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

Transcription

1 Management Qualty and Equty Issue Characterstcs: A Comparson of SEOs and IPOs Thomas J. Chemmanur * Imants Paegls ** and Karen Smonyan *** Current verson: November 2009 (Accepted, Fnancal Management, February 2010) JEL classfcatons: G24 (Investment Bankng); G30 (General Corporate Fnance). Keywords: Seasoned Equty Offerngs; Management Qualty; Asymmetrc Informaton. * Professor of Fnance, Carroll School of Management, Boston College, 440 Fulton Hall, Chestnut Hll, MA e-mal: chemmanu@bc.edu. Phone: (617) Fax: (617) ** Assocate Professor of Fnance, John Molson School of Busness, Concorda Unversty, 1450 Guy Street, Montreal, QC H1H 1L8, Canada. e-mal: paegls@jmsb.concorda.ca. Phone: (514) , ext Fax: (514) *** Assstant Professor of Fnance, Sawyer Busness School, Suffolk Unversty, 8 Ashburton Place, Boston, MA e-mal: ksmonya@suffolk.edu. Phone: (617) Fax: (617) For helpful comments or dscussons, we thank Alce Boname, Mark Lu, Debarsh Nandy, Evgena Portnaguna, Antonette Schoar, Susan Shu, and Hassan Tehranan, semnar partcpants at Boston College, as well as conference partcpants at the 2005 Amercan Fnance Assocaton Meetngs and the 2008 Fnancal Management Assocaton Meetngs. We also thank Sandra Caraballo for research assstance. Thomas Chemmanur acknowledges fnancal support from a Boston College Research Incentve Grant.

2 Management Qualty and Equty Issue Characterstcs: A Comparson of SEOs and IPOs Abstract We use a unque sample of hand-collected data on the management qualty of frms makng SEOs or IPOs to analyze the relatonshp between the management qualty of a frm and ts SEO characterstcs, and to compare the effect of management qualty on equty ssue characterstcs n SEOs and IPOs. We hypothesze that hgher qualty managers are more credble to outsders, thereby reducng the nformaton asymmetry facng ther frm n the equty market and outsders nformaton producton costs about the frm. Thus, equty ssues of frms wth hgher management qualty wll be assocated wth more reputable underwrters, smaller underwrtng spreads and other expenses, and smaller dscounts (for SEOs). Further, snce better managers are able to select better (larger NPV for a gven scale) projects, hgher management qualty wll also be assocated wth larger offer szes. Fnally, snce we expect SEO frms to suffer from a smaller extent of nformaton asymmetry compared to IPO frms, the above effects wll be smaller for SEO frms compared to IPO frms. Our emprcal results support the above hypotheses. Our drect tests of the relatonshp between management qualty and nformaton asymmetry, and our comparson of nformaton asymmetry n SEOs versus IPOs, provde further support for the above hypotheses.

3 Management Qualty and Equty Issue Characterstcs: A Comparson of SEOs and IPOs The qualty of a frm s management has always been wdely regarded by practtoners (lke venture captalsts and fnancal analysts) as an mportant measure of frm qualty. Recently there has been ncreasng nterest n the academc lterature regardng the relatonshp between the qualty and reputaton of a frm s management and ts nteracton wth the fnancal markets. In partcular, Chemmanur and Paegls (2005) study the relatonshp between a frm s management qualty and varous aspects of ts ntal publc offerng (IPO), and show that management qualty affects the characterstcs of a frm s IPO. 1 Chemmanur and Paegls (2005) argue that ther results are explaned by better and more reputable managements beng able to certfy the qualty of ther frm to the fnancal markets, thus reducng the extent of nformaton asymmetry between frm nsders and outsders. Ths means that fnancal ntermedares such as nvestment banks and nsttutonal nvestors wll ncur lower costs of producng nformaton about frms wth better qualty managements, whch may n turn affect the characterstcs of such frms securtes ssues. Whle the above results are clearly nterestng n ther own rght, t s mportant to note that an IPO represents a very specfc event n the lfe of a frm, snce t typcally represents the very frst nteracton of the frm wth the fnancal markets. In partcular, frms gong publc are most often young and mmature, and do not have a sgnfcant record of operatng performance and other fnancal data that equty market nvestors can use to assess the frm s value. The queston that arses n ths context s therefore whether the qualty and reputaton of a frm s management s mportant n medatng the nteracton between the frm and the fnancal markets even after t has matured suffcently beyond the IPO, and has accumulated a sgnfcant track record of operatng performance and other fnancal varables. One can argue a pror that the role of management qualty and reputaton n the nteracton between a frm and the equty market s 1 Chemmanur and Paegls (2005) fnd that IPO frms wth hgher qualty managers have lower underprcng and underwrtng expenses, more reputable underwrters, and larger nsttutonal nterest n ther IPO. 1

