a general indication of the valuation method
or combination of methods used to value the company is sufficient without the need to give any kind of
approximate figures. In contrast, other members consider that underwriters should include in the
prospectuses a detailed indication of the method of valuation of the issuer, together with an indication of the
approximate non-binding values of the share that would result from the application of such method. This
typically happens in France, Germany, and Italy, on which we focus on. Starting from a population of 375
IPOs, we obtain a final sample of 130 IPOs valued using multiples for which there is full disclosure about
The “level of disclosure concerning price information” is defined in Article 8.1 of the Directive and item 5.3.1 of
Annex III.
2
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the comparable firms both in the prospectus and in the first equity research report published after the IPO,
thereby allowing a comparison between the two selections of peers made by the same investment bank.
Descriptive statistics of the sample used in the paper and of the rest of the population of IPOs are reported in
Appendix A. Results of tests for sample bias, overall, suggest that our sample is representative of the
population of IPOs. Nevertheless, we correct for potential selection bias in our econometric analysis using
Heckman selection models.
Table 1 describes the selection of peers and the use of multiples by underwriters. Panel A shows that
underwriters select on average 6.7 peers to value IPOs, as published in official prospectus, and keep the same
average number of peers when providing analyst coverage after the IPO. However, an average of 5.9 peers
are either used in the IPO prospectuses but not in post-IPO reports (removed) or used after the IPO but not
before (added). Given that the report is released on average only 4 months after the IPO prospectus, this high
number of changed peers asks for investigation. Panel B documents that six multiples are used by
underwriters in the peer comparables valuation. The Enterprise Value-to-EBITDA (EV/EBITDA) and the
Price-to-Earnings (P/E) ratios are the most common multiples, adopted in 79.2% and 72.3% of the sample
IPOs, respectively.
[ TABLE 1 ]
3.2 Methodology
The baseline hypothesis of the paper (Hypothesis 1) is that the valuation of comparable firms selected by
the underwriter at the time of the IPO is significantly higher than that of comparable firms selected by the
same investment bank providing post-IPO analyst coverage to the same firm. We empirically test this
hypothesis by directly comparing the distribution of the valuation multiples associated with the peers
published in prospectus with that of the peers published in the equity report. We then test for significant
differences.
10
Hypothesis 2 concerning the bargaining power effect and hypothesis 3 concerning the reputational capital
effect are tested in a multivariate setting. A fundamental issue arising in this analysis is selection bias. The
underwriter’s bias in the selection of peers that we observe in our sample may be affected by self-selection,
caused by the ex-ante underwriter’s decision whether to disclose or not the comparable firms used in the
valuation of the IPO. The OLS approach may therefore suffer from the presence of unobservable factors that
affect both the treatment selection (the probability of an IPO to be subject to disclosure) and the treatment
outcome (the magnitude of the bias in peer selection). This unobservable factor could be the underwriter’s
willingness to bias the selection of peers. Let’s assume that underwriters are able to anticipate the extent to
which the offer price of an IPO needs to be raised. Since they know in advance how biased the selection of
peers will have to be in order to justify the initial IPO valuation, they may decide not to publish the peers in
those IPOs that are subject to excessive manipulation, whereas they may be willing to disclose peers only in
those IPOs where their bias is limited. In this case, the observed underwriter’s bias in peer selection would
be biased downward.
To control for self-selection, we use a two-step Heckman procedure that corrects for unobservable factors
that drive both the disclosure decision and the underwriter’s bias the selection of peers. In the first step, the
probability of being subject to disclosure of peers by underwriters is modeled on the population of IPOs
occurring on main markets of the stock exchanges of France, Germany, and Italy during 1999-2013. In the
second step, we employ a direct measure of the underwriter’s opportunistic behavior in the selection of peers
as dependent variable. This variable is labelled valuation bias, and is defined as follows:
valuation bias =
1
𝑁
∑𝑁
𝑗=1 𝑙𝑛 (
𝑀(𝑗) 𝑢𝑛𝑑𝑒𝑟𝑤𝑟𝑖𝑡𝑒𝑟
𝑀(𝑗) 𝑎𝑛𝑎𝑙𝑦𝑠𝑡
)
where M(j) is the average of the j-th multiple used to value the IPO (e.g., P/E), with N being the number of
multiples used to value the IPO firm (N varies from 1 to 6). The average across the multiples used gives the
firm-specific valuation bias.
