خطر شکایت های قانونی و قیمت گذاری IPO
|کد مقاله||سال انتشار||تعداد صفحات مقاله انگلیسی||ترجمه فارسی|
|17819||2002||27 صفحه PDF||سفارش دهید|
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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Financial Economics, Volume 65, Issue 3, September 2002, Pages 309–335
We examine the relation between risk and IPO underpricing and test two aspects of the litigation-risk hypothesis: (1) firms with higher litigation risk underprice their IPOs by a greater amount as a form of insurance (insurance effect) and (2) higher underpricing lowers expected litigation costs (deterrence effect). To adjust for the endogeneity bias in previous studies, we use a simultaneous equation framework. Evidence provides support for both aspects of the litigation-risk hypothesis.
Firms conducting Initial Public Offerings (IPOs) typically earn a return of approximately 15% on their first day of trading. While the magnitude of this initial return varies over time and as a function of firm characteristics, it shows no signs of dissipating. The persistent and systematic underpricing of IPO issues is puzzling, and this apparent violation of market efficiency has received considerable attention from researchers. There currently exist three main theories for these high initial returns: signaling, information asymmetry, and litigation risk (Ibbotson et al., 1994). A substantial body of literature empirically tests the first two potential explanations, and evidence indicates that information asymmetry is an important determinant of IPO initial returns. However, much of the magnitude of and variation in initial returns remains unexplained. Interestingly, litigation risk, the third potential explanation for underpricing, has received relatively little attention in the empirical literature. The idea that IPO firms and underwriters intentionally underprice their shares to insure against future liability is intuitively appealing, yet the existing evidence on this is at best mixed and inconclusive. Skeptics of the litigation-risk hypothesis (e.g., Alexander, 1993) often point to the high costs of underpricing relative to the average lawsuit settlement costs and the low historical lawsuit frequency (around 6% for our sample) as anecdotal evidence against this hypothesis. However, this ‘back-of-the-envelope’ reasoning ignores many important factors. First, it is possible that the lawsuit frequency and settlement payments are low precisely because most firms have used underpricing as a form of insurance. Further, as discussed in more detail below, this argument omits many of the costs associated with lawsuits. For a firm planning to go public, the potential costs of litigation are substantial. One of the most highly publicized costs of litigation is the settlement payment, which averages $3.3 million in our sample and represents 11% of the total proceeds raised. Notably, some of the cases settle for considerably larger amounts. For example, in four cases the settlement amount exceeds 35% of proceeds raised, and in one case the settlement amount is nearly 50% of proceeds. Further, these settlement amounts are only one portion of the total costs associated with a lawsuit. There are other, potentially more important, costs of litigation that are often overlooked because they are not directly observable. Examples of such costs include reputation costs to both the IPO firm and its managers, legal fees, and the opportunity cost of management time dedicated to the lawsuit. As discussed later, several companies in our sample cite such costs in their decisions to settle their lawsuits. Because litigation is costly, managers have incentives to insure against such costs. One way to effectively insure against these costs is to lower the probability of being sued. For this reason, all firms and their underwriters conduct due diligence prior to the IPO, i.e., they investigate all aspects of the firm's business, finances, management, and projections and discuss their findings in the IPO prospectus. However, it is not feasible to foresee every possible future event, and there are obvious limits to what can be incorporated into a prospectus. A second way to lower the probability of being sued is to decrease the potential damages that plaintiffs can recover. Alexander (1993) emphasizes that the amount of the expected settlement reward is a major determinant of the probability of being sued. For this reason, underpricing is a particularly attractive form of insurance. Unlike other forms of insurance that firms can purchase, underpricing lowers the potential damages that plaintiffs can recover, and thus reduces plaintiffs’ incentives to bring a lawsuit against the firm. To understand why underpricing potentially lowers the probability of being sued, we briefly discuss some specifics of the securities laws. The Securities Acts of 1933 and 1934 give investors the right to bring a lawsuit against an IPO firm for material untruths or omissions in the prospectus and provide guidelines for the calculation of associated damages. Almost all IPO-related lawsuits against the issuer are brought under Sections 11 and 12 of the Securities Act of 1933 and Section 10(b) of the Securities Act of 1934. Under Section 11, damages for direct purchasers in the IPO are based on the difference between the offer price and either the sale price or the security's price at the time of the lawsuit, depending on whether or not the share was sold. Persons who bought the stock in the aftermarket are eligible to receive damages under Section 11 if they can show reliance on the prospectus. For these aftermarket purchasers, damages are based on the lower of the offer price and the price at which the security was bought. Thus, for all suits brought under Section 11, damages are directly related to the offer price. A firm that underprices its IPO by a greater amount has a lower offer price, meaning that it has lower potential damages and a decreased probability of being sued. Sections 12 and 10(b) similarly apply to both direct and aftermarket purchasers. However, damages under both these sections