4 ether less or more mportant n the case of more mature frms compared to that n the case of frms gong publc. On the one hand, snce equty market nvestors have sgnfcantly more nformaton n evaluatng mature frms, the extent of asymmetrc nformaton they face n the context of a seasoned equty offerng (SEO) s lkely to be smaller than n the case of an IPO. 2 Ths, n turn, mples that the effect of management qualty on equty offerng characterstcs s lkely to be smaller n the case of frms makng SEOs compared to those makng IPOs. On the other hand, gven that more mature frms have broader product lnes, may be geographcally more dversfed, and operate on a larger scale, the effect of hgher qualty frm management (wth the ablty to select better projects for the frms and to mplement them more ably) on frm value may be much greater than that n the case of frms gong publc. The latter argument mples that the effect of management qualty on equty offerng characterstcs may be greater n SEOs than n IPOs. In summary, the queston whether management qualty s an mportant determnant of SEO characterstcs and whether t s more or less mportant n SEOs compared to IPOs can only be answered emprcally. However, there has been no emprcal analyss so far on how the qualty and reputaton of a frm s management team affects ts nteracton wth the fnancal markets subsequent to the IPO. Our objectve n ths paper s to remedy ths gap n the lterature. We make use of measures of management qualty and reputaton developed n Chemmanur and Paegls (2005) and other measures developed for the frst tme n the current paper and a unque sample of hand-collected data on the management qualty of frms makng SEOs and those makng IPOs to analyze three mportant ssues for the frst tme n the lterature. Frst, we study the relatonshp between the management qualty of a frm and the characterstcs of ts SEO. Second, we study whether management qualty s more or less mportant n affectng equty ssue characterstcs n SEOs versus IPOs. Thrd, we drectly test whether frms makng 2 For example, by the tme a frm makes an SEO, nvestors would have access to at least a few quarters of publcly released (audted) nformaton about the operatng performance of the frm. Recall that such nformaton would not be avalable to nvestors at the tme of a frm s IPO, snce prvate frms are not requred to publcly dsclose such nformaton. 2

5 SEOs face a lower extent of asymmetrc nformaton n the equty market compared to those makng IPOs, and whether a hgher qualty management team s assocated wth a lower extent of nformaton asymmetry facng the frm n the equty market. There may be two mportant channels through whch the qualty and reputaton of a frm s management team may affect the characterstcs of an equty ssue (whether an SEO or an IPO). The frst channel s the ablty of frm management wth hgher qualty and reputaton to certfy ther frm value more effectvely and thus reduce the extent of asymmetrc nformaton between frm nsders and outsders n the equty market; some of the dscusson n ths and the next paragraph s loosely based on that n Chemmanur and Paegls (2005) n the context of IPOs. Ths certfcaton may arse n the followng manner. Frst, senor members of a frm s management team buld up reputatonal captal over ther career, snce they are nvolved n repeated dealngs wth the fnancal markets as part of ther job (e.g., rasng bank fnancng or arrangng prvate placements of equty). Second, these managers know that there s a sgnfcant probablty that they wll leave ther frm to jon another, and that ther future employer wll be nfluenced by ther reputaton n dealng wth the fnancal markets n decdng whether or not to hre them, as well as n decdng ther compensaton package. Thrd, managers know that overprcng or hypng ther frm s stock (or decevng the fnancal markets n other ways) may tarnsh ther personal reputaton n the equty market, thereby dmnshng ther future value n the labor market; the greater the personal reputaton a manager has at stake, the greater the future loss from msprcng her frm s equty. As a consequence of the above, better and more reputable managers are more lkely to prce ther frm s equty farly, so that such frms are faced wth less nformaton asymmetry about frm value between nsders and outsders; see Chemmanur and Fulgher (1994) for a formal theoretcal model demonstratng these effects. 3 3 Chemmanur and Fulgher (1994) develop a theoretcal analyss demonstratng that reputable, long-lved players assocated wth a frm can help reduce the extent of nformaton asymmetry facng t n the equty market, thereby ncreasng the offer prce for ts equty. Analogously, reputaton of a frm s management can help reduce the extent of nformaton asymmetry t faces n the equty market, yeldng t a hgher offer 3

6 Gven the mportance of manageral reputaton and qualty n certfyng frm value dscussed above, underwrters and other fnancal ntermedares wll use management qualty, n addton to other measures of frm qualty, when choosng frms to underwrte equty ssues. Therefore, an underwrter s rsk of damagng her own reputaton wll be lower when underwrtng the equty ssue of a frm wth a management team of hgher qualty and reputaton. Ths mples that frms wth hgher management qualty and reputaton wll be assocated wth more reputable underwrters. 4 Further, gven the reducton n nformaton asymmetry resultng from manageral certfcaton, underwrters and other ntermedares may need to ncur lower costs n acqurng and transmttng nformaton about frms wth hgher management qualty and reputaton. Ths, n turn, mples that such frms need to provde underwrters and other ntermedares only a lower amount of compensaton for underwrtng ther equty ssues, thus reducng ther costs of sellng equty. Fnally, the above reducton n outsders nformaton acquston costs for hgher management qualty frms mples that the SEO dscount provded n the offerngs of such frms wll be smaller; see, e.g., Chemmanur and Jao (2006) for a theoretcal analyss of the relatonshp between the outsders nformaton producton costs and the SEO dscount. 5 A second channel through whch the qualty of a frm s management team may affect ts equty ssue characterstcs s drectly through manageral ablty n selectng and mplementng projects. Better and more reputable managers may be able to select better projects for ther frm, characterzed by a larger NPV for any gven scale. Ths means that hgher management qualty frms are lkely to have a larger equlbrum scale of nvestment and therefore larger equty offer szes, ceters parbus: see Fgure 1. We test the mplcatons of the above arguments regardng the prce for ts equty. Ths reducton n nformaton asymmetry also mples that outsders, lke underwrters, need to ncur only lower costs to acqure nformaton about frms havng more reputable managements. 4 See, agan, Chemmanur and Fulgher (1994) for a theoretcal framework formalzng some of the above arguments. 5 The SEO dscount s defned as the dfference between the ssung frm s closng market prce on the last tradng day pror to the ssue and ts SEO offer prce. 4

