Freshen up before going public: Do environmental, social, and governance factors affect firms' appearance during the initial public offering?

Published in: Business Strategy and The Environment

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Going public is considered a strategic business decision associated with various costs and value-creation opportunities.

Studying the decision to go public and its related phenomena and implications has a long-established history since the development of equity markets in the twentieth century. The literature covers almost all countries with established equity markets ranging from developed to least developed. Also, all types of firms have been investigated. However, agreed conclusions have not yet been reached, and findings may differ according to the market development, the period, and the types of firms, large or SMEs. In the same regard, various theories (hypotheses) have been developed to explain the IPO decision, the underpricing, and the post-IPO stock performance. Again, no clear-cut explanation has been achieved.

Previous studies have linked IPOs to financial and business factors. However, given the emergence and importance of Environmental, Social, and Governance (ESG) issues and the mandatory non-financial reporting in Europe, IPO-related attributes could be related to ESG factors through quality signaling, asymmetric information, and compliance channels.

In this paper, we track the going public journey for Italian SMEs, verifying the various theories related to the IPO. We study the underpricing and potential determinants, emphasizing board structure and sustainability indicators. And the post-IPO stock performance. The analysis is performed using regression analysis, paying attention to diagnostic statistics for the model's appropriateness. We demonstrate two relevant findings.

On the one hand, underpricing is negatively related to ESG rating pre-IPO, revealing an improved informational environment and compliance anticipation by SMEs. Investors have enhanced quality information to better price the security issuance, thus lowering underpricing.

On the other hand, such a negative relationship is statistically significant only in the year just before the IPO unveils the positive quality signaling and window-dressing practices. The post-IPO stock return is less correlated with the firm’s financial and ESG variables, suggesting that markets can incorporate financial and sustainability information into stock returns in the long run.

In this regard, our findings have direct implications for the SMEs willing to go public and for market investors.

SMEs are usually characterized by a higher degree of asymmetric information; thus, firms might forgo part of the IPO price to attract investors through underpricing.

Since SMEs are less-known firms, improving the financial and sustainability records before going public is essential to give a serenity signal to the market. External equity financing could be a valuable source of funds to boost SMEs' future growth and innovation activity. Moreover, SMEs attempting to go public should anticipate compliance and oversight security, especially regarding sustainability-related mandatory reporting.

On the other hand, investors could view the listing of SMEs as an investment opportunity at the IPO. However, on average, investors should expect a decreasing stock performance post-IPO; thus, managing the investment horizon is essential.

At the regulatory level, a platform for SMEs should be established to register all SMEs wishing to go public for some years before the IPO; this improves visibility and reduces informational asymmetries around the firm, obtaining better results at the IPO.

Ultimately, going public is an essential corporate strategic decision for value creation. The decision can – somehow- be considered irreversible since the de-listing is least likely. Firms can use the IPO to show the public the responsible practices the firm is adopting toward society and the environment. Such image-improving could enhance a firm’s value through several value drivers, such as maximizing future cash flows or reducing the cost of capital, depending on the relationship to risk categories (systematic or idiosyncratic).

However, firms should be aware that going public is associated with additional costs, such as compliance with regulations that might affect future cash flows and competitiveness.

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Authors at the Department of Management

Murad Harasheh, Senior Assistant Professor

Academic disciplines: Economics of Financial Intermediaries and Corporate Finance  

Teaching areas: Corporate Finance, Financial Valuation, Sustainability Finance, Energy and Commodity Finance

Research fields:  Corporate Finance and Governance, Sustainability Finance, Financial Markets, Energy Finance

Murad Harasheh is a senior assistant professor of Finance at the Department of Management of the Alma Mater and a research associate at Yunus Social Business Center of Bologna. He was awarded his Ph.D. 2014 in Economics, Law, and Institutions from the School of advanced studies of Pavia (IUSS). In 2021, he obtained the Italian National Scientific Qualification (ASN) as a 2nd tier (Associate) Professor in “Economics of Financial Intermediaries and Corporate Finance.” Previously, he collaborated with the Italian Authority for Energy Regulations (ARERA) as an economist and energy markets analyst. His primary research interests are related to corporate finance, firm valuation, energy and commodity finance, and sustainability economics.