Agency Problems and the Performance of Venture-backed IPOs in Germany: Exit Strategies, Lock-up Periods, and Bank Ownership

Abstract

The agency problems for initial public offerings are well documented in the literature. The objective of this research is to investigate the potential conflicts of interest for the ‘Neuer Markt’ in Germany. Of special interest are venture-backed IPOs and those in which banks acted as venture capitalist, underwriter, and provided analyst recommendations. High initial returns and outperformance are observed over the first 6 months of trading, which decreases significantly over the subsequent 18 months. The individual performance depends on the VC's underwriter and bank affiliation, exit behaviour, and lock-up commitment. Venture capitalists, and especially banks, timed their exit well. This indicates some serious agency problems in the German IPO market.

Keywords:

• Initial public offerings
• venture capital
• agency problems
• bank equity ownership

Notes

¹In the meantime the German Stock Exchange has created the Entry Standard as a new market segment based on the idea of a lower market segment with less listing requirements.

²There were only three IPOs with venture capital ownership of less than 4%.

³We thank Stefanie Franzke and the Center for Financial Studies (CFS), Frankfurt, for providing the VC reputation classification data. Franzke (2004) also distinguishes between venture and bridge financing. We control for this effect by using her classification scheme. However, this separation between venture and bridge financing does not impact our results. Therefore, we do not report these findings here, but the results are available from the authors on request.

⁴It is possible that the first month of trading is biased due to the price support of the underwriter. To account for this fact we repeated all the analysis excluding the data from the first month of trading. Our results are robust and are not influenced by the returns in the first month.

⁵We repeated the analysis by employing the DAX and the DAFOX indices as benchmarks. The latter index was provided by the ‘Karlsruher Kapitalmarktdatenbank’. The empirical findings reported here are all robust with respect to the index employed. This result is not surprising because we are interested in the relative performance between various sub-groups.

⁶Some IPOs at Germany's ‘Neuer Markt’ show very large initial and long-run buy-and-hold returns. We repeated the analyses without the outliers. Our results documented in Sections 4 and 5 are not affected by these so-called outliers.

⁷We repeated the analysis by employing the Dow Jones Euro Stoxx style indices for constructing the SMB and HML factors. We do not find any major differences in our results between the MSCI and Dow Jones analysis. Therefore, we do not document the additional findings in this paper but the results are available from the authors on request.

⁸Given the previous research we do not expect major differences in results than in our BHAR analysis. Drobetz et al. (2004) also apply the Fama-French model and do not find different results. However, to make sure that our results are robust we report the results from the Fama-French model in all Tables later on.

⁹A more detailed analysis of stock recommendations for IPOs at the ‘Neuer Markt’ is provided in Bessler and Stanzel (2006). They find that the stock recommendations of these analysts are often too optimistic resulting in a long-run underperformance.

¹⁰For a more detailed analysis of the IPO allocation see Bessler and Kurth (2006). It is interesting to note that capital gains are tax exempt in Germany after a 12-months holding period. Consequently, the best performing IPOs have a significant increase in trading volume and a significant price decline beginning exactly the day after this tax lock-up expiration. It appears that the best performing IPOs were allocated to the privileged customers.

¹¹In addition, we did the same analysis for all 101 venture-backed IPOs without any distinction between banks and non-banks. We do not document our results here because they do not offer any additional insight.

¹²For a more detailed analysis of conflicts of interest and research quality of affiliated analysts, i.e. analysts belonging to the underwriter, see Bessler and Stanzel (2006). For IPOs at the ‘Neuer Markt’ they find empirical evidence that, on the one hand, the forecasts of the affiliated analysts are inaccurate and positively biased and that, on the other hand, the stock recommendations of these analysts are often too optimistic resulting in a long-run underperformance.

¹³In 2006 the German government decided to lower this threshold further to 3%.