7 effect of management qualty on equty ssue characterstcs n the context of SEOs n the frst part of the paper. [Insert Fgure 1 here] In the second part of the paper we emprcally analyze the potental dfferences n the effect of management qualty on equty ssue characterstcs n SEOs and n IPOs. 6 As dscussed earler, these dfferences depend upon whether the effect of the asymmetrc nformaton faced by the frm (whch can be expected to be lower for SEOs) on equty ssue characterstcs domnates the effect of the need for hgher qualty management teams for managng larger, geographcally more dversfed frms, wth broader product lnes. In the second part of the paper we also compare the management qualty of frms makng SEOs to that of frms makng IPOs. Gven that frms makng SEOs are larger frms wth potentally better resources, we expect them to be able to hre hgher qualty managers and therefore have better management teams. In the thrd and fnal part of the paper, we drectly analyze whether a hgher qualty management team reduces the extent of asymmetrc nformaton facng the frm makng an equty ssue (ether an SEO or an IPO). In ths secton, we also study whether the extent of asymmetrc nformaton facng a frm makng an SEO s lower compared to that for a frm makng an IPO. The results of the frst part of our paper ndcate that the qualty and reputaton of a frm s management ndeed affect ts SEO characterstcs. These results can be summarzed as follows. Frst, frms wth better and more reputable managers have larger SEO offer szes (controllng for frm sze and other frm qualty varables). Second, more reputable underwrters are assocated wth frms of hgher management qualty and reputaton. Thrd, underwrtng expenses (both the underwrtng spread and the other expenses of ssung equty) are negatvely related to management qualty and reputaton. Fourth, frms of hgher management qualty and reputaton are assocated wth smaller SEO dscounts. 6 We thank an anonymous referee for suggestng that we undertake an analyss of the dfferences n the effect of management qualty on equty ssue characterstcs n SEOs versus IPOs. 5

8 The results from the second part of our emprcal analyss ndcate that management qualty has a smaller effect on equty ssue characterstcs (offer sze, underwrter reputaton, underwrtng spread, and other offerng-related expenses) n SEOs compared to that n IPOs. Ths seems to ndcate that the effect of a lower extent of nformaton asymmetry faced by frms makng SEOs domnates the effect of the need for hgher qualty managements for managng larger, geographcally more dversfed frms, wth broader product lnes. Our comparson of the qualty of management teams n SEO frms versus IPO frms ndcates that the management team resources avalable to frms makng SEOs are greater than those avalable to frms makng IPOs. Ths s consstent wth the fact that, SEO frms, beng larger and therefore havng a larger amount of fnancal resources avalable to them, are able to attract hgher qualty managers. The results from the thrd part of our emprcal analyss ndcate that, regardless of whether the frm s makng an SEO or an IPO, a hgher qualty management s assocated wth a lower extent of asymmetrc nformaton facng the frm makng the equty ssue. Further, our results ndcate that frms makng SEOs face a lower extent of asymmetrc nformaton compared to those makng IPOs. Overall, our fndngs suggest that management qualty and reputaton are ndeed mportant dmensons of frm qualty even for frms that have matured beyond the IPO. Our fndngs are consstent wth better and more reputable frm management beng able to convey the value of ther frm more credbly to outsders, thus reducng the nformaton asymmetry facng the frm n the equty market, even n the context of an SEO. The fndngs of our drect tests regardng the relatonshp between the qualty of a frm s management team and the extent of the nformaton asymmetry facng the frm provde addtonal support to the above noton. Gven our fndng that frms makng SEOs face a lower extent of nformaton asymmetry compared to those makng IPOs, t s not surprsng that the effect of management qualty on equty ssue characterstcs s lower for frms makng SEOs compared to those makng IPOs. 6

9 Our paper s related to several strands n the emprcal lterature. Frst, t s related to the newly emergng lterature on the relatonshp between the nature of a frm s management and varous aspects of ts fnancal polces. Apart from Chemmanur and Paegls (2005) dscussed n detal above, our paper s related to Chemmanur, Paegls, and Smonyan (2009), who study the relatonshp between the qualty and reputaton of a frm s management and ts debt, dvdend, and nvestment polces. Another mportant paper n ths lterature s Bertrand and Schoar (2003), who fnd that manager fxed effects can explan some of the heterogenety n the nvestment, fnancal, and organzatonal practces of frms. Our paper s also related, though less drectly, to the broader lterature that has examned varous aspects of seasoned equty offerngs, such as SEO dscount and underprcng (see, e.g., Corwn, 2003), the role of underwrter reputaton n SEOs (e.g., McLaughln, Safeddne, and Vasudevan, 2000; Loughran, 2008), post-seo operatng performance (e.g., Loughran and Rtter, 1997), post-seo stock return performance (e.g., Jegadeesh, 2000; Brav, Mchaely, Roberts, and Zarutske, 2009), and the nvestment and tradng behavor of nsttutonal nvestors around SEOs (e.g., Chemmanur, He, and Hu, 2009; Gbson, Safeddne, and Sont, 2004). The rest of the paper s organzed as follows. Secton I summarzes the hypotheses we test n ths paper based on theoretcal arguments made n the ntroducton. Secton II descrbes our data and sample selecton procedures. Secton III descrbes varous measures of management and frm qualty. Secton IV presents the results of our tests of the relatonshp between management qualty and SEO characterstcs. Secton V reports the results of our tests of the relatve magntude of the effect of management qualty on equty ssue characterstcs n SEOs versus IPOs. Secton VI presents the results of our tests of the relatonshp between management qualty and asymmetrc nformaton for frms makng SEOs and IPOs. Secton VII concludes wth a summary of our results and our nterpretaton of them. 7

