Signaling corporate strategy in IPO communication: a study of biotechnology IPOs on the NASDAQ.

A clear corporate strategy communication can be a signal to financial analysts and public investors at the time of an initial public offering (IPO). This study examines IPO prospectuses of 57 biotechnology firms listed on the NASDAQ between 1997 and 2002. Using regression analysis, this article shows that the clarity, intensity, and consistency of the corporate strategy signal are not strong enough to affect the 1st-day initial returns. However, consistent communication of a prospector strategy negatively impacts 30-day initial returns, whereas consistent communication of a defender strategy positively impacts 30-day initial returns.

Keywords: corporate strategy; communication; IPO; market signal

**********

Uncertainty characterizes the time surrounding an initial public offering (IPO). It is difficult to predict how the market will perform following the IPO date (Ibbotson, 1975). Similarly, determining a fair market value of the firm is complex because of the newness of the firm to the market (Certo, 2003) and the entrepreneurial nature of some IPO firms (Certo, Daily, & Dalton, 2001; Daily, Certo, Dalton, & Roengpitya, 2003). Researchers attribute this uncertainty to information asymmetry or knowledge gaps between informed and uninformed investors (Ibbotson, 1975; Ibbotson, Sindelar, & Ritter, 1988; Rock, 1986). Although some debate exists about which investors are more informed, this article takes the positions that (a) IPO issuers are more informed than public investors and (b) institutional investors are more informed than small investors (Daily et al., 2003; Ritter & Welch, 2002).

Extant research has applied signaling theory widely to address this information asymmetry dilemma (Daily et al., 2003). Signaling theory suggests that certain indicators provide signals to potential investors about the capabilities of the IPO firm and therefore the likely future value of the firm (Deeds, DeCarolis, & Coombs, 1997). Research reports that credible communication outlining important information at the time of an IPO can reduce the information asymmetry between IPO issuers and investors. So far, the types of information included in research are (a) the composition of the board; (b) the reputation of the underwriter; (c) the source and amount of venture capital; (d) the nature of the firm's intellectual capital; and (e) the ability of those within the firm to manage knowledge. Credible communication also helps IPO issuers reduce the information asymmetry between informed and uninformed investors and maximize the value of going public (Azarmi, 2002; Bukh, Nielsen, Gormsen, & Mouritsen, 2002; Carter, Dark, & Singh, 1998; Certo et al., 2001; Megginson & Weiss, 1991; Neck, Welbourne, & Meyer, 2000; Rosenstein & Wyatt, 1997). One possible explanation for the link between credible communication and the value of an IPO is that shareholders increasingly seek strategic information (such as the information described above) in order to explain an investment opportunity (Brown, 1997; Desai, 2000; Higgins & Diffenbach, 1989; Neck et al., 2000).

A group of studies reports that communication on corporate strategy received by the stock market has a significant impact on the value of shares in the market (Day & Fahey, 1990; Higgins & Bannister, 1992; Higgins & Diffenbach, 1985; Parnell & Wright, 1993). However, we are not aware of any published studies that empirically examine the relationship between corporate strategy communication and returns to IPO investors on both the 1st day and in the short-term after-IPO market (e.g., 30-day returns). This oversight is surprising because the communication of corporate strategy has been extensively argued to affect the market price and shareholder value in the long after-IPO market (e.g., a year or more after the event; Day & Fahey, 1990; Desai, 2000; Higgins & Bannister, 1992; Higgins & Diffenbach, 1985). This article proposes that the communication of corporate strategy at the time of an IPO provides cues to assist analysts and investors in deciding whether or not to invest in an IPO firm. This view becomes particularly important when the IPO firm first goes public because IPO managers must find a mechanism to communicate their firm's quality in order to reduce the ex ante uncertainty and thus reduce the need to discount the stock price to attract less-informed investors (Daily et al., 2003). Through the credible communication of corporate strategy, investors and analysts will better understand a firm's strategic posture, activities, and plans and then be able to assess the fit between internal resources, the firm's corporate strategy, and the external environment in which the firm operates. Thus, by obtaining strategic information, investors and analysts are in a better position to infer the potential value of the firm (Day & Fahey, 1990). This article proposes a significant advantage for an IPO firm that provides as part of IPO documentation an overview of the firm's corporate strategy as "information cue" (Miles & Snow, 1978).

