Academic journal article Journal of Small Business Management

The Initial Public Offerings of Restaurant Firms: The Case of Industry-Specific Micromarket Capitalization Offerings

Academic journal article Journal of Small Business Management

The Initial Public Offerings of Restaurant Firms: The Case of Industry-Specific Micromarket Capitalization Offerings

Article excerpt

We investigate the pricing characteristics of 59 initial public offerings (IPOs) of firms in the restaurant industry. Many of these offers are by extremely small micromarket capitalization companies, ones that are typically excluded from other studies of IPOs. We find that the choice of underwriter and the issuing company's subsequent financial performance significantly affect the level of underpricing and aftermarket performance. Companies that employ small, regional investment banking houses as underwriters fail to attract much investor interest, resulting in less underpricing and poorer aftermarket performance. In addition, investors appear to accurately appraise those firms that subsequently suffer from poor financial performance. This is demonstrated through greater underpricing to compensate investors for the greater perceived risk.

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Introduction

Initial public offerings (IPOs) of common stock are typically used by companies as a vehicle to raise additional capital or as a means to allow the original entrepreneurs to "cash out" their investment. To date, most studies focus on the analysis of relatively large offers and provide only a cursory view of any unique characteristics that may be specific to a particular industry. In this study, we focus exclusively on the IPOs for firms in the restaurant industry. This subset of IPO firms is interesting because of the inherent "ease of entry" associated with this industry, which fosters an intensely competitive environment and provides an opportunity for extremely small firms to get established and subsequently go public through the initial offer of common stock. By looking at a specific industry we hope to uncover answers of how pricing of IPOs is related to the characteristics of firms in this notably competitive industry with few barriers-to-entry.

The sample used in this study provides the opportunity to investigate the pricing of IPOs for extremely small corporate enterprises. These micromarket capitalization firms are not typically included in other studies of firms going public. For example, in the largest comprehensive study of IPOs to date, Ibbotson, Sindelar, and Ritter (1994) include only large listed issues for their sample after 1984. For our purposes we define large listed issues as those traded on the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), or through the National Association of Security Dealers Automated Quotation (NASDAQ). Including only large listed issues effectively acts to exclude many of the smallest issues that trade through conventional over-the-counter (OTC) markets.

Because of the relatively small size of many of these IPOs in the restaurant industry, restaurant company IPOs, besides being less likely to be able to secure listing on one of the major exchanges, are also less likely to be able to employ the highest quality underwriters and have venture capital backing and more likely to encounter trading illiquidity at issue and to experience operating problems and postoffering financial distress. Listing may provide a signal of the quality of the underwriting company, especially when comparing firms with common stock that trades in major markets (NYSE, AMEX, and NASDAQ) to those that trade through the conventional OTC market. This is because firms listed on other than the major exchanges are less likely to be actively followed by analysts and covered by the financial press. Underwriter reputation affects IPO pricing, because market participants interpret this reputation information as a signal of placement difficulties and of potential litigation related to the offer (Rock 1986). Because of potentially severe asymmetric information problems of private firms that file for an IPO, the presence of venture capital backing may provide substantial certification benefits that may affect the level of IPO underpricing (Megginson and Weiss 1991). Market liquidity is important for the establishment of a fair price and to narrow bid-ask spreads. …

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