10 I. Summary of Hypotheses As we argued above, the qualty and reputaton of a frm s management may affect ts SEO characterstcs n a varety of ways. We now summarze the hypotheses arsng from the above arguments, whch wll serve as the bass for our emprcal tests. Our frst set of hypotheses deals wth the relatonshp between management qualty and varous SEO characterstcs, as well as wth the role of underwrters n the SEO: H1: A frm s SEO offer sze wll be postvely related to ts management qualty and reputaton. H2: The SEO of a frm wth a hgher management qualty and reputaton wll be assocated wth more reputable underwrters. H3: The underwrtng spread and other expenses related to the SEO wll be negatvely related to a frm s management qualty and reputaton. H4: The magntude of the SEO dscount n a frm s equty offerng wll be negatvely related to ts management qualty and reputaton. Our second set of hypotheses relates to the comparson of management qualty n frms makng SEOs versus those makng IPOs, and our comparson of the effect of management qualty on equty ssue characterstcs n SEOs versus IPOs: H5: The management qualty of frms makng SEOs wll be hgher compared to that of frms makng IPOs. Dependng on whether or not the effect of a lower extent of nformaton asymmetry faced by frms makng SEOs domnates the effect of the need for hgher qualty management teams for managng larger, geographcally more dversfed frms, wth broader product lnes, we have two alternatve hypotheses: H6A: The effect of management qualty on equty ssue characterstcs wll be smaller for SEOs compared to that for IPOs. H6B: The effect of management qualty on equty ssue characterstcs wll be larger for SEOs compared to that for IPOs. 8

11 Our thrd set of hypotheses deals wth the effect of management qualty on the extent of asymmetrc nformaton facng frms makng equty ssues (ether an SEO or an IPO) and our comparson of the extent of asymmetrc nformaton facng frms makng SEOs versus those makng IPOs: H7: Frms makng SEOs wll face a lower extent of asymmetrc nformaton n the equty market compared to frms makng IPOs. H8: The extent of asymmetrc nformaton facng a frm (ether one makng an SEO or that makng an IPO) wll be negatvely related to the qualty and reputaton of ts management team. II. Data and Sample Selecton The data used n ths study came from several dfferent databases. The lst of seasoned equty offerngs was obtaned from SDC/Platnum Global New Issues Database. We restrct ourselves to a sample of frms that conducted an SEO between 1993 and After elmnatng non-underwrtten ssues, ssues wth offer prces of less than $5, spn-offs, fnancal frms (all frms wth SIC codes between 6000 and 6999), foregn frms, and frms wth no nformaton on Compustat we were left wth 1,974 frms. Of the remanng companes, 6 dd not have prospectuses and 338 dd not have management nformaton avalable n ther prospectuses. After elmnatng these frms, we were left wth 1,630 frms n our sample of SEO frms. Panel A of Table I shows how we arrved at our fnal SEO sample. [Insert Table I here] The lst of ntal publc offerngs conducted durng the same sample perod of was obtaned from SDC/Platnum Global New Issues Database as well. After elmnatng REITs, closed-end funds, unt IPOs, spn-offs and equty carve-outs, fnancal frms, foregn frms, and former LBOs we were left wth 2,061 frms. Further, we elmnated venture captal (VC)-backed IPOs to remove any confoundng effects arsng from the presence of venture captalsts and to 9

12 solate the effect of management qualty on equty ssue characterstcs. 7 Next, 46 frms wth offer prces of less than $5 were elmnated. Fnally, after elmnatng IPOs for whch the nformaton on management qualty was not avalable n ther prospectuses, we were left wth 1,002 frms n our sample of IPO frms. Panel B of Table I shows how we arrved at our fnal IPO sample. The data on management qualty both for SEOs and IPOs were hand-collected from the prospectuses of frms conductng SEOs and IPOs, respectvely (see the next secton for the descrpton of management qualty varables). The prospectuses were obtaned from Thomson Fnancal Database. In partcular, nformaton on the management team sze, tenure, former work experence, level of educaton, and board membershps of the team members came from the management secton of the prospectuses. The data necessary to calculate the CEO domnance were obtaned from the executve compensaton sectons of the prospectuses. SEO and IPO characterstcs were taken from SDC/Platnum Global New Issues Database. Accountng nformaton was obtaned from Compustat. Fnally, the data necessary to calculate asymmetrc nformaton varables were obtaned from IBES. III. Measures of Management Qualty and Reputaton, and Frm Qualty In ths secton, we descrbe our measures of management qualty and reputaton as well as proxes for other aspects of frm qualty that we use as control varables n varous regressons. Snce most of these measures were frst used by Chemmanur and Paegls (2005), our descrptons of these measures wll follow those n that paper. 7 VCs can affect the management qualty of IPO frms ether by selectng managers, or by performng varous roles (e.g., legal representaton, selectng underwrters) that would be performed by management n non-vc-backed frms. See, e.g., Hellman and Pur (2002), who fnd that VCs play a sgnfcant role n the professonalzaton of start-up frms n general, and n the hrng of ther top managers n partcular. Chemmanur and Paegls (2005) also exclude VC-backed IPOs from ther analyss for smlar reasons. 10

13 A. Measures of Management Qualty and Reputaton We measure management qualty and reputaton along the followng three broad dmensons: management team resources, management team structure, and management reputaton n the busness communty. To measure each of these dmensons, we make use of several dfferent measures. Management team resources refer to the human and knowledge resources (ncludng both educaton and relevant work experence) avalable to frm management. Ths s measured by the number of executve offcers (defned as those wth a rank of vce presdent or hgher) on a frm s management team (TSIZE). Team resources also depend upon knowledge and educaton of ts members, whch we measure n two ways. Our second measure of team resources s the percentage of the management team members wth an MBA degree (PMBA). We also measure the percentage of management team members who are Certfed Publc Accountants (PCPA). Hgher percentages of MBAs and CPAs mply hgher management qualty. The thrd factor that ncreases management team resources s a pror top management experence. We look at the percentage of the management team who have served as vce presdents or hgher pror to jonng the frm (PFTEAM). The greater the value of ths varable, the better the management qualty. Fnally, management team resources are also enhanced by the presence of managers who are n charge of the frm s core functonal areas. Our ffth measure, therefore, s the percentage of the management team n the core functonal areas: operatons and producton, research and development, marketng and sales, and fnance (CORE). Clearly, hgher values of CORE mean better management qualty. The second dmenson along whch we measure management qualty, namely, management team structure, reflects the extent of unformty or heterogenety n the tenures of management team members, and ther relatve mportance to the management team. We look at the average tenure of the management team (TENURE), defned as the average number of years 11

