Management Quality and Equity Issue Characteristics: A Comparison of SEOs and IPOs

By Chemmanur, Thomas J.; Paeglis, Imants et al. | Financial Management, Winter 2010 | Go to article overview

Management Quality and Equity Issue Characteristics: A Comparison of SEOs and IPOs


Chemmanur, Thomas J., Paeglis, Imants, Simonyan, Karen, Financial Management


We use hand-collected data on the management quality of firms making seasoned equity offerings (SEOs) or initial public offerings (IPOs) to analyze the relationship between management quality and equity issue characteristics, and to compare the effect of management quality on SEOs versus IPOs. We hypothesize that higher quality managers are more credible to equity market investors, thereby reducing the information asymmetry they face in the market and outsiders' information production costs. Therefore, the equity issues of higher management quality firms will have more reputable underwriters, smaller underwriting spreads, and other expenses, and smaller SEO discounts. Further, since better managers will be able to select better projects, higher management quality firms will have larger offer sizes. Finally, since SEO firms are likely to suffer from less information asymmetry compared to IPO firms, these effects will be smaller for SEOs than for IPOs. Our findings support the above hypotheses. Our direct tests of the relationship between management quality and information asymmetry, and our comparison of information asymmetry in SEOs versus IPOs provide further support for these hypotheses.

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The quality of a firm's management has always been widely regarded by practitioners (like venture capitalists and financial analysts) as an important measure of firm quality. Recently, there has been increasing interest in the academic literature regarding the relationship between the quality and reputation of a firm's management and its interaction with the financial markets. In particular, Chemmanur and Paeglis (2005) study the relationship between a firm's management quality and various aspects of its initial public offering (IPO). They show that management quality affects the characteristics of a firm's IPO. (1) Chemmanur and Paeglis (2005) argue that their results are explained by better and more reputable management's ability to "certify" the quality of their firm to the financial markets, thereby reducing the extent of information asymmetry between firm insiders and outsiders. This means that financial intermediaries, such as investment banks and institutional investors, will incur lower costs of producing information concerning firms with better quality management, which may, in turn, affect the characteristics of such firms' securities issues.

While the above results are clearly interesting in their own right, it is important to note that an IPO represents a very specific event in the life of a firm since it typically represents the very first interaction of the firm with the financial markets. In particular, firms going public are most often young and immature, and do not have a significant record of operating performance and other financial data that equity market investors can use to assess the firm's value. Therefore, the question that arises in this context is whether the quality and reputation of a firm's management is important in mediating the interaction between the firm and the financial markets even after it has matured sufficiently beyond the IPO, and has accumulated a significant track record of operating performance and other financial variables. One can argue a priori that the role of management quality and reputation in the interaction between a firm and the equity market is either less or more important in the case of more mature firms when compared to the case of firms going public. Since equity market investors have significantly more information when evaluating mature firms, the extent of asymmetric information they face in the context of a seasoned equity offering (SEO) is likely to be smaller than in the case of an IPO. (2) This, in turn, implies that the effect of management quality on equity offering characteristics is likely to be smaller in the case of firms making SEOs as compared to those making IPOs. Alternatively, given that more mature firms have broader product lines, may be geographically more diversified, and operate on a larger scale, the effect of higher quality firm management (with the ability to select better projects for their firms and to implement them more ably) on firm value may be much greater than in the case of firms going public. …

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