infrastructure required to secure a position of market leadership and to acquire a customer base However, this perspective was largely reversed in late 2000 as investors realised that ongoing infusions of cash could not underpin the development of a company that lacked a sustainable business model. To the extent that our sample includes post-April 2000 IPO's the power of our tests to find a relation between underpricing and cash burn will be reduced 3.3 Underpricing and the Information Content of Going Concern Warnings McKeown(2000)on the information content of audit qualifications issued pre-lPU lhe sand This hypothesis is motivated by recent research in the US undertaken by Willenborg Australian IPO market provides a different setting in which to examine the extent to which information asymmetries between issuer and investor are mitigated by the signalling effect of audit qualifications, and the extent to which this signalling is incorporated into the relative underpricing of a particular issue In Rock's(1986)model, underpricing is required to compensate uninformed investors for the winners curse problem. Beatty and ritter(1986) argue that the level of underpricing is related to the ex ante tainty of the aftermarket value of the IPO. IPOs with greater ex ante uncertainty are more difficult to value. To compensate investors for the greater uncertainty, higher risk IPOs have higher initial returns. Therefore, IPOs with higher ex ante uncertainty are more underpriced than those with lower ex ante uncertainty. Empirical support for this monotonic relationship can be found in Ritter(1984), Beatty and Ritter(1986), Wolfe and Cooperman (1990), How, Izan and Monroe(1995), and Lee, Taylor and Walter(1996a) Willenborg and McKeown(2000)extend the model by predicting that a going-concern opinion issued for an IPO candidate has the ability to affect the level of uninformed investors'ex ante uncertainty about the true value of an offering and hence the anticipated level of underpricing. This argument draws on the information content of the audit qualification as a proxy for the volatility or skewness of future returns in the secondary market, rather than as a predictor of investment failure. Consistent with their hypothesis, Willenborg and McKeown (2000) find that securities with going-concern opinions suffer less first-day underpricing than similar securities without going-concern Notwithstanding the robustness of Rock's(1986) model of underpricing and the significan results documented by Willenborg and McKeown(2000)in a US setting concentrating on the small deal"(IPO proceeds up to US$10 million) segment of the IPO market, the direction of our final hypothesis is not obvious. It appears equally reasonable to contend that the issuance of a qualified audit opinion for an IPO candidate is a signal of a poor quality investment opportunity In this respect, investors would demand a greater risk premium to subscribe to the issue which in
10 infrastructure required to secure a position of market leadership and to acquire a customer base. However, this perspective was largely reversed in late 2000 as investors realised that ongoing infusions of cash could not underpin the development of a company that lacked a sustainable business model. To the extent that our sample includes post-April 2000 IPO’s the power of our tests to find a relation between underpricing and cash burn will be reduced. 3.3 Underpricing and the Information Content of Going Concern Warnings This hypothesis is motivated by recent research in the US undertaken by Willenborg and McKeown (2000) on the information content of audit qualifications issued pre-IPO. The Australian IPO market provides a different setting in which to examine the extent to which information asymmetries between issuer and investor are mitigated by the signalling effect of audit qualifications, and the extent to which this signalling is incorporated into the relative underpricing of a particular issue. In Rock’s (1986) model, underpricing is required to compensate uninformed investors for the winner’s curse problem. Beatty and Ritter (1986) argue that the level of underpricing is related to the ex ante uncertainty of the aftermarket value of the IPO. IPOs with greater ex ante uncertainty are more difficult to value. To compensate investors for the greater uncertainty, higher risk IPOs have higher initial returns. Therefore, IPOs with higher ex ante uncertainty are more underpriced than those with lower ex ante uncertainty. Empirical support for this monotonic relationship can be found in Ritter (1984), Beatty and Ritter (1986), Wolfe and Cooperman (1990), How, Izan and Monroe (1995), and Lee, Taylor and Walter (1996a). Willenborg and McKeown (2000) extend the model by predicting that a going-concern opinion issued for an IPO candidate has the ability to affect the level of uninformed investors’ ex ante uncertainty about the ‘true’ value of an offering and hence the anticipated level of underpricing. This argument draws on the information content of the audit qualification as a proxy for the volatility or skewness of future returns in the secondary market, rather than as a predictor of investment failure. Consistent with their hypothesis, Willenborg and McKeown (2000) find that securities with going-concern opinions suffer less first-day underpricing than similar securities without going-concern opinions. Notwithstanding the robustness of Rock’s (1986) model of underpricing and the significant results documented by Willenborg and McKeown (2000) in a US setting concentrating on the “small deal” (IPO proceeds up to US$10 million) segment of the IPO market, the direction of our final hypothesis is not obvious. It appears equally reasonable to contend that the issuance of a qualified audit opinion for an IPO candidate is a signal of a poor quality investment opportunity. In this respect, investors would demand a greater risk premium to subscribe to the issue which in