14 team members have been wth a frm. Hgher average tenure may ndcate coheson and shared experences, and thus would mply lower transacton costs among team members. However, longer tenures mght also ndcate the presence of complacency and rgdfyng effects on team nteractons. An deal team would have members from dfferent cohorts, whch would allow for an nflow of new deas and perspectves. Thus, a hgher management qualty would be assocated not only wth a longer average tenure, but also wth a hgher dsperson of tenures. Our second measure of team structure, therefore, s tenure heterogenety, defned as the coeffcent of varaton of the team members tenures (TENHET). The thrd measure of team structure we use s CEO domnance. On the one hand, a strong-wlled and domnatng chef executve offcer may severely dmnsh possble contrbutons from subordnate team members. On the other hand, a strong CEO may mprove the coheson of the management team. Thus, whle we beleve that CEO domnance s an mportant measure of team qualty, we are agnostc about the drecton of the expected mpact (postve or negatve) of ths measure on management qualty. Our measure of CEO domnance s the rato of CEO salary and bonus n the fscal year precedng the ssue to the average salary and bonus of other team members lsted n the executve compensaton secton of the prospectus (FCEO). Assumng that CEOs have a substantal nfluence over ther own pay and nearly total nfluence over ther subordnates pay, ths measure reflects the gap between the CEO s assessment of her own worth to the frm and her assessment of other team members worth, and s thus a good measure of CEO domnance. 8 The thrd dmenson along whch we measure management qualty, namely, management reputaton n the busness communty, reflects the reputaton bult up by members of the management team. Ths s measured by the number of corporate boards (apart from that of ther 8 Smlar measures have been used n the strategy and organzatonal behavor lterature to study the nfluence of management team qualty and reputaton on frm performance: see, e.g., D Aven (1990) and Hambrck and D Aven (1992), who use such measures to study the deteroraton of management team qualty around bankruptces. 12

15 own frm) that management team members st on (BOARDS). Whle the measures dscussed above also partally measure management reputaton, ths varable s a better ndex of the reputaton and vsblty of a frm s management n the busness communty. Agan, the greater the value of ths varable, the hgher the qualty and reputaton of a frm s management. Table II summarzes our measures of management qualty and reputaton for frms conductng SEOs and IPOs, as well as dependent varables (SEO and IPO characterstcs) that wll be used n subsequent regressons. The average (medan) management team sze of frms conductng SEOs (TSIZE) was 6.45 (6) wth the smallest management team consstng of only one person, and the largest one of 18 members. On average 6.8% of managers of SEO frms had an MBA degree (PMBA), 7.5% were CPAs (PCPA), 44.1% had held a top management poston at another frm pror to jonng the SEO frm (PFTEAM), and 54.7% held postons n the core functonal areas (CORE). The average tenure (TENURE) ranged from 1 to 34 years, wth a mean (medan) of 6.48 (5.25) years. On average, CEOs of SEO frms were earnng 47.6% more than the average member of ther management team (FCEO). [Insert Table II here] Though the varables descrbed above are expected to measure management qualty and reputaton, each of them may have unque lmtatons as a measure of the underlyng unobservable construct. Therefore, we use common factor analyss to construct a sngle varable for each management qualty dmenson descrbed above that captures varaton common to the observable proxes of management qualty. 9 In order to ensure that varous factors are capturng only the effects of management qualty (and not those of frm sze or frm age) we use frm-szeand frm-age-adjusted proxy varables to extract the factors. Team resources factor (TRF) score s obtaned usng common factor analyss on the frm-sze-adjusted TSIZE, MBA, CPA, FTEAM, 9 A number of papers n the emprcal corporate fnance and accountng lterature make use of factor analyss to solate the unobservable construct underlyng several proxy varables. See, e.g., Gaver and Gaver (1993) and Guay (1999), who make use of factor analyss to study the sze of a frm s nvestment opportunty set. 13

16 and CORE varables. Team structure factor (TSF) score s obtaned usng common factor analyss on the frm-age-adjusted TENURE, TENHET, and frm-sze-adjusted FCEO varables. 10 We construct these factors usng the combned sample of SEO and IPO frms snce ths allows us to use such factors to compare the management qualty of SEO frms to that of IPO frms and to analyze the effect of management qualty on SEO versus IPO characterstcs (see secton V). Table III reports the results of the above common factor analyss. Panel A presents startng communaltes, calculated as the squared multple correlatons obtaned from regressng each of the management qualty measures on the other measures wthn the same dmenson, whle Panel B reports the egenvalues of the reduced correlaton matrces. As suggested by Harman (1976), the number of factors needed to approxmate the orgnal correlatons among ndvdual measures s equal to the number of summed egenvalues needed to exceed the sum of communaltes. In our sample the summed communaltes are less than the egenvalues for the frst factor n the factor analyss for each dmenson of management qualty and reputaton, suggestng that one factor n each of the dmensons parsmonously explans the ntercorrelatons among the ndvdual measures. Correlatons between the common factor scores and ther respectve orgnal measures of management qualty are reported n Panel C, whle Panel D reports summary statstcs of the team resources factor (TRF) and the team structure factor (TSF) scores. [Insert Table III here] B. Proxes for Other Aspects of Frm Qualty In order to separate the effects of management qualty and reputaton from those of other dmensons of frm qualty, we control for these other dmensons usng the followng proxes. Frst, we use two frm qualty varables commonly used n the fnance lterature: frm sze and 10 Snce the unadjusted TENURE and TENHET varables are most hghly correlated wth frm age, we adjusted these varables for frm age. On the other hand, snce the CEO domnance varable (FCEO) s most hghly correlated wth frm sze, we adjusted ths varable for frm sze. 14

