THE INITIAL PUBLIC OFFERING AS A MARKETING TOOL
By
Jae H. Song, & Yinsog Rhee
Herberger College of Business
St. Cloud state University, St. Cloud, Minnesota, USA
(320)255-3282 (Song)
e-mail: jhsong@stcloudstate.edu
(320)255-4989 (Rhee)
Carl R. Adams
Carlson School of Management
University of Minnesota, Minneapolis, Minnesota, USA
(612)625-3542
1
TITLE: THE INITIAL PUBLIC OFFERING AS A MARKETING TOOL
SUMMARY
Current literature treats the initial public offering (IPO) as strictly a capital
acquisition or a financial signalling event. Practitioners intuitively appreciate that it can
also have substantial marketing effect in terms of increased revenue trends and better
revenue to sales expense ratios. In addition it points to the possibilities of estimating
the financial value of the marketing effects. This would allow a recalculation of the cost
of capital using the IPO. The current popularity of IPO’s adds to the importance of this
paper’s conclusions.
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INTRODUCTION
An initial public offering (IPO) is the first selling of a company’s stock to the
public. It is considered a major milestone for the company. The IPO provides equity
capital from a broad segment of the public and an opportunity to disseminate
information on the business by a prospectus distributed to investors, a registration
document filed with the U.S. Securities and Exchange Commission (SEC), and road
shows to financial institutions. The prospectus and SEC registration include information
on management, financial data, details of the offering, and relevant risk factors. This
additional transparency, publicity, and broader stock ownership established by the IPO
indicate that the IPO is not a merely way to raise capital.
The literature on IPO’s is largely limited to understanding the IP O in terms of
pricing the IPO (Tinic, 1988; Kim, Krinsky, & Lee, 1993) and the financial motivation for
an IPO (Fagano, Panetta, & Zingales, 1998). IPO’s are typically “under-priced”.
Information signaling is another line of related literature. Theories on information
signals view various corporate activities such as the announcement of a strategy,
acquisition, new product, earnings forecast, dividend increase, stock split, or a stock
repurchase as a signal to investors of future economic performance (Lev, 1992 & 1995).
The literature on pricing, motivation and signaling is all concerned with the IPO as an
investment issue.
This paper studies the impacts of the IPO on the underlying product and service
markets, not the financial markets. Jeff Bezo’s comment (Harvard Business School
Case, 1999) indicating that the motivation for the IPO of Amazon.com was not only to
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raise capital but also to raise public awareness is an indication that substantial
marketing benefits may also be obtained from an IPO. Martha Stewart likely could have
sustained substantial expansion without an IPO. However, her recent IPO was
obviously orchestrated to produce tremendous publicity benefits for the firm1.
It seems clear that the IPO “communication opportunity” can be used to enhance
general public awareness, develop credibility for the venture, improve knowledge of
product and service characteristics, build an appreciation for future capabilities of the
venture, and showcase the management team. This type of communication can be a
valuable part of any marketing plan. Tying the IPO to product/service marketing
broadens the implications of the IPO beyond being a financial activity, i.e., to being part
of a product market strategy. We believe that it is valuable and useful to integrate both
the financial and marketing perspectives of an IPO considering the growing importance
of stock markets in the current economic conditions. One demonstration of the
significance of the marketing effect of an IPO would be an increase in sales volume
associated with the IPO. The next section presents a specific hypothesis related to this
marketing effect. This is followed by sections on data and sources of data, analysis of
data and results, and implications and conclusions.
HYPOTHESIS
At this preliminary stage in our thinking about the marketing effects of IPO’s, we
seek to demonstrate simply increased sales as a result rather than attempt to measure
the specific characteristics of awareness, credibility, product knowledge, plan
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knowledge, and management capability noted above. Thus, the proposed hypothesis
is:
An IPO has a positive impact on the company’s revenue.
A company that wants to go public is required to file a registration document with
the U. S. SEC and provides information to potential or actual investors. The documents
to investors are called prospectuses. The document to a potential investor before the
IPO occurs is a preliminary prospectus. After the IPO, there is a final prospectus.
Information contained in the registration document or prospectus includes a statement
of the business, bibliographical material on the officers and directors of the company,
the amount of shares each insider -- officers, directors and shareholders owning more
than10% of the securities – owns, complete financial statements including existing
debts and equity securities and how they are capitalized, uses of proceeds, and any
legal proceeding involving the company including strikes, lawsuits, antitrust actions, and
copyright/patents infringement suits.