turn induces a greater level of underpricing when the firm lists in the secondary market. While this enhanced risk premium may not be fully reflected in a firms stock price on the first day of trading, it is reasonable to assume that a proportion of the cost of the premium is borne by the entrepreneur(in the form of underpricing )who, in effect, "leaves money on the table' in order to allow the underwriter to sell the issue Investigation of audit qualification using Australian IPO firms offers a different perspective to the US market setting since IPO auditors in Australia can not formally qualify their attestations as investigating accountants. This is an important regulatory dimension and the extant literature has not explored how the accounting profession reconciles this apparent constrainton signaling power with the onus imposed by professional guidelines. In the australian regulatory environment it is necessary to consider a broader measure of audit qualification designed to incorporate circumstances where investigating accountants, or management, can formally approve an entity's accounts while implicitly questioning the ability of that firm to operate as a going- concern. In the Australian setting there is an"investigating accountants report "contained in the prospectus. Further, the accounting firms can influence management in the preparation of the prospectus to adequately disclose risks of concern to the accounting firm thereby mitigating the need for comment by the accountant or auditor we refer to this broader measure as the issuance of a going-concern warning. An opinion of this nature can be contained in a number of locations within the company's prospectus including: the ' Risk Factors' section prepared by company directors; or the report issued by the Investigating Accountant Our hypothesis extends research on the information content of pre-IPO audit qualifications to the australian context where recent amendments to the asX Listing rules have enhanced the average risk profile of a firm raising public equity through an IPO. Consistent with Rock's(1986) model of underpricing and the results documented by Willenborg and McKeown(2000)in a US setting, we hypothesise that the inclusion of a going concern warning by management or the investigating accountant will reduce the extent of underpricing. H3: The extent of underpricing for Australian technology IPOs is negatively associated with the inclusion in the prospectus of a going-concern'warning by either the management or the independent accounting firm retained by the IPO candidate
11 turn induces a greater level of underpricing when the firm lists in the secondary market. While this enhanced risk premium may not be fully reflected in a firm’s stock price on the first day of trading, it is reasonable to assume that a proportion of the cost of the premium is borne by the entrepreneur (in the form of underpricing) who, in effect, ‘leaves money on the table’ in order to allow the underwriter to sell the issue. Investigation of audit qualification using Australian IPO firms offers a different perspective to the US market setting since IPO auditors in Australia can not formally ‘qualify’ their attestations as investigating accountants. This is an important regulatory dimension and the extant literature has not explored how the accounting profession reconciles this apparent ‘constraint’ on signaling power with the onus imposed by professional guidelines. In the Australian regulatory environment it is necessary to consider a broader measure of audit qualification designed to incorporate circumstances where investigating accountants, or management, can formally approve an entity’s accounts while implicitly questioning the ability of that firm to operate as a goingconcern. In the Australian setting there is an “investigating accountant’s report” contained in the prospectus. Further, the accounting firms can influence management in the preparation of the prospectus to adequately disclose risks of concern to the accounting firm thereby mitigating the need for comment by the accountant or auditor. We refer to this broader measure as the issuance of a going-concern warning. An opinion of this nature can be contained in a number of locations within the company’s prospectus including: the ‘Risk Factors’ section prepared by company directors; or the report issued by the Investigating Accountant. Our hypothesis extends research on the information content of pre-IPO audit qualifications to the Australian context where recent amendments to the ASX Listing Rules have enhanced the average risk profile of a firm raising public equity through an IPO. Consistent with Rock’s (1986) model of underpricing and the results documented by Willenborg and McKeown (2000) in a US setting, we hypothesise that the inclusion of a going concern warning by management or the investigating accountant will reduce the extent of underpricing. H3: The extent of underpricing for Australian technology IPOs is negatively associated with the inclusion in the prospectus of a ‘going-concern’ warning by either the management or the independent accounting firm retained by the IPO candidate