17 frm age. We use the natural logarthm of the book value of the frm s assets as a proxy for the frm sze (LNBVA). Frm age s defned as the natural logarthm of one plus the frm age (LFAGE). The larger and older the frm, the hgher the frm qualty. 11 Second, we control for the number of outsde drectors, defned as the number of drectors that are lsted n the management secton of the prospectus and are not executve offcers of the company (ODIR). There are two ways n whch the number of outsde drectors nfluences frm qualty. Frst, outsde drectors may provde addtonal knowledge (nputs and perspectves) to the frms management. Second, they also provde lnkages to external partes, such as underwrters, fnancal nsttutons, and audtors. The greater the number of outsde drectors, the better the frm qualty. 12 IV. Management Qualty and SEO Characterstcs In ths secton we test our hypotheses regardng the relatonshp between management qualty and varous SEO characterstcs both n unvarate and multvarate settngs. A. Unvarate Tests Table IV reports the results of our unvarate tests of the relatonshp between management qualty and varous SEO characterstcs. We splt the sample of SEO frms by frm sze and management qualty factor score (TRF and TSF) quntles. We refer to the frms n the lowest management qualty factor score quntle as low management qualty frms, and those n the hghest management qualty factor score quntle as hgh management qualty frms. [Insert Table IV here] We analyze the followng fve SEO characterstcs. Frst, offer sze (LNOFF) s measured as the natural logarthm of the offer sze (n $). Second, underwrter reputaton (REP) s measured 11 These two measures of frm qualty have been wdely used n the lterature (see, e.g., Rtter, 1984; Mchaely and Shaw, 1994). 12 Several studes n the corporate control lterature have shown that outsde drectors enhance frm value (see, e.g., Cotter, Shvdasan, and Zenner, 1997; Borokhovch, Parrno, and Trapan, 1996). 15

18 as the natural logarthm of one plus the lead underwrter s reputaton as measured by Loughran and Rtter (2004). 13 Thrd, underwrtng spread (SPREAD) s measured as a percentage of the offer prce. Fourth, other offerng-related expenses (EXP) s measured as a percentage of the offer sze. Ffth, SEO dscount (DISC) s measured as the rato of the closng prce on the day pror to the ssue to the SEO offer prce mnus one, expressed as a percent. We fnd that the team resources factor score (TRF) has a statstcally sgnfcant nfluence on SEO characterstcs (except for the SEO dscount). In partcular, we fnd that hgh management qualty frms are assocated wth more reputable underwrters, have larger offer szes, and ncur lower expenses of ssung equty (both n terms of underwrtng spread and other offerng-related expenses) compared to low management qualty frms. For example, hgh management qualty frms, on average, pay 0.33 percentage ponts less n underwrtng spread and 0.46 percentage ponts less n other offerng-related expenses, have by $11.64 mllon larger offer szes, and the average reputaton measure of ther underwrters s hgher by The team structure factor score (TSF) has a statstcally sgnfcant mpact on offerngrelated expenses; frms n the hghest TSF score quntle, on average, pay 1.26 percentage ponts less n other offerng-related expenses compared to the frms n the lowest TSF score quntle. The dfferences n other SEO characterstcs between hgh and low management qualty frms (measured by TSF score) are not statstcally sgnfcant. B. Multvarate Tests Prevous studes have found certan SEO characterstcs to be correlated (e.g., a negatve relatonshp between underwrtng expenses and offer sze, or a negatve relatonshp between SEO dscount and underwrter reputaton). Thus, varous SEO characterstcs are nter-related and the same unobservable factors that lead to, for example, better underwrter reputaton are also lkely to lead to lower SEO dscount or underwrtng spread. We conjecture that management 13 Ths measure takes on values from 0 (least reputable underwrters) to 9 (most reputable underwrters). 16

19 qualty s an mportant determnant of SEO characterstcs and s lkely to determne them jontly, along wth other exogenous (control) varables. Therefore, to study the relatonshp between management qualty and varous SEO characterstcs, we make use of seemngly unrelated regresson (SUR) methodology whch allows us to jontly test our hypotheses H1 through H4 that management qualty s mportant n determnng all of the SEO characterstcs we study here. 14 We run the followng system of SUR regressons: LNOFF = α X + ε REP = β Χ + φ SPREAD = γ Χ + ϕ EXP = δ Χ + η DISC = θ Χ + ν. (1) On the left-hand sde we have offer sze, underwrter reputaton, underwrtng spread, other offerng-related expenses, and SEO dscount as dependent varables, and on the rght-hand sde we have the vector of explanatory varables X, whch ncludes management qualty varables TSIZE, PMBA, PCPA, PFTEAM, CORE, TENURE, TENHET, FCEO, and BOARDS, as well as frm sze, frm age, and the number of outsde drectors as control varables. We also nclude n these regressons two addtonal measures of frm qualty as control varables. The frst varable s the vablty dummy (VIABILITY) whch s equal to one f n a fve-year perod snce the ssue date an SEO frm s stll traded on NYSE/AMEX/NASDAQ or f t s delsted due to a merger or an exchange offer, and zero otherwse. The second varable s the varablty of SEO frm s stock returns (VARIABILITY) measured as the standard error of daly returns from CRSP for the perod that starts 365 days before and ends 40 days before the SEO ssue date. These two 14 We thank an anonymous referee for suggestng that we use SUR methodology for our analyss n ths secton gven our conjecture that management qualty varables along wth other exogenous (control) varables jontly determne all the endogenous varables (SEO characterstcs). We have also conducted a smlar analyss usng an OLS regresson framework, and fnd that our results are qualtatvely unchanged. 17