Prior to the effective date, the first date that the IPO is on sale to the public, the
management team has a series of meetings in several different cities over a short time
period. In these meetings, referred to as road shows, potential investors including
brokers and analysts question management. Management explains and answers
questions about the business, products, and competition; the quality of management is
introduced to participants. Prospectuses and road shows enhance the general
awareness of the business and its products, and thus should have a positive impact on
promoting the company’s products and services.
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Further, through the IPO, a larger number of potential investors become new
stockholders. Stock ownership would give an additional incentive for the shareholder
to promote the company and become a consumer of the products of the company. If
you were a shareholder of Barnesandnoble.com, an Internet bookseller, you would be
more likely to buy books from Barnes & Noble than from other online booksellers and to
speak highly of the company to others.
DATA AND SOURCES OF DATA
From the high technologies group, 50 IPO’s that occurred in the period from
January 1997 to June 1998 were selected randomly for investigation. During this
period, there were 170 IPO’s in the high technologies group, which includes computer
and communication hardware, software, and services companies. The source of this
data is IPO Data Systems, a commercial data provider on the Internet.
Eight or more quarters of data were collected (4 or more quarters before and
after the IPO effective quarter). Data on total revenues and corresponding sales and
marketing expenses data were collected from the EDGAR database2. For some
companies, sales and market expenses were combined with general and administrative
expenses in the income statement in the EDGAR database.
Sales and marketing expenses include the cost of storing and preparing goods
for sale; displaying, advertising, promoting sales, making sales, and delivering the
goods to the buyers if seller pays the cost of delivery. General and administrative
expenses include expenses for accounting, personnel, and credit and collection, any
other expenses that apply to overall operation. General occupancy expenses, such as
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rent, insurance, and utility expenses are classified as general and administrative
expenses; they may be allocated between selling, and general and administrative
expenses.
ANALYSIS OF DATA AND RESULTS
Two variables, total revenues, and the ratio of total revenues to sales expenses3
were analyzed. The trend changes in total revenues and total revenues to sales
expenses ratios are shown in Table 1. For the total revenues, 31 firms out of 50 show
that the trend increased at the IPO effective quarter. Total revenues to sales expenses
ratio shows revenue per one-dollar sales expenses. Thirty-three firms out of 50 show
an increase after the IPO. Stated in terms of a quadratic trend equation Q:
y = a0 + a1 t + a2 t2 ---- (Q)
Where y indicates total revenues or ratio of revenues to sales expenses, t is time;
the sign of a 2 shows the trend change of total revenues or the ratio. A positive value of
a2 is for an increasing trend and a negative value of a 2 for a decreasing trend. The
results support the hypothesis4.
----------------------------Inset TABLE 1
----------------------------To further support the hypothesis of market impact, we investigate the
relationship between revenues and sales expenses. Simple regression lines between
revenues and sales expenses were fitted; the first regression line (A) uses the data for
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the whole period, the second one (B) is for data in the period before and including IPO
quarter. Let the regression line A and B be:
y = α 1 + β 1 x + ε ----- (A)
y = α 2 + β 2 x + ε ----- (B)
Where y is total revenues and x is sales expenses. The difference of slopes (β 1 - β 2)
indicates the impact of the IPO on revenues. Namely,
(β 1 - β 2) > 0; IPO increases revenue per unit of sales expense
(β 1 - β 2) = 0; IPO doesn’t increase or decreases revenue per unit of sales
expense
----------------------Insert FIGURE 1
-------------------------
In Figure 1, line A is for the whole period; line B is for the pre-IPO period and line
C is for the post-IPO period. The point D indicates the IPO quarter. If the IPO has a
positive impact on revenue increase per unit of sales expense, the line A has a steeper
slope than line B (the case shown). For this case, the residual of regression line A at D,
the IPO quarter, which is the quarter that line B and C meet, is a negative value.
The comparison between the two regression lines A and B for our samples is
summarized in Table 2. Twenty-two firms show that their slopes of line A are larger
than the slopes of line B, an indication that revenue growth per unit sales expense in the
post-IPO period is larger than the same growth in the pre-IPO period for these firms.
Thirteen out of thirty -five firms indicate that revenue growth per unit sales expense
decreased in the post-IPO period. This again indicates the validity of the hypothesis (pvalue is 0.087), but in addition indicates a measure of the marketing effect. This effect
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can be related to our knowledge of how increased expenditures in the category of sales
expenses can be expected to increase revenues.
