The Two-Tier Board System and Underpricing of Initial Public

Offerings: Evidence from Austria

Lalith P. SamarakoonUniversity of St. Thomas, St. Paul, Minnesota, USA

and

Palani-Rajan KadapakkamUniversity of Texas at San Antonio

Academic Corporate Reporting & Governance Conference

California State University – Fullerton

September 22, 2011

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Two-tier Board Structure

Supervisory Board Consists of independent, non-executive directors and employee

representatives. Directors are elected by the shareholders, while employees of a company

that has a works council are entitled to appoint their representatives to the supervisory board.

Responsible for appointing and terminating the members of the management board, overseeing and providing support to the management board, and approving important business transactions.

Management Board Consists of several persons such as the chief executive officer, chief

operating officer and the chief financial. Responsible for the day-to-day management of the firm.

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Research Objective & Contribution

Objective Examine the relation between IPO underpricing and two-tier board

structure in Austria.

Contribution Very little previous work on IPO underpricing in the context of

dual boards. Strong world-wide trend towards recommending or requiring

increased board independence. Understanding the impact of dual boards on IPO underpricing is

important.

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Related Literature Board independence

Strongly independent boards may signal effective monitoring and control, and thereby reduce agency costs and uncertainty (Fama and Jensen, 1983; Shleifer and Vishny, 1997).

Supportive empirical evidence on board independence Market reacts positively to the appointment of outside directors

(Wyatt, 1990). Lower financial statement fraud (Beasley, 1996; Uzun et al., 2004) Lower likelihood of accounting enforcement actions by the SEC for

GAAP violations (Dechow et al., 1996) Improved timeliness and informativeness of earnings (Bushman et al.,

2004; Vafeas, 2000) Higher likelihood of CEO replacement following poor performance

(Weisbach, 1998). Lower IPO underpricing (Hasan and Hadad, 2009).

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Related Literature CEO dualism

Separate CEO and chairman positions increases the independence and the strength of the board (Jensen and Mackling, 1976; Fama and Jensen, 1983).

Empirical evidence confirm that stronger corporate governance is viewed positively by investors owing to reduction of agency problems. Investors react positively to announcement of seasoned equity

offerings by U.S. firms in which different people hold the CEO and chairman positions (Huang and Tompkins, 2010).

Higher underpricing in IPO firms that have CEO duality (Chahine and Tohme, 2009).

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Hypothesis Strong boards with independent directors and separation of CEO and

chairman positions are perceived as providing effective monitoring of the management.

In a two-tier board system, the quality of the signal that an effective monitoring system in place is very clear and strong since the monitoring and managing tasks are legally split between a supervisory board and a management board.

A larger supervisory board relative to the management board may signal more effective monitoring and supervision and leads to lower agency costs and, hence, lead to lower underpricing.

Based on the agency theory, we hypothesize that a larger board ratio will be associated with lower underpricing.

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Sample and Data

Common share IPOs in the Vienna Stock Exchange during 2000 to 2010. Sample size is 30. Collected data on

First-day of trading Offer price First-day close Number of shares offered Issuer’s industry Ownership structure (Foundations, Corporations and Individuals) Number of directors in the supervisory and management boards

Data source: Vienna Stock Exchange

Short-run IPO Underpricing

Methodology

Calculating Initial Returns

Univariate Analysis of Underpricing: Issue year Issuer’s industry Board ratio

i

iii PriceOffer

PriceOfferCloseDay -FirstIR

Where, i= ith issue

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Short-run IPO Underpricing

Methodology Cross-sectional Analysis

Independent variables BoardRatio (-): # directors in the supervisory board / # directors in the

management board OwnCon (+ /-): % ownership of foundations, corporations and large

individual blockholders with more than 10% shares. OSize (-): natural logarithm of issue proceeds Sentiment (+): cumulative market return over the three-month period

before the first day of trading of the IPO Industry Dummies (-/+): Inve (Investment), Htech (High Tech), Real

(Real Estate), Bank (banking), Indu (Industrials) Ente (Entertainment)

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IRi = α + β1BoardRatio+ β2OwnCon+ β3OSize+ β4Sentiment+ βi10i=5 Industry Dummyj + εi

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Table 1: Descriptive Statistics