4. Sample selection and methodology 4.1 Sample select Using the Connect 4 database of company prospectuses, we identify a population of 403 firms that filed for official quotation on the AsX by lodging a prospectus with the Australian Securities and Investment Commission(ASiC) between January 1, 1999 and December 31, 2000 The Connect 4 database classifies firms into year groups on the basis of prospectus filing dates As a result, our sample excludes those firms that filed for quotation before January 1, 1999 but did not, in fact, list on the AsX until after December 31, 1998. A total of 165 firms filed for quotation in 1999 and a further 238 firms filed for quotation in 2000. We eliminate 27 firms that filed for quotation but did not list on the AsX until after December 31, 2000 because of the need to calculate the standard deviation of post-IPO returns using intra-day return data for all IPO candidates for 180 days after listing. This restriction also ensured that every firm in the final sample had been operational as a public company for at least six months. We also eliminate 36 firms that filed for quotation during the two-year window but later cancelled their ipo b ithdrawing their prospectus, as well as 57 firms that lodged a prospectus in relation to a rights issue as part of a seasoned equity offering IINSERT TABLE I HERE Our study focuses on the phenomenon of underpricing in the context of Australian technology firms. To this end, we limit our sample of IPo candidates to those australian-based firms that may be classified into technology segments on the basis of the industry definitions developed by the Wall Street Research Net(WSRN). The technology industry segments identified by WSRN are: Search/portals; content/communities; e-tailers; financial services; e-commerce enablers security; performance software; hardware; high technology manufacturing:: Internet services advertising/marketing; consultants/designers; speed/bandwidth; ISPs/ access providers; and biotechnology(including biopharmaceutical). These data screens culminate in a final sample size of 156 Austral ian technology firms 4.2 Methodolo Model of Underpricing We estimate the following regression model to test our explanations of underpricing for Australian technology firm
12 4. Sample Selection and Methodology 4.1 Sample Selection Using the Connect 4 database of company prospectuses, we identify a population of 403 firms that filed for official quotation on the ASX by lodging a prospectus with the Australian Securities and Investment Commission (ASIC) between January 1, 1999 and December 31, 2000. The Connect 4 database classifies firms into year groups on the basis of prospectus filing dates. As a result, our sample excludes those firms that filed for quotation before January 1, 1999 but did not, in fact, list on the ASX until after December 31, 1998. A total of 165 firms filed for quotation in 1999 and a further 238 firms filed for quotation in 2000. We eliminate 27 firms that filed for quotation but did not list on the ASX until after December 31, 2000 because of the need to calculate the standard deviation of post-IPO returns using intra-day return data for all IPO candidates for 180 days after listing. This restriction also ensured that every firm in the final sample had been operational as a public company for at least six months. We also eliminate 36 firms that filed for quotation during the two-year window but later cancelled their IPO by withdrawing their prospectus, as well as 57 firms that lodged a prospectus in relation to a rights issue as part of a seasoned equity offering. [INSERT TABLE 1 HERE] Our study focuses on the phenomenon of underpricing in the context of Australian technology firms. To this end, we limit our sample of IPO candidates to those Australian-based firms that may be classified into technology segments on the basis of the industry definitions developed by the Wall Street Research Net (WSRN). The technology industry segments identified by WSRN are: Search/portals; content/communities; e-tailers; financial services; e-commerce enablers; security; performance software; hardware; high technology manufacturing; Internet services; advertising/marketing; consultants/designers; speed/bandwidth; ISPs/access providers; and biotechnology (including biopharmaceutical). These data screens culminate in a final sample size of 156 Australian technology firms. 4.2 Methodology Model of Underpricing We estimate the following regression model to test our explanations of underpricing for Australian technology firms:
