European initial public offering (IPO) activity has been relatively volatile over the last economic cycle.
The reasons behind the volatility of IPO activity are numerous because the decision whether to go public or not is never taken lightly as it has big implications on the functioning of a firm. The decision-making process is therefore a complex one and needs to be handled with utmost care and precision since listed companies will be required to subject to substantial regulatory requirements and public attention.
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Build-up and financial crisis
After attaining all-time highs in 2007, European IPO activity across all exchanges suffered its worst year in a decade throughout 2008. Confidence in capital markets lagged due to the crumbling of the global financial system and European markets experienced a steeper decline in money raised compared with US and Greater-China markets. Despite a strong downfall in IPO activity, the London Stock Exchange was the most successful European market, attracting more than 50% of the total international offerings of 2008.
When focusing on the ‘big fishes’, only three IPOs in 2008 were able to break the €1bn offering value benchmark while more than ten IPOs in 2007 had an offering value north of €1bn. If we compare the top ten IPOs of 2007 with those of 2008, money raised dropped over 60%.
Post financial crisis
During 2009, capital markets continued to experience a loss in investor confidence. This loss in confidence boosted uncertainty about the future and thus impacted both value and volume of the European IPO market, only the fourth quarter of 2009 showed some signs of recovery with a steep increase in value compared to the same period of the previous year. Looking at the ‘big fishes’ in 2009, only two IPOs managed to raise over €1bn, with the largest IPO of 2009 being PGE Polska Grupa Energetyczna on the Warsaw Stock Exchange.
During 2010, European capital markets experienced a rebound in both value and volume. The right word to describe European IPO activity in 2010 would be “recovery” since it hosted over 380 IPOs, compared to less than 130 in 2009. When comparing values, over €26bn was raised in 2010, almost quadrupling compared to the previous year.
Sovereign debt crisis and aftermath
In the first quarters of 2011, capital markets in Europe took a strong start of the year with major IPOs in Madrid, London, and Warsaw. A total of over 400 IPOs in Europe raised over €26,5bn, which is a steep rise in volume and a moderate rise in value. Pressure in the pricing of the IPOs offset the growth potential in 2011.
Political uncertainty loomed around the corner in the second half of 2011 with the Arabic spring and the instability of the eurozone caused by the sovereign debt crisis that reached a peak with the Greek debt crisis. Debt ratings throughout Europe, both of companies and countries, continued to fall and sparked even more uncertainty about the future with market uncertainty indexes reaching peaks in the second half of 2011. The political uncertainty continued throughout 2012 with rather challenging market and political conditions. IPOs were down in volume to 263 in 2012, compared to over 400 in 2011.
Throughout 2013, European capital markets continued to gain momentum after a better than expected fourth quarter of 2012. Investor confidence grew stronger and volatility became less stressful. 2013 ended with the strongest quarter since 2007 and set the tone for further recovery in 2014.
The momentum of PE-backed IPOs continued to grow throughout 2014, it contributed significantly with 56% of total proceeds being attributed directly to PE. Two of the largest deals of 2014 were PE-backed IPOs, with both increasing their share price at the end of the year. These positive aftermarket price increases are crucial for the continued popularity of these kind of exits.
End of the euphoric capital markets
2016 was a challenging year for European IPOs. Total value amounted to €28bn, which was a drop of over 50% compared to the previous year. The main reasons that PWC UK pushes forward are political uncertainty, falling oil prices and concerns of a slowdown in the Chinese economy.
The market volatility that followed the political crises made that 2016 was a difficult year for capital markets, the potential triggering of article 50 which would separate the UK from the EU only aggravated investor confidence. Compared to 2016, 2017 was a great year but it was still no match for 2015 in terms of volumes and value. The value of European IPOs amounted to €44bn, which was an increase of over 55% compared to the previous year, with volumes increasing more than 30%.
The upheaval of capital markets in 2017 was mainly due to the following through of deals that were postponed in 2016 due to the political uncertainty that was triggered by the Brexit vote. These improved political conditions throughout Europe provided a stable environment for capital markets to recover. Yet, political uncertainty remains at all-time highs inside of the European union and its satellite countries.
Aftermath of the Brexit vote and political instability
2018 started out on full steam for capital markets who wanted to act quickly before the window of opportunity shut because of the imminence of Brexit. Total value raised stood at €37bn, which was a drop of 20% compared to the previous year with volumes dropping over 10%. The steepest drop in capital markets activity was on the Italian and Euronext exchanges with values dropping between 80% and 50% in 2018.
