The Effect of a Unification Clause on IPO Underpricing and Company’s Financing Decisions

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School of Business | Master's thesis
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Objective of the Study The objective of this thesis is to study whether a unification clause can mitigate investors’ concerns of managerial entrenchment in dual-class companies. There has been a lot of academic discussion on whether control enhancing mechanisms, such as dual-class structure or takeover defenses, entrench managers or enable them to create value for shareholders in the long-term. A unification clause states that if the insiders’ ownership falls below a specified ownership threshold, all superior voting shares will convert to common shares and insiders will lose majority of their control. Unification clauses are a relatively new phenomenon, and have not been previously studied. More specifically, the focus of this paper is to study the effect of a unification clause on company’s IPO underpricing and financing decisions. Data and Methodology The dataset consists of 128 dual-class IPOs listed on NYSE and Nasdaq between years 2001-2015, obtained from SDC New Issues database. I manually check if the company has granted a unification clause in their IPO prospectus. To study the financing decisions, I gather security issuance data of these same companies during two subsequent years post-IPO. Previous papers studying dual-class structure have been mostly focusing on the comparison between single- and dual-class companies, which are found to be fundamentally different. My unique sample consisting of only dual-class companies tackles this challenge, and hence provides a clearly controlled setting to study the effect of a unification clause. I run OLS regression to study the relation between a unification clause and IPO underpricing. For the second part, to study how a unification clause affects company’s financing decisions, I use multinomial regression models. Empirical Findings I find that companies who grant a unification clause experience less underpricing, suggesting that company insiders must pay a price if they want to enhance their control. This is consistent with the majority of existing papers, finding a negative correlation between control enhancing mechanisms and firm valuation. In addition, I find evidence that protected managers have more discretion over SEO decisions, and are more likely to exploit overvaluation. Overall, my results provide evidence to support the view that public markets perceive control enhancing mechanisms as a measure that increase managerial entrenchment, and secure managers private benefits.
Thesis advisor
Kaustia, Markku
unification clause, IPO underpricing, security issues, control enhancing mechanisms
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