IPO firm value and its connection with cornerstone and wider signalling effects

Abstract

‘Cornerstone’ investor agreements, in which high net-worth entities receive a guaranteed block of IPO shares, constitute an important potential signal of IPO value. Their recent emergence in the Hong Kong market setting, in tandem with detailed prospectus disclosures on such items, opens-up a new field of inquiry in the IPO information signalling arena. I demonstrate a strong link between such agreements' various dimensions (i.e., presence, size, number of investing parties and lock-up period) and initial IPO value, as measured by market-to-book and Tobin's Q, at various points during the first 30days' trading. Consistent with signalling arguments, cornerstone-invested entities display stronger post-listing earnings growth. Global coordinators' on-market stabilization actions are also inversely related to all four cornerstone dimensions (presence, size, number and lock-up period). The present study also examines the dual-tranche structure of HKEx-organized IPOs and finds that the proportion of shares initially assigned the retail (placing) tranche is inversely- (positively-) related to market-to-book and Tobin's Q multiples. This result is consistent with more informed (institutional, corporate and high net-worth individual) investors squeezing-out retail investors in the most attractive issues. Higher valuation multiples are also evident where the placing arm is internationally-based and in issues containing secondary offers.