Frontiers of Entrepreneurship Research
Volume 32 | Issue 5
CHAPTER V. ENTREPRENEURIAL
CHARACTERISTICS
Article 1
6-9-2012
FOUNDER STATUS, DEFENSIVE
MECHANISMS AND IPO UNDERPRICING
Asma Fattoum
Catholic University of Lyon, [email protected]
Frédéric Delmar
EMLYON Business School
Recommended Citation
Fattoum, Asma and Delmar, Frédéric (2012) "FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING,"
Frontiers of Entrepreneurship Research: Vol. 32: Iss. 5, Article 1.
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Fattoum and Delmar: FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING
Entr e pre n eurial Charact eristi cs
FOUNDER STATUS, DEFENSIVE MECHANISMS
AND IPO UNDERPRICING

Asma Fattoum, ESDES- Catholic University of Lyon, France
Frédéric Delmar, EMLYON Business School, France
Abstract
This paper addresses the propensity to use defensive mechanism at IPO by controlling shareholders
and its consequences for underpricing. We specifically examine the difference in behavior and its financial consequences between founder-CEO and non-founder CEO. We argue the former to be not only
more likely to use these mechanisms but also to be more penalized at the IPO. We test our hypotheses using a unique hand-collected dataset of all 468 IPO’s completed in the French capital markets
from 1992 to 2010. Our results indicate that founder-CEOs are more likely to implement at the IPO
defensive mechanisms such as dual share classes, pyramid structures and voting pact agreements than
non-founder CEOs. Moreover, defensive mechanisms generate an underpricing, which is significantly
higher in firms led by founder-CEOs than in non-founder managed firms.
Introduction
An initial public offering (IPO) produces very often considerable consequences on a firm’s
ownership structure, control and management. Indeed, at the IPO ownership structure faces
important changes in terms of concentration and identity of main shareholders as pre-IPO
controlling shareholders have no more the opportunity to freely select new shareholders. Such
changes on firm’s ownership structures may transfer firm control to new shareholders, which is in
turn may implement significant changes at the top management team level. While these potential
consequences of an IPO do not constitute an obstacle for incumbent controlling shareholders
who are actually using an IPO as exit strategy and a mean to transfer ownership, control and
management of the firm, it does constitute a considerable threat for those who desire to keep full
control of the firm and who are undertaking an IPO only to access financial resources needed for
future investments.
This study examines the set of defensive strategies implemented by pre-IPO controlling
shareholders to reduce potential threats of loss of control over the firm. In addition, it investigates
the consequences of the implementation of such defensive strategies on the valuation of the firm
at the IPO. In doing so, this study addresses specifically four research questions. First, what kinds
of defensive mechanisms controlling shareholders use to mitigate the threat of losing firm control
at IPO? Second, are firms with founder-CEOs more likely to use defensive mechanisms than non
founder-CEOs at the IPO? Third, does the implementation of defensive mechanisms lead to
IPO underpricing, and as a result, force controlling shareholders to “leave money on the table”?
Finally, does the extent of underpricing caused by defensive mechanisms implementation differ
significantly between founder and non-founder CEOs?
By addressing these four research questions, this study extends previous research (Gomez-Mejia
et al., 2007; Wasserman, 2008; Fattoum & Delmar, 2011) by highlighting differences in cognitive
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biases between founder and non-founder CEOs and by stressing the consequences of those biases
on strategic decisions at the IPO and consequently on economic wealth of the two types of CEOs
at the IPO. For instance, Gomez-Mejia et al. (2007) study illustrated how founding families reject
participation in cooperatives although this decision is associated with lower economic risk to
preserve their socio-emotional wealth. Similarly, Wasserman (2006, 2008) studies indicated that
founder-CEOs strong attachment to their firms makes them accept lower compensation than
non founder-CEOs. Our paper contributes to this stream of research by showing that founderCEOs’ strong psychological ownership feelings leads them to believe that they are the only one
legitimate to own and manage the firm. In turn, these feelings push them to implement defensive
mechanisms at the IPO even though this decision implies considerable penalties in the form of
IPO underpricing (Fattoum & Delmar, 2011).
Building upon the psychological ownership research, we suggest that founder-CEOs are more
likely than non-founder CEOs to put in place defensive mechanisms at the IPO to prevent loss
of control (hypothesis 1). This is because founder-CEOs have more opportunities (1) to exercise
strong and extended control over the firm before the IPO, (2) to acquire firm specific knowledge
and (3) to invest more time, money and energy in the firm than anyone else. These opportunities
enhance founder-CEO’s feelings of possessiveness, their predisposition to resist change, to believe
that they are the only individuals legitimate and experienced to control the firm, and as a result,
enhance their determination to use defensive mechanisms.