11
The explanatory variables we include in the second step of the Heckman procedure are defined as
follows3. First, the bargaining power hypothesis predicts that valuation bias is higher for underwriters with
greater market share in terms of amount of capital raised, and in case of venture capital-backed IPOs. We
measure the market share of each underwriter in terms of IPO proceeds raised in the European stock
exchanges during 1995-2013. This measure is calculated with reference to the population of IPOs in Europe
during 1995-2013, from the Euripo database4. Given that European-based measures of reputation are
downwardly biased for US-based investment banks, we also include a dummy variable to identify US
underwriters (US investment bank dummy equals to 1). Then, we control for the presence of venture
capitalists by introducing a dummy that equals 1 in case of VC-backed IPO. Second, the reputational capital
hypothesis predicts that valuation bias is lower for underwriters that take companies public more frequently,
and for IPOs backed by venture capitalists that take companies public more frequently. We measure the
degree of repeatedness of underwriters and venture capitalists in the IPO market by computing the market
share in terms of number of IPOs underwritten and backed, respectively, in European stock exchanges.
Again, these measures are calculated with reference to the population of IPOs in Europe during 1995-2013.
The Hypothesis 3.c predicts that valuation bias is lower when the underwriter and the venture capitalist
repeatedly interact with each other in the IPO market. We proxy for this degree of interaction by including a
dummy equal to 1 if the underwriter-VC matching occurred in at least another IPO in European markets
during the three years preceding the IPO date.
Hypothesis 4 predicts that long run performance is poorer for IPOs with larger valuation bias. We test this
hypothesis in a cross-sectional regression on long-run performance. We calculate the buy-and-hold abnormal
return (BHAR) of each IPO firm as in Loughran and Ritter (1995), and use it as dependent variable. We take
daily returns from the beginning of the holding period until the minimum between the end of the holding
period and delisting date. As in Vismara et al. (2012), the holding period starts from the 22nd day of trading,
as underwriters can stabilize prices during the first 21 days, and ends at the one-, three-, and five- year IPO
3
We include the US investment bank and the VC-backing dummies in the first step of the Heckman procedure, where
we model the probability of an IPO to be subject to disclosure of the comparable firms selected. We also employ a
number of extensively used control variables at the firm, offer, and market level (see, e.g., Ritter, 1991).
4
Over 4,000 firms went public in Europe during 1999-2013. See Vismara et al. (2012) for a description of the database.
12
anniversary, or at the delisting date if this occurs earlier. The FTSE Euromid index is used as benchmark. As
control variables, we include firm and market indicators in line with previous studies (e.g., Levis, 2011).
4. Results
Table 2 compares the average mean, median, minimum, and maximum values of the valuation multiples
the peers selected by the underwriter, as reported in prospectus, with that of the peers selected as analyst, as
reported in the first equity research report after the IPO. We find that for all the three most common
valuation multiples, i.e. EV/EBITDA, P/E, and Enterprise Value-to-Sales (EV/Sales), a significant difference
exists between the valuations of the two groups of peers. The valuation of the peers selected as analyst is
persistently lower. The average EV/EBITDA, P/E, and EV/Sales of the peers selected as underwriter is 18.4,
44.4, and 15.1, respectively, while it drops to 12.6, 27.1, and 5.4 in the selection made as analyst. The
differences in means are not statistically significant for the other three multiples, i.e. EV/EBIT, Price-to-Cash
Flows (P/CF), and Price-to-Book Value (P/BV), arguably due to the limited number of observations.
