Private investor meetings before IPOs contribute to longer-term vision
f your company were going public, how might it encourage investors to be less reactive to bad news or bumps along the way — to keep a longer-term perspective and stay onboard?
According to research by W. P. Carey Assistant Professor of Accountancy Badryah Alhusaini, and colleagues from Washington University and Notre Dame, it’s not impossible.
They analyzed R&D-intensive firms that took advantage of the Jumpstart Our Business Startups (JOBS) Act of 2012 to examine the impact of private communications on institutional myopia.
Under the JOBS Act, emerging growth companies may talk privately with investors for months before an initial public offering (IPO). These early discussions are a considerable departure from previous regulations in which the only direct dialogue between managers and investors occurred during the “road show,” a short meeting broadcast to the public at least once, during which only information limited to the formal IPO documents is shared.
Public vs. private disclosure
“When firms provide information publicly, it becomes available not only to potential investors but also competitors,” Alhusaini says. As a result, firm managers often provide less detail about scientific or technological innovations, strategies, and products.
“Investors are then unable to properly evaluate the firm and often focus instead on current performance to assess the long-term health of the company.” They’re also less patient with poor performance. Firm managers, in turn, become more focused on short-term earnings goals. The result: Both parties have myopic behavior by fixating on the short term.
Alhusaini and her research collaborators thought if managers cause myopia by withholding relevant details from public disclosure to keep it from competitors, private disclosure should allow more openness and less myopia.
A game-changer
The JOBS Act’s “test the waters” provision remedies that hesitancy to share, allowing firm managers to meet with investors privately to discuss the firm and gauge investor interest in a public offering outside the confines of a conventionally restrictive process.
The study quotes one manager as saying, “During the IPO process, the ability to conduct testing-the-waters meetings and increase our dialogue with potential investors was a game-changer. Biotech companies like ours have complicated technology, an opaque regulatory pathway, and a complex commercial story. The additional time with investors gave us time to clarify questions about these aspects of our business in a more robust way that would not have been possible in a traditional half-hour roadshow meeting.”
Measurable benefits
“A simple idea inspired the paper: If firms provide more information to investors, investors will have a more holistic view of the company and its direction,” says Alhusaini. “If investors are more comfortable with the firm, they will be more long-term-oriented, rather than focusing only on the next quarter.”
That is precisely what Alhusaini and her team found in their study, which analyzed 237 firms that went public between 2010 and 2014. “With private disclosure, investors and firm managers are more focused on long-term value,” Alhusaini says.
The study also found that investors in the JOBS Act IPO firms did not jump ship when companies missed performance benchmarks. Investors also held their ownership positions longer than in other non-JOBS Act IPO firms within the same industry.
The study quotes another manager as saying, “A core group of investors has stuck with our company over several years since the IPO. They know our story and are the least likely to call me right after an earnings announcement in a panic over some small detail.”
Alhusaini hopes her research sheds light on a positive aspect of private, selective disclosure — often viewed as harmful among traders for creating a less level playing field. “Our paper shows an interesting benefit: less myopia, which the literature had previously overlooked,” she says.
— Melissa Crytzer Fry