Corporate Governance and IPO Pricing
Y.T. Mak, R.S.K Tan, Y.C.W. Tan, and H.P. Tee
ABSTRACT
This paper examines the association of corporate governance variables and IPO pricing. Results
show that managerial ownership is positively related to both offer price and market price
premium, which is consistent with a high level of managerial ownership reducing agency costs
leading to a closer alignment of interests between managers and shareholders. High blockholder
ownership is positively related to offer price premium but not market price premium which
implies that underwriters, but not investors, perceive that the quality of the IPO is associated
with blockholder ownership. Board size is negatively associated with both measures of IPO
pricing, suggesting that smaller boards are better. The other conventional corporate governance
variables are not significant. Family ownership and family management are negatively related to
both offer price and market price premium, which is consistent with the suggestion that the lack
of separation of ownership and management causes family-controlled firms to suffer from cloudy
financial vision, resulting in a negative relationship with pricing. However, family chairman is
positively associated with offer price premium which implies that underwriters view family
leadership on the board as beneficial. The other family governance variables are not significant.
None of the board expertise variables examined are significantly related to IPO pricing.
1
I. Introduction
The launching of an initial public offering (IPO) is a pivotal event in a firm's history. In the preIPO period, firms tend to have high levels of inside ownership. Consequently agency issues of
the type considered by Jensen and Meckling (1976) are not of first order concern. As noted by
Engel et al. (2002), the IPO is a key event in separating ownership from control for most firms. It
is often the first event in a firm’s history that requires careful consideration of how to treat the
owner-manager agency conflict.
Firms undergoing IPOs face many crucial governance decisions. If sound corporate
governance1 practices are highly valued by investors, these attributes should be reflected at the
time of the IPO. Addressing whether corporate governance practices serve as a signal of the
quality of the investment in a given IPO is potentially valuable for IPO firm owners. Failure to
effectively communicate the potential quality and soundness of an investment in the firm may
prevent firm owners from extracting full value at the time of the IPO.
Johnson et al. (2000) find that corporate governance variables2 explain more of the
variation in exchange rates and stock market performance during the Asian crisis than do
macroeconomic variables. Nikomborirak and Tangkitvanich (1999) identify weak practices such
as poor audits, low accounting transparency, expropriation of companies’ funds by directors,
managers and blockholders, risky investments by managers and shady business deals which
exacerbate the crisis, leading to currency and stock market declines.
1
Corporate governance, which refers to the set of internal and external controls that seeks to harmonize manager
shareholder conflicts resulting from this separation, play an important role in ensuring that the interests of public
shareholders are protected (John and Senbet, 1998).
2
The corporate governance variables studied include judicial efficiency, corruption, and rule of law, enforceable
minority shareholder rights, anti-director rights, creditor rights, and accounting standards.
2
The crisis has highlighted many of the corporate governance problems of familycontrolled companies in East Asia3. La Porta et al. (1998) report that the three largest
shareholders own 49 percent of the voting rights of ten largest Singapore firms, providing
evidence of significantly higher blockholder ownership relative to the United States. La Porta et
al. (1999) investigate the control structure of firms in 27 countries and find that in the case of
Singapore 45 percent of large4 publicly traded firms are controlled5 by the state, 45 percent by
family and 5 percent are widely held. These numbers should be compared to the averages across
the 27 countries which are 20, 35 and 25 percent. As for medium-sized6 publicly traded firms in
Singapore, the percentages are 30, 60 and 10 while the respective averages are 16, 53 and 11
percent. Claessens et al. (2000), in their study of 9 East Asian countries7, report that the
corresponding percentages for all firms in Singapore as of the end of fiscal year 1996 are 23.5,
55.4 and 5.4 percent8.
In this paper, we investigate the relationship of corporate governance variables and the
pricing of 269 Singapore IPOs issued between 1994 and 2001. The corporate governance
characteristics examined include conventional corporate governance, family governance and
board expertise variables.
The control variables are firm size, leverage, asset tangibility,
underwriter reputation, and retained ownership. Two measures of IPO pricing are used as
dependent variables. The first measure is the ratio of the offer price to the net tangible asset
3
While family control allows the family to more closely monitor the managers, outside investors face the risk of
expropriation by family shareholders and family management.
4
These are the top 20 firms ranked by market capitalization of common equity at the end of 1995.
5
Using 10 percent of voting rights as the criterion for control.
6
The smallest 10 firms in each country with market capitalization of common equity of at least $500 million at the
end of 1995.
7
The nine East Asian countries are Hong Kong, Indonesia, Japan, South Korea, Malaysia, Philippines, Singapore,
Taiwan and Thailand.
8
They comment that the concentration of control seems to diminish with the level of economic development of the
country; with Japan having the largest share of widely held shares, and Indonesia, Thailand and Singapore having
the smallest share of widely held firms.
3
(NTA) per share, which captures the premium attached to the IPO by informed underwriters. The
second measure is the ratio of the first-day closing price to the NTA per share, which captures
the premium attached to the IPO by investors.
Our results indicate that for conventional corporate governance variables, managerial
ownership is positively related while board size is negatively related to both offer price premium
and market price premium. Blockholder ownership is positively associated with offer price
premium but not market price premium.
For family governance variables, the proportion of family ownership and the proportion
of family members in senior management positions have negative relationships with both offer
price premium and market price premium. The appointment of family Chairman is positively
related to the offer price premium, but not the market price premium
For board expertise variables, none of the variables examined has significant association
with IPO pricing.
The remainder of the paper is organized as follows. Section II briefly describes the
institutional environment in Singapore. Section III reviews research on corporate governance and
IPOs
. Section IV discusses the data and sample selection issues. Section V presents the results.
Section VI provides a summary of the results, touches on the limitations of study and areas for
future research.