In addition, because implementation of defensive mechanism creates substantial agency costs and
opportunities for private benefits expropriation, stock offer price (the price at which shares are initially
offered to investors) should be discounted to attract a large number of new investors. This discount,
often referred to as underpricing, captures the amount of money left on the table by incumbent
controlling shareholders, in compensation for stronger control over the firm. Consequently, we suggest
that the use of disconnecting mechanisms is positively related to IPO underpricing (hypothesis 2).
Moreover, since both founder-CEOs and non-founder CEOs may implement defensive mechanisms,
we suggest that CEO status moderates the effect of defensive mechanisms implementation on IPO
underpricing. Particularly, building upon research suggesting that founder-CEOs exhibit stronger
psychological attachment to their firm and higher degrees of overconfidence and self-efficacy than non
founder-CEOs, we propose that the underpricing resulting from using defensive mechanisms will be
stronger in founder-CEOs led firms than in other firms (hypothesis 3).
We empirically test our three hypotheses using the population of all 468 IPOs undertaken in
the French capital market from January 1992 to December 2010. The French context is particularly
suitable to test our hypotheses for three reasons. First, the use of defensive mechanisms is widely
diffused in French firms. Second, previous research has documented that the French context provided
limited protection to minority shareholders, which makes the issues of private benefits extraction and
immunity from the market for corporate control more salient than other contexts. Third, the empirical
investigation of the antecedents and consequences of defensive mechanisms implementation has
received little attention in the French context. In total, we identified 468 IPOs under the observation
period. Two-thirds were led by founder-CEOs (296 IPOs) and one-third was completed by non
founder-CEOs (172 IPOs). Our findings provide strong support for the three hypotheses.
This paper is structured as follows. The first section describes our theoretical framework. We
start by describing the most popular defensive mechanisms implemented at IPOs. We then describes
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Fattoum and Delmar: FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING
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our theoretical arguments built upon psychological ownership which suggests that founder-CEO’s
are more inclined to put in place defensive mechanisms at the IPO than non founder-CEOs. We
invoke signaling theory and agency theory to suggest that the use of disconnecting mechanisms
has a negative effect on firm IPO valuation. Further, this negative effect is significant primarily in
IPOs led by founder-CEOs. The second section describes the method and data used to test our
hypotheses. The third section depicts the major findings of our regressions models. Finally, we
conclude by discussing theoretical and empirical implications of our study.
Theory and Hypotheses
Defensive mechanisms implemented at IPOs
The most prevalent defensive mechanisms to be implemented by incumbent shareholders for
protection against the risk of losing control over the firm as a result from ownership structure
dilution rely primarily on one principal: disconnecting cash flow rights (ownership) from voting
rights (control). Although the frequency of their implementation varies considerably all around
the world, three mechanisms are commonly considered as very effective in disconnecting cash
flow rights from voting rights. These three mechanisms are dual class shares, pyramidal ownership
structures and voting pacts agreements.
The dual class shares mechanism is undoubtedly the most popular defensive technique used
all around the world thanks to the simplicity of its implementation and the effective protection
it provides to incumbent shareholders. Implementing a dual class shares structure involves simply
the issue of shares granting superior voting rights to specific shareholders, the issue of shares with
limited voting rights to new shareholders buying such shares at the IPO, or both (Nenova, 2003;
Villalonga, & Amit, 2006). In this way, cash flow rights dilution produced at the IPO as a result of
the new shares issue will generate very little changes on the incumbent shareholders voting rights.
Therefore, the controlling shareholders can still keep full control over the firm although their actual
cash flow rights have been severely diluted. The second defensive mechanism – often referred to as
pyramidal structures – allows a focal controlling shareholder to control the firm through a cascade
of trusts, funds and holdings (Villalonga, & Amit, 2006; Faccio and Lang, 2002; Claessens et al.,
2002). This cascade grants controlling shareholders the opportunity to decouple cash flow rights
from voting rights, especially when trusts, funds and holding companies are positioned at the top
of the pyramid (Boubaker & Labegorre, 2008, Bebchuk et al. 1999). Finally, voting pact agreements
among controlling shareholders increase their voting power to levels which are above their actual
cash flow rights taken separately. As a result, members of the voting pact agreement which generally
spans several years may resist the prospect of firm control transfer to new shareholders.