[ TABLE 2 ]
Evidence in Table 2 documents statistical difference also between median and minimum multiples, but
not between maximum multiples, which suggests that underwriters tend to exclude peers with low valuations
at the moment of valuing the IPO. We further investigate this point by plotting in Figure 1 the distributions
of the valuation multiples not only of the peers published in prospectus (‘underwriter’) and in the equity
report (‘analyst’), but also of the changed peers. These are comparable firms that were initially included in
the prospectus and then did not appear in the equity report (‘removed’), and peers that were not initially
included in prospectus but were then added to the equity report group (‘added’). The average number of
removed and added peers in each IPO is the same (2.9). Figure 1 reveals that, for all multiples used, the
mean and median value of the removed peers is higher than that of the added peers. We argue that
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underwriters tend to include comparable firms with high valuations in the prospectus, in order to raise the
valuation of the IPO, and to subsequently remove these peers when acting as analyst; at the same time, peers
with low valuations, initially excluded from the prospectus, are subsequently included in the equity report.
This proves an upwardly biased selection of peers by underwriters at the time of the IPO with respect to their
selection after the IPO, consistent with our Hypothesis 1.
[ FIGURE 1 ]
4.1 Bargaining power vs. reputational capital
Table 3 shows the results of the two-step Heckman procedure that tests our hypotheses on the influence of
bargaining power and reputational capital on valuation bias, while correcting for sample selection. We report
both the results of the first step on the population of main market IPOs, that determines the Mills ratio, and
of the second step estimated on our core sample, where valuation bias is the dependent variable. We first test
our hypotheses on bargaining power in Model 1. The effects of reputational capital are tested in Model 2,
while the underwriter-VC matching is tested separately in Model 3 and joint with the other variables in
Model 45.
Results of the Heckman’s second step in Table 3 show that the coefficients of the underwriter’s market
share variable, measured in terms of capital raised, is positive and significant both when tested alone (Model
1) and in the full model (Model 4). This confirms that underwriters with more bargaining power, as proxied
by the amount of IPO proceeds raised, perform a more biased selection of peers at the IPO (Hypothesis 1.a).
The venture capital backing variable is also positive and significant, documenting that the certification effect
of venture capitalists is a further source of bargaining power for underwriters of VC-backed issuers
(Hypothesis 1.c). Although its coefficient is statistically significant only at the 10% level in Model 1, it
5
The US investment bank variable is excluded in Model 1 and in the full model specification (Model 4) due to high
correlation with the underwriter market share (capital raised) variable. Big US banks indeed only deal with very large
IPOs in Europe and they all belong to the top-tier set of underwriters in terms of capital raised.
14
becomes significant at the 1% level in the full model specification in Model 4. US investment banks are also
positively associated with valuation bias, supporting Hypothesis 1.b (Model 2).
The reputational capital hypothesis predicts that valuation bias is lower for underwriters that take
companies public more frequently, and in IPOs backed by venture capitalists that take companies public
more frequently. The coefficient of the underwriter’s market share in terms of number of IPOs is negative
and significant (5% level) when this hypothesis is tested independently (Model 2), while it loses significance
in the full model specification (Model 4). The coefficient of the venture capitalist’s market share is instead
negative and always significant at the 1% level. Overall, hypothesis 3 finds support, with more repeat players
performing a less biased selection of peers at the IPO. The influence of venture capitalists on underwriters is,
however, much more significant than the underwriters’ incentive itself. Hypothesis 3.c predicts that valuation
bias is lower when the underwriter and the venture capitalist repeatedly interact with each other in the IPO
market. The coefficient of the dummy variable of the previous matching between underwriter and venture
capitalist is negative and weakly significant when tested alone (Model 3), but its impact increases (5% level)
when the effect is tested along with the other variables (Model 4). This suggests that a certain degree of
interaction between an underwriter and a venture capitalist alleviates the underwriter’s opportunistic
behavior in the valuation of the IPO. Since the survival of their business depends also on one another’s future
revenues, the likelihood of misconduct decreases. Another possible explanation of the negative coefficient of
this variable is more empirically driven. Given the positive impact on valuation bias of the bargaining power
of underwriter and venture capitalists, their matching leads to a negative interaction.