2019 was even worse for capital markets than 2018 was, with volumes decreasing a staggering 50% to 106 and value crumbling to €22.1bn. The toxic mix of US trade relations and Brexit uncertainty made investor confidence drop to a low not seen since the sovereign debt crisis.
Going into 2020, high uncertainty remains because of US-China trade relations, imminent Brexit, and political instability in the EU. Early indications hinted on a recovery of the market only to be surpassed by the start of the Covid-19 crisis. Nevertheless, because high stock market valuations, companies might jump in the window of opportunity by raising capital when share prices are high.
Defining the indicators
Through the review of the academic literature and the help of the supporting professor P. Thomas, we identified ten different factors which affect the decision of firms on whether to list or not. In the following section we will define and explain each of these factors throughout the timeline of the last economic cycle. Some indicators were rather difficult to quantify and for others it was impossible to find a complete dataset for the whole timeline. Nevertheless, they were included to give the reader a global view on why European firms go public.
Uncertainty
It is well known across financial markets that uncertainty reduces investor confidence. However its importance, it is a difficult concept to grasp, and even more so to quantify. We find strong evidence that uncertainty influences IPO activity with the Brexit vote and the sovereign debt crisis as strong influencing factors. The heightening political uncertainty throughout 2018 and 2019 can also explain the drop in capital markets activity even though financial markets surged in the same period. As a proxy value of uncertainty, we opted for the World Uncertainty Index that is provided by the IMF, it gives a weighted view on the global uncertainty since European capital markets are affected by uncertainty everywhere.
Market volatility and market conditions
We find clear evidence in our sample data of the theories of Schill (2004), Pastor and Varonesi (2005) who find an inverse correlation of market volatility and IPO activity. This evidence is the clearest around market defining events such as the 2008 financial crisis, the 2011 sovereign-debt crisis, and the 2016 Brexit vote. Given this, we lack this same relationship during the period of continued IPO decline during 2018 and 2019, we therefore conclude that there are other factors influencing the capital markets in this period.
We also find evidence of firms wanting to maximise their valuation at the moment of an IPO, the so called ‘Window of opportunity’ that Ritter (2003) describes. He finds a clustering of IPOs during strong industry and market conditions, which means that firms select the timing of their IPO in order to opportunistically take advantage of a temporarily favourable market.
Availability of funding
Bancel and Mittoo (2009) find strong support that funding for growth is a major motivation of going public, in their study of European CFOs, over 70% of them indicate that the raising of funds is the most important objective of their IPO. Around 75% of their sample data firms had raised new capital during their listing. Ritter and Welch (2002) find that the main goal that firms have in a listing is the raising of new capital for growth purposes.
In recent years, there have been more options than ever for a firm to raise funds, both trough debt and equity solutions. Chemmanur and Fulghieri (1999) argue that the decision to go public with the goal of raising equity financing in public markets is a substitute to raising private equity from a smaller group of large investors. They also theorize that firms tend to go public when they are more mature and with a better publicly known track record.
The first alternative to equity financing via an IPO is the raising of debt. Where public firms can rely on equity financing, private firms tend to have higher leverage ratios, which were found to be a consequence of private firms’ stronger reliance on short-term debt. Differences in taxation of equity and debt also play a large role in the growing preference of debt in Europe. This bias is due to the fact that interest payments are tax deductible in most European states while equity is mostly subject to additional taxes. Combined with historically low interest rates and the corporate bond markets, this tax bias disincentivises companies in Europe to choose equity financing over debt financing.
We can find moderate evidence that debt issuance replaced fund raising through IPOs. Especially during the period after Brexit, we find a growing bond market while capital markets are in decline and therefore the issuance of long-term bonds could provide a new viable solution to the long-term financing needs of European firms. These bond markets and the emergence of the secondary bond market could prove to be a real rival to the stock market in the near future. A non-negligible element to understand the emergence of the European bond market is the growing balance sheet of the European Central Bank, which started to include the buying of European bonds in its quantitative easing programs and the lowering interest rates. Through this program, the volume of issuance in European bond markets nearly doubled between 2006 and 2016.
Equity financing is not only possible through an IPO where a private company goes public and sells a portion of its shares to the general public. During our period of interest, we saw the gradually increasing importance of venture capital and private equity. Venture capital and private equity give an option to the firm to raise funding, while still remaining a private company.