The relationship between defensive mechanisms and founder-CEO status
Although relying on distinct motivations and processes, two different theoretical frameworks
suggest controlling shareholders such as founder-CEOs to be more inclined to implement
defensive mechanisms at the IPO than non founder-CEOs. These two theoretical frameworks
build primarily on psychological ownership theory and agency theory.
Psychological ownership theory suggests founder-CEOs to likely feel a greater sense of
possessiveness and of psychological attachment to the firm they have created than non-founder
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CEOs (Pierce et al., 2001). This state of mind is much more prominent for founder-CEOs than
non-founder CEOs for three reasons. First, founder-CEOs have often experienced complete and
long control over the firm since its founding. The legitimacy of this control is explained by the
fact that founder-CEOs generally hold the largest ownership stake in the firm. This in turn, grants
them the opportunity to have the strongest imprinting effect on the mission, values, goals and
strategy of the firm (Kelly et al., 2000; Packalen, 2007; Boeker & Karichalil; 2002). Moreover, as
the founder-CEOs’ involvement in the creation and development of the firm is generally longer
than non-founder CEO, they are likely to build up specific tacit knowledge and expertise about the
firm, and hence, to centralize decision making process and to control information flow (Geeraerts,
1984; Kelly et al., 2000; He, 2008; Pierce et al., 2001; Townsend et al., 2009). Similarly, status as
founder-CEO confers prestige and charismatic roles facilitating their executive power (Adams et
al., 2005; Buyl et al., 2011; Dobrev & Barnett, 2005).
Second, founder-CEOs have intimate familiarity with the firm they have created since they
have ipso facto the longest tenure in the firm. This longevity facilitates the acquisition of explicit
and tacit knowledge of internal and external stakeholders dealing with the firm, and therefore,
increases their familiarity with the firm (He, 2008; Pierce et al., 2001; Townsend et al., 2009).
Third, founder-CEOs feel that they have more than any other shareholder self-invested in
the firm to prosper. Their longer tenure means they have often invested significantly more time,
energy, money, talent, values, and identity to develop the firm to the IPO stage than any CEOs who
have joined a firm at later stages of the firm’s development (Fischer & Pollock, 2004; Gimeno et
al., 1997; Nelson, 2003; Pierce et al., 2001). In sum, the founder-CEOs’ psychological ownership
is arguably stronger than other CEOs because of the prominent control of, familiarity with and
self-investment in the firm.
The feeling of psychological ownership may trigger several positive behavioral effects. This
includes stronger attachment, deeper sense of responsibility to invest more time and energy than
any other stakeholders, as well as a strong feeling of protection, care and nurturing duties towards
the firm (Ikavalko et al 2010; Pierce, et al., 2001). For instance, Wasserman (2006) study indicates
that the founder-CEO’s strong psychological ownership leads to accept lower than average
salaries. Gimeno et al. (1997) found that founder-CEOs’ ensured the survival of their ventures,
despite enduring below-average performance, because of their strong attachment and feeling of
responsibility towards their firm.
In contrast, the feeling of psychological ownership may trigger negative behavioral effects.
This includes a tendency to exclude others from controlling the firm, make business decisions
independently, and resist change particularly when it is imposed (Ikavalko et al 2010; Pierce, et al.,
2001). For example, several studies indicate that a strong founder-CEOs’ psychological ownership
increased their overconfidence and self-efficacy compared to non founder-CEOs (Busenitz & Barney,
1997; Chen et al., 1998; Forbes, 2005) making them believe they are the only competent and legitimate
managers to successfully manage the firm (Wasserman, 2008). Gomez-Mejia et al. (2007) show
that founding-families owning olive oil mills in Southern Spain were more likely to refuse joining
cooperatives, a decision associated with greater loss of control but lower economic risk, to preserve
their socio-emotional wealth than non founding-family firms preferring to join the cooperatives.
Perhaps more importantly, another negative behavioral consequence of psychological
ownership takes the form of agency costs resulting from private benefits expropriation. More
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Fattoum and Delmar: FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING
Entr e pre n eurial Charact eristi cs
specifically, strong feeling of possessiveness may lead founder-CEOs to be more prone to extract
private benefits at the expense of minority shareholders than other CEOs appointed by institutional
controlling shareholders. This opportunistic behavior is likely because private benefits are entirely
captured by the founder-CEO while profits produced by value maximizing strategies will be shared
with other shareholders in the form of residual claims. Examples of private benefits extraction
include non-pecuniary consumption, private utilization of scarce resources, disproportionate
compensation levels and special dividends.