Variable Mean Median StandardDeviation

Minimum Maximum

IR (%) 3.02 0.56 11.86 -19.47 31.25

BoardRatio 2.10 2.00 0.78 1.00 4.50

OwnCon (%) 77.10 85.67 24.71 0.00 100.00

OSize 4.10 4.20 1.60 1.28 7.18

Sentiment (%) 5.09 5.68 5.89 -6.55 14.09

IR is the initial return which is the difference between the first-day closing price and the issue price as a percent of the issue price. BoardRatio measures the relative board size and is the ratio of the number of directors in the supervisory board to the number of directors of the management board. OwnCon is the ownership concentration which is measured as the ownership percentage of foundations, corporations and large individual holders with more than 10% before the IPO. OSize represents the offer size and is calculated as the natural logarithm of total proceeds of the issue. Sentiment is the market return over the three-month period preceding the first day of trading of each IPO. The number of observations is 30.

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Table 2: Average Initial Returns by Year

Year Number of Issues Average initial return

% t-stat

2000 6 -0.85 -0.66

2001 3 -2.93 -0.85

2002 1 -4.64 -0.63

2003 4 -0.95 -0.66

2005 5 11.95 1.52

2006 6 1.11 -0.38

2007 5 9.27 1.12Initial return is the difference between the first-day closing price and the issue price as a percent of the issue price. Two sample t-statistics for testing the difference between average initial returns in a given year and the overall average initial returns are shown. ***, ** and * indicate statistical significance at the 0.01, 0.05, and 0.10 level, respectively. The number of observations is 30.

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Table 3: Average Initial Returns by Industry

Industry Number of Issues Average initial return

% t-stat

Investment 2 0.50 -0.30

High Tech 7 1.15 -1.67

Real Estate 7 3.75 0.15

Banking 2 11.95 0.99

Industrial 6 -0.77 -0.77

Entertainment 3 -14.81 -2.55**

Utilities 3 2.61 -0.06

Initial return is the difference between the first-day closing price and the issue price as a percent of the issue price. Two sample t-statistics for testing the difference between average initial returns in a given industry and the overall average initial returns are shown. ***, ** and * indicate statistical significance at the 0.01, 0.05, and 0.10 level, respectively. The number of observations is 30.

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Table 4: Initial Returns by Board Ratio

Issue size Average initial return(%)

Standarddeviation

of initial returns(%)

Average board size (#)

Number of IPOs

Number %

Low: BoardRatio ≤ 2.0 4.98 11.63 1.5 16 53

High: BoardRatio > 2.0 0.77 12.15 2.7 14 47

Low – High 4.21BoardRatio measures the relative board size and is the ratio of the number of directors in the supervisory board to the number of directors of the management board. The median Board Ratio is 2. Board ratios up to 2 are classified as low, and above 2 as high. The number of observations is 30.

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Table 5: Regression Results

1 2 3 4 5 6 7 8 9 10 11 12Constant 0.16

(2.69)**-0.03

(-0.45)0.02

(0.39)0.01

(0.48)0.03

(1.40)0.00

(0.20)0.03

(1.07)0.02

(1.14)0.04

(1.52)0.05

(2.48)**0.03

(1.33)0.13

(1.32)

BoardRatio -0.06(-2.34)**

-0.06(-2.98)**

OwnCon 0.08(1.02)

-0.05(-0.68)

OSize 0.00(0.09)

0.01(1.45)

Sentiment 0.35(1.11)

0.29(0.82)

Inve -0.03(-1.17)

-0.07(-0.98)

Htech 0.11(2.18)**

0.09(1.25)

Real 0.01(0.23)

-0.03(-0.43)

Bank 0.09(0.86)

0.00(0.01)

Indu -0.05(-1.62)

-0.06(-0.80)

Ente -0.20(-6.26)***

-0.17(-2.39)**

Util -0.01(-0.08)

Adj-R2 0.13 -0.01 -0.03 -0.01 -0.03 0.13 -0.03 0.01 -0.01 0.23 -0.04 0.32

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Key Results & Implications

Relative board size is strongly negatively related with underpricing.

Confirm the prediction based on the agency theory, which posits that more effective monitoring implied in a relatively larger supervisory board will lead to lower agency costs, and thus lower underpricing.

Imply that firms seeking to raise external capital will be helped by adopting strong corporate governance standards.