II. Institutional Environment in Singapore
A.
External Control Mechanisms
Corporate governance in the United States is basically market-oriented in the sense that
the external market serves to correct any managerial failure that may arise through takeovers.
4
This is, however, not the experience of Singapore and other East Asian countries. Chandrasegar
(1995) provides two reasons for this difference. Firstly, Asians avoid confrontation and
aggression in their business approach, and it is not in line with their culture to participate in
hostile takeovers. Secondly, merchant bankers in Singapore will not act prior to clearance with
the government agency administering the Takeover Code.
Further as pointed by Mak and Li (2001), high ownership concentration in Singapore,
especially among government and family shareholders explains, in part, the rarity of hostile
takeovers in Singapore and the absence of shareholder activism (Gillan and Starks, 2000).
B.
Internal Control Mechanisms
To offset the weak external market, Singapore companies need to have good internal
controls. The board of directors and the takeover market are substitute mechanisms for
managerial monitoring (Brickley and James, 1987).
Under the Singapore Companies Act, a board is required to have at least two independent
directors to ensure armslength monitoring of management. According to Mak and Chng (2000),
who studied 150 Singapore listed firms between 1998 and 1999, the average board has 57
percent non-executive directors, the average board size is 7 and only 23 percent of companies
adopt a unitary leadership structure. These features do not seem to be indicative of ineffective
boards which, according to Jensen (1993), tend to be large, dominated by executive directors,
and characterised by a unitary leadership structure. However, the large stakes held by directors,
family members and passive shareholders in Singapore firms result in the difficulty of removing
ineffective directors, which limits the efficiency of internal control.
5
C.
Quality of Singapore’s Corporate Governance System
Singapore adopts a hybrid of government-based and family-based control system. A
survey conducted by PriceWaterhouseCoopers (1997) reports that the corporate governance
system in Singapore is rated higher than other Asian countries like Hong Kong, Taiwan and
Malaysia but is less efficient than countries like United States, United Kingdom and Australia.
The Standard & Poor's Company Transparency & Disclosure Survey (2001) uses
ownership structure, investor relations, board structure, management structure, financial
transparency and information disclosure to measure the quality of corporate governance in
companies. The survey rates 11 Singapore companies as among the top one-third of companies
sampled in the Asia Pacific region in terms of corporate governance.
Singapore is less affected by the Asian financial crisis than most other Asian countries
and commentators have attributed the robustness of the Singapore economy to the relatively
good disclosure and corporate governance (Mak and Chng, 2000).
Although Singapore’s corporate governance is widely recognized as being among the
best in Asia, the Government continues to emphasize the need to meet international standards of
disclosure. In response to the crisis, the Monetary Authority of Singapore set up a Financial
Sector Review Group in late 1997 and the Corporate Regulation and Governance Policy
Committee9 in December 1999. The Corporate Governance Committee issued a report in March
2001 together with a proposed Code of Corporate Governance. The Singapore Exchange (SGX)
and relevant authorities accepted the report, its recommendations and the Code in April 2001.
9
This committee is formed to look into company legislation and regulatory framework, disclosure and accounting
standards and corporate governance in Singapore.
6
With effect from January 2003, the annual reports of companies listed on the SGX must disclose
their corporate governance practices and provide explanations for deviations from the Code10.
III. Prior Research, Model and Hypotheses
A.
Initial Public Offerings
Traditionally, studies of the relationship between corporate governance and firm value
have considered existing listed firms and utilized accounting measures such as Tobin’s Q (Morck
et al., 1988) and market-to-book ratios (Chung and Pruitt, 1994). More recent studies (e.g.,
Goergen, 1998), however, have seen a shift to the examination of corporate governance in the
context of IPOs.
There is extensive evidence of IPO underpricing11 in many developed and emerging
markets. Underpricing occurs when the firm's agreed-upon offer price is less than the market
price at the close of the trading on the first day. The offer price is determined by the underwriters
in concert with the company, while the market price is determined by investors. The aggregate
amount of underpricing is colloquially referred to as "money left on the table" which is a transfer
of wealth from IPO firm owners to investors including underwriters and their clients (Daily and
Dalton, 2000).
The degree of underpricing in the United States is substantial. In 1999, the median firstday IPO gain is 30 percent. With the value of IPO deals exceeding a record $69 billion in 1999,
10
Singapore has shifted from a predominantly merit-based philosophy to one of disclosure-based where
shareholders, and not regulators, will monitor the governance of companies and companies will be required to
practice a high level of disclosure.
11
In an efficient market, the market price reflects the fair value of an IPO. Hence, an increase in stock prices on the
first trading day is taken as evidence of underpricing and thus undervaluation since price is assumed to be equivalent
to value. However, a contrasting viewpoint is that in an inefficient market, underwriters underprice IPOs with
respect to the maximum value, which is far above the fair value that is attainable in the long-run. Hence, differences
exist between the price and the value of an IPO. According to Purnanandam and Swaminathan (2001), IPOs are
surprisingly overvalued relative to the valuations of peer firms in the industry.
7
this means that a staggering amount of more than $20 billion is left on the table (Daily and
Dalton, 2000). In the United Kingdom, Brennan and Franks (1997) find a first-day return of 9.42
percent while Levis (1993) reports a mean underpricing of 11.5 percent. In Singapore, Ding
(1996) finds an average initial return of 32.2 percent for IPOs listed between 1987 and 1994
while Hameed and Lim (1997) report a first-day return of 29.89 percent for IPOs listed between
1993 and 1995.