In sum, the mindset produced by strong feelings of possessiveness and attachment to the firm
described above may explain why the founder-CEOs are determined, more than any other CEOs,
to use mechanisms enabling them to minimize any potential loss of control of their firm at the
IPO. Therefore, we suggest that:
H1: At the IPO, founder-CEO led firms are more likely to implement defensive mechanisms
than non founder-CEO managed firms.
The relationship between defensive mechanisms and IPO underpricing
The primary consequence of the implementation of defensive mechanisms at the IPO is the
creation of substantial agency costs. Such agency costs do not derive from the misalignment between
professional managers’ interests and shareholders’ interests (Type I agency costs) but instead from
the misalignment between controlling shareholders’ interests and minority shareholders’ interests
(Type II agency costs). In particular, defensive mechanisms grant controlling shareholders
immunity from the market for corporate control. This in turn, provides opportunity for controlling
shareholders to extract private benefits at the expense of minority shareholders without bearing
serious risks of contestation by minority shareholders and/or control shifts to other shareholders.
Consequently, firm valuation and the interest from new investors at IPO are likely to greatly suffer
if defensive mechanisms – allowing for substantial agency costs and opportunities for private
benefits expropriation – are implemented. More specifically, stock offer price (i.e., the price at
which shares are initially offered to investors) should be greatly discounted in order to attract
a large number of new investors. This discount, often referred to as underpricing, captures the
amount of money left on the table by incumbent controlling shareholders, in compensation for
stronger control over the firm and resulting private benefits extraction. Therefore, we suggest:
H2: There is a positive relationship between the number of defensive mechanisms used and
firm IPO underpricing.
The relationship between the use of defensive mechanisms and IPO underpricing is likely
to depend on whether the IPO is undertaken by a founder-CEO or a non founder-CEO. This
differential effect across the two groups is likely to occur for two main reasons. First, the scope
of opportunities for private benefits extraction is likely to be wider for a founder-CEO than a
non founder-CEO appointed by an institutional controlling shareholder. For instance, defensive
mechanisms and immunity from the market for corporate control may permit founder’s family
to maintain their grip on executive positions in the firm and to pay them disproportionate
compensation even though it is in the best interests of minority shareholders to appoint nonfamily members executives from an efficient labor market. Second, founder-CEOs are likely to
exhibit stronger psychological attachment to their firm and higher degrees of overconfidence and
self-efficacy than non founder-CEOs. This attachment, over-confidence and self-efficacy is likely
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to encourage founder-CEOs to accept higher IPO underpricing than non-founder-CEOs because
of their stronger belief that they will be able to overturn the situation in the future and increase
firm valuation post-IPO. Therefore, we suggest:
H3: Underpricing resulting from defensive mechanisms use will be stronger in founder-CEOs
led firms than in non-founder CEOs managed firms.
Method
Sample and Data Collection
To test our three hypotheses, we used a hand collected dataset including all IPOs undertaken in
the French capital market from January 1992 to December 2010. In total, our population included
468 IPOs. About two-thirds of IPOs were undertaken by founder-CEOs (296 IPOs) whereas onethird of IPOs were completed by non founder-CEOs (172 IPOs). We collected data from multiple
sources including IPO prospectus and reference documents filed with the French financial markets
authority (AMF), Bloomberg and Thomson One.
As shown in Table 1, IPOs involving founder-CEOs exhibited significantly different
characteristics than non founder-CEOs relative to size, age, equity, governance, family control
and defensive mechanisms. Indeed, IPOs led by founder-CEOs had significantly smaller market
value and age than other IPOs. In addition, while founder-CEOs retained more equity than other
CEOs at the IPO (42 percent vs. 20 percent), VC/Private equity ownership was significantly lower
in founder-CEOs led firms than other firms (11 percent vs. 24 percent). In contrast, there is no
significant difference between the two groups in term of public equity released at the IPO, which
was on average equal to 24 percent. Moreover, founder-CEOs cumulated executive and chairman
positions more often than non-founder CEOs (77 percent vs. 51 percent) and they were more
likely to involve family members in the board of directors (52 percent vs. 30 percent). Finally,
descriptive statistics presented in Table 1 indicate significant differences between the two groups
in term of defensive mechanisms implemented at the IPO. In particular, 92 percent of founderCEOs put in place at least one defensive mechanism at the IPO while this ratio falls to 64 percent
for non founder-CEOs. The most commonly used defensive mechanism for both founder and non
founder CEOs was dual class shares (85 percent and 60 percent respectively), followed by pyramid
structures (39 percent and 23 percent respectively), and finally voting pact agreements (21 percent
and 9 percent respectively).