Underpricing.=a+阝MEDA;+阝2 TECHCRASH;+阝3 MKTSENTIMENT;+β4BURN;+ 阝5QGCi+β6 SINSTOWNER i+β ONTROL i+β Retained i+β 9SIGMA_180;+ β0 PROSPRISK i+β MAGe i+β12 ACCTREPUTE+β3 AUDREPUTE;+ β14 UWREPUTE;+β1 SDELAYi+阝16LNE( PROCEEDS)i+β 7LN TA;+β SUNITi+ 阝9l/ PRICE;+Ei(1) Definition and measurement of the specific variables are discussed below. We first consider three alternative measures of the dependent variable, the level of underpricing. We then consider, in turn, variable measurement for the three hypotheses of interest, and other variables expected to impact the underpricing for Australian technology firms. Definition and measurement of the specific variables are summarised in Table 2 IINSERT TABLE 2 HEREI Underpricing Consistent with the extant australian literature we use three distinct measures of the underpricing phenomenon. First, an unadjusted measure of underpricing (Lee et al., 1996a) RawRtn, is calculated as the closing sale price on the first day of listing divided by the subscription price per share, minus unity. Secondly, a continuously compounded measure of underpricing( How et al., 1995), LnRtn, is calculated as the natural logarithm of the closing price of the first day of listing divided by the subscription price per share. This measure reduces the influence of outlying observations and increases the normality of the distribution of returns Finally, a market index adjusted measure of underpricing(Lee et al., 1996a), MktAdjRtn, is calculated as per the unadjusted underpricing measure(RawRtn)less the New All Ordinaries value on the listing date divided by the New All Ordinaries value on the prospectus registration date, minus unity. These underpricing metrics are calculated using aftermarket data obtained from the Securities Industry Research Centre of the Asia-Pacific("SIRCA") for each firm included in the sampl A market index adjusted measure of underpricing is of particular relevance in an Australian capital markets setting where issuance procedures prevent the issuing firm from changing the offer price and (or )the quantity of shares issued pursuant to the prospectus lodged with ASIC. An adjustment to the offer price and (or) quantity may only be made by lodging a supplementary prospectus with ASIC. This represents an important difference from the prevailing US
13 Underpricingi = a + b1MEDIA i + b2TECHCRASHi + b3MKTSENTIMENTi + b4BURN i + b5QGC i + b6INSTOWNER i + b7CONTROLi + b8RETAINED i + b9SIGMA_180 i + b10PROSPRISK i + b11AGEi + b12ACCTREPUTEi + b13AUDREPUTE i + b14UWREPUTEi + b15DELAYi + b16LN_E(PROCEEDS)i + b17LN_TA i + b18UNIT i + b191/PRICEi + ei (1) Definition and measurement of the specific variables are discussed below. We first consider three alternative measures of the dependent variable, the level of underpricing. We then consider, in turn, variable measurement for the three hypotheses of interest, and other variables expected to impact the underpricing for Australian technology firms. Definition and measurement of the specific variables are summarised in Table 2. [INSERT TABLE 2 HERE] Underpricing Consistent with the extant Australian literature, we use three distinct measures of the underpricing phenomenon. First, an unadjusted measure of underpricing (Lee et al., 1996a), RawRtn, is calculated as the closing sale price on the first day of listing divided by the subscription price per share, minus unity. Secondly, a continuously compounded measure of underpricing (How et al., 1995), LnRtn, is calculated as the natural logarithm of the closing price of the first day of listing divided by the subscription price per share. This measure reduces the influence of outlying observations and increases the normality of the distribution of returns. Finally, a market index adjusted measure of underpricing (Lee et al., 1996a), MktAdjRtn, is calculated as per the unadjusted underpricing measure (RawRtn) less the New All Ordinaries value on the listing date divided by the New All Ordinaries value on the prospectus registration date, minus unity. These underpricing metrics are calculated using aftermarket data obtained from the Securities Industry Research Centre of the Asia-Pacific (“SIRCA”) for each firm included in the sample. A market index adjusted measure of underpricing is of particular relevance in an Australian capital markets setting where issuance procedures prevent the issuing firm from changing the offer price and (or) the quantity of shares issued pursuant to the prospectus lodged with ASIC. An adjustment to the offer price and (or) quantity may only be made by lodging a supplementary prospectus with ASIC. This represents an important difference from the prevailing US