[ TABLE 3 ]
4.2 Long-run performance
The long-run performance hypothesis predicts that the extent to which underwriters upwardly bias the
selection of peers to obtain a higher valuation, as measured by valuation bias, should be negatively correlated
with the long performance of IPOs. Table 4 reports the results of the cross-sectional regression on one-,
15
three-, and five-year BHAR on our sample of 130 IPOs aimed at testing this hypothesis, as well as estimates
on the whole population of 375 IPOs. The coefficient of the valuation bias variable is not significant in the
first regression, where the dependent variable is one-year BHAR. This documents that the way in which
underwriters select peers when valuing IPOs does not have immediate consequences on the one-year stock
performance. However, the influence of valuation bias becomes increasingly significant the longer is the
time window over which returns are measured. The coefficient is negative and significant at the 5% level in
the regression on 3-year BHARs, and at 1% level after 5 years. The evidence is therefore consistent with our
hypothesis 4, demonstrating that the more biased is the selection of peers made by underwriters to raise the
valuation of the firms they take public, the poorer is the long run performance of the firms’ shares.
We also test whether the disclosure about the valuation methods and the comparable firms selected by the
underwriter affects long-term performance of IPOs, by running the regression on the whole population of
IPOs in the main markets of France, Germany, and Italy. We include a disclosure dummy to identify our
sample. Results in Table 4 show that, over a one- and three-year time horizon, disclosure does not
significantly affect stock performance. However, the coefficient of the disclosure dummy becomes positive
and significant at the 1% level when the dependent variable is the 5-year BHAR. Consistent with the
predictions of the literature on voluntary disclosure (Verrecchia, 1983; Lev and Penman, 1990), IPOs with
higher disclosure overperform those that do not reveal information about how the underwriter defined the
offer price.
[ TABLE 4 ]
5. Robustness tests
In this section, we check whether the results are robust to the time between the publication of the
prospectus, and the regulatory change brought by the implementation of the Prospectus Directive.
16
First, the time elapsing between the first and the second selection of peers, made as underwriter at the
time of the IPO and as analyst in the aftermarket, is likely to affect the extent to which the two groups of
peers may change. As the time window widens, comparable firms initially included in the IPO prospectus
may not have the same degree of comparability at the time the equity report is released. An average time
window of 5 months hardly justifies an average change of 5.9 out of 6.7 peers, as it is very unlikely that the
issuer or some of the peers firms have changed their business model so radically. However, we acknowledge
that part of the bias may be due to the time length rather than to the underwriter’s opportunistic behavior. To
control for this, we introduce a ‘time prospectus-report’ variable, defined as the number of days elapsing
between the publication date of the prospectus and that of the equity report.
Second, the Prospectus Directive, aimed at enhancing the level of disclosure and transparency of official
IPO prospectuses in Europe, becomes effective on July 1, 2005. This increased the fraction of IPOs
disclosing the names and valuations of the comparable firms selected by the underwriter. We test whether it
also affected the bias in the selection of comparable firms. We therefore repeat the two-step Heckman
procedure on valuation bias. The time prospectus-report variable and that of the equity report, is included in
the second step estimation; the regulatory change dummy, equal to 1 in case the IPO occurred after the
introduction of the Prospectus Directive, is included both in the first and second step estimation.
Results are shown in Table 5. The coefficients of the newly added variables are never significant,
suggesting that neither the time between the IPO prospectus and the equity research report, nor the
implementation of the Prospectus Directive influence the underwriter’s bias in the selection of peers. All our
hypotheses keep being supported by the results.