Dependent Variables
We use two dependent variables to test our hypotheses: Number of disconnecting mechanisms
adopted at IPO and IPO underpricing. The number of defensive mechanisms is our dependent
variable in H1. Three main mechanisms which disconnect cash flow rights from voting rights
can be put in place at the IPO: (1) dual class shares, (2) pyramid structures and (3) voting pact
agreements. These three devices can be implemented separately or simultaneously. Therefore, we
operationalized this dependent variable as a count of the number of mechanisms used at the IPO.
Accordingly, this variable ranges from zero when no mechanisms are adopted to three when dual
class shares, pyramid structures and voting pact agreements are put in place concurrently.
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Fattoum and Delmar: FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING
Entr e pre n eurial Charact eristi cs
IPO underpricing is our dependent variable for H2 and H3. We measured IPO underpricing
as the percentage difference between the end of the third day of trading stock price and the offer
price, adjusted for market index return (Barry et al., 1990; Ritter and Welch, 2002; Ljungqvist,
2007; Certo et al 2009; Certo et al, 2007; Boulton et al 2010). Therefore:
IPO Underpricing = ([(P1 – P0) / P0] – [(M1-M0) / M0]) x 100
Where:
• P1 is the firm’s stock price value at the end of the third trading day.
• P0 is the firm’s stock offer price, the price at which shares are initially offered to investors.
• M1 is the closing value of the market index SBF250 observed on the third trading day.
• M0 is the opening value of the market index SBF250 observed on the first trading day.
Independent Variables
Founder-CEO status was operationalized using a dummy variable. This variable takes a value
of 1 if the CEO at the IPO is one of the founders of the firm and 0 otherwise. To determine
whether the CEO is one of the founders of the firm we relied on different data sources including
IPO prospectus, annual reports, Who’s is Who in France and Factiva.
Control Variables
We included in regression models several control variables. In particular, we controlled for the
effects of (1) industry (2) time, (3) firm size, (4) firm age, (5) CEO duality, (6) equity retained
by the CEO at the IPO, (7) VC/Private equity ownership at the IPO, (8) public equity released at
the IPO (9) family control and (10) IPO procedure. We used Industry Classification Benchmark
(ICB) developed by Dow Jones and FTSE to capture firm’s primary industry. In particular, we
employed nine dummy variables to proxy the ten industries included in ICB taxonomy. Similarly,
we employed a set of dummy variables to operationalize the year at which the focal IPO was
undertaken over the period 1992-2010. We measured firm size using the logarithm of firm total
capitalization on the basis of the offer price in Euros and we defined firm age as the number of
years separating its founding date and IPO date. We measured CEO duality using a dummy variable
taking value of 1 if the CEO combined the executive and chairman positions and 0 otherwise.
Moreover, we operationalized the amount of equity kept by CEO and VC/Private equity at the
IPO using the percentage of cash flow rights they held respectively on the first trading day (Gomes,
2000). Similarly, public equity released at the IPO was measured as a cash flow rights percentage.
We identified family controlled firms using a dummy variable taking value of 1 if two conditions
are met simultaneously: (a) at least two family members sit on the board of directors and (b)
family owns at least five percent of cash flow rights (Gomez-Mejia et al, 2003). Finally, as three
procedures can be implemented to set the offer price at the IPO (fixed price, auction and mixed
procedure) we used two dummy variables to control for this effect on underpricing. Fixed price
procedure was the less commonly used one (4.27 percent of the time). Mixed procedure was used
39.10 percent of the time and auction procedure was used 56.83 percent of the time. As auction
procedure was the most commonly used, we set it as the reference group. Descriptive statistics and
Pearson correlation coefficients for all variables included in our model are presented in Table 2.
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Results
To test H1, we used Poisson linear regression models since the dependent variable capturing the
number of mechanisms implemented at the IPO is a count measurement. The results of Poisson
linear regression models are presented in Table 3. Model 1 included only control variables. This
model indicates that the rates of defensive mechanisms used decrease with firm size (β = -0.13
p<0.01) and increase with CEO equity kept at the IPO (β = 0.01 p<0.01). In Model 2, we added the
main independent variable indicating founder-CEO status (binary). Our findings indicate, all else
being equal, founder-CEO led firms to have an incidence rate ratio 1.12 times higher than nonfounder CEOs for the number of defensive mechanisms adopted at the IPO (β = 0.20; p<0.05).
This result provides support for H1.
