In a recent speech, Commissioner Jackson focuses on the traditional IPO 7% spread, which he refers to as a “tax.” From time to time, such as in the correspondence between Congressman Issa and then Securities and Exchange Chair Schapiro and in academic literature, questions have been raised regarding the IPO book building process and “IPO underpricing”; however, I don’t think an SEC Commissioner has previously taken on this topic. The speech cites to Professor Jay Ritter’s work and notes that the Commissioner’s staff undertook an effort to look at more recent data, which included data from more than 700 middle market IPOs over a 15-year period beginning in 2001. There is a link to the supplemental research (you may access here). The following chart illustrates the study findings from 2001 to 2016:
Larger companies are able to use their bargaining power to negotiate lower spreads, Commissioner Jackson observes. While this is true, it’s also important to consider that the market dynamics for larger companies going public are quite different. Their securities tend to be purchased more broadly by institutional investors and there is more liquidity in their stocks. Commissioner Jackson suggests that the “middle market tax” may be another deterrent for smaller and middle market companies to defer or avoid undertaking IPOs. The Commissioner also draws a connection to the availability of private capital. However, in practice, private capital is more readily available for the largest tech companies and not as readily available for smaller and middle market companies. For example, more mezzanine or late-stage private placements are completed for tech companies and for larger cap companies generally (across industries) than are completed for smaller and midcap biotech and life sciences companies. The smaller and midcap life science companies, to the extent that they can complete private placements, rely on dedicated sector investors and insiders and almost “must” go public in order to raise substantial amounts of capital. Larger companies have many more financing choices. Going public, I would argue, is more important to smaller and midcap companies. While, of course, it is important to consider all of the many factors that may be at play that affect the IPO market, the underwriting spread may have the least effect on a company’s decision. Additional disclosure regarding “underpricing” is unlikely to have an effect on the IPO dynamics. Studying research coverage and the lack of institutional investor participation in smaller IPOs may be more directly impactful for smaller and midcap companies.