[ TABLE 5 ]
6. Conclusions
17
The peer comparables approach, which is the most common methodology used in valuing IPOs, provides
underwriters with a certain degree of discretion in the selection of comparable firms. Underwriters may
opportunistically use such discretion to strategically select peers and raise the valuation of IPOs. Using a
sample of 130 IPOs taking place in France, Germany, and Italy between 1999 and 2013, we are able to
compare the peers selected by the underwriter to define the IPO price with those selected by the same
investment bank when providing analyst coverage to the same firm shortly thereafter. We find that
investment banks select on average 6.7 peers to value IPOs, both as underwriter and as analyst, but 5.9 of
these peers change, with four months being the average time elapsing between the two selections. This
documents a substantial revision by the underwriter in its own selection criteria after such a short time
window.
By comparing the valuation distribution of the two groups of peers, we find that the peers selected at the
time of the IPO have significantly higher valuation multiples. This confirms the previously documented
propensity of underwriters to overvalue IPOs, but the fact that this overvaluation is acknowledged by the
same bank, who revises its own choice of peers shortly thereafter, is a totally novel finding. We also show
that this opportunistic behavior depends on the bargaining power and reputational capital at stake.
Underwriters with more bargaining power suffer lower expected loss from misvaluation, while repeat players
appropriately price issues in order not to damage their reputation. We also find that more biased selections of
peers by underwriters result in poorer long run performance.
18
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20
Table 1. Selection of peers and use of multiples.
The sample is composed of 130 IPOs in regulated markets in France, Germany, and Italy during 1999-2013 for which we were able
to access to the peers used by the underwriter to value the company at the IPO (IPO prospectus) and after as analyst (post-IPO equity
research report). Panel A compares the number of peers selected as underwriter at the IPO (from IPO prospectus) vs. those selected
as analyst (from post-IPO equity research report). The number of peers changed from prospectus to report includes peers that were
used in the IPO prospectuses but not in the post-IPO reports (removed) as well as peers that were used after the IPO but not before
(added). Panel B shows the frequencies for each multiple used by the underwriters at the IPO.
Panel A. Selection of peers
Underwriter at the IPO (IPO prospectus)
Analyst after the IPO (Equity Research Report)
Changed from prospectus to report
Panel B. Use of multiples
Sample
EV/Sales
EV/EBITDA
EV/EBIT
P/E
P/CF
P/BV
21
mean median
6.7
6
6.7
6
5.9
5
no.
%
130
58
44.6
103
79.2
40
30.8
94
72.3
32
24.6
37
28.5
Table 2. Multiples of peers selected before and after the IPO.
The table shows the averages of the mean, median, minimum and maximum values of the valuation multiples of the set of peers
selected by the same investment bank as IPO underwriter (IPO prospectus) and as analyst (post-IPO equity research report).
Significance levels at 1% (***), 5% (**), and 10% (*) are based on the t-test for the difference in means.
No.
IPOs
EV/Sales
58
EV/EBITDA 103
EV/EBIT
40
P/E
94
P/CF
32
P/BV
37
22
mean
15.1
18.4
36.5
44.4
43.0
7.4
Underwriter's peers
median
min
7.9
2.8
15.6
9.4
29.5
15.3
38.4
21.7
33.1
15.1
6.7
3.0
max
57.2
41.4
83.4
88.4
106.2
15.6
mean
5.4**
12.6***
21.1
27.1*
28.9
2.5
Analyst's peers
median
min
4.1***
1.9**
11.7***
7.8**
19.2
13.3
23.3***
15.2**
20.0
11.3
2.3
1.8
max
14.2
21.0
38.2
60.4
87.8
4.5
Table 3. Heckman selection model on valuation bias.