To test H2 and H3, we used OLS regression models with robust standard errors since the
dependent variable IPO adjusted underpricing is a ratio measurement. The findings of these
regression models are presented in Table 4. Model 1 indicates that control variables included are
not significantly correlated with IPO adjusted underpricing (except several industry and time
dummy variables not shown in Table 4). In contrast, Model 2 shows the number of defensive
mechanisms put in place at the IPO to be positively associated with IPO adjusted underpricing (β
= 2.99; p<0.05). Hence, each additional defensive mechanism adopted increases underpricing by
3 percent. As average market value of firms in our sample at the IPO is equal to 661 million Euros,
each additional defensive mechanisms generates a considerable adjusted underpricing which is
equal to 19.76 million Euros. This result provides support for H2.
Finally, Models 3 and 4 provide the results of regressions examining the effects of defensive
mechanisms on IPO adjusted underpricing for each of the two sub-samples: sub-sample
#1 includes 296 firms led by founder-CEOs at the IPO while sub-sample #2 consists of firms
led by non founder-CEOs at the IPO. Findings reported in Table 5 provide support for H3 as
they indicate that the number of defensive mechanisms is positively correlated with adjusted
underpricing only for the sub-sample including firms led by founder-CEOs at the IPO (β = 4.30;
p<0.05). In particular, each additional defensive mechanism implemented in such firms produces
an adjusted underpricing of 5.10 million Euros (average market value for sub-sample #1 is 118.74
million Euros) or 4% penalty on initial valuation. In contrast, the implementation of defensive
mechanisms in firms led by non founder-CEOs at the IPO does not generate statistically significant
adjusted underpricing. This result provides support for H3.
Discussion
How do controlling shareholders deal with the threat of losing firm control at the IPO? Are
founder-CEOs more active in implementing defensive mechanisms to cope with such threat than
non founder-CEOs? What are the implications of such defensive mechanisms on IPO valuation?
Do these implications differ across founder-CEOs and non-founder CEOs led firms? This study
contributes to theoretical and empirical research on entrepreneurship and corporate governance
by providing answers to these research questions.
In the empirical context all 468 IPOs undertaken over the period 1992-2010 in the French
capital markets, this study shows that founder-CEOs rely more heavily on defensive mechanisms
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Fattoum and Delmar: FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING
Entr e pre n eurial Charact eristi cs
such as dual class shares, pyramidal structures and voting pact agreements than non founderCEOs to mitigate the threat of loss of control at the IPO. Building upon psychological ownership
theory, we suggest that this finding can be explained by the stronger feelings of possessiveness and
psychological attachment that founder-CEOs have towards their firms than non-founder-CEOs.
This state of mind is more intense for founder-CEOs because they have more often complete control
over the firm since its founding, intimate familiarity with the firm and have committed to major
self-investment all along firm’s life (Pierce et al., 2001). In turn, founder-CEOs intense mind-set of
psychological ownership generates a greater predisposition to reject other shareholders’ attempts
to control the firm, to take strategic decisions independently, to defend against change particularly
when it is imposed, revolutionary and subtractive and to extract private benefits (Ikavalko et al
2010). For all these reasons, we suggest that founder-CEOs are more inclined than other CEOs to
value firm control and to impose the use of defensive mechanisms at the IPO.
The consequences of defensive mechanisms implementation on firm valuation are considerable.
Indeed, our findings suggest that for the sample which includes all 468 IPOs, the larger the number
of defensive mechanisms implemented at the IPO, the greater IPO underpricing. Financially, each
additional defensive mechanism used creates, on average, an underpricing of 19.76 million Euros
or 3% penalty on initial valuation. However, founders CEO are not only the ones most likely to use
these mechanisms they are also the one most “punished” by the market. IPOs done none-founder
CEO do not incur an underpricing even when defensive mechanisms are used. Founder-CEOs are,
on the contrary, punished by the market, at least short-term. Founder-CEOs need to be prepared
to leave on average 4% of their initial valuation for each mechanisms used.
Building upon agency theory, we suggest that this significant amount of underpricing
corresponds to agency costs created by defensive mechanisms which grant controlling shareholders
immunity against the market for corporate control, which in turn, lowers considerably costs of
private benefit extraction. More importantly, we found that the relationship between defensive
mechanisms used and underpricing is statistically significant only for firms led by founder-CEOs.
We suggest that this result is in line with both agency theory and psychological ownership theory.