A plethora of theories have surfaced in response to the underpricing phenomena. The
information asymmetry hypothesis explains that information imbalance may occur between
issuers and underwriters (Baron, 1982), between issuers and investors (Allen and Faulhaber,
1989) and between investors (Rock, 1986). Imperfect information by either party will lead to
underpricing of the new issue. Allen and Faulhaber (1989) and Welch (1989) suggest that
underpricing of IPOs acts as a signal of firm quality where owners of high-quality firms have the
incentives to underprice with the aim of subsequently selling their retained shares at a higher and
more informed price. The ownership dispersion hypothesis proposed by Brennan and Franks
(1997) suggests that underpricing of an IPO usually results in oversubscription of shares and the
issuer rationing the allocation of shares. Such dispersed ownership structure may improve
liquidity and lower the required rate of return so as to achieve a higher equilibrium price in the
secondary market (Booth and Chua, 1996).
In this study, we analyze the relationship between corporate governance variables and
IPO pricing to pinpoint the governance variables that serve as signals of IPO quality. To be
specific, we wish to seek answers to the question of whether corporate governance matters to
investors’ valuation and underwriters’ valuation. There are several possible answers. We will
analyze three such possibilities below.
8
The first possibility is where both the underwriters and investors believe that corporate
governance does not matter. There will be no relationship between the corporate governance
variables, offer price, market price and underpricing premium.
The second possibility is where both the underwriters and investors believe that corporate
governance matters. Under this scenario, good corporate governance will be positively related to
the offer price and market price. However, if both the underwriters and investors assign the same
value to corporate governance, there will be no relationship between corporate governance and
underpricing premium even if corporate governance matters. In other words, the absence of a
relationship between corporate governance and underpricing is consistent with either corporate
governance being irrelevant to the underwriters and investors or corporate governance being
relevant where both the underwriters and investors assign the same value to corporate
governance.
The third possibility is where corporate governance matters but the underwriters and
investors do not assign the same value to it. Under this scenario, corporate governance will again
be positively related to the offer price and market price. However, note that the empirical
relationship between corporate governance and underpricing premium will depend on the
relative valuation of corporate governance by the underwriters and the investors. If the
underwriters assign a higher value to an IPO with good corporate governance, the IPOs will
show less underpricing. Conversely, if investors assign a higher value to an IPO with good
corporate governance, such IPOs will show greater underpricing.
It can be seen from the above discussion that it is difficult to conclude whether corporate
governance matters by examining underpricing. Thus, we use the following two measures of IPO
pricing namely the offer price set by the underwriters adjusted for NTA per share, and the first-
9
day closing price set by investors adjusted for NTA per share. These two measures are analogous
to the market-to-book ratios commonly used as proxies of Tobin’s Q in empirical research on
seasoned firms.
B.
Conventional corporate governance
Conventional corporate governance comprises ownership structure and board structure.
According to Jensen and Meckling (1976) and Mikkelson and Ruback (1985), the ownership of
the firm is likely to affect the level of agency problems and the ability of stockholders to control
agency problems. Ownership is defined by two characteristics, namely, managerial ownership
and blockholder ownership.
Fama (1980) believes that the board of directors is the central internal control mechanism
for monitoring managers. Shleifer and Vishny (1997) suggest that firm value depends on the
quality of the monitoring and decision-making on the part of the board. Three characteristics that
measure the monitoring potential of a board are board size, board composition and board
leadership structure (Jensen, 1993).
Managerial Ownership
Jensen and Meckling (1976) argue that costs can be lowered by increasing the level of
managerial ownership so as to align the interests of the agent with those of the principal. Ceteris
paribus, lower agency costs will result in higher firm value.
H1: There is a positive relationship between managerial ownership and IPO pricing.
The managerial entrenchment hypothesis, however, predicts that increased levels of
managerial ownership may result in reduced corporate performance (Craswell et al., 1997).
Dahya et al. (1998) argue that manager-owners are protected by their strong stakes in the
10
company and are unlikely to be displaced even in times of poor performance. Morck et al. (1988)
and McConnell and Servaes (1990) find that firm value is positively related to managerial
ownership at lower levels of ownership. However, this association weakens at higher levels,
suggesting that high levels of managerial ownership may shield entrenched managers from the
discipline of the market for poor corporate control. Stulz (1988) likewise finds a curvilinear
relationship between managerial ownership and firm value. Initially, firm value rises as
ownership becomes more concentrated and monitoring costs decrease. However, as management
becomes more insulated, firm value eventually decreases. Thus, while an increase in managerial
ownership can help align the interests of shareholders and managers, excessive managerial
ownership is likely to lead to managerial entrenchment. In our robust tests, squared managerial
ownership will be used to test for the curvilinear relationship.
Blockholder Ownership
Berle and Means (1968) suggest that blockholder ownership improve corporate
governance by acquiring better information on managerial performance. This view is shared by
Shleifer and Vishny (1986) who find that large shareholders have more incentive to monitor
managers. Shivdasani (1993) suggests that large shareholders facilitate takeovers. Kaplan and
Minton (1994) believe that blockholder ownership aids corporate governance as it allows large
shareholders to exert greater influence and remove managers who do not maximize stockholders’
wealth. Bergstrom and Rydqvist (1990) study the expropriation hypothesis using a sample of
Swedish firms with dual classes of shares and report no evidence that large shareholders utilize
high voting power to expropriate minority shareholders. Similarly Denis and Denis (1994) do not
find any evidence that majority-controlled U.S. firms perform worse than widely held firms.
H2: There is a positive relationship between blockholder ownership and IPO pricing.
11
La Porta et al (1998) find that good accounting standards and shareholder protection
measures are associated with a lower concentration of ownership. In the presence of poor
investor protection, ownership concentration usually means that only the large shareholders can
hope to receive a return on their investment. La Porta et al (1999) suggest that, very often, these
large shareholders are controlling shareholders with the power and the interests to expropriate
minority shareholders. Shleifer and Vishny (1997) argue that the benefits of blockholder
ownership may not be applicable in environments with very high blockholder ownership.
