Impact of Corporate Governance on the Pricing and Performance of Bank IPOs

By Dempere, Juan M. | Review of Business, Fall 2007 | Go to article overview

Impact of Corporate Governance on the Pricing and Performance of Bank IPOs


Dempere, Juan M., Review of Business


Introduction

This study aims to determine the effect of corporate governance-related variables on pricing and performance of initial public offerings (IPOs) by banking holding companies (BHCs). Specifically, this study tests the cross-sectional variation of the BHC IPOs' underpricing and long-run performance. The rest of this paper is organized as follows: section 2 presents the relevant literature review and some testable hypotheses; section 3 explains the methodology and models used in this research work; section 4 describes the sample and some descriptive statistics; section 5 presents empirical results; section 6 summarizes the main findings of this research work; and section 7 provides the references used in this paper.

Literature Review and Hypotheses

Certo, Daily, and Dalton (2001) find a negative and significant relation between IPO underpricing and the size of the board of directors. I believe that banks benefit from a wide variety of directors with different business background, knowledge, and experience. Also, the larger the bank's board, the wider the bank's network that can be established with the communities it serves. The advantages associated with large boards should reduce the uncertainty that results from potential problems associated with limited sources of specialized advice and experience at the board level, as well as problems related with narrow community networking. This reduced uncertainty may motivate investors to expect a low IPO underpricing. These arguments support the following hypothesis:

Hypothesis 1: The board size of a BHC has a negative relation with its IPO's underpricing, but a positive relation with the BHC's long-term performance.

Certo, Daily, and Dalton (2001) find that the proportion of outside directors is positively related to IPO underpricing. The uncertainty that results from potential problems associated with poor board independence may motivate investors to demand a high return from high underpricing. Therefore, there is a negative relation between the degree of underpricing of BHC IPOs and the degree of board independence. Conversely, there is a positive relation between the long-term performance of a BHC IPO and the degree of its board independence that can be explained by the benefits that BHCs can obtain from the outside directors' critical, objective and independent oversight and monitoring of managerial decisions. Consequently, the following hypothesis is presented:

Hypothesis 2: The proportion of outside directors on the board of a BHC has a negative relation with its IPO's underpricing and a positive relation with its long-term performance.

Rechner and Dalton (1989) find that firms with CEO/chairman duality consistently have a poor performance as compared to those with independent leadership structure. A BHC with the CEO/chairman duality condition may face conflicts of interests from the CEO/chairman's biased and subjective self-monitoring. Investors can demand a high underpricing when the same person is both CEO and chairman of the board. Similarly, a CEO/chairman duality condition also has significant negative effects on the long-run performance of BHC IPOs. Therefore, the following hypothesis is formulated:

Hypothesis 3: The CEO/chairman duality condition of a BHC has a positive relation with its IPO's underpricing, but a negative relation with its long-term performance.

In this study, three committees are considered the most important and common in the sample: the audit, nominating, and compensation committees. Investors can demand a high underpricing due to the uncertainty associated with the conflicts of interest that exist when inside directors participate in these committees. Likewise, those BHC IPOs where inside directors integrate these committees will exhibit comparatively inferior long-run performance. Accordingly, the following hypothesis is offered:

Hypothesis 4: The low levels of underpricing and long-term performance are expected when the Audit, Nominating, and Compensation Committees of a BHC are completely independent. …

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