Underpricing is generally defined as the difference between the price at which the firm's stock was initially offered and the stock's closing price on the 1st day of trading (Ibbotson, 1975; Ibbotson et al., 1988; Ritter, 1998). Although a number of theoretical explanations (e.g., risk-averse underwriter, information asymmetry, and bandwagon) exist for IPO underpricing, this article adopts the information asymmetry approach. Therefore, we assert that if IPO communication is credible, then underpricing will be minimized and so the 1st-day returns will be close to expected returns (Certo et al., 2001; Ritter, 1998).

Of the studies that examine the relationship between an IPO event and investor returns, most focus on the returns on the 1st day of an IPO event as an indicator of information asymmetry in the market (Bukh et al., 2002; Certo, 2003; Certo et al., 2001; Durukan, 2002; Megginson & Weiss, 1991; Neck et al., 2000; Rosenstein & Wyatt, 1997). However, we also propose that returns at some stage after an IPO event should be examined because of market instability and opportunistic behavior surrounding the IPO event. By taking a slightly longer term view (in this case, 30 days after an IPO event), this research controls for the effect of opportunistic investors who order stocks before the 1st day and then on-sell these stocks soon after (Finkle & Lamb, 2002; Ritter, 1991, 1998). Accordingly, this research includes both investor returns on the 1st day and 30 days after an IPO event to examine the effect of the strategy signal.

This article is structured as follows: We begin by presenting a theoretical framework, based on market signal and corporate strategy theory, before presenting research hypotheses. Next, the population of biotechnology IPO firms used in the nominated time period is described and an overview of the content analysis method used for data analysis is provided. Finally, we discuss our findings and the implications of these for both research and practice.

LITERATURE REVIEW

Corporate Strategy and Shareholder Value

Corporate strategy can influence the performance of an organization (Mintzberg, Lampel, Quinn, & Ghoshal, 2003). With a sound corporate strategy, a firm can consistently create high value through its integrated business activities; with a weak corporate strategy, the value of a firm's business activities deteriorates (Goold, Campbell, & Alexander, 1994). Thus, shareholders see corporate strategy as an important proxy for the likely value of the firm (Day & Fahey, 1990).

Corporate strategy provides a navigation map to the investors and analysts (Desai, 2000). The effective communication of corporate strategy is important because it builds relationships with and encourages the involvement of investors and analysts (Bukh et al., 2002; Desai, 2000). Effective communication of corporate strategy can also enhance shareholder satisfaction (Higgins & Bannister, 1992) and build employee morale (Burgi & Roos, 2003). Credible communication further enables managers within the firm to crystallize and clearly articulate corporate strategy to employees and investors alike. This, in turn, helps managers reinforce or redevelop strategic choices (Burgi & Roos, 2003) and increases the confidence stakeholders place upon the strategic ability of management (Mintzberg et al., 2003).

Although those within the firm endeavor to better communicate corporate strategy, evidence suggests that shareholders also seek to better understand the strategic posture of the firm (Day & Fahey, 1990; Rapport, 1981). Possible explanations for this phenomenon are as follows: (a) The environment in which many firms operate is ever more dynamic and competitive (Brown, 1997; Lynch, 2000; Mintzberg et al., 2003; Rapport, 1981); or (b) traditional financial measures are no longer comprehensive indicators of internal management capabilities (Beattie, 1999; Eccles, Hertz, Keegan, & Philips, 2001). This second point is especially relevant with IPO firms, which often lack financial history; furthermore, any history might be distorted by a long R&D stage and negative profit (Cumby & Conrod, 2001).

Corporate Strategy as an IPO Market Signal