THE REPUTATION OF UNDERWRITERS, THE BONDING HYPOTHESIS, AND THE IMPACT ON THE INFORMATION ENVIRONMENT OF U.S. CROSS-LISTED FIRMS DISSERTATION Presented in Partial Fulfilment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of the Ohio State University By Gilberto Loureiro, M.Sc. The Ohio State University 2007 Dissertation Committee: Approved by Professor G. Andrew Karolyi , Co-advisor ____________________ Co-advisor Professor Anil Makhija, Co-advisor ____________________ Co-advisor Professor Henrik Cronqvist Graduate Program in Business Administration ABSTRACT The first essay of this dissertation tests whether hiring a reputable underwriter to sponsor equity offerings of foreign firms, that occur when they cross-list on a U.S. stock exchange, is a “reputational bonding” mechanism. In line with the Bonding Hypothesis of Stulz (1999) and Coffee (1999, 2002), I find that foreign firms that cross-list in the U.S. and undertake IPOs are more likely to employ reputable underwriters if the firms come from countries with poor shareholder protection. The additional monitoring provided by reputable underwriters may help overcome the skepticism of U.S. investors, and explains the higher valuation these firms obtain after the offering. There is, however, a price to be paid for this bonding benefit. I find that issuers from countries with low shareholder protection tend to be more underpriced if they are sponsored by prestigious underwriters. In the second dissertation essay, I examine whether the decisions to raise equity and hire a reputable underwriter to conduct the offering impacts the information environment of foreign firms cross-listed on a U.S stock exchange. Using a sample of cross-listed firms from 1980 to 2004, I find that those that raise equity and hire a reputable underwriter, within three years after cross-listing, observe higher analyst coverage and more accurate earnings forecasts. ii Furthermore, I conclude that these improvements in the firm’s information environment are likely to positively affect firm value – the empirical evidence shows a positive relation between analyst coverage/forecast accuracy and Tobin’s q. More importantly, the valuation of firms sponsored by top underwriters tends to be more sensitive to improvements in forecast accuracy. Overall, the results of this essay complement the findings of Lang et al. (2003) and shed some light on the monitoring role of reputable underwriters via their impact on firm’s information environment. iii ACKNOWLEDGMENTS I would like to thank my advisors Andrew Karolyi and Anil Makhija and my committee member Henrik Cronqvist for their constant guidance, encouragement, and insightful comments. Their contribution was fundamental in all stages of my research. I am also grateful to Rüdiger Fahlenbrach for his comments and cooperation. I also thank René Stulz, the seminar participants at the Ohio State University, and my colleagues who participate at the doctoral seminars for their helpful comments and suggestions. A special thanks to Roger Loh, Angie Low, Taylor Nadauld, and Carrie Pan for their interest in my research and helpful suggestions. Finally, I thank the University of Minho and the Fundação para a Ciência e a Tecnologia (FCT) for financial support. iv VITA January 21, 1974………………… … Born in Valongo (district of Porto), Portugal. 1997 … “Licenciatura” in Economics, Faculdade de Economia do Porto, Portugal. 2002 Master of Science in Business Administration – Finance, Universidade do Minho, Portugal. FIELDS OF STUDY Major Field: Business Administration Concentration: Finance v TABLE OF CONTENTS ABSTRACT ii ACKNOWLEDGMENTS iv VITA v LIST OF TABLES ix LIST OF FIGURES xi CHAPTER 1: Introduction 1 CHAPTER 2: The reputation of underwriters: A test of the Bonding Hypothesis 6 2.1. Introduction 6 2.2. Literature review and hypotheses 12 2.2.1. Cross-listing and the Bonding Hypothesis: the role of underwriter reputation12 2.2.2. Benefits of hiring a reputable underwriter 14 2.2.3. IPO underpricing and the cost of reputable underwriters 15 2.2.4. Main Hypotheses 19 2.3. Data 20 2.4. Descriptive statistics and univariate analysis 24 vi 2.5. Multivariate analysis 30 2.5.1. The likelihood of hiring a reputable underwriter 30 2.5.2. Robustness checks 36 2.5.3. The value of hiring a reputable underwriter 42 2.5.4. The cost of hiring a reputable underwriter 46 2.6. Other Analyses 49 2.6.1. Seasoned equity offerings: Later SEOs 49 2.6.2. Private placements 52 2.7. Conclusions 53 CHAPTER 3: The impact of hiring a reputable underwriter on the information environmnet of cross-listed firms 56 3.1. Introduction 56 3.2. Data and descriptive statistics 65 3.3. Multivariate Analysis 71 3.3.1. The impact of raising equity and hiring a reputable underwriter on a firm’s information environment 71 3.3.2. Robustness Checks 77 3.3.3. Forecast accuracy: “star” versus “non-star” analysts 82 3.3.4. Underwriter reputation, analyst coverage and forecast accuracy, and their impact on firm value 84 3.4. Other Analysis 88 3.4.1. Univariate analysis: Differences before and after cross-listing 88 vii 3.4.2. Alternative hypotheses 91 3.5. Conclusion 95 CHAPTER 4: Conclusions 98 LIST OF REFERENCES 101 APPENDIX A: List of variables used in Chapter 3 108 APPENDIX B: Estimation procedure to mitigate sample selection bias 111 APPENDIX C: Tables 113 APPENDIX D: Figures 157 viii LIST OF TABLES Table 1: Summary Statistics . 113 Table 2: Tests of equality of means: Variables segmented by CM measure of underwriter reputation and by Anti-self-dealing (ASD) index 116 Table 3: Probit regressions: The probability of hiring a reputable underwriter . 119 Table 4: Robustness check of the probability of choosing a reputable underwriter – Heckman model. 