The table reports the estimates of the two-step Heckman selection model on valuation bias. The first step models the likelihood to
fully disclose information about the peers selected by the underwriters at the IPO and in post-IPO equity research reports. The second
step models valuation bias, defined as the logarithm of the ratio between the mean multiple of peers selected as underwriter and the
mean multiple of the peers selected as post-IPO analyst. Underwriter market share is measured both in terms of capital raised and of
number of companies taken public in Europe during 1995-2013 (source: Euripo database), scaled at 1 for the underwriter with the
highest market share. US investment bank equals 1 if the underwriter is US-based; VC backing equals 1 if the IPO firms is VCbacked, 0 otherwise; VC market share measured in terms of number of IPOs backed in Europe during 1995-2013 (source: Euripo
database), scaled at 1 for the underwriter with the highest market share; previous UW-VC matching equals 1 if the VC has backed at
least one IPO in Europe during 1995-2013 underwritten by the same investment bank in the 3 years before the IPO, 0 otherwise
(source: Euripo database); firm size is the log of the issuer’s last fiscal year total assets before the IPO, adjusted for inflation (2013
purchasing power, source: Eurostat); firm age is the log of 1 plus firm age in years of the issuer at the IPO; leverage is pre-IPO total
debt divided by total assets; pre-IPO market return (volatility) is FTSE Euromid index return (standard deviation of daily returns)
over the 100 trading days before the IPO; negative earnings equals 1 in case the issuer reported negative earnings in the last fiscal
year before IPO, 0 otherwise; dilution is the number of primary shares divided by pre-IPO shares outstanding. Heteroskedasticity
corrected clustered robust t-statistics are in brackets. ***, **, and * represent statistical significance at the 1, 5, and 10 percent levels,
respectively.
First step
UW market share (cap. raised)
(1)
0.63***
(2.79)
UW market share (no. IPOs)
US investment bank
VC backing
1.14***
(6.39)
-0.11
(-0.63)
0.16*
(1.72)
VC market share (no. IPOs)
(2)
-0.82**
(-2.25)
0.54**
(2.53)
0.58***
(4.01)
-0.74***
(-3.59)
Previous UW-VC matching
Firm size
Firm age
Leverage
Pre-IPO market return
Pre-IPO market volatility
Negative earnings
Dilution
-0.28***
(-4.47)
-0.03
(-0.39)
-0.10
(-0.45)
-3.68***
(-3.28)
-63.76*
(-1.80)
-0.62**
(-2.37)
-0.87**
(-2.04)
Mills ratio
Constant
Observations
Uncensored observations
Wald Chi-squared
23
3.63***
(4.39)
375
(3)
0.03
(0.80)
-0.04
(-0.88)
-0.31***
(-2.71)
-1.82***
(-2.84)
-19.95
(-1.04)
-0.02
(-0.37)
-0.04
(-1.03)
-0.37***
(-3.13)
-2.01***
(-2.58)
-31.35
(-1.50)
-0.39*
(-1.79)
0.09**
(2.30)
-0.08*
(-1.86)
-0.33***
(-2.79)
-1.17*
(-1.91)
-5.61
(-0.30)
0.14
(0.96)
-0.07
(-0.15)
375
130
27.5
0.31
(1.27)
0.59
(1.09)
375
130
43.9
0.03
(0.22)
-0.34
(-0.77)
375
130
18.4
(4)
0.68***
(3.23)
-0.26
(-0.79)
0.60***
(4.33)
-0.69***
(-3.42)
-0.52**
(-2.49)
0.02
(0.53)
-0.02
(-0.57)
-0.35***
(-3.29)
-1.59***
(-2.61)
-21.12
(-1.20)
0.14
(0.86)
0.09
(0.22)
375
130
55.5
Table 4. Valuation bias and long-run performance.
