Who's Leaving Money on the Table? Evidence from IPOs within Business Groups

• Published date: 01 June 2017
• Date: 01 June 2017
• DOI: http://doi.org/10.1111/ajfs.12175

Who’s Leaving Money on the Table?

Evidence from IPOs within Business Groups*

Woojin Kim**

Seoul National University Business School, Republic of Korea

Chan Lim

Krannert School of Management, Purdue University, United States

Tae Jun Yoon

Seoul National University Business School, Republic of Korea

Received 31 August 2016; Accepted 28 December 2016

Abstract

This paper examines how controlling shareholders of business groups may pass on the cost

of IPO underpricing to minority shareholders. Based on a sample of IPOs made in Korea, we

find that sale of secondary shares in Korea in general does not reduce underpricing as it does

in the US. However, we do find less underpricing or even overpricing when the offered

shares are directly sold by the controlling shareholders. On the other hand, sale of secondary

shares held by affiliated firms leads to a negative market reaction for the selling firms, imply-

ing a direct wealth transfer from shareholders of affiliated firms to IPO subscribers. These

findings suggest that minority shareholders in certain affiliated firms, or scapegoats, may bear

the cost of underpricing while controlling shareholders of the business group remain effec-

tively protected instead.

Keywords IPO; Underpricing; Secondary shares; Controlling shareholders; Wealth transfer;

Korea

JEL Classification: G32, G34

*The authors thank Yong Huang, Jungwon Suh, and other seminar participants at the 2016

Korean Securities Association Annual Meeting, Seoul, Korea; the 2016 Asian Finance Associa-

tion Conference, Bangkok; the Asian Law and Economics Association, Seoul, Korea; Korea

University; Sungkyunkwan University; and Seoul National University for their helpful com-

ments. Special thanks to the Guest Editor, Hoje Jo, and the Editor, Kwangwoo Park, for valu-

able suggestions that have greatly improved the paper. This paper is an extension of Tae Jun

Yoon’s Master’s thesis at Seoul National University. This study was supported by the Institute

of Management Research at Seoul National University, and Institute of Finance and Banking

of Seoul National University.

**Corresponding author: Woojin Kim, SNU Business School, Seoul National University, 1

Gwanak-ro, Gwanak-gu, Seoul 08826, Korea. Tel: +82-2-880-5831, Fax: +82-2-880-5831,

email: woojinkim@snu.ac.kr

Asia-Pacific Journal of Financial Studies (2017) 46, 413–444 doi:10.1111/ajfs.12175

©2017 Korean Securities Association 413

1. Introduction

Underpricing is a well-documented phenomenon in initial public offerings (IPOs)

all around the world (Ritter, 2003). One of the factors that has been suggested in

the literature to affect the degree of underpricing is the relative proportion between

primary or new shares and secondary or old shares being offered at the IPO. Pri-

mary shares are newly issued by the IPO firm and the proceeds contribute to

increases in paid-in-capital, while secondary shares are already issued shares and

thus simply change hands from existing shareholders (e.g., founders or venture cap-

italists) to IPO subscribers.

A few studies report less underpricing in IPOs where secondary or old shares

held by existing shareholders are being sold (Barry, 1989; Habib and Ljungqvist,

2001; Ljungqvist and Wilhelm, 2003). These studies document that the offer price

in IPOs with secondary shares is relatively higher, and the extent of underpricing is

less pronounced than in IPOs that only offer primary shares.

These findings are consistent with the selling shareholders’ interest to maximize their

total proceeds by increasing the offer price. Pagano (1993) argues that IPOs provide

shareholders with the opportunity for diversified investment. Many subsequent studies

also report the sale of secondary shares in IPOs as an exit strategy by entrepreneurs and

venture capitalists (Black and Gilson, 1998; Ang and Brau, 2003; Brau et al., 2003,

2007). If selling shareholders have an influence on the offer price, more secondary shares

offered in IPOs may lead to a higher offer price and therefore less underpricing.