-----------------------Insert TABLE 2
------------------------
Table 3 shows a summary of the results of the sign of the residuals at the IPO
quarter in regression line A. Since regression line A covers both pre and post IPO
periods, a negative value in the residual at the IPO quarter indicates an upward bending
in the relationship between revenues and sales expenses starting at the IPO quarter.
This is shown in Figure 1 lines B and C. A negative value in the regression line
between revenues and sales expenses indicates an increasing impact of the IPO on
revenue. Conversely, a positive value in the residual corresponds to a decreasing
relationship between revenues and sales expenses, which is a negative impact of the
IPO on revenues. Twenty-five firms (67.5%) show that the IPO had a positive impact in
increasing revenues and twelve firms (32.5%) indicated that the IPO was associated
with decreasing revenues. The analysis of residuals also supports the hypothesis (pvalue is 0.023).
-------------------Insert TABLE 3
---------------------
IMPLICATIONS AND CONCLUSIONS
Is this a general phenomenon holding for all IPO’s or a phenomenon that is
significant for some IPO’s? The results of the study indicate that an IPO does have a
marketing impact. This is a surprising result considering the current and past academic
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focus on the IPO as principally a financial phenomenon. Practitioners have recognized
the non-financial aspects of the IPO. The practical significance of this is enhanced by
the increasing number of IPO’s and the publicity accorded to them.
Companies can take advantage of the promotional benefits available with an IPO
by engaging marketing managers in the process. IPO information content, formats, and
distribution channels should be reviewed with an eye toward achieving more effective
dissemination of information to the public as customers as well as investors. Customeroriented product and service information in a format that is easy to comprehend by the
public should be added to the prospectus or provided in addition. Channels for
distributing the IPO information and the IPO stocks themselves should be broadened so
that the public can reach the information more easily.
Also, if IPO’s have a significant marketing impact, a part of the IPO cost should
be considered a marketing cost. This will lower the real capital cost of the IPO. This line
of studies warrants further investigation. In attempting to measure the financial value to
attribute to the marketing effects, it should be possible to estimate changes in revenue
attributable to the IPO and an estimate of the marketing cost to achieve that level of
revenue change.
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empirical test of IPO signaling models. Journal of Business Finance and Accounting,
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APPENDIX. TABLES AND FIGURE
TABLE 1
Trend Changes in Revenues and Revenues to Sales Expenses Ratio
Variables
Total
Revenues
Total
Revenues to
Sales
Expenses
Ratio
†
*
Trend Change
No. of Firms
Increasing
31 (62%)†
No Change
10 (20%)
Decreasing
9 (18%)
Increasing
33 (66%)*
No Change
1 (2%)
Decreasing
16 (32%)
p< .1
p< .05
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Table 2
Difference in Slopes
Difference in
Slopes
No. of Firmsa
(β 1 - β 2) > 0
22 (63%)†
(β 1 - β 2) = 0
13 (37%)
To see the marketing impact more clearly, fifteen firms with their R2 are smaller than
0.5 were excluded.
a
†
p < .1
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TABLE 3
Residuals at IPO Quarter and Number of Firms
Residuals at
IPO Quarter
No. of Firmsb
Negative
25(67.5%)*
Positive
12(32.5%)
To see the marketing impact more clearly, 13 firms with their R2 are smaller than 0.5
were excluded.
b
*
p < .05
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FIGURE 1
Regression Lines between Revenues and Sales Expenses
A
Revenues
C
D
B
Sales Expenses
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Endnotes
1
Form S-1/A for Martha Stewart Living Omnimedia, Inc filed on Oct 14, 1999 with the
U.S. SEC, Use of Proceeds Section states that approximately $91.7 million from IPO
will be used for IPO expenses ($9.17 million), for stock repurchase ($41.7 million), and
the remainder for short-term investment. This indicates no urgent need of the proceeds
from the IPO.
2
DGAR, the Electronic Data Gathering, Analysis, and Retrieval system, performs
automated collection, validation, indexing, acceptance, and forwarding of submissions
by companies and others who are required by law to file forms with the U.S. Securities
and Exchange Commission (SEC) (www.sec.gov).
3
To avoid repetition, we use the term ‘sales expenses’ to indicate sales and marketing
expenses, or general and sales expenses, whatever is available in EDGAR database.
4
For the test of P M = 0.5 vs. P M > 0.5, the p-value for Total Revenues is 0.059 and for
Total Revenues to Sales Expenses Ratio is 0.016,respectively. The parameter P M is
the proportion of companies with an increasing trend change. Thus, the alternative
hypothesis, P M > 0.5, means a positive marketing impact.
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