The table reports the estimates of the OLS regression on long-run performance of IPOs. The dependent variable is buy-and-hold
abnormal return (BHAR) computed from the 22nd day of trading to the one-, three-, and five-year IPO anniversary, or to delisting
date if earlier, over the FTSE Euromid index. The disclosure sample is the core sample of the paper (130 IPOs), while the population
includes all the IPOs on main markets of Germany, France, and Italy during 1999-2013 (375 IPOs). Disclosure is a dummy equal to 1
if the IPOs belongs to this paper’s sample of 130 IPOs. Other independent variables are defined as in Table 3. Heteroskedasticity
corrected clustered robust t-statistics are in brackets. ***, **, and * represent statistical significance at the 1, 5, and 10 percent levels,
respectively.
Valuation bias
1-year
-0.61
(-1.45)
Disclosure sample (130)
3-year
5-year
-0.25**
-0.33***
(-2.13)
(-2.67)
Disclosure
VC backing
Firm size
Firm age
Leverage
Pre-IPO market return
Pre-IPO market volatility
Constant
Observations
Adjusted R-squared
24
-0.03
(-0.13)
0.12
(1.06)
-0.20*
(-1.86)
-0.08
(-0.25)
1.84
(1.26)
38.77
(1.29)
-0.88
(-0.56)
125
0.06
0.43***
(3.18)
0.04
(0.84)
0.05
(0.95)
0.09
(0.72)
1.33*
(1.72)
32.20
(1.59)
-1.05*
(-1.86)
119
0.17
0.49**
(2.39)
0.14
(1.63)
0.05
(0.60)
-0.03
(-0.13)
2.00
(1.43)
94.38**
(2.36)
-2.71**
(-2.56)
115
0.14
Population of IPOs (375)
1-year
3-year
5-year
0.26*
(1.82)
0.10
(0.59)
0.03
(0.62)
-0.02
(-0.40)
0.25
(1.30)
2.01*
(1.71)
18.61
(0.67)
-0.64
(-0.83)
361
0.01
0.09
(1.15)
0.18**
(2.18)
0.04
(1.57)
0.01
(0.24)
0.09
(1.00)
0.23
(0.43)
22.52
(1.60)
-0.82**
(-2.32)
329
0.02
0.65***
(5.40)
0.34**
(2.21)
0.07
(1.57)
-0.01
(-0.25)
-0.03
(-0.22)
1.15
(1.41)
54.49**
(2.28)
-2.01***
(-3.02)
317
0.10
Table 5. Robustness checks on valuation bias.
The table reports the estimates of the two-step Heckman selection model on valuation bias as in Table 3, with the inclusion of the
following two control variables. Time prospectus-report is the number of days elapsing between the publication date of the
prospectus and that of the equity report; prospectus directive is a dummy equal to 1 if the IPO occurs after the implementation of the
EU Prospectus Directive (July 1, 2005), 0 otherwise. Heteroskedasticity corrected clustered robust t-statistics are in brackets. ***, **,
and * represent statistical significance at the 1, 5, and 10 percent levels, respectively.
