Ownership Structure and the Survival of Listed Firms: Evidence from Korean Reverse Mergers

• Author: Yonghyun Kwon,Seung Hun Han
• Published date: 01 June 2015
• DOI: http://doi.org/10.1111/ajfs.12094
• Date: 01 June 2015

Ownership Structure and the Survival of

Listed Firms: Evidence from Korean Reverse

Mergers*

Seung Hun Han

Department of Business and Technology Management, Korea Advanced Institute of Science and Technology

Yonghyun Kwon**

Department of Business and Technology Management, Korea Advanced Institute of Science and Technology

Received 13 November 2013; Accepted 14 July 2014

Abstract

We examine the impact of ownership structure on the post-performance of Korean firms that

go public as the result of a reverse merger. Although a reverse-merger announcement has

positive cumulative abnormal returns (CARs), we find that 24.8%of reverse-merged firms

become delisted because of poor post-performance, seemingly due to the agency problem.

We also find that expected changes in management after a reverse merger positively affect the

CARs of public target firms around the time of the reverse-merger announcement. However,

the post-performance of reverse-merged firms is relatively poor compared to firms that

undertake regular initial public offerings. Further, we find that ownership concentration

alleviates poor performance following a reverse merger.

Keywords Reverse merger; Delisting; Ownership structure; Agency problem

JEL Classification: G32, G34

1. Introduction

A reverse merger is an important alternative for private firms that wish to go

public. It allows such firms to access public capital markets by circumventing

many of the requirements, expenses, and time-consuming processes associated

*We thank an anonymous referee and participants at the 2011 Multinational Finance

Society conference for their helpful comments. This work was supported by the National

Research Foundation of Korea Grant funded by the Korean Government (NRF-2011-330-

B00046).

**Corresponding author: Yonghyun Kwon, Department of Business and Technology Manage-

ment, Korea Advanced Institute of Science and Technology, 373-1 Gwahangno, Yuseong-gu,

Daejeon 305-701, South Korea. Tel: +82-42-350-6309, Fax: +82-42-350-4340, email:

kwon4711@kaist.ac.kr.

Asia-Pacific Journal of Financial Studies (2015) 44, 387–420 doi:10.1111/ajfs.12094

©2015 Korean Securities Association 387

with regular initial public offerings (IPOs). Access to public markets enables

newly listed firms to obtain the capital necessary for growth and allows former

private shareholders to receive capital gains and exit their investments. Increasing

the number of listed firms also promotes capital market development because

public market investors gain more investment opportunities. Thus, the perfor-

mance of newly listed firms is a major, traditional topic for corporate finance

research (Ritter and Welch, 2002). Reverse merger is also a potentially important

issue in emerging markets because of its increasing usage. For growth-stage firms

in emerging markets, a reverse merger is a shortcut for access to public finance

(Efird, 2008). For example, Brown et al. (2010a) suggest that there are many

reverse mergers in the Australian Stock Exchange (ASX). They argue that private

firms’ shareholders consider a reverse merger to be an important alternative way

of going public because of its simplicity compared to an IPO. Further, Jindra

et al. (2012) show that a reverse merger can provide a relatively easy way for

firms in emerging markets to enter international capital markets such as those

of the United States. However, despite the growing interest in reverse mergers,

and their importance for firms and capital markets, scarcely any literature has

investigated the performance of reverse-merger firms compared to that of IPO

firms. Moreover, despite the popularity of reverse mergers in the market, many

reverse-merged firms have a significantly lower likelihood of survival than regular

IPO firms, because the poor post-performance of reverse-merger firms is a

potentially serious problem (Gleason et al., 2005). Yet few studies examine the

determinants of the long-term performance of reverse-merged firms. Therefore,

this study analyzes the post-performance of reverse mergers, and finds the fac-

tors (i.e. ownership structure) that affect such performance by using samples

from Korea.

Korean reverse mergers are suitable for our study for three reasons. First, the

reverse merger is favored by Korean private firms, and shows significant post-

performance variations. For example, Neosemitech

1

was listed on the Korea

Securities Dealers Automated Quotations (KOSDAQ) in June 2009 by using a

reverse merger and, at that time, it was included in the top 30 firms for market

capitalization on KOSDAQ. However, Neosemitech was delisted from KOSDAQ

within a year because of poor financial performance. As a result, 7287 minority

shareholders of the firm sustained losses totaling KRW 258 billion (about US

1

Neosemitech was founded in March 2000. Its major business is manufacturing wafers used

in semiconductors and solar cells. Neosemitech acquired 33%of D&T shares and was listed

in KOSDAQ in June 2008. In June 2009, Neosemitech announced a reverse merger. However,

because an accounting firm did not accept the firm’s audited financial statement in 2009,

Neosemitech entered a delisting review process, and was finally delisted from KOSDAQ in

August 2010.

S. H. Han and Y. Kwon

388 ©2015 Korean Securities Association

$234 million) in only 2 days. On the other hand, Celltrion

2

is an example of a

successful reverse merger. As of 31 December 2013, the market capitalization of

Celltrion is KRW 3.9 trillion (about US$3.5 billion), making it the largest KOS-

DAQ firm. In other words, the reverse merger of Celltrion led to almost a four-

fold increase in its market value compared to the value of the consolidated firm

immediately after the reverse merger. Further, although Korean regulations

became stricter in 2006, a reverse merger remains a popular option. Almost

one-third of newly listed firms in KOSDAQ used a reverse merger during our

sample period. This finding indicates that the reverse merger is a significant

alternative method for going public in Korea. Therefore, the popularity of

reverse mergers in Korea, and the variations in their post-performance provide a

good experimental set for investigating the factors affecting reverse-merger

performance.

Second, a Korean reverse-merger sample, especially during our research period,

provides a homogeneous reverse mergers samples that is free from the impact of

regulation (i.e. listing requirements) and fluctuations compared to prior studies (i.e.

reverse mergers in the United States market). Becoming a public company in the

stock market involves many factors, such as financial status. These requirements

have a significant impact on the post-performance of newly listed firms. To test our

main research hypothesis, which investigates the determinants of reverse-merger

post-performance, a homogenous reverse-merger sample that is free from regulation

changes is essential. The Korean government made substantial revisions to listing

regulations from 2000 until June 2006, but then made no further revisions until

December 2010. In this regard, a Korean reverse-merger sample is suitable. We

therefore use 129 reverse mergers announced from June 2006 to December 2010.

3

Consequently, our sample is more homogeneous compared to samples used in

other reverse-merger research.

Third, the Korean government provides a strict definition of a reverse merger

that is unique and significant for sampling in an empirical study, especially for an

event study. In 2005, the US Securities and Exchange Commission (SEC) defined a

“reverse merger” as a private business that merges with a public firm, or a public

firm that merges with a formerly private firm. In this study, we define a reverse

merger as a private firm that merges with a public firm, a process that includes

2

Celltrion was founded in February 2002. Its major business is manufacturing biosimilar

medicines. After the second failure of an IPO review, Celltrion became incorporated with OR

CHEM in KOSDAQ in May 2008. As a result, Celltrion is the largest company in terms of

market capitalization in KOSDAQ as of 31 December 2013. Celltrion reports that its 2013

net profit reached KRW 102 billion (about US$92 million).

3

There were 268 newly listed companies that passed the IPO requirements from June 2006 to

December 2010 on KOSDAQ. Further, 70 firms listed on the Korea Stock Exchange (KSE)

used IPOs, and only three used reverse mergers. These numbers show that reverse mergers

are more common in the KOSDAQ than the KSE.

Ownership Structure and the Survival of Listed Firms

©2015 Korean Securities Association 389