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E-MailThe following post comes to us from Carsten Burhop of Max Planck Institute for Research on Collective Goods; David Chambers of Cambridge Judge Business School at University of Cambridge; and Brian Cheffins, Professor of Corporate Law at the University of Cambridge.
The role that regulation should play in the development of securities markets is much debated and a persistent lull in initial public offerings helped to prompt some deregulation through the enactment of the 2012 Jumpstart Our Business Startups (JOBS) Act. While the appropriate scope of public regulation of securities markets is a contentious issue and while the market for newly listed firms can be a bellwether for the development of public equity markets, the empirical literature on regulation of IPOs is small and generally inconclusive. In our paper, Regulating IPOs: Evidence from going public in London and Berlin published on SSRN, we use history to offer insights concerning regulation of IPOs and the development of public equity markets. In particular, we draw upon hand-collected Initial Public Offering (IPO) datasets to undertake a comparative study of the London and Berlin stock markets between 1900 and 1913, a period that coincides with the apogee of an era of global financial development unmatched until the end of the 20th century.
Perhaps the key paper in the limited empirical literature dealing with regulation of IPOs is Carol Simon’s classic study of the 1933 Securities Act. Her findings indicate that at least in some circumstances investors can benefit from tough regulation because of lower IPO failure rates. This insight leads us to test a series of hypotheses using our data on Berlin and London IPOs.
The departure point for our analysis is that Germany was a “first-mover” with respect to IPO regulation. Reforms occurring in 1884 and 1896 considerably tightened up rules affecting public offerings of shares. In contrast, in the US disclosure requirements were negligible as the 20th century opened. Likewise, Britain only engaged in extensive statutory regulation of public offerings of shares after World War II.
We generate and test three hypotheses based on the regulatory pattern in place as the 20th century opened. First, given Germany’s tougher regulatory regime, IPO failure rates should have been lower on the Berlin Stock Exchange (BSE) than the London Stock Exchange (LSE). Second, given that the LSE imposed various constraints on companies seeking a quotation on its “Official List” and left a “junior” market where companies went public by “Special Settlement” largely unregulated, riskier ventures should have opted for Special Settlements and their failure rate should have been higher. Third, even if the relative lack of regulation by the LSE resulted in riskier ventures going public by way of Special Settlement rather than by becoming officially quoted, investors in Special Settlement IPOs may not have been prejudiced, assuming there were enough “winners” to offset the failures.
To test these hypotheses we construct datasets using contemporary sources that encompass 335 Berlin Stock Exchange (BSE) IPOs and 825 London Stock Exchange (LSE) IPOs, with 267 of these companies obtaining an official quotation and 558 going public by way of a Special Settlement. A striking finding of our study is that the IPO failure rate on the BSE or the LSE’s Official List before World War I was better than what one finds today. The logical expectation would be the opposite, given regulatory trends. IPOs are considerably more tightly regulated now, as measured by the well-known LLS index of the strength of securities law, than they were in the early 20th century.
In terms of our hypotheses, our results largely verify our first two but not the third. As predicted, the failure rate of BSE IPOs was lower than that of LSE IPOs between 1900 and 1913, though the failure rate of IPOs of companies that sought an Official Quotation was low. Moreover, the failure rate of IPOs by way of a Special Settlement on the LSE was considerably higher than it was for Official Quotation IPOs even after other relevant variables are controlled for.
Share price data, first available in 1916, indicates that LSE Special Settlement IPOs performed very poorly relative to the overall London market. Hence, while a potential drawback with tight IPO regulation is that it will deter riskier ventures from going public and thereby reduce the investment opportunity set, in this particular case the average investor would have benefitted from having less IPO choice.
The full paper is available for download here.