First step
UW market share (cap. raised)
(1)
0.62***
(2.79)
UW market share (no. IPOs)
US investment bank
VC backing
1.16***
(6.43)
-0.11
(-0.63)
0.14
(1.57)
VC market share (no. IPOs)
(2)
-0.81**
(-2.24)
0.61***
(2.78)
0.57***
(3.98)
-0.76***
(-3.79)
Previous UW-VC matching
Firm size
Firm age
Leverage
Pre-IPO market return
Pre-IPO market volatility
Negative earnings
Dilution
-0.29***
(-4.58)
-0.03
(-0.41)
-0.09
(-0.39)
-3.31***
(-2.86)
-45.85
(-1.20)
-0.63**
(-2.38)
-0.89**
(-2.08)
Time prospectus-report
Prospectus Directive
-0.21
(-1.16)
Mills ratio
Constant
Observations
Uncensored observations
Wald Chi-squared
25
3.81***
(4.49)
375
(3)
0.04
(0.88)
-0.04
(-0.84)
-0.32***
(-2.81)
-2.00***
(-2.96)
-28.64
(-1.35)
-0.03
(-0.54)
-0.04
(-0.89)
-0.39***
(-3.24)
-2.32***
(-2.93)
-43.44*
(-1.92)
-0.39*
(-1.80)
0.09**
(2.40)
-0.07*
(-1.79)
-0.34***
(-2.92)
-1.46**
(-2.21)
-19.02
(-0.90)
0.02
(0.81)
0.08
(0.79)
0.15
(1.05)
-0.12
(-0.25)
375
130
29.2
0.03
(1.48)
0.08
(0.76)
0.39
(1.61)
0.63
(1.11)
375
130
47.4
0.02
(0.83)
0.12
(1.24)
0.04
(0.34)
-0.41
(-0.89)
375
130
21.0
(4)
0.68***
(3.25)
-0.21
(-0.65)
0.60***
(4.36)
-0.72***
(-3.56)
-0.53**
(-2.51)
0.02
(0.61)
-0.02
(-0.48)
-0.37***
(-3.42)
-1.72***
(-2.72)
-28.61
(-1.46)
0.03
(1.25)
0.07
(0.74)
0.15
(0.98)
0.02
(0.04)
375
130
58.6
Figure 1. Distributions of the valuation of peers. The graph compares the distributions of the valuation multiples of the peers published by the investment bank as IPO underwriter and as postIPO analyst. The graphs show the average of the minimum, median, mean, and maximum values of the EV/Sales, EV/EBITDA, EV/EBIT, P/E, P/CF, and P/BV ratios. ‘Underwriter’ are peers
selected by the underwriter at the time of the IPO and published in the official prospectus; ‘removed’ are peers that were published in the prospectus but are not included in the equity research
report published after the IPO; ‘added’ are peers that were not included in prospectus but are published in the equity report; ‘analyst’ are peers reported in the first available equity research report
after the IPO.
26
Appendix A. Descriptive statistics.
The table reports the descriptive statistics of the sample of 130 IPOs and the rest of the population of main market IPOs in France,
Germany, Italy during 1999-2013 (245 IPOs). Variables are defined as in Table 3. ***, **, * represent significance levels at the 1%,
5%, and 10% levels of the two sample t-tests for the difference in means and the Wilcoxon signed rank test for the difference in
distributions.
UW market share (cap. raised, %)
UW market share (no. IPOs, %)
US investment bank (%)
VC backing (%)
VC market share (no. IPOs, %)
Previous UW-VC matching (%)
Firm size (total assets, 2013 M€)
Firm age (years)
Leverage (%)
Pre-IPO market return (%)
Pre-IPO market volatility (%)
Negative earnings (%)
Dilution (%)
1-year BHAR (%)
3-year BHAR (%)
5-year BHAR (%)
27
Sample (130)
mean
median
31.3
31.2
24.5
24.4
65.4
30.0
16.2
0.0
3.8
304.7
125.8
24.0
16.0
37.4
28.6
4.3
4.2
0.8
0.7
9.3
22.5
22.4
13.3
-7.7
-4.3
-16.2
-7.4
-3.0
Rest of population (245)
mean
median
31.6
29.5
29.2
24.8
31.5
29.8
6.5
0.0
5.1
6,783.5
162.2
29
12
44.9
30.1
6.4
6.9
0.8
0.8
18.4
114.8
25.0
8.8
-12.7
-3.6
-19.3
-28.3
-44.8
Difference
between groups
-0.3
1.7
-4.7
-0.4
33.9***
0.2
9.7
0.0
-1.3
-6,478.8
-36.4
-5.0
4.0
-7.5
-1.5
-2.1**
-2.7**
0.0
-0.1
-9.1**
-92.3
-2.6
4.5
5.0
-0.7
3.1
20.9**
41.8**