In a leveraged buyout, commonly referred to as an LBO, a company is acquired by a specialized investment firm using a relatively small portion of equity and a relatively large portion of debt financing. Investment firms specializing in debt buyouts are now referred to as private equity companies. Recent figures show us that private equity has increased despite a slowdown after the 2008 crisis. Since 2002, the value of private sector assets had already increased sevenfold, a rate twice as fast as the US equity markets, according to McKinsey. The number of companies under LBOs in the United States climbed from 4,000 to 8,000 between 2006 and 2017, while the number of publicly traded companies fell 16% to 4,300, and even halving the 1996 levels.
The growing maturity of the private equity sector is rivalling IPO activity with high amounts of dry powder and more interesting valuations for a potential exit. When looking at size, firms in Europe that qualified to go public, tended to prefer an exit through an LBO, SBO or acquisition. Secondly, the VC market does not qualify as a full-bodied competitor to the European stock exchanges in the same way that private equity does. But the maturing of both asset classes is proving to be a strong rival to IPOs. By keeping companies private for a longer period of time than they would have been historically, PE and VC in lesser extent, both cause a lowering of IPO activity in Europe.
Enhanced visibility, credibility, and reputation
The enhanced visibility, credibility, and reputation is rather difficult to quantify when a firm goes public. Given this, Pollock and Gulati (2007) study the visibility-enhancing effects of IPOs, they found that multiple signals such as analyst coverage and post-IPO alliances were positively affected by the listing of a peer group of 404 companies that went public between 1995 and 2000. The announcement of corporate actions, such as the adoption and execution of long-term incentive plans and business plans (Westphal and Zajac, 1994 and 1998), together with stock repurchase plans (Westphal and Zajac, 2001) was proven to be key in the enhancement of the legitimacy of a firm and therefore reduce uncertainty concerning its future.
In conclusion, we find evidence in the academic literature that a company can improve its credibility and reputation through an IPO that also brings a higher level of visibility. Even though it might not be the main reason for a firm to go public, it remains an important factor for formerly private firms without a proven track record who are under high scrutiny from their stakeholders.
Exit strategy
The argument that a firms listing is the first step in the exit strategy of the owner was put forward by Zingales (1995), he argues that the owner is maximising his proceeds through the sale of a part of the cash flow rights at the time of listing and the sale of the ownership rights at a later stage. This split sale is only possible through the enhanced stock liquidity that follows an IPO, which enables owners to sell shares in multiple stages, Mello and Parsons (1998).
Bancel and Mittoo (2009) also find differences across countries with UK firms highly valuing the possibility of pre-IPO investors to exit while mainland European firms tend to give lesser importance to the opportunity of exit. This difference might be explained by the differences in the shift of ownership that follow an IPO, while firms that list in the UK experience a strong shift in ownership structure, mainland Europe firms continue to have their pre-IPO investors maintain control.
Bancel and Mittoo (2009) find moderate support of CEOs for the sale of the company being the major motivation of the firm, nevertheless the support is higher with firms who do not decrease their leverage after the listing. When their research was done, only a small portion of IPOs were PE backed listings. Starting from 2013, PE exits accounted for almost 50% of volume and 60% of value of total listings, this changed the structure of the capital markets and therefore the emergence of IPOs as viable exit strategies for private equity firms. Black and Gilson (1998) confirm this theory and argue that an IPO offers a window of exit to PE and venture capital firms.
To help align interests in private equity exits, new mechanisms such as lock-up periods were invented to convince public investors in subscribing in PE backed exits. Given that financial sponsors keep a presence post IPO, while they have a high degree of monitoring experience, sends positive signals to potential subscribers of the initial listing.
Rebalancing power with creditors
Pagano et al. (1998) use a sample of 69 Italian firms that concluded their IPO process during the 1980’s in order to compare the financial metrics of the firms before and after the IPO. The empirical evidence was then used to conclude that the firms that initiated the IPO process in Italy mainly aimed to reduce their cost of debt and to rebalance their leverage. Those firms who executed an IPO had a reduction of 0.3 percentage points in their cost of debt.
We find evidence both in academic literature and empirical studies that an IPO can reduce the cost of borrowing and rebalance bargaining power with creditors through the reduction of uncertainty, higher information diffusion and credibility of a firm that goes public.
External monitoring and corporate governance
Bancel and Mittoo (2009) state that large firms consider external monitoring an important benefit of going public, while small firms do not. External monitoring is also seen as a benefit in most mainland European models, while Anglo-Saxon firms see it more as a cost. Jensen and Meckling (1976) find that the firm’s listing and higher scrutiny from the market facilitates better corporate governance when ownership and control are separated. The higher levels of scrutiny from analysts also heightens the discipline of managers since they have a closer control from the outside.