environment, where subscription prices are often not determined until (non-binding)offers have been received from potential subscribers (Hanley, 1993) Stock Hype Drawing from prior discussions, we expect Bi to be positive if stock hype( MEDIa)is associated with underpricing. However, Hypothesis I is not solely motivated by a belief that media-induced hype influences the initial pricing of offerings in the secondary market. A further dimension to the hype story incorporates the underlying sentiment of the market per se. To this end, we include an indicator variable for the period before the tech-crash(tEChCrash) and a measure of recent underpricing on previous IPOs(MKTSENTIMENt) We predict that B2 an and B3 will be positive since those firms listing prior to the bursting of the dot com bubble' are likely to have greater euphoria associated with their listing We operationalise media-induced hype(MEDIA) by reviewing John Fairfax-owned print publications, The Industry Standard(an Australian venture capital and technology magazine and web site), and AustraliaInternet com(an Australian web site that publishes technology-specific content and Internet industry commentary) for articles relating to those firms included in our sample. We select the John Fairfax publications archives because it includes daily newspapers (such as The Sydney Morning Herald and The Australian Financial Review) as well as periodicals(such as Shares magazine, Business Review Weekly and Personal Investor. We select a 10-day window prior to the seven-day period immediately preceding the quotation of the firm on the Asx. This observation window is chosen because Australian corporate law imposes a seven-day ' media black-out period pre-listing, which prevents systematic attempts by issuers to enhance publicity about a prospective offering by publishing media releases. There are possible real economic actions, other than the IPO, that would reasonably be expected to affect firm value Therefore we have chosen a 10-day window preceding the ' media black-out period to reduce the likelihood of picking up corporate announcements of economic substance The number of mentions in the media for each IPO range from zero to 35 stories. Because it is unlikely that the information content of news varies directly with the each news story, to reduce measurement error we measured the news intensity on a five point scale based upon the frequency of stories. A value of 1 was assigned for media to those firms with less than 6'mentions'in the Refer Demers and Lev(2001)and Keating, Lys and Magee(2001) for discussion on the downturn in technology stocks during this period. Because the decline in the secondary market for technology stocks April, 2000 is known ex poste the effect of this change is considered further in the sensitivity analysis http://www.newsstore.f2.com http://www.thestandard.com.au 9http://www.australia.internet.com
14 environment, where subscription prices are often not determined until (non-binding) offers have been received from potential subscribers (Hanley, 1993). Stock Hype Drawing from prior discussions, we expect b1 to be positive if stock hype (MEDIA) is associated with underpricing. However, Hypothesis 1 is not solely motivated by a belief that media-induced hype influences the initial pricing of offerings in the secondary market. A further dimension to the hype story incorporates the underlying sentiment of the market per se. To this end, we include an indicator variable for the period before the tech-crash (TECHCRASH)6 and a measure of recent underpricing on previous IPOs (MKTSENTIMENT). We predict that b2 an and b3 will be positive since those firms listing prior to the ‘bursting of the dot com bubble’ are likely to have greater euphoria associated with their listing. We operationalise media-induced hype (MEDIA) by reviewing John Fairfax-owned print publications 7 , The Industry Standard (an Australian venture capital and technology magazine and web site8 ), and AustraliaInternet.com (an Australian web site that publishes technology-specific content and Internet industry commentary9 ) for articles relating to those firms included in our sample. We select the John Fairfax publications archives because it includes daily newspapers (such as The Sydney Morning Herald and The Australian Financial Review) as well as periodicals (such as Shares magazine, Business Review Weekly and Personal Investor). We select a 10-day window prior to the seven-day period immediately preceding the quotation of the firm on the ASX. This observation window is chosen because Australian corporate law imposes a seven-day ‘media black-out’ period pre-listing, which prevents systematic attempts by issuers to enhance publicity about a prospective offering by publishing media releases. There are possible real economic actions, other than the IPO, that would reasonably be expected to affect firm value. Therefore we have chosen a 10-day window preceding the ‘media black-out’ period to reduce the likelihood of picking up corporate announcements of economic substance. The number of mentions in the media for each IPO range from zero to 35 stories. Because it is unlikely that the information content of news varies directly with the each news story, to reduce measurement error we measured the news intensity on a five point scale based upon the frequency of stories. A value of 1 was assigned for MEDIA to those firms with less than 6 ‘mentions’ in the 6 Refer Demers and Lev (2001) and Keating, Lys and Magee (2001) for discussion on the downturn in technology stocks during this period. Because the decline in the secondary market for technology stocks in April, 2000 is known ex poste the effect of this change is considered further in the sensitivity analysis. 7 http://www.newsstore.f2.com.au 8 http://www.thestandard.com.au 9 http://www.australia.internet.com