Board Size
It has been argued that larger boards are better able to monitor top management as the
CEO may find it more difficult to dominate a large board (Zahra and Pearce, 1989). However,
John and Senbet (1998) argue that although an increase in board size increases the board’s
monitoring capacity, it may also lead to poorer communication and decision-making. Jensen
(1993) asserts that large boards hinder the exchange of ideas between directors. Similarly,
Eisenberg, Sundgren and Wells (1998) argue that coalition costs among directors increase as
board size grows thus facilitating the CEO’s dominance over board members. Yermack (1996)
reports a negative relationship between the firm’s market value and the size of the board based
on a sample of 452 large US Industrial corporations between 1984 and 1991 which supports the
view that large boards are less effective.
H3: There is a negative relationship between board size and IPO pricing.
In our robustness tests, squared board size will be used to test for the presence of any
curvilinear relationship.
12
Board Composition
Fama and Jensen (1983) propose that outside directors can add value both as monitors of
management and providers of “relevant complementary knowledge”. They have the incentives to
uphold their reputation as decision control specialists in relation to the demand for their
directorial services. This makes them more effective monitors of management vis-à-vis inside
directors. Rosenstein and Wyatt (1990) find that the appointment of an outside director results in
a significant increase in firm value.
H4: There is a positive relationship between the proportion of outside directors and IPO
pricing.
In contrast, the managerial hegemony theory challenges the view that the board can
resolve agency problems through monitoring.
Kosnik (1987) views boards as passive
instruments that hold allegiance to the managers who selected them and depend on top
executives for information. Baysinger and Hoskisson (1990) argue that the amount and quality of
information possessed by outside directors are inferior to those possessed by inside directors.
Outside directors usually serve on multiple boards and may not truly understand the business.
Bhagat and Black (1997) find that the proportion of independent directors is unrelated to
performance.
Board Leadership Structure
Jensen (1993) concludes that a board with a unitary leadership structure is less effective
in monitoring management. It may result in managerial dominance, as the Chairman who is also
the CEO, may be more aligned with management than the shareholders. Under a dual leadership
structure, power is not concentrated in any individual but is spread out allowing the Board to
perform its fiduciary duties thus increasing its monitoring ability (Mak and Li, 2001).
13
H5: There is a positive relationship between a dual leadership structure and IPO pricing.
C.
Family Governance
As reported in La Porta et al. (1999) and Claessens (2000), there is extensive family
ownership and family control in East Asian firms. While this may allow the family to monitor
managers more closely, outside investors face the risk of expropriation by family shareholders.
In addition, family management may not have been subjected to similar screening and hiring
procedures and may not be as competent. In this section, we will discuss several characteristics
of family governance namely, family ownership, family directors, family Chairman, family
CEO, family representation in senior managerial positions and family representation on audit
committees.
Family Ownership
Claessens et al (2000), in their study of 9 East Asian countries, find that more than two
thirds of the sample firms are controlled by a single owner. Separation of management from
ownership control is rare. Claessens et al. (1999) report the ability and incentives of controlling
shareholders to expropriate from minority shareholders. They find that firms that use dual-class
shares, stock pyramiding and cross holdings have lower market values. Morris (1989) believes
that the absence of separation of ownership from management causes family businesses to suffer
from cloudy financial vision. Psychological conflicts within the family such as nepotism and
sibling rivalry can lead to a confusing organizational structure in which authority and
responsibility are vaguely defined, thereby offsetting the benefits of monitoring (Kets de Vries,
1993). Shleifer and Vishny (1997) argue that family-controlled firms may make decisions in
favor of family shareholders at the expense of public investors.
14
H6: There is a negative relationship between family ownership and IPO pricing.
Fama and Jensen (1983), however, argue that family relationships among owners and managers
have numerous opportunities for exchange with one another, thus creating advantages in
monitoring and disciplining related decision agents to reduce agency costs. Robustness tests
using squared family ownership will be performed to examine the presence of a curvilinear
relationship.
Family Directors
Family members often play a crucial role on the board, especially in East Asian firms.
Pant and Rajadhyaksha (1996) study the placement practices in Asian family businesses and find
that family ties surpass ability in determining appointments. La Porta et al. (1999) find that, in
most countries, non-cumulative voting for directors is practised and the appointment of each
director is voted separately. This enables controlling family shareholders to vote in their own
family members on the board. Lim (1997) reports that family members of holding companies
frequently sit on the board as either executive or non-executive directors. Claessens et al. (1999)
report that concentration of family control rights adversely affects market valuation.
H7: There is a negative relationship between the proportion of family directors and IPO
pricing.
Family Member as Chairman of the Board
If the presence of family directors on the board adversely affects market valuation, the
appointment of a family member as the Chairman of the Board is likely to generate unfavorable
responses.
15
H8: There is a negative relationship between the appointment of a family member as
Chairman and IPO pricing.
Family Member as CEO
The 1997 Arthur Andersen/Mass Mutual American Family Business Survey12 reports that
86.7 percent of family-controlled firms appoint a family member to the position of CEO and
approximately a third of them have no full-time work experience outside of the family business.
Yeung and Soh (2000) observe that in family-controlled firms, the successor to the CEO is often
a related member so as to enhance the family’s voice in the business. In their study of 157
publicly listed Chinese family firms, they find that 84.7 percent have family members holding
key positions of Chairman, CEO and managing director. Johnson et al. (1985) report that stock
prices increase with the announcement of deaths of founder CEOs. Yermack (1996) finds a
negative relationship between firm value and the presence of founding CEO on the board.
H9: There is a negative relationship between the appointment of a family member as CEO
and IPO pricing.
In contrast, Morck et al. (1988) observe that Tobin’s Q increases when a founding family
member holds one of the top two positions. McConaughy (2000) reports that founding family
CEOs in family controlled firms receive less incentive pay than non-family CEOs in family
controlled firms after controlling for size, managerial ownership and tenure. McConaughy et al.
