Academic journal article IUP Journal of Applied Finance

The Impact of Corporate Board Structure on the Pricing Performance of Initial Public Offerings

Academic journal article IUP Journal of Applied Finance

The Impact of Corporate Board Structure on the Pricing Performance of Initial Public Offerings

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Going public is a strategic decision for an IPO firm. This move requires substantial effort from top level management, including board of directors. One important facet of this process is to design an effective governance system. Once the issuing firm decides to approach investment bank and regulatory body for new issue, the promoter finds that the composition and competency of board is crucial for getting successful subscription of the issue. Further, board structure and financial interest are interlinked and dependent on each other. During new issue mechanism, a lot of agency problems also arise regarding information disclosure and value of the firm leading to more information asymmetry between insiders and outside investors. Owing to unavailability of historical price information and even limited access to other information (even if at all it might have an additional cost), investors are constantly relying on various signaling factors, i.e., investment bank prestige, post-issue promoter group retention, auditor reputation, parent group affiliation, and venture capitalist support to make an assessment about the quality of the issue. More recently, Certo et al. (2001), Filatochev and Bishop (2002), Certo et al. (2007), Mnif (2009), and Gao and Jain (2011) evaluated signaling effect of corporate governance board to resolve issues related to IPO pricing and performance.

Formal certification hypothesis was first presented by Booth and Smith (1986). Subsequently, a series of models have been developed to explore other certification of attestation of quality for IPOs. Certification in IPOs has been studied primarily from the angle of reputation of underwriters (Carter et al., 1998) and venture capitalists' affiliation (Megginson and Weiss, 1991; and Lee and Wahal, 2004) associated with an issue. Carter et al. (1998) find lesser underpricing for IPOs sponsored by reputed underwriters. Marisetty and Subrahmanyam (2005) used business group affiliation to evaluate pricing of IPOs. Loughran and Ritter (2004) considered underwriter prestige, and Beatty (1989) used auditor reputation as additional certification of quality for issue. Existing studies found using a number of other certification as signaling, i.e., relationship with banks (James and Weir, 1990), institutional association (Hamao et al., 2000), and management quality (Chemmanur and Paeglis, 2005). These studies suggest that certification instruments help to resolve information asymmetry among investors and hence reduce pricing error. Board structure and its characteristics are also perceived as an additional certification of attestation of quality for potential investors (Marshall, 1991; and Finkle, 1998).

Signaling hypothesis advances the scope for usability of corporate board configuration from two viewpoints: (a) it is observable and known in advance; and (b) difficult and costly to imitate. Besides, it is well documented that effective board is highly influential in creating more corporate value (Jensen and Meckling, 1976; and Shleifer and Vishny, 1997). Charreaux (1997) and Hung (1998) suggest that effective board and governance structure continuously engages in wealth maximization activities, and also ensures smooth protection for existing shareholders' wealth. Corporate board also ensures that the information communicated before the issue is credible. A well-structured board can have a certifying effect on firm value, similar to the certification effect of underwriters, auditors, or venture capitalists. In other words, high quality boards of directors can convey the intrinsic value of the firm (certify the firm's value) more credibly to potential investors, thus reducing the information asymmetry, resulting in lower underpricing. However, the relationship between the quality of board of directors and underpricing has so far received little attention in the literature. One objective of this study is to remedy this gap in the literature. …

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