The Importance of Prospectus-based Disclosure in the Interpretation of IPO Pricing Outcomes

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My recent publication in the European Journal of Finance assesses the link between voluntary prospectus-based disclosure and a range of IPO pricing outcomes¹ for issuers listing on HKEX. A significant amount of disclosure is necessary for an entity contemplating stock listing on an organised exchange market. For any firm granted initial public offering (IPO) approval, publication of a listing prospectus precedes the general invitation for investor subscriptions.²

Prospectus disclosure information is wide-ranging and addresses, among other things, the listing entity’s business focus, ownership, governance, industry and regulatory background, as well as its pre-listing financial performance. As a legal document, the mass of prospectus information on offer serves an important role in reducing information asymmetry between insider-owners and outside public investors. Careful study of such prospectus disclosure potentially helps in attenuating investors’ adverse selection risks. Two of the pivotal areas to consider in this regard are the issuer’s declarations on risk factors and planned use of issue proceeds. The voluntary or discretionary disclosure component concerns the amount of detail divulged. While all issuers provide some level of disclosure on both risk factors and planned fund uses, the level of coverage varies considerably across IPO firms.

With regard to declarations on risk factors, issuers and their advisors typically disclose on (1) macroeconomic, (2) business, and (3) offer-based risks. For the second area of disclosure on planned use of proceeds, issuers routinely earmark funds to at least one of the following: (1) Drawing-down liabilities, (2) new investments, and (3) working capital. In many IPOs, issuers indicate an intention to channel proceeds to all three end uses. The question then of course is how does the balance of declared risk factor and intended fund uses impact on pricing outcomes?

The outcomes of relevance include the ‘fixing’ of final offer price, IPO subscription demand, initial investor returns, after-market stock volatility and liquidity, and longer-run returns. A pivotal issue is whether disclosure is exogenous or endogenous. The latter presupposes that declarations anticipate subsequent pricing outcomes. Exogenous disclosure suggests voluntary declarations shape pricing pricing outcomes.³ In reality, most disclosure contains endogenous and exogenous elements. The challenge is thus one of determining which of the two dominates. I discuss more on this topic later in this piece. 

In my study, discrete risk factor counts yield significant explanatory power. Issue-based counts exert short-lived effects on return volatility. On the other hand, business and global risk factor counts bear little connection with initial pricing, but display strong negative linkage with long-run returns. Issue-based enumerations thus forewarn on adverse-selection, while non-issue counts inform on the longer-run.

With regard to my study’s second major disclosure area, greater assignment of issue proceeds to real investment (debt repayment) supports (weakens) IPO subscription. Final offer prices thus tend to be higher in firms that explicitly prioritise growth options. The price formation process strongly embeds this outcome. Firms stressing greater focus on investment uses are more likely to price new stock at the top of disclosed offer ranges. Such findings offer prescriptive value for issuers and supporting bank sponsors: Greater ‘specificity’⁴ on growth options typically boosts issue proceeds.