are based on the investor's purchase price rather than the offer price. Because there is no direct link between the offer price and subsequent damages in these cases, the litigation-risk hypothesis is more applicable to Section 11 lawsuits. Based on the institutional facts of the securities laws, Ibbotson (1975) and Tinic (1988) hypothesize that underpricing represents a form of insurance against future litigation. The issuer and the underwriter agree to set the offer price below the expected market value of the securities because this decreases the probability of future litigation as well as the amount of damages in the event of a lawsuit. Consistent with this, Tinic (1988) finds that the initial returns of a sample of IPOs prior to the Securities Act of 1933 are significantly lower than those of a sample of firms that went public after this Act was implemented. Drake and Vetsuypens (1993) note that these results can be misleading because they do not control for the time variation in initial returns unrelated to litigation risk. Using a cross-sectional framework, they find that the initial returns of firms that are ultimately sued are no different than those of non-sued firms. Drake and Vetsuypens interpret these results as inconsistent with the litigation-risk hypothesis, since sued firms do not appear to be overpriced. However, their analysis suffers from the following endogeneity problem. Under the litigation-risk hypothesis, initial returns can be related to the probability of a lawsuit along two dimensions. First, firms with higher litigation risk should underprice their IPOs by a greater amount as insurance against litigation. This implies that initial returns are an increasing function of litigation risk. Second, firms that buy more insurance against litigation, i.e., underprice more, expect to be sued less often. This implies that litigation is a decreasing function of initial returns. Because the probability of being sued is itself an endogenous variable that could depend on underpricing, a comparison of initial returns across sued and non-sued firms is problematic. The objective of this paper is to examine the relation between underpricing and litigation risk in more depth. Specifically, we want to simultaneously address two distinct but related questions: (1) whether litigation risk affects IPO issuers’ incentives to underprice their issues, and (2) whether underpricing lowers the expected litigation costs by reducing lawsuit probabilities. This study contributes to the literature in several ways. First, we address the shortcomings of earlier studies by using a cross-sectional, simultaneous-equation approach. This research design provides a better specified test of the litigation-risk hypothesis and enables us to draw inferences on the validity of the hypothesis with more confidence. Second, we are able to directly examine both dimensions of the litigation-risk hypothesis, i.e., the extent to which issuers underprice their IPOs as a form of insurance against future litigation (the insurance effect) as well as whether underpricing is effective in reducing expected litigation costs (the deterrence effect). Results show that the relation between the probability of a lawsuit (more specifically, a Section 11 lawsuit) and initial returns lends support to both the insurance and the deterrence aspects of the litigation-risk hypothesis. First, firms with higher legal exposure tend to underprice their offerings by a significantly greater amount, suggesting that firms use underpricing as a form of insurance against future litigation. As discussed in more detail later, the OLS regression produces the opposite result, thus highlighting the importance of controlling for endogeneity in this context. Second, consistent with the effectiveness of underpricing as a form of insurance, we find evidence that underpricing decreases the expected litigation costs by reducing lawsuit probability. Section 2 discusses the related literature in more detail. Section 3 describes the data selection process and provides some descriptive statistics. Section 4 details the simultaneous-equation methodology used in this study. Section 5 presents evidence on the relation between IPO underpricing and litigation risk. Conclusions are offered in Section 6.
نتیجه گیری انگلیسی
Potential litigation costs are quite significant for firms that have recently gone public. Attorney fees, the costs of management time allocated to the lawsuit, reputation costs, and settlement costs represent an enormous potential liability for a young firm. Unlike most forms of insurance, IPO underpricing is a viable form of insurance against all of these costs because it lowers plaintiffs’ potential recoverable damages, and thus lowers the probability of being sued. This paper investigates the extent to which firms underprice their IPOs as a form of insurance and whether underpricing is effective in deterring litigation. Our examination of the relation between underpricing and litigation risk emphasizes the importance of controlling for endogeneity. For example, results from OLS regressions contradict the insurance effect component of the litigation risk hypothesis. However, this finding is overturned once we jointly model initial returns and litigation risk in a simultaneous equations system. Specifically, we find that firms with higher litigation risk underprice their IPOs by significantly greater amounts. Further, consistent with the deterrence effect of underpricing, there is evidence that firms that engage in more underpricing significantly lower their litigation risks, especially for lawsuits occurring closer to the IPO dates. After controlling for the endogeneity of initial returns and lawsuit probability, we find support for both the insurance and deterrence aspects of the litigation-risk hypothesis. The simultaneous-equation framework used in this study is potentially useful for other settings. Many corporate finance events are similarly endogenous in nature, and researchers’ ability to account for such endogeneity in future studies potentially affects the conclusions that are drawn.