Economies of scope and IPO activity in Europe

Abstract

Initial public offering (IPO) activity in Europe has recently come to a near-halt and, similarly to the US, this decline has been more pronounced among small firm IPOs. Three alternative explanations have been proposed: the economies of scope hypothesis states that getting big fast has become more important, resulting in small firms being acquired; the regulatory overreach hypothesis, which states that small firms are remaining private due to an increase in the regulatory costs borne by publicly traded firms; and the market conditions hypothesis, which states that poor stock market levels have resulted in low IPO volume. Although Europe is characterized by more fragmented regulation and by the existence of second markets with lower compliance costs, we argue that the decline in the number of IPOs is partly attributable to the economies of scope explanation. The Panic of 2008 and the Eurozone crisis of 2011 have also temporarily depressed IPO volume, consistent with the market conditions hypothesis. We present evidence of an increased difficulty for small firms to remain profitable, their underperformance, and their higher propensity to be acquired soon after the IPO, relative to large firms. We document that these patterns persist even among second market IPOs, where the regulatory overreach hypothesis does not apply. Controlling for the impact of market valuations, we investigate IPO activity in a time-series setting and unveil a downward trend in European IPOs over time.