(2001) suggest that firms controlled by the founding family have greater value and operate more
efficiently than other firms. These findings are consistent with the family incentive alignment
1997 Research Findings, The Arthur Andersen/Mass Mutual American Family Business Survey’ 97
(http://www.massmutual.com/fbn/html/res97.html)
12
16
hypothesis, which states that founding family managers have more incentive than non-family
counterparts to improve firm performance.
Family Management
The 1997 Arthur Andersen/Mass Mutual American Family Business Survey finds that the
criteria used to select family members for permanent management positions in the firm may not
be adequate to ensure the efficient running of the company. Claessens et al. (2000) find that 60
percent of the firms that are not widely held have top management that are related to the family
of the controlling shareholder.
H10: There is a negative relationship between the proportion of family members in senior
management positions and IPO pricing.
Family Member on Audit Committee
There is widespread support for the audit committee to consist of non-executive directors
as they are more likely to be independent of management’s influence and are more likely to
undertake activities and procedures that enhance internal controls and corporate governance
(Beasley, 1996). The PriceWaterhouseCoopers Survey (1997) reports that the audit committee is
the most important source of assurance of effective internal control to shareholders. It plays a
vital role in acting as guardians to public shareholders by helping to ensure the quality of
financial reporting and control system. The Blue Ribbon Committee (1999) strongly advocates
that the committee be independent of management’s influence. Scarbrough et al. (1998)
conducted a study on Canadian audit committees and find that those made up of solely nonemployee directors are more likely to have frequent meetings with the chief auditor and to
17
review the internal auditing program and results of internal auditing. DeZoort and Salterio (2001)
report that the independence and audit knowledge of audit committee members increases the
likelihood that committee members will advocate a “substance” approach in an accounting
dispute with management.
As of 1991, it is mandatory for Singapore listed companies to have at least 3 members on
the audit committee and the majority must not be executive directors or related to a director of
the company. According to Section 201B of the Singapore Companies Act, the Chairman of the
audit committee must be a non-executive director.
H11: There is a negative relationship between the presence of family members on audit
committee and IPO pricing.
D.
Board Expertise
Past studies emphasize mainly the board’s role as an independent control mechanism.
The broader literature on boards (e.g. Demb and Neubauer, 1992; Lorsch and MacIver, 1989),
however, suggests that directors also provide advice to management. Recent studies have
considered other aspects of board composition such as the presence of foreign directors, board
experience and reputation.
Foreign Directors
In view of the on-going process of globalization in equity markets and corporate
governance systems, the inclusion of foreign directors can enhance the expertise of the board.
Foreign directors may possess knowledge of foreign markets that can assist the firm in entering
overseas markets. Randøy and Oxelheim (2001) find that Norwegian and Swedish firms create
value through the inclusion of Anglo-American non-executive directors on their boards.
18
H12: There is a positive relationship between the presence of foreign directors and IPO
pricing.
Board Experience and Reputation
Directors with other directorships are able to engage in information sharing and acquiring
of common industry knowledge. They have valuable reputation capital at stake and are less
likely to collude with management. Brickley et al. (1994) find that the proportion of board
directors that are “professional directors” has a large positive influence on abnormal returns.
H13: There is a positive relationship between the proportion of directors with outside
directorships and IPO pricing.
The number of directorships held by directors may be an indication of their experience
and may increase the pricing of IPOs initially but this may be eroded when other board
commitments increase to a limit that stretches their resources. The empirical proxy used by
Kaplan and Reishus (1990) and Gilson (1990) to measure the value of reputation capital is the
number of other directorships held. Proponents of governance reform have strongly advocated
limits to the number of board seats a director may hold (Business Week, 1997). Core et al (1999)
find that the presence of "busy"13 directors is positively associated with measures of excess CEO
compensation suggesting that such directors are less likely to engage in significant managerial
monitoring. Shivdasani and Yermack (1999) find positive association between CEO involvement
in the selection of new directors and "busy"14 appointments. They infer that if “busy”
appointments indicate directors who are indifferent or overtaxed, then there is association
between less valuable appointments and CEO involvement.
13
Core et al (1999) define directors to be busy if they serve on three or more boards if they are employed and six or
more boards if they are retired.
19
H14: There is a negative relationship between the average number of directorships held by
directors and IPO pricing.
In order to examine if a curvilinear relationship is present, robustness tests will be carried
out using the squared number of directorships held by directors.
E.
Control Variables
Firms with different governance may differ on other dimensions. Our cross-company
comparison may therefore reflect these other differences. To mitigate these concerns, we draw
from prior literature and incorporate firm-level characteristics to control for differences in firm
size, leverage, asset tangibility, underwriter reputation and retained ownership.
Dalton et al. (1998) note that several aspects of firm size may influence the governance of
organizations in ways that temper a board's ability to effect change. Pfeffer and Salancik (1978)
argue that larger firms have far more influence over their environments than smaller firms and
are concomitantly more likely to enlist the support of critical constituencies. Haveman (1993)
suggests that having control over such resources makes it easier for larger firms to initiate and
sustain change, resulting in higher pricing by underwriters and investors.
The free cash flow hypothesis proposed in Jensen (1986) argues that managers tend to
misuse free cash flow15 for their own utility maximization. High levels of debt16 reduce agency
costs because the fixed payments of corporate debt will disgorge any such free cash flow.
14
Shivdasani and Yermack (1999) use Core at al (1999)'s definition of "busy".
Free cash flow is defined as the discretionary cash flow in excess of that needed to fund all positive net present
value projects.
16
Stulz (1990) argues that increased leverage increases firm value as managers are restricted from investing in poor
projects.