Indeed, as founder-CEOs have wider scope of private benefit extraction than non founder-CEOs,
agency costs implications of defensive mechanisms are likely to be higher in founder-CEOs led
firms than other firms. Moreover, cognitive processes triggered by stronger feelings of psychological
ownership for founder-CEOs which translate into greater over-confidence and self-efficacy push
founder-CEOs to bear higher IPO underpricing than non-founder-CEOs. This because they
might be more confident in their ability to increase firm valuation post-IPO. These findings extend
previous research examining the relationship between the use of defensive mechanisms and IPO
underpricing (Fattoum & Delmar, 2011) in that it puts in evidence founder-CEOs’ cognitive biases
which lead them to use defensive mechanisms more often than non founder-CEOs, and more
importantly, to accept higher financial penalties resulting from this behavior.
This study is also interesting because it ties back to a more general discussion on the
entrepreneurial income vs. other types of income. Much of the self-employment literature tend
to find that self-employed earn less than employees. This earning differences– known as psychic
income– is often ascribed to the entrepreneurs’ preferences for delayed pay-offs, risk and overconfidence or just the need for autonomy. Our research indicates that while this might be true,
it is also likely that the market punish entrepreneurial firms more than other type of firms. If it
was only specific characteristics or preferences among entrepreneurs defining their actions, then
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we would only observe a higher probability of using mechanisms. However, we see that foundersCEOs are also more likely to be forced to leave money on the table. This has both theoretical and
policy implications. This suggests a sorting procedure not favoring entrepreneurial actions where
founder-CEOs or entrepreneurs when using the same economic actions as other are penalized.
This has not been yet been observed or theorized. It is likely to strong policy implications as if
these results stand, entrepreneurial actions offer lower rewards than other economic activities, at
least in France.
In sum, this study contributes to previous research in entrepreneurship and corporate
governance by putting in evidence differences in cognitive biases between founder-CEOs and
non founder-CEOs and by highlighting the behavioral and financial implications of those biases
in the context of IPOs. It provides also several opportunities for future research. For instance,
this study investigates the interrelationships between founder-status, defensive mechanisms
and underpricing in a single context. The French context constitutes an ideal setting to test our
hypotheses since defensive mechanisms are legally allowed, frequently implemented, and because
it offers lower levels of protection to minority shareholders than other legal contexts such as
Germany, Scandinavian countries, UK and USA (La Porta et al., 1998). However, future studies
should investigate whether our findings hold in other institutional contexts. Moreover, our study
examined the effect of defensive mechanisms on short-term founder-CEO economic wealth
(underpricing). Future research should examine whether the financial penalties incurred by
founder-CEOs who implement defensive mechanisms persist over the long run post-IPO.
CONTACT: Asma Fattoum; [email protected]; (T): +33(0)4 72 32 50 48; (F): +33(0)4
72 32 51 58; ESDES- Catholic University of Lyon, 23, Place Carnot- 69286 Lyon Cedex 02- France.
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Fattoum and Delmar: FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING
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Table 1: Descriptive Statistics: Founder-CEO vs. Non Founder-CEO at IPO
Founder-CEO IPOs
N= 296
Non Founder-CEO IPOs
N= 172
Mean differences
Variable
Mean
(St.d)
Mean
(St.d)
Firm age
11.01
(8.52)
21.92
(25.62)
-10.91**
Firm market value
118.74
(328.24)
1,593.69
(6,428.81)
-1474.95**
Public Equity released
23.11
(10.68)
24.50
(11.99)
-1.39
CEO equity
42.07
(25.79)
20.12
(28.79)
21.95**
VC/Private equity ownership
11.45
(16.89)
24.82
(27.94)
-13.37**
CEO duality
0.77
(0.42)
0.51
(0.50)
0.26**
Family Control
0.52
(0.50)
0.30
(0.46)
0.22**
Dual Class Shares
0.85
(0.35)
0.60
(0.49)
0.25**
CEO pyramid structures
0.39
(0.49)
0.23
(0.42)
0.16**
CEO pacts agreements
0.21
(0.41)
0.09
(0.29)
0.12**
No mechanisms
0.08
(0.28)
0.36
(0.48)
-0.28**
One mechanism
0.46
(0.50)
0.37
(0.48)
0.09
Two mechanisms
0.39
(0.49)
0.24
(0.43)
0.15**
Three mechanisms
0.07
(0.26)
0.02
(0.15)
0.05*
Table 1 reports mean comparison tests (t tests) for ratio variables and proportion comparison tests for dummy
variables. Significance levels: ** p<.01; * p<.05.