The above logic is mostly applicable in the US, where most firms are stand-

alone. That is, if each firm mostly remains independent from other firms, then the

sale of secondary shares must come from insiders who have a direct cash flow stake

in the IPO firm, such as founders or venture capitalists. In this scenario, any cost

from underpricing must be borne by the selling insiders, and as such there is little

room for ethical concerns.

However, it is well documented that firms outside the US typically have control-

ling shareholders and at the same time belong to a business group. For firms that

are members of business groups, there is another type of potential shareholder in

IPO firms; a type that is generally not observed in the US. Specifically, since there

are multiple member firms in a business group which are mostly linked through

inter-corporate equity ownership, an important class of shareholders in an IPO firm

in a business group is another member firm, potentially publicly traded.

In a business group, important investment and financing decisions are typically coor-

dinated at the group level rather than at the firm level. For example, in large acquisitions

of a firm or an asset, member firms typically form a consortium and bid as a group.

1

1

In September 2014, Hyundai Motor Group, the second largest business group in Korea,

made a bid for KEPCO (Korea Electric Power Corporation)’s urban real estate at a highly

controversial price of KRW10.5 trillion (roughly USD8.75 billion). The bid was to be

financed by three publicly traded member firms, namely, Hyundai Motor Corporation, Kia

Motor Corporation, and Hyundai Mobis Corporation.

W. Kim et al.

414 ©2017 Korean Securities Association

Another example is the periodical promotion of corporate executives generally

announced at the end of the year, not at the firm level but at the group level.

At Samsung, the largest business group in Korea, a unit named Future Strategy

Office is responsible for group-level financing, human resources, auditing, public

relations, and other matters related to individual affiliated firms. The media often

refers to this unit as the “control tower” of the business group, but it is widely

understood that they also serve the controlling family’s interest. For example, this

office plans the divestiture of its affiliates, coordinates mergers between member

firms, and designs the structure of IPOs of its private affiliates. Executives of affili-

ated firms maintain a close communication with this office in carrying out impor-

tant business decisions.

2

This unit even provides legal support to the controlling

family for their personal lawsuits.

3

Under such an environment, selling shareholders in IPOs may well be coordi-

nated at the business group level for the benefit of the controlling shareholders. The

following anecdote highlights how controlling shareholders may avoid any cost

from potential underpricing even when they have a large and direct interest in IPO

firms.

On August 25, 2014, Samsung announced the IPO of one of its member firms,

Samsung SDS, an IT solution provider whose major clients are other member firms

of the group. The offered shares were to be all secondary or old shares. According

to previous studies based on US data, we would expect a relatively small underpric-

ing for this IPO since there are no primary shares and all offered shares are being

sold by the existing shareholders.

In a strict contrast, the first-day closing price of Samsung SDS was 72.4% above

the offer price. The exact offer price was KRW190,000, roughly USD160, even

though the shares traded in the over-the-counter market at almost double the offer

price prior to the IPO. According to the local media, allowing such underpricing

was somewhat expected considering the huge criticism of Samsung Life Insurance

when it went public in 2010 at a relatively high offer price so that minority IPO

subscribers experienced a subsequent loss.

4

However, such huge underpricing in an

all-secondary-share-IPO is difficult to reconcile with the existing literature based on

US data.

To explain this discrepancy, we propose that such underpricing is possible if

controlling shareholders can find some other entity, which we refer to as ‘scapegoat’

from here on, who is willing (or influenced) to sell even if the offer price is rela-

tively low. In the Samsung SDS IPO, even though the controlling family members

had large direct ownership in this firm, 19.07% to be exact, they did not sell any of

their shares through the IPO but rather kept all of their holdings. Instead, the

2

Asia Today, January 3, 2015 (in Korean).

3

Chosun Weekly, May 19, 2014 (in Korean).

4

For example, http://www.businesspost.co.kr/news/articleView.html?idxno=4799 (in Korean).

Who’s Leaving Money on the Table?

©2017 Korean Securities Association 415