20 addtonal control varables were used by Fernando, Gatchev, and Spndt (2005) as measures of frm qualty n ther study of how frms and underwrters choose each other. 15 We expect management qualty proxes as well as frm sze and frm age to have postve coeffcents n offer sze and underwrter reputaton regressons and negatve coeffcents n underwrtng spread, other offerng-related expenses, and SEO dscount regressons. In other words, we expect frms wth hgher management qualty to be assocated wth larger offer szes, more reputable underwrters, lower equty ssue costs, and lower SEO dscounts, as specfed n hypotheses H1 through H4. Further, older and larger frms are more lkely to have larger projects and thus rase more money to nvest n such projects, whch leads to larger offer szes and lower underwrtng expenses (assumng economes of scale n underwrtng). Older and larger frms are also lkely to be assocated wth more reputable underwrters. Regressons 1 to 5 n Panel A of Table V report the results of our estmaton of SUR system (1) presented above. Frst, we fnd that frms wth better and more reputable managements have larger SEO offer szes. In partcular, we fnd that frms wth larger management teams (TSIZE), hgher percentages of CPAs (PCPA), and more domnant CEOs (FCEO) have sgnfcantly larger offer szes. Contrary to our expectatons, average team tenure (TENURE) has a negatve mpact on offer sze. Our results are also economcally sgnfcant. For an average frm, a one standard devaton ncrease n TSIZE leads to a $2.7 mllon ncrease n the offer sze (about 6% of the medan SEO offer sze). One standard devaton ncreases n the percentage of 15 Fernando, Gatchev, and Spndt (2005) also use the number of analysts followng the frm as another measure of frm qualty. We have chosen not to nclude ths measure of frm qualty n our regressons, snce we use t later as one of the measures of nformaton asymmetry facng the frm (see secton VI). Snce we conjecture (and later show) that the reducton n nformaton asymmetry s one of the channels through whch management qualty can affect equty ssue characterstcs of a frm, ncludng the number of analysts followng the frm along wth management qualty varables n the SUR regresson system (1) would double-count nformaton asymmetry n such regressons. However, we have also estmated our regressons by ncludng the natural logarthm of one plus the number of analysts as another measure of frm qualty along wth the vablty and varablty measures. The results were essentally the same, though slghtly weaker (the effect of management qualty on SEO characterstcs n these regressons was slghtly less sgnfcant). Ths s consstent wth our hypothess that one of the channels through whch management qualty affects a frm s equty ssue characterstcs s by reducng the extent of nformaton asymmetry facng the frm, so that controllng drectly for nformaton asymmetry wll make ths relatonshp less sgnfcant. 18

21 CPAs (PCPA) and n the CEO domnance (FCEO) each lead to $1.9 mllon ncreases n the offer sze. These ncreases are equal to about 4.1% of the medan SEO offer sze. 16 [Insert Table V here] Second, we fnd that SEO frms wth better and more reputable managements are assocated wth more reputable underwrters. In partcular, we fnd frms wth larger management teams (TSIZE), hgher percentages of MBAs (PMBA) and managers n core functonal areas (CORE), and wth greater management team tenure heterogenety (TENHET) are underwrtten by more reputable underwrters. The coeffcent estmates of the frst two of these varables are sgnfcant at the 5% level, the coeffcent estmate of CORE s sgnfcant at the 1% level, and the coeffcent estmate of TENHET s sgnfcant at the 10% level. 17 In addton, a one standard devaton ncrease n the percentage of management team members n core functonal areas (CORE) ncreases the underwrter reputaton measure by 0.17 (about 2.4% (2.1%) of the mean (medan) SEO frm underwrter reputaton measure). Also, a one standard devaton ncrease n management team sze (TSIZE) leads to an ncrease n the underwrter reputaton measure by 0.13 (about 1.8% (1.6%) of the mean (medan) SEO frm underwrter reputaton measure). Fnally, one standard devaton ncreases n the percentage of MBAs n the management team 16 In unreported results, we have also run such regressons usng the extent of asymmetrc nformaton facng the frm (as measured by the analysts forecast error) and the wthn-frm busness and geographc segment concentraton (calculated as the sum of the squares of each segment s (busness or geographc) sales as a percentage of the total frm sales) as control varables. Consstent wth our hypothess that t s through reducng the nformaton asymmetry facng the frms that a hgher management qualty affects SEO characterstcs, we fnd that ncludng both an asymmetrc nformaton measure and management qualty measures n a regresson reduces the sgnfcance of the effect of management qualty on such ssue characterstcs (snce asymmetrc nformaton measure pcks up the effect of management qualty). In other words, our fndngs suggest that ndeed t s largely through asymmetrc nformaton that management qualty affects equty ssue characterstcs. We have chosen not to report these results n the current secton snce specfcatons that nclude the analysts forecast error consderably reduce our sample sze; these results are avalable to nterested readers upon request. However, we have ncluded the analysts forecast error and the wthn-frm busness and geographc segment concentraton measures as addtonal control varables n some regresson specfcatons of our analyss of the relatve effect of management qualty on IPO versus SEO characterstcs n secton V of the paper. 17 We also perform the same estmaton usng the natural logarthm of one plus the market share of the lead underwrter n the year before the ssue as a measure of underwrter reputaton. The market share was calculated by takng the total amount of money rased by the lead underwrter n the SEO market n the year precedng the ssue and dvdng t by the total amount of money rased n that year n the SEO market. The results were qualtatvely unchanged usng ths alternatve specfcaton. 19