122 Table 5: Regressions of Tobin’s q . 123 Table 6: Multifactor regressions using calendar-time returns 125 Table 7: Regressions of first-day returns 127 Table 8: Two-stage OLS regressions of first-day returns 129 Table 9: Regressions of Gross Spreads 131 Table 10: Probit regressions: Later SEOs 133 Table 11: Summary statistics: Private placements 135 Table 12: Probit regressions: Private placements . 136 Table 13: Sample size and summary statistics 138 Table 15: Firm-level regressions of analyst coverage and forecast accuracy one year after raising equity/cross-listing 141 ix Table 16: Firm-level regressions of analyst coverage and forecast accuracy – Heckman model 143 Table 17: Firm-level regressions of analyst coverage and forecast accuracy – Matched sample . 146 Table 19: Regressions of Tobin’s Q . 151 Table 20: Univariate analysis of differences in means before and after cross-listing. 154 Table 21: Firm-level regressions of analyst coverage and forecast accuracy – Alternative hypotheses 155 x [...]... decisions of foreign firms, and to test the Bonding Hypothesis In particular in this paper, I examine the choice of underwriter, and the monitoring benefits versus the costs it imposes on the foreign firm In contrast with previous tests of the Bonding Hypothesis, which focus on bonding mechanisms that apply uniformly to all cross-listed firms on a US stock exchange, this paper provides an important contribution... SEOs, of the same group of firms after they have cross-listed and issued equity simultaneously These firms face a different environment because they already have a history of stock prices in the U.S market, other sources of public information including more analyst forecasts (Lang et al., 2003), and a base of U.S institutional investors Therefore, the skepticism of other U.S investors, stemming from the. .. (especially Israeli firms) that become public only in the U.S and not in their home market 20 those that occur more than one month after cross-listing3 Because the predictions, in the context of the bonding hypothesis, are similar for Foreign IPOs and Foreign SEOs, I test the main hypotheses of this paper on a joint sample of these two types of issuers Throughout the paper, unless otherwise specified,... governance mechanisms and, therefore, larger reductions in the cost of capital The Bonding Hypothesis of Stulz (1999) relies on these arguments Coffee (1999; 2002) emphasizes the “legal bonding In other words, cross-listed firms are subject to a more stringent legal environment, since they have to harmonize their financial statements with GAAP rules and SEC disclosure requirements; furthermore, they become... Foerster and Karolyi, 1999) A more recent stream of the literature, initiated by Stulz (1999) and Coffee (1999; 2002), offers an alternative explanation, the Bonding Hypothesis According to the Bonding Hypothesis, cross-listing in the U.S is a mechanism by which managers and controlling shareholders of foreign firms purposely subject the firm to superior legal, regulatory, and other institutional monitoring,... belong to the group of Foreign IPOs and Foreign SEOs, and 136 offerings of firms that cross-listed and only later (more than one month after cross-listing) raised equity Data on offer prices, issue dates, number of primary and secondary shares offered, venture capitalist-backed deals, gross spreads, and proceeds of the deal are collected from SDC Thomson Financial The number of shares outstanding and. .. However, as for long-term performance (over 3 years after the offering) there is no evidence that this particular group of firms outperforms their peers, suggesting that the benefits of bonding may decay and not be long lasting To the best of my knowledge, the role of underwriter reputation, as a vehicle of the bonding hypothesis, has not yet been tested I also extend my analysis to other equity issues,... all firms cross-listed on a U.S exchange market, hiring a prestigious underwriter to conduct an equity offer is a voluntary decision That decision will depend on how firms weigh the costs and benefits of hiring a top underwriter 13 2.2.2 Benefits of hiring a reputable underwriter In the context of the Bonding Hypothesis of Stulz (1999) and Coffee (1999; 2002) explained above, the main benefit of hiring... common law countries dominate the market of equity issues in the U.S Overall, firms from common law countries account for 33% of the Foreign IPOs and 48% of all SEOs, followed by Western European firms with 22% and 23%, respectively The total number of underwriters conducting all equity offerings is 272 Figure 3 shows the number of underwriters and the percentage of them in the top CM rank The number of. .. deal the reputation of the underwriter corresponds to its market share in the previous year The lead manager (underwriter) is given full credit for the operation Whenever there is more than one lead underwriter I equally divide the proceeds of the offering by each one of them I track down the major mergers and acquisitions of investments banks, described by Ljungqvist et al (2006), and calculate the . THE REPUTATION OF UNDERWRITERS, THE BONDING HYPOTHESIS, AND THE IMPACT ON THE INFORMATION ENVIRONMENT OF U. S. CROSS-LISTED FIRMS DISSERTATION Presented in Partial Fulfilment of the. certain bonding activities. A study of these choices provides a setting to understand the “reputational bonding decisions of foreign firms, and to test the Bonding Hypothesis. In particular in. decisions to raise equity and hire a reputable underwriter to conduct the offering impacts the information environment of foreign firms cross-listed on a U. S stock exchange. Using a sample of