15
20
Mishra et al. (2001) find that firms with relatively more tangible assets have lower value.
Since the ratio of market to book value is often used to measure firm value, this ratio is likely to
be low when asset tangibility is high.
Booth and Smith (1986) show that an underwriter's reputation can serve as the bonding
mechanism to satisfy investors that the security's price is accurate. An underwriter who
completely misjudges the true equilibrium price will lose either potential investors if the price is
too high or potential issuers if the price is too low, and suffer a diminished reputation capital.
Carter and Manaster (1990) find that the relative position of the underwriter's name within
tombstone security offering advertisements can explain IPO returns. They show that prestigious
underwriters are associated with lower risk offerings and better-governed firms.
Higher retained ownership implies attractive opportunities that may be captured in the
future. Leland and Pyle (1977) suggest that firms with incumbent shareholders retaining high
ownership have higher values. They argue that the issuer incurs a cost when he forgoes personal
diversification in favor of retention, and is therefore likely to do so only if he is optimistic about
the prospects of the company.
IV. Data and Sample Selection
The sample consists of firms that are publicly listed for the first time on the SGX between
1994 and 2001 for which all information on the dependent and explanatory variables are
available.
Out of a total of 328 IPOs listings, 269 firms meet the sampling criteria. 55 IPOs are
omitted due to insufficient disclosure of certain information such as share ownership, directors’
experience and management background while another 4 are omitted due to extreme outlying
values.
21
Secondary data pertaining to the offer price, share ownership, board structure, family
governance and board expertise variables are manually collected from the prospectuses17. First
day closing prices are obtained from the SGX Library. Closing prices stated in foreign currencies
and their respective exchange rates are extracted from the DataStream database. Table I
summarizes the definition of all the variables.
Insert Table I
V. Results
A.
Descriptive Statistics
Table II presents the mean, standard deviation and range of the dependent, explanatory
and control variables. The average offer price to NTA per share is 2.59, and the average first day
closing price to NTA per share is 3.13.
The mean managerial ownership and boardholder ownership are 44 percent and 66
percent respectively. The board size ranges from 4 to 14, with a mean of 6.87. A typical board
has equal representation of executive and non-executive directors. The dual leadership structure
is adopted by 52 percent of the sample firms.
Family ownership averages 37 percent and family directors occupy 27 percent of the
board seats. Family chairman, family CEO and family presence on audit committee are found in
56 percent, 55 percent, 38 percent of the sample respectively. Family members in senior
management positions average 9 percent.
17
Prospectuses issued between 1994 to 1997 are obtained from the SGX library, while those from 1998 to 2001 are
downloaded from the SGX website as the website only holds IPOs for the last 4 years.
22
For the board expertise measures, 30 percent of the sample firms have a foreign director
on their boards. Approximately, 94 percent of directors hold other directorships simultaneously,
and the mean number of directorships held is 10.68.
On average, firms have a leverage ratio of 56 percent and a fixed asset ratio of 33
percent. The average underwriter has 21 percent of the market share, and the mean retained
ownership by incumbent shareholders is 77 percent.
Insert Table II
B.
Regression Results
The relationship between corporate governance variables and IPO pricing is analyzed
using 3 different models which differ according to the set of explanatory variables included.
Each of the models is in turn estimated with offer price premium or market price premium as the
dependent variable. Models 1 and 4 are regressions against family governance variables,
conventional corporate governance mechanisms and the control variables using the offer price
premium and the market price premium as dependent variables respectively. Models 2 and 5 are
regressions against the board expertise variables, conventional corporate governance
mechanisms and control variables. Models 3 and 6 are the full models.
White’s general heteroscedasticity tests show that the assumption of homoscedasticity is
not violated. Jarque-Bera tests show that there is no violation of the normality assumption. The
F-statistics for all 6 models are significant at the 1 percent level as shown in Table III.
Insert Table III
Managerial ownership is positively related to offer price premium (Models 1 and 3),
which is consistent with a high level of managerial ownership reducing agency costs leading to a
23
closer alignment of interests between managers and shareholders (Jensen and Meckling, 1976).
High blockholder ownership is also positively related to offer price premium. Board size is
negatively associated with offer price premium, suggesting that smaller boards are better, which
is consistent with Yermack (1996). The leadership structure and the proportion of outside
directors are not significant.
The association of the conventional corporate governance variables with market price
premium is similar to those reported for offer price premium except for blockholder ownership.
Investors’ perception of the IPO is not associated with the level of blockholder ownership.
Results show that family ownership and family management are negatively related to
offer price premium. This is consistent with Morris' (1989) suggestion that the lack of separation
of ownership and management causes family-controlled firms to suffer from cloudy financial
vision, resulting in a negative relationship with pricing. However, the appointment of family
chairman is positively associated with the offer price set by underwriters. Family directors and
family presence on audit committee are not related to IPO pricing. Similar findings on family
directorships are also reported by Mishra et al. (2001) in their sample of 120 Norwegian firms.
The impact of family governance variables on market price premium is similar to that on
offer price premium, except for family Chairman. Underwriters, but not investors, view that
family leadership on the board at the time of IPO is beneficial.
The appointment of foreign directors, the proportion of directors with experience and the
average number of directorships held by the board have no association with IPO pricing.
Firm size is positively related to offer price premium. This is consistent with the negative
relationship between firm size and returns as recorded in the literature. Asset tangibility has
negative association with offer price premium implying that firms with a substantial proportion
24
of their assets in property, plant and equipment have lower pricing. Retained ownership is
positively related to the offer price premium which implies that underwriters regard high equity
retention as a signal of the firm’s quality. Leverage is only marginally significant (Model 2).
Underwriter reputation does not explain offer price premium.
The results for market price premium are similar to those based on offer price premium,
except that underwriter reputation is positively related to and leverage is not related to market
price premium. Investors associate a more prestigious underwriter with higher firm value (Booth
and Smith, 1986).