On the downside, Maksimovic and Pichler (2001) find that enhanced transparency forces a listed firm to disclose formerly secret strategic information to the outside that might be of use to competitors and other third parties. Pagano and Roell (1998) argue that the -smaller- group of pre-listing investors monitor the firm more closely than a large number of minority shareholders.
Enhanced stock liquidity and lower cost of capital
Booth and Chua (1996) argue that one of the main motivations of achieving a large initial ownership through under-pricing is to enhance secondary market stock liquidity. They thus conclude that liquidity is positively correlated with the number of shareholders and the number of non-block institutional investors. Therefore, firms that want to go public to enhance stock liquidity need to have a broad shareholder base in order to increase stock liquidity post-IPO.
In conclusion, we find evidence that an IPO reduces the cost of capital, but empirical studies find that decision makers in firms do not necessarily give a strong weight to it in their decision on whether to list. However, stock liquidity is found to be relatively more important in the listing decision since it brings advantages such as effective managerial incentive schemes, a better way of valuing the firm, and a way for existing shareholders to time their exit.
Cost of the initial public offering and of being listed
The overall cost for companies that proceed with their listing varies strongly across countries and firm sizes and complexities. This global cost of going public comprises a fixed cost and variable cost. The Federation of European Securities Exchanges estimated the costs to be the following; 10 to 15% of the amount raised from an initial offering of less than € 6 million, 6 to 10% from less than € 50 million, 5 to 8% from between € 50 million and € 100 million, 3 to 7.5% from more than € 100 million.
The costs of being listed are more complex to compute since information production costs are prone to change, exchange listing fees are variable, independent research and rating providers are not always relevant and the overall cost might be biased because of the intermediary growth of the firm. Secondly, hidden costs are impossible to precisely quantify, those costs comprise elements such as regulatory compliance.
In conclusion, we find that executives of firms that consider an IPO are not always well informed about the total costs and benefits of a listing. Nevertheless, costs of an initial public offering remains important, and more so if the firm is smaller in size. This high cost for smaller firms heavily affects their decision when they think of going public, and in turn impacts total volume on European stock exchanges.
M&A strategy
Maksimovic et al. (2013) argue that private firms participate by a lesser degree in mergers and acquisition compared to their listed peers. This is given an explanation by Lyandres et al. (2008) who find that a private firm has difficulties assessing the precise value of its equity. This valuation uncertainty can be mitigated by the listing of the firm where it will be possible to have a spot valuation through the share price. Brau et al. (2003) theorize that the shares created through an IPO can be used as a currency for future mergers and acquisitions.
Regression model
In the third section, we are going to analyse the effect of our main factors on the European IPO activity between 2007 and 2019, we are therefore dealing with a time series. The main influencing factors were chosen through the analysis of the academic literature and the creative combustion of the writer. In total, we have; the value of European IPOs, the volume of European IPOs, the European uncertainty index, the EuroStoXX 600 market index, the VStoxx 50 volatility index, and the corporate debt ratio in the Eurozone as variables.
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Test result for unit root, cointegration and long-term relationships
The outcome of the tests conducted on each time series leads us to the result that every variable is integrated of order 1 or I(1), which means that their first differences are stationary and there is no need for any additional root tests. Secondly, to analyse the long-term relationship between the variables, we used the Johansen Cointegration procedure. This test allowed to determine whether the variables were cointegrated or not. When we looked at the results of the cointegration test, we could reject the null hypothesis of no cointegration and find that there is at least one relation of cointegration. Since we had proven that the two time series were at least cointegrated to the first rank, we estimated the parameters of our indicators using the Estimated Vector Error Correction Model (VECM). Since it gave no clear result, we proceeded to the analysis of our data through a regression model.
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Regression of European IPOs in terms of value
The table 3 the relation between the value of European IPOs, the uncertainty index in Europe during the last quarter, the EuroStoxx 600 index, the VStoxx 50 volatility of the last quarter, and the debt ratio of companies in the eurozone. We find empirical evidence that the uncertainty index in Europe during the last quarter has a negative effect on IPO activity that is statistically significant at the 1% level. There is also evidence that the EuroStoxx 600 index of the same quarter has a positive effect on IPO activity that is statistically significant at the 1% level.
We find moderate evidence that the volatility of the EuroStoxx 50 of the last quarter is statistically significant enough to prove that its coefficient negatively impacts IPO activity. The debt ratio in the eurozone suffers from the same low statistical significance and we therefore cannot strongly conclude that both impact significantly IPO value in Europe during the 2007-2019 period.
