The effects of stricter regulation on the going public decision of small and knowledge‐intensive firms

• Author: Andrea Signori,Michele Meoli,Peter‐Jan Engelen,Silvio Vismara
• DOI: http://doi.org/10.1111/jbfa.12417
• Published date: 01 January 2020
• Date: 01 January 2020

DOI: 10.1111/jbfa.12417

The effects of stricter regulation on the going

public decision of small and knowledge-intensive

firms

Peter-Jan Engelen1,5 Michele Meoli2Andrea Signori3

Silvio Vismara2,4

1Utrecht University, the Netherlands

2Department of Management, Information and

Production Engineering, University of Bergamo,

Italy

3Catholic University of Milan, Italy

4University of Ghent, Belgium

5University of Antwerp, Belgium

Correspondence

SilvioVismara, Department of Management,

Informationand Production Engineering, Univer-

sityof Bergamo, via Pasubio 7b, 24044 Dalmine

(BG),Italy.

Email:silvio.vismara@unibg.it

Abstract

This paper studies the impact of increased securities regulation

on the IPOs of small and high-tech, knowledge-intensive firms.

We take advantage of the adoption of European SOX-like provi-

sions, staggered at different dates across European countries, to

test its influence on the going public decision. Starting from the

population of European private firms during 1995–2012, we find

that the likelihood of going public has decreased among small and

high-tech, knowledge-intensive firms. Consistently, we document a

6% and 8.5% decrease in the industry-adjusted Tobin’s Q of small

and knowledge-intensive firms that go public after the regulatory

change.

KEYWORDS

Europe, IPOs, regulation, SOX, underpricing, valuation

JEL CLASSIFICATION

G30, G38

1INTRODUCTION

Several studies address the impact of institutional and regulatory differences on the depth and breadth of IPO mar-

kets.For instance, the passage of the US Sarbanes-Oxley (SOX) Act in 2002 has stimulated a still ongoing debate about

the unintended consequences of regulation on IPO activity.In particular, the considerable increase in compliance costs

has been blamed by many commentators for the recent decline in US IPO volume. Even though it is undeniable that

enhanced disclosure requirements are costly for firms (Ahmed, McAnally, Rasmussen, & Weaver, 2010), recent stud-

ies question that heavy-handed regulation is the primary cause of such an IPO slowdown (Gao, Ritter, & Zhu, 2013).

Nevertheless, the Jumpstart Our Business Startups (JOBS) Act was passed in 2012 with the aim to facilitate funding

by easing some of the SOX provisions for firms with less than US$ 1 billion in annual revenues. Dambra, Field, and

Gustafson (2015) document a significant post-JOBS increase in IPO activity.

[Correctionadded on 4 March 2020, after online publication: An additional affiliation has been added for first author, Peter-Jan Engelen.]

188 c

2019 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/jbfa JBus Fin Acc. 2020;47:188–217.

ENGELEN ET AL.189

Thispaper analyzes the impact of regulatory changes on the European IPO market.1Following SOX, European mem-

ber states have introduced corporate governancecodes aimed at tightening existing regulation and increasing disclo-

sure requirements.2Focusing on the European setting is interesting for at least two reasons. The first one is identifi-

cation. While investigating the economic effects of a single regulatory event,such as US SOX, is challenging due to the

presence of potentially confounding factors, these SOX-likeprovisions have been introduced at staggered dates across

European countries, which allows us to better isolate their effect. The second reason is the availability of European pri-

vate firm data. While US-based studies haveassessed the impact of regulatory interventions on the IPO market mainly

by looking at changes in IPO volume overtime (e.g., Dambra et al., 2015), we investigate how increased regulation has

affected a private firm’s trade-off between going public and staying private.

The analysis focuses on two characteristics that crucially shape the benefits and costs of the introduction of SOX-

likeprovisions at the firm-level, namely size and proprietary knowledge. We expect a negative impact of the regulatory

change on the likelihood of small firms and high-tech and knowledge-intensive services (HTKIS) firms going public.

Concerning firm size, increased compliance costs that firms have to bear to comply with tighter regulation are charac-

terized by a fixed component, which becomes proportionally larger for small firms (Coates, 2007; Iliev,2010). More-

over,increased disclosure requirements worsen the informational gap that small firms have to fill during the IPO pro-

cess compared to large, established firms, for which a certain amount of information is already available in the public

domain(Chemmanur & Fulghieri, 1999). As for the role of proprietary knowledge, firms for which the value of secrecy is

higher,such as high-tech and knowledge-intensive firms, are particularly concerned about enhanced disclosure, since

it may undermine their competitive position in the long term (Himmelberg & Petersen, 1994). Based on these argu-

ments, tighter regulation is likely to have worsened the economic trade-off associated with the going public decision

for small and HTKIS firms. We therefore expect the likelihood of going public, to havedecreased after the regulatory

change among small firms (relative to large firms), due to increased compliance costs; and among HTKIS firms (rela-

tive to other firms), due to increased loss of confidentiality.Furthermore, the negative effects of increased compliance

costsand the loss of confidentiality are likely to reflect in the market valuation of these types of companies that, despite

the regulatory tightening, still decide to go public. As a result, among firms that go public after the regulatory change,

we expect small and HTKIS firms to receive lower valuations at the IPO moment relative to large and non-HTKIS

firms.

We test our hypotheses starting from the population of private firms of 25 different European countries (obtained

from the Amadeus database) and on the sample of 3,789 firms that went public during 1995–2012. Table1 shows the

timeline of the introduction of the regulatory changes in every singleEuropean c ountry.Denmark, Malta and Germany

even anticipated the enactment of US SOX in 2002, while the majority ofthe new codes were adopted within the first

two years. The first SOX-like regulatory change in our sample was implemented in Denmark on 6 December 2001,

preceding the United States. Most countries implemented a new regulatory setting within two years from the adop-

tion of the US SOX, while others were as late as 2007. The differences in the enactment of these regulatory changes

are unlikely to be due to differences in macroeconomic trends across countries, as there is a substantial geographical

diversity among both ‘earlyadopters’ (e.g., Germany and Greece) and countries that adopted regulatory changes more

than three years after SOX (e.g.,Belgium, Poland and Sweden).

In order to test our hypotheses on the impact of SOX-like provisions on private firm’s likelihood to go public, we

follow Pagano, Panetta, and Zingales (1998) and run a probit regression where the dependent variable is a dummy

equal to 0 if a firm stays private, and equal to 1 if it goes public in a given year. Our main explanatory variable is EU

SOX, a step dummy equal to 1 after the introduction of the new EU SOX-likeregulations in the firm’s country, which is

interactedwith our focal variables, namely firm size and a dummy variable identifying HTKIS firms, and a set of controls.

1Otherstudies in the IPO literature find evidence of the impact of regulation on the pricing of securities, see Akyol, Cooper,Meoli, andVismara (2014), Engelen

andVan Essen (2010), and Johnston and Madura (2009). See also Lee, Strong, and Zhu (2014) outside an IPO context.

2Fora detailed description of the specifics of US SOX see Coates (2007), and for detailed overviews of regulatory changes in Europe see Ferran (2004) and

Enriquesand Volpin (2007).