C.
Robustness Tests
In the regression models, the presence of foreign directors is measured using a dummy
variable because many boards do not have foreign directors and those that do generally have
only one foreign director. The model is re-run using the proportion of foreign directors and the
results are similar to earlier findings.
In our discussion, it was suggested that four variables might exhibit curvilinear
relationships, namely, managerial ownership, board size, family ownership and average number
of directorships. The analysis is re-run by including squared managerial ownership, squared
board size, squared family ownership and squared average number of directorships. This method
for testing curvilinear relationship is consistent with McConnell and Servaes (1990). None of the
four variables show evidence of non-linearity in these robustness tests.
25
V. Conclusion
Our results are consistent with standard corporate governance arguments in the literature
such as the minimisation of expected agency costs due to the separation of ownership and
control.
For conventional corporate governance variables, managerial ownership is positively
related to while board size is negatively related to both offer price premium and market price
premium. Blockholder ownership is positively related to only offer price premium.
The proportion of family ownership and the proportion of family members in senior
management positions have negative relationships with both offer price premium and market
price premium. The appointment of family Chairman is positively related to the offer price
premium, but not the market price premium. Thus family leadership on the board at the time of
the IPO is associated with underwriters’ perception. Family ownership and involvement in
management are negatively related to IPO pricing. Family-owned firms that are in the process of
going public should pay attention to how they retain control after the IPO, in order to maximize
their offer and market share price.
The proportion of foreign directors, the number of directors with experience and the
number of directorships held by each director are not related to IPO pricing. Thus, there is no
evidence that foreign directors and the number of directorships held enhance corporate
governance.
Control variables that significantly affect both the offer price premium and market price
premium are firm size, asset tangibility and retained ownership. Leverage is marginally
significant for offer price premium. Underwriter reputation is related to only market price
premium.
26
There are some areas that future research can examine. First, given that poor corporate
governance practices among East Asian countries have been identified as a major cause of the
East Asian financial crisis, it would be interesting to examine whether the impact of corporate
governance on firm value has changed after the crisis. Second, in this study, the percentage of
directors having other board seats and the average number of outside directorships held by
directors are used as board expertise variables, without considering whether the board seats are
in related companies or in companies from similar industries. Having board seats in certain
companies may enhance the contribution of directors through their ability to acquire updated
information. Finally, the literature can be further advanced by examining the impact of family
governance and board expertise in other Asian markets as differences exist between the
institutional environment of Singapore and those of these countries.
27
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33
Table I
Definition and Measurement of Variables
The sample consists of firms, that are publicly listed for the first time on the SGX between 1994 and 2001, for which all
information on the independent and explanatory variables are available. Secondary data pertaining to the offer price, share
ownership, board structure, family governance and board expertise variables are manually collected from the prospectuses.
First day closing prices are obtained from the SGX Library. Closing prices stated in foreign currencies and their respective
exchange rates are extracted from the DataStream database.
Variable
Definition
Measurement
OFFPRE
Offer Premium
Offer price / Net tangible assets per share
MKTPRE
Market Premium
First day market price/Net tangible assets per share
MNGOWN
Managerial Ownership
Shares owned by executive directors and management/Total number of shares (after IPO)
BLKOWN
Blockholder Ownership
Shares owned by substantial shareholders / Total number of shares (after IPO)
BRDSIZE
Board Size
Total number of executive and non-executive directors, excluding alternate directors
OUTDIR
Proportion of Outside Directors
Number of outside directors / Total number of directors
LDRSTR
Leadership Structure
Dummy variable, with 1 if dual leadership structure, 0 otherwise
FAMOWN
Family Ownership
Shares owned by family members / Total number of shares (after IPO)
FAMDIR
Proportion of Family Directors
Number of family directors / Total number of directors
FAMCHR
Family Member as Chairman of Board
Dummy variable, with 1 if family member is chairman, 0 otherwise
FAMCEO
Family Member as CEO
Dummy variable, with 1 if family member is CEO, 0 otherwise
FAMMGT
Proportion of Family Members in Senior
Management Positions
Number of family members in senior management positions / Total number of senior
management positions listed in prospectus
FAMAUDC
Family Members on Audit Committee
Dummy variable, with 1 if family member is on audit committee, 0 otherwise
FORDIR
Foreign Directors on Board
Dummy variable, with 1 if foreign director is on board, 0 otherwise
DIREXP
Proportion of Directors with Experience
Number of directors holding other current directorships / Total number of directors
NUMDIR
Average Number of Directorships held
by Directors
Total number of other current directorships held by directors / Total number of directors
FIRMSIZE
Firm Size
Natural logarithm of market capitalization obtained using closing price on the second day
of listing
LEVERAGE
Leverage
Total liabilities / Total assets
ASSETAN
Asset Tangibility
Fixed assets / Total assets
UWREP
Underwriter Reputation
Underwriter’s market share / Total market share
RTOWN
Retained Ownership
Sum of post-listing shares of incumbent shareholders/Total number of shares (after IPO)
34
Table II
Summary Statistics
The sample consists of firms, that are publicly listed for the first time on the SGX between 1994 and 2001, for
which all information on the independent and explanatory variables are available. Out of a total of 328 IPOs
listings, 269 firms meet the sampling criteria. 55 IPOs are omitted due to insufficient disclosure of certain
information such as share ownership, directors’ experience and management background while another 4 are
omitted due to extreme outlying values. The definition of the variables are contained in Table I.
Variable
Mean
Median
Std. Dev.