When looking at the R² adjusted of 63.4%, one can observe that given the fact that not all ten factors were quantifiable, we still managed to explain a significant part of European IPO activity in terms of value.
Regression of European IPOs in terms of volume
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The table 4 gives the relation between the volume of European IPOs, the uncertainty index in Europe, the EuroStoxx 600 index, the VStoxx 50 volatility, and the debt ratio of companies in the eurozone.
We find empirical evidence that the debt ratio in the eurozone has a negative effect on IPO activity in terms of volume that is statistically significant at the 10% level. The effect of the debt ratio on IPO activity in Europe is thus different in terms of value and volume. There is evidence that the EuroStoxx 600 index of the same quarter has a positive effect on IPO activity that is statistically significant at the 1% level, which is in line with what we found in the regression for IPO value.
We only find moderate evidence that the volatility of the EuroStoxx 50 is statistically significant enough to prove that its coefficient negatively impacts IPO activity in terms of volumes. The uncertainty index in Europe has a statistically significant impact only if we look at the last quarter, which proves there is a lag of approximately three months. Lastly, we find that our model and variables are less adapted to explain volumes than values of European IPO activity.
Conclusion of statistical analysis
When analysing the dataset of our variables, we find empirical evidence for theories that were put forward in earlier parts of this study such as the link between market volatility and IPO activity. The positive correlation that the EuroStoxx 600 index has with both the value and volume of European IPO activity is statistically significant at the 1% level, this means that we find evidence to support the link between market valuations and IPO value and volumes over time.
We find empirical evidence that the uncertainty index in Europe during the last quarter has a negative effect on IPO activity in terms of value, but not in terms of volume. The opposite is true for the volatility of the EuroStoxx 50, which has a rather negative impact on IPO volumes but a statistically insignificant impact on IPO value in Europe.
Secondly, we find that our model and variables are less adapted to explain volumes than values of European IPO activity. It is also undesirable to extrapolate stronger conclusions out of our models since the dataset is only as strong as its assumptions and thus the factors and proxies on which they are based. In the section ‘limitations’ we will go deeper in the limitations of both the statistical analysis and study as a whole.
Conclusion
In conclusion, we were able to define ten factors that influence the decision-making process of European firms on whether to list or not through empirical data and the review of academic literature. Some factors such as the pursuit of an M&A were found to be of lesser importance than market volatility and market conditions.
Through this study we were able to give a broad view on all the factors that go into the decision-making process of a European firm and highlight the evolution that the European stock exchanges went through between the 2007-2019 period. We advance the academic literature in two ways, (i) firstly by defining and explaining the evolution of ten factors that influence IPO activity and (ii) the testing of the most important factors through statistical analysis.
We were able to find empirical evidence that uncertainty in Europe during the last quarter has a negative effect on IPO value, but in a lesser degree on volume. Secondly, the EuroStoxx 600 market index has a positive influence on IPOs both in terms of value and volume, this proves theories such as the window of opportunity, where firms take advantage of favourable market conditions for the timing of their listing.
Political distress also proves to be of important influence on IPO activity in Europe, with market defining events such as the 2016 Brexit vote and the 2011 sovereign debt crisis. Differences in political systems have effects that are not easily measurable, but the difference in taxation in most European countries of dividends and interests on debt disincentivises equity financing since interests are tax-deductible.
We still see that there is a large heterogeneity among European capital markets and there is a growing need for a real European IPO ecosystem with adapted regulation that in turn will attract more investors and firms.
Limitations and further discussion
This study represents several limitations. Firstly, the choice was made to prefer giving the reader a broad perspective on the deciding factors that European firms take into account when they consider an IPO, this comes at the cost of preciseness since we could only go so far in the level of detail. Secondly, we were dealing with a large number of secondary data such as PWC UKs European IPO report, which was rather useful to compile the value and volume of IPOs in Europe, nevertheless the use of secondary data for our main variables poses risks to the usefulness and the interpretation of our regression models.
Lastly, this study aimed to give its reader a broad view on the mechanics of the European IPO ecosystem and is made to be used as a basis for further research. Therefore, the conclusions that come out of the statistical analysis are not strongly taken since there were questions arising about the preciseness of the data and the correct link between proxy values and their respective factors.
The proxy values are also non falsification proof and with the help of more micro-level data, it would be possible to extrapolate stronger conclusions. Further research into this topic might clarify new factors and their relative importance to IPO activity.
