THE SPAC MARKET.

• Author: Rodrigues, Usha R.

TABLE OF CONTENTS I. BACKGROUND A. Popularity B. Literature II. SPACs III. (IL)LIQUIDITY IN THE SPAC MARKET A. Why Liquidity Matters B. Trading Data on SPAC (Il)liquidity 1. Methodology 2. Descriptive Statistics 3. (II)liquidity C. Regulatory Evidence of Liquidity Challenges in SPACs IV. RECOMMENDATIONS A. Disclosure Rules and Information Asymmetry Across Markets B. (Tentative) Recommendations INTRODUCTION

Special purpose acquisition companies (SPACs) exploded in popularity in the past few years, to such a degree that they made up 60% of IPOs in 2020, 66.3% in 2021, and 69.4% in 2022. (1) Celebrities from Colin Kaepernick to Jay-Z have launched SPACs, (2) but perhaps the most feverish attention came in October 2021, when a SPAC called Digital World Acquisition Corp (DWAC) announced plans to acquire Trump Media & Technology Group (TMTG), a social media company headed by former president Donald Trump. (3)

The SPAC frenzy has now abated, a casualty of some combination of higher interest rates, regulatory crackdown, and oversupply. (4) But the SPAC phenomenon was an innovation in the capital markets unprecedented since the very beginning of modern securities markets in 1933. (5) If SPACs are dead, an autopsy is in order.

It has been conventional to decry SPACs as exploiting the rules to create an end run around the more vexatious aspects of the traditional IPO process. (6) On this view, SPACs can be dismissed as mere regulatory arbitrage, a product of pandemic-fueled retail investing exuberance best left in the rear-view mirror.

This article rejects that view. We argue that SPACs represent more than back-door, low-rent IPOs. They create a new kind of market for private companies--that, and not regulatory sleight-of-hand, is their real innovation. In a companion paper we describe how, in the buildup to the IPO, the Securities Act of 1933 (the '"33 Act") tightly constrains the kind of information a private company can disclose and the manner in which it is disclosed. This approach, premised on the assumption that the public is prone to hysteria, results in information trickling out over time. Only when the regulators and underwriters deem the offering ready for the public will they greenlight the IPO. Thus, U.S. securities law intentionally structures a traditional IPO by decoupling the accumulation of information about a still-private company from the time when it begins to trade. (7)

Although SPACs trade on the NYSE and the NASDAQ, they represent a fundamentally different kind of market from the traditional exchanges upon which they trade. SPACs' chief innovation is to allow the public to trade on information about private companies before they ever actually go public.

To understand this market, first an understanding of SPAC mechanics is critical. Conceptually, however, SPACs are simple. They go public at a price of $10, then commence a time-limited hunt for an acquisition target---a private company looking to access the public markets. (8) The money from the IPO is set aside in escrow, and shareholders have a right to redeem their shares and get their $10 back (plus interest) at the time of the merger, or if a merger does not occur. In this subsequent acquisition, termed the "deSPAC," the once-private firm instantly becomes public. (9) The de-SPAC is thus the functional equivalent of an IPO, effected via merger rather than public offering. And in the time period between announcement of a proposed target and the closing of the merger, the SPAC shares reflect, in a truncated and indirect form, the value of the still-private target. This is the SPAC market. (10)

So, the SPAC market exposes the general public to the value of still-private firms. Whether this exposure is a net benefit is a policy question. For investors, there is the possibility of rich reward but also accompanying risk. On the company side, SPACs offer the potential to bring companies to the public markets that the traditional IPO process overlooks, thus potentially reinvigorating the public capital markets and fostering growth. (11)

The fundamental question is whether this novel market SPACs create--composed of private companies yet open to the public--is worth preserving. This paper aims to describe a key characteristic of the SPAC market--indeed, of any market: its liquidity. We have two main findings and one philosophical observation. We begin, as one always should, with philosophy.

It has become commonplace to refer to SPACs in recent years as experiencing a "bubble." (12) But a "bubble," in financial terms, generally refers to a situation where an asset's price exceeds its fundamental value. (13) SPACs, before the de-SPAC, generally held their value at around $10 per share, even at peak frenzy. (14) They remained what they had always been--essentially, an option to buy into the shares of a still-private company. Before the announcement of the target, they were a bet (or an option to bet) on SPAC management. After the announcement, they created an indirect optionality on the information in a still-private company.