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Fattoum and Delmar: FOUNDER STATUS, DEFENSIVE MECHANISMS AND IPO UNDERPRICING
Entr e pre n eurial Charact eristi cs
Table 2: Descriptive Statistics and Pearson Correlations
Variable
Mean St.d
1
2
3
4
IPO underpricing
12.57 2.41
1.00
Defensive mechanisms
1.26
.82
.13
1.00
Firm age†
2.26
.96
.01
.05
1.00
Firm market value†
4.34
1.47
-.06
-.34
.08
1.00
CEO duality
.68
.47
.05
.19
-.08
-.21
5
6
7
8
9
10
11
1.00
Founder-CEO equity
34.00 28.91
.09
.51
.08
-.41
.36
1.00
Public equity released
23.62 11.19
-.10
-.18
-.10
.00
-.04
-.36
1.00
VC/PE ownership
16.37 22.53
-.10
-.34
-.07
.22
-.18
-.51
.09
1.00
Family control
.44
.50
.09
.29
.07
-.26
.24
.51
-.30
-.35
1.00
Founder status
.63
.48
.10
.30
-.23
-.31
.27
.37
-.06
-.29
.21
1.00
Fixed price IPO
.04
.20
-.03
.01
.02
-.03
-.04
.01
-.12
.07
-.06
-.10
1.00
Mixed price IPO
.39
.49
.07
.08
-.07
-.27
.23
.03
.15
-.06
.02
.08
-.17
† Natural log transformation. N= 468 observations. Correlations greater than .12 are significant at p<.05.
Table 3: Poisson Regression Predicting the Number of Defensive Mechanisms Adopted at IPO
Model 1
Variable
Firm age†
Firm market value†
CEO duality
CEO equity
Public equity released
VC/Private equity ownership
Family control
Founder status
Industry
Year
Intercept
Wald chi2
Log pseudo likelihood
Model 2
Coeff.
(S.E)
0.03
-0.13**
0.03
0.01**
0.01
0.01
0.03
Yes
Yes
0.48
Coeff.
(S.E)
(0.03)
0.05
(0.03)
(0.03)
(0.08)
(0.01)
(0.01)
(0.01)
(0.06)
-0.12*
0.00
0.01**
0.01
0.01
0.03
0.20**
Yes
Yes
0.24
(0.03)
(0.08)
(0.01)
(0.01)
(0.01)
(0.06)
(0.07)
(0.55)
(0.55)
390.14
466.21
-557.58
-555.74
N= 468 observations; † Natural log transformation - Significance levels: ** p<.01; * p<.05.
All models include dummy variables controlling for industry and year. Effects are not shown.
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FRONTI ERS OF E NTR E PRE NE URSHIP RES EARCH 2012
Table 4: OLS Regression Predicting Adjusted IPO Underpricing
Model 1
All IPOs
Variable
Coeff. (Robust S.E)
Model 2
All IPOs
Coeff.
(Robust S.E)
Model 3
Model 4
Founder-CEO IPOs Non Founder-CEO
IPOs
Coeff.
(Robust
Coeff. (Robust
S.E)
S.E)
0.12
(1.62)
1.78
(1.39)
Firm age†
0.91
(1.06)
0.73
(1.06)
Firm market value†
1.29
(0.88)
1.62
(0.89)
3.36
(1.96)
0.86
CEO duality
-2.00
(2.33)
-1.87
(2.33)
1.13
(3.57)
-3.76
(3.27)
CEO equity
-0.02
(0.04)
-0.05
(0.05)
-0.06
(0.07)
-0.04
(0.08)
(0.93)
Public equity released
-0.11
(0.11)
-0.10
(0.11)
0.17
(0.17)
-0.31*
(0.13)
VC/PE ownership
-0.06
(0.06)
-0.05
(0.06)
0.01
(0.11)
-0.11
(0.07)
Family control
2.81
(2.51)
2.67
(2.51)
2.75
(3.17)
-1.92
(3.74)
Fixed price IPO procedure -1.65
(4.05)
-2.00
(4.14)
1.07
(6.78)
-4.38
(4.94)
Mixed IPO procedure
0.84
(2.62)
0.34
(2.59)
-2.52
(3.34)
6.82
(4.57)
Founder status
3.24
(2.32)
2.62
(2.31)
##
2.99*
(1.47)
Defensive mechanisms
##
4.30*
(1.68)
3.06
Industry
Yes
Yes
Yes
Yes
Yes
Year
Yes
Yes
Yes
Yes
Yes
Intercept
2.10
(15.14)
15.58
Degrees of freedom
N
Adj. R2
(9.40)
-1.38
431
(9.58)
430
-23.46
262
(3.03)
(13.24)
136
468
468
296
172
11.25
12.15
15.12
23.63
N= 468 observations: † Natural log transformation - Significance levels: ** p<.01; * p<.05. All models include dummy
variables controlling for industry and year. Effects are not shown.
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