22 (PMBA) and n the management team tenure heterogenety (TENHET) ncrease the underwrter reputaton measure by 0.11 and 0.10, respectvely (about 1.5% (1.4%) and 1.4% (1.2%) of the mean (medan) SEO frm underwrter reputaton measure, respectvely). These results ndcate that frms wth better and more reputable management teams are assocated wth more reputable underwrters. Thrd, we fnd that SEO frms wth better and more reputable managements are assocated wth lower underwrtng spreads. In partcular, frms wth larger (TSIZE), more heterogeneous (TENHET), and CEO-domnated (FCEO) management teams, as well as those wth hgher percentages of CPAs (PCPA), and managers n core functonal areas (CORE) ncur lower underwrtng spreads. The coeffcent estmates of all these varables are sgnfcant at the 1% level, except for PCPA and TENHET, whch are sgnfcant at the 5% level. These results are also economcally sgnfcant. In partcular, we fnd that a one standard devaton ncrease n the percentage of team members n the core functonal areas (CORE) results n a 0.07 percentage ponts reducton n underwrtng spread. Ths represents 1.3% of the medan offer sze (wth $ offer prce and 2.5 mllon shares offered) and results n a savngs of approxmately $35,000. Smlarly, a one standard devaton ncrease n TSIZE results n a 0.08 percentage ponts decrease n the underwrtng spread (a savngs of about $41,000). Fnally, a one standard devaton ncrease n the CEO domnance (FCEO) leads to about $35,000 savngs on the underwrtng spread. Fourth, we fnd that frms wth better and more reputable managements are assocated wth lower other offerng-related expenses. In partcular, we fnd that TSIZE, TENURE, TENHET, and CORE all have a sgnfcantly negatve nfluence on the other offerng-related costs. A one standard devaton ncrease n the average tenure (TENURE) results n a 0.36 percentage ponts declne n the rato of other expenses to the offer sze. Ths represents 17.0% of the medan offer sze and results n a savngs of around $177,000. Smlarly, a one standard devaton ncrease n the percentage of team members n core functonal areas (CORE) results n 20

23 a 0.24 percentage ponts decrease n the rato of other expenses to the offer sze (a savngs of about $117,000). Fnally, a one standard devaton ncrease n TSIZE leads to about $70,000 savngs on the other offerng-related expenses. Our results suggest that better and more reputable managers have a certfyng effect on frm qualty and thus ncur lower costs of ssung equty, as measured by both the underwrtng spread and the other offerng-related expenses. Ffth, we fnd that frms wth better and more reputable managements are assocated wth lower SEO dscounts. In partcular, SEOs of frms wth more domnant CEOs (FCEO) are assocated wth smaller SEO dscounts. The coeffcent estmate of FCEO s sgnfcant at the 5% level. A one standard devaton ncrease n the CEO domnance results n a 0.44 percentage ponts decrease n the SEO dscount whch s 10.9% (16.9%) of the average (medan) SEO dscount. Ths result provdes evdence that frms wth hgher qualty managements have smaller SEO dscounts. 18 Regressons 6 to 10 n Panel A of Table V report the results of our estmaton of the SUR system (1) where ndvdual management qualty proxes are replaced by the management qualty factor (TRF and TSF) scores. As expected, the TRF score has a sgnfcantly postve mpact on offer sze and underwrter reputaton, and a sgnfcantly negatve mpact on underwrtng spread, other offerng-related expenses, and the SEO dscount. As expected, the TSF score has a sgnfcantly negatve mpact on underwrtng spread and other offerng-related expenses. Overall, these results provde further support for our hypotheses H1, H2, H3, and H4 that management qualty postvely affects SEO offer sze and underwrter reputaton and negatvely affects underwrtng expenses and the SEO dscount. Panels B and C of Table V report the results of our estmaton of the SUR system (1) wth only one selected management qualty proxy (TSIZE, CORE, TENHET, and FCEO n each case) 18 We also studed the relatonshp between management qualty and reputaton and SEO underprcng whch s the percentage dfference between the closng stock prce on the ssue day and the SEO offer prce. Although management qualty had an overall negatve effect on the sze of SEO underprcng, the statstcal sgnfcance of ths relatonshp was weaker. 21

24 as an ndependent varable n addton to control varables. Consstent wth the results n Panel A of Table V, TSIZE, CORE, and TENHET have a sgnfcantly postve nfluence on underwrter reputaton; TSIZE, CORE, and FCEO have a sgnfcantly negatve nfluence on underwrtng expenses (both spread and other expenses); and TSIZE and FCEO have a sgnfcantly postve nfluence on offer sze and a sgnfcantly negatve nfluence on the SEO dscount. V. Comparson of Management Qualty and ts Effect on Equty Issue Characterstcs n SEO and IPO Frms In ths secton we nvestgate whether management qualty s more or less mportant n affectng the equty ssue characterstcs of SEOs compared to IPOs. On the one hand, snce SEO frms are more mature, wth longer hstores of operatng performance, the degree of asymmetrc nformaton facng such frms n the equty market can be expected to be lower. Therefore, management qualty may be less mportant n SEOs snce the asymmetry of nformaton s one of the man channels through whch manageral qualty can be expected to affect equty ssue characterstcs (H6A). On the other hand, snce SEO frms are larger, geographcally more dversfed frms, wth broader product lnes, management qualty can be of greater mportance n runnng such complex operatons and thus more mportant n determnng the equty ssue characterstcs of such frms (H6B). We frst compare the qualty of management teams between SEO and IPO frms (H5) and then compare the effect of management qualty on SEO versus IPO characterstcs. We accomplsh ths by comparng our SEO sample wth a sample of IPOs conducted durng the same sample perod of A. Comparson of Management Qualty n SEO and IPO Frms Frms conductng SEOs are expected to have management teams of hgher qualty compared to frms conductng IPOs (H5), snce the former are larger frms wth potentally better resources, able to hre hgher qualty managers. 22