We have traced SPACs' evolution over almost two decades. Consequently, we take the long view. Certainly, in the 2020-21 time period, the SPAC market exploded. (15) Especially after 2017, when 73% of SPACs listed on the NASDAQ and 23% listed on the NYSE, a robust market in these companies developed. (16) It arguably became oversaturated--indeed, we believe that it did. But it is imprecise to refer to SPACs as an asset class as experiencing a bubble--what they saw was rapid growth. This observation--that SPACs were not a bubble--is more than semantic: it sets the stage for the liquidity data that follow.

Our first key point is that liquidity increased markedly from 2019-22. (17) Where in 2010-17 we see relatively little liquidity, in 2019-22 we see much more. The question of what to make of this marked increase in liquidity is complicated. One plausible takeaway may be the limited utility of generalizing much from this most recent period in the evolution of the SPAC form; it remains to be seen the extent to which it was an aberration.

Yet another development occurred over the span of our sample--SPACs conquered the major national exchanges. In the period from 2010-12, there were few SPACs, and most did not list on a national exchange, but rather traded over-the-counter (OTC). Only after 2013 were a majority of SPACs listed on the NASDAQ, and only in 2017 did they begin to list on the NYSE. (18) So while we see an increase in liquidity in recent years, we must keep in mind how relatively new SPACs are to the national exchanges.

The second finding relates to a theme in both our companion pieces: as currently structured, SPACs suffer from a fatal flaw. They allow shareholders to vote for proposed mergers and still redeem their shares--to approve a transaction while simultaneously heading for the exit. We argue in Redeeming SPACs for the recoupling of the vote and redemption right to avoid this perverse result. (19)

It turns out, as we show in Redeeming SPACs, that redemption levels provide a fairly good sorter of value-increasing de-SPAC transactions. Those with high levels of redemptions are quite bad for shareholders that remain through the de-SPAC, but those with low levels of redemptions are quite good. (20)

Our second finding in this paper is that this same bifurcation exists in the SPAC market when it comes to liquidity. Shares that suffer from low liquidity have high redemptions, and those with high liquidity are SPACs where the majority of shareholders stay in. We further present evidence from the regulatory record that certain SPACs struggled to maintain minimum numbers of shareholders, a lack of numerosity that indicates a poor level of liquidity.

The levels of liquidity we find, however, are striking. For the low-redemption firms, we find levels of liquidity in the SPAC market that compare favorably against measures in the public market for new IPOs. But firms with high levels of redemptions not only suffer from low liquidity--that level of liquidity is markedly lower than that of recent IPOs.

It remains to be seen whether the SPAC market maintains the levels of liquidity of 2019-22. In some sense, though, that question is irrelevant. The fundamental question remains: is the market SPACs create one worth having? And, properly understood, our data show that such a market can function; that is, it can provide a level of liquidity on par with that of the IPO market. Much like Michael Milkin created a market for junk bonds--excuse us, high-yield debt--SPACs demonstrate the viability of a public market for information on private firms and a demand for firms with higher valuation risk than those that typically undertake an IPO. The question whether such a market is advisable remains for another day.

1. BACKGROUND

   1. Popularity

      The IPO market in recent years has surged, and SPACs make up a significant and unusually high share of those IPOs: 25.6% percent in 2018, 34.5% in 2019, 60.0% in 2020, 66.3% in 2021, and 69.4 % in 2022.21 This staggering increase has meant that SPACs are now driving a considerable portion of the total IPO market. Celebrities have launched SPACs in noteworthy numbers, prompting warnings from the SEC in an investor alert specifically tailored to the phenomenon. (22) Celebrities, sports stars, and politicians from Ciara to Shaquille O'Neal to Paul Ryan have launched their own SPACs or been associated with their founding. (23) Just as notably, there have been several high-profile SPAC failures, including Nikola Motor Company and Lordstown Motors, which led to potential criminal and civil securities fraud charges. (24)

      Toward the end of 2021, SPAC IPO activity sharply decreased, in part because of worries that regulatory intervention was imminent and in part because of broader market factors. (25) On March 30, 2022, the SEC formally proposed new rules to regulate SPACs. (26) These proposals provide for...