The impact of banking market structure on IPO activity

Abstract

The pecking order theory (POT) dictates a hierarchy in a firm’s financing choices, suggesting that firms prefer debt financing over equity financing. The foremost advantage of being listed is thought to be the ability to tap the public equity markets. Hence, prospective issuers - and especially small businesses that are faced with limited debt financing options - have strong incentives to transition into the public domain. To maximize the proceeds raised from their listing, issuers often tend to leave more money on the table, opportunistically manipulate earnings and, in doing so, jeopardize their post-IPO performance. However, up to now, far too little attention has been paid to how financing constraints in debt markets can influence equity financing activities and, in particular, IPOs. Filling this gap in the literature, my thesis investigates the impact of local banking market concentration on three important outcomes of the going-public process: IPO underpricing, earnings management, and post-issue performance. The evidence is primarily drawn from county-level data on banking market structure, rather than state-level data, based on the intuition that a firm generally applies for a loan (debt capital) to one of the local bank branches within the county where the firm’s headquarters are located. To conduct my investigation, I assemble a large and comprehensive sample of
U.S. IPO firms, across 300 counties, listed over the period from 1998 to 2017,
which I merge with hand-collected data on local banking market concentration. The results of my investigation are important for a large portion of prospective issuers which rely on bank loans as their sole source of finance and view an IPO as a way of permanently overcoming their financing constraints.
Firstly, I investigate the impact of local banking market concentration on IPO first-day returns, i.e., IPO underpricing. My findings indicate that, in concentrated banking markets, there are fewer IPOs and that small issuers not backed by venture capital (SNVCs) incur higher underpricing. This is consistent with the market power hypothesis, which predicts that bank concentration leads to higher borrowing costs in debt financing markets. Moreover, I find that prospective issuers have their IPOs sooner and are less underpriced when the available banks are of small size.
Secondly, I explore the association between local banking market structure and the level of earnings management. The results indicate that issuers tend to take a more conservative stance on earnings reporting when the local banking market is concentrated. Specifically, the evidence from our multivariate analyses shows that concentration gives rise to lower accrual-based IPO earnings management, in line with the information hypothesis. Notably, the relationship between the level of inter-bank competitiveness and earnings management is only significant for IPOs without venture capital backing, as their financing options are limited.
Lastly, my findings shed light on the relationship between local banking market concentration and post-IPO performance. First, the baseline results indicate that issuers in a more concentrated banking system have lower long-term stock performance, especially in year one and year five after listing. However, this effect is only significant for non-venture-capital-backed IPOs. Next, my analysis finds no evidence to support the conjecture that a higher level of local bank concentration may have a more substantial impact on post-IPO performance when the IPO occurs during a hot market period.
Overall, the empirical evidence supports that the structure of the local banking market is a crucial determinant of IPO activity, including IPO underpricing, earnings management and post-IPO performance. However, the impact of local bank concentration is only significant for small issuers without venture capital backing, as they have limited financing alternatives. My thesis not only contributes to the IPO, banking market structure, and financial reporting literature but also identifies practical implications for regulators, the accounting profession, and for investors’ decision-making.

Date of Award	13 Oct 2022
Original language	English
Awarding Institution	University of Portsmouth
Supervisor	Song Zhang (Supervisor), Andrew Wood (Supervisor) & Konstantinos Kallias (Supervisor)