Minimum
Maximum
OFFPRE
2.59
2.23
1.35
0.39
10.12
MKTPRE
3.13
2.68
1.68
0.50
11.57
MNGOWN (%)
43.53
47.74
25.78
0.00
85.00
BLKOWN (%)
66.03
68.09
12.30
0.00
93.00
BRDSIZE
6.87
7.00
1.81
4.00
14.00
OUTDIR (%)
50.12
50.00
16.86
18.18
90.00
LDRSTR
0.52
1.00
0.50
0.00
1.00
FAMOWN (%)
37.13
39.20
31.39
0.00
85.89
FAMDIR (%)
27.20
28.57
23.58
0.00
80.00
FAMCHR
0.56
1.00
0.50
0.00
1.00
FAMCEO
0.55
1.00
0.50
0.00
1.00
FAMMGT (%)
8.79
0.00
14.05
0.00
71.43
FAMAUDC
0.38
0.00
0.49
0.00
1.00
FORDIR
0.30
0.00
0.46
0.00
1.00
DIREXP (%)
93.58
100.00
10.90
50.00
100.00
NUMDIR
10.68
8.86
7.32
1.44
48.00
FIRMSIZE
18.34
18.26
0.93
16.45
21.84
LEVERAGE (%)
56.39
58.14
18.01
1.17
97.15
ASSETAN (%)
33.33
33.34
20.18
0.00
92.09
UWREP (%)
21.34
15.58
18.71
0.21
44.84
RTOWN (%)
76.55
75.00
7.29
35.05
97.22
35
Table III
The Effect of Corporate Governance on IPO Pricing
The dependent variable for Models 1, 2 and 3 is offer price premium, while that for Models 4, 5 and 6 is
market price premium. The independent variables are conventional corporate governance mechanisms,
family governance variables, board expertise variables and control variables for the sample of 269 Singapore
IPO firms between 1994 and 2001. Models 1 and 4 include conventional corporate governance mechanisms,
family governance variables and the control variables. Models 2 and 5 include conventional corporate
governance mechanisms, board expertise variables and the control variables. Models 3 and 6 are the full
models. The t-statistics are in parentheses. The table also reports the F statistic and the p value for the
hypothesis that the joint effect of all the variables equals zero. The symbol*** indicates the coefficient is
significantly different from zero at the 1 percent level or less, ** at 5 percent or less, * at 10 percent or less.
Hypothesized
Sign
Variable
MNGOWN
BRDSIZE
-
7.39***
6.49***
-
0.276
-
0.0001
Positive
LDRSTR
Positive
FAMOWN
Negative
FAMDIR
Negative
FAMCHR
Negative
FAMCEO
Negative
FAMMGT
Negative
FAMAUDC
FORDIR
Negative
Positive
DIREXP
Positive
NUMDIR
Negative
FIRMSIZE
-
LEVERAGE
ASSETAN
-
UWREP
-
RTOWN
-
F
p-value
0.649***
(7.61)
0.007
(1.52)
-0.008**
(-2.18)
0.0008
(-0.20)
0.032***
(3.06)
0.116
(0.68)
0.0007
(0.10)
-0.003
(-0.21)
0.688***
(7.49)
0.007*
(1.65)
-0.009**
(-2.27)
0.003
(0.62)
0.031***
(2.82)
Negative
OUTDIR
Adjusted R
0.010**
(2.15)
0.012
(1.52)
-0.215***
(-3.74)
0.003
(0.49)
0.318
(1.62)
-0.012**
(-2.24)
-0.007
(-0.94)
0.467
(1.55)
0.362
(1.22)
-0.013*
(-1.84)
0.198
(0.83)
Positive
0.009**
(2.40)
0.013**
(2.14)
-0.151***
(-3.28)
0.003
(0.63)
0.251
(1.59)
-0.013***
(-2.92)
-0.007
(-1.25)
0.551**
(2.28)
0.341
(1.43)
-0.014**
(-2.44)
0.199
(1.03)
2
0.004
(1.12)
0.012*
(1.80)
-0.139***
(-2.82)
0.004
(0.83)
0.047
(0.29)
Dependent Variable = MKTPRE
Model 4
Model 5
Model 6
0.009**
(2.28)
0.013**
(2.08)
-0.159***
(-3.30)
0.003
(0.55)
0.249
(1.54)
-0.013***
(-2.90)
-0.007
(-1.25)
0.559**
(2.30)
0.347
(1.45)
-0.014**
(-2.43)
0.205
(1.05)
0.122
(0.74)
0.0003
(0.05)
-0.002
(-0.16)
0.653***
(7.31)
0.006
(1.56)
-0.008**
(-2.11)
0.001
(0.27)
0.032***
(3.06)
Positive
BLKOWN
Dependent Variable = OFFPRE
Model 1
Model 2
Model 3
0.808***
(7.61)
0.007
(1.41)
-0.012***
(-2.72)
0.011**
(2.34)
0.045***
(3.39)
-0.130
(-0.63)
0.003
(0.38)
-0.0001
(-0.01)
0.838***
(7.47)
0.007
(1.42)
-0.014***
(-2.96)
0.013**
(2.59)
0.043***
(3.21)
0.10**
(2.10)
0.012
(1.54)
-0.206***
(-3.44)
0.003
(0.55)
0.326
(1.61)
-0.012**
(-2.24)
-0.007
(-0.93)
0.459
(1.52)
0.361
(1.21)
-0.013*
(-1.83)
0.188
(0.77)
-0.130
(-0.63)
0.003
(0.33)
0.0003
(0.02)
0.802***
(7.20)
0.007
(1.35)
-0.013***
(-2.76)
0.0113**
(2.28)
0.044***
(3.36)
6.19***
7.54***
7.77***
6.31***
0.210
0.269
0.281
0.284
0.274
0.0001
0.0001
0.0001
0.0001
0.0001
36
0.005
(1.23)
0.011
(1.36)
-0.189***
(-3.16)
0.005
(0.80)
0.137
(0.70)