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

The following examples show the difference between consistent communication and inconsistent communication on the administrative dimension. A consistent communication highlights the high percentage of R&D staff, and the R&D or marketing background of the CEO and the focus of top management on R&D and marketing. For example,

As of June 30, 2000, we had 128 full-time employees, 98 of whom

comprise the research staff and are engaged in research,

development, and scale-up activities.

Our top management team members are mainly from R&D, marketing, and

business development sectors.

Our president, chief executive officer, and a member of our board

of directors, Dr.... joined us in January 1997.... During his 10

years at ... he was responsible for business development, sales,

and marketing functions.

By contrast, inconsistent communication on the same dimension may indicate the low percentage of R&D staff, the engineering background of the CEO, and the focus of the top management on operations and financial management. Specific examples are as follows:

As of December 31, 2000, we employed approximately 247 persons, of

whom ... approximately 43 employees are engaged in research and

development, 21 in business development, sales, and marketing, 162

in operations and manufacturing, and 21 in intellectual property,

finance, and other administrative functions.

... has served as our president, chief executive officer, and a

director since October 1999. Prior to joining us, Mr.... was vice

president of engineering.

Our top management team is composed of the president, chief

financial officer, and chief operating officer.

The above sets of examples show how we interpreted signal clarity and signal consistency* These have some practical implications for the IPO communication of strategic management* The IPO firms should place importance on the clear, multiple, and consistent strategy signals through all three dimensions: (a) product/market dimension, (b) technological dimension, and (c) administrative dimension* These three dimensions establish the credibility of the strategy communication in the IPO process and reduce the confusion among the investors and analysts toward the strategy and potential value of the firm.

Table 2 provides the results for the content analysis. Line 1 shows that 60% of IPO cases clearly identified their overall strategic objectives. More specifically, 49% of IPO firms communicated a prospector strategy, whereas none of them clearly claimed an analyzer or defender strategy* Another 11% communicated a mixed strategy* Prospector signals dominated all three dimensions. This result appeared consistent with the characteristics of the biotechnology industry in which prospectors dominate (Weisenfeld-Schenk, 1994).

Table 2 also shows that the most common index signals were risk taking (100% of the IPO firms), recruitment of the CEO (100%), success posture (96%), product innovation (95%), and product/market breadth (93%). It is interesting that 57% of firms described an analyzer success posture, whereas only 26% described a prospector posture and 13% a defender posture. In addition, 46% of firms indicated their technology focus as a defender, whereas 42% indicated an analyzer management structure. This analysis clearly demonstrates that an IPO prospectus contains multiple signals to communicate strategy.

However, only 49% of firms clearly articulated an overall prospector strategy from their statement of "strategic objective*" This finding reveals that a significant portion of IPO biotechnology firms were not deliberately labeling themselves as "prospector," even though they are in a prospector-dominated industry (Weisenfeld-Schenk, 1994). This reluctance to identify prospector intentions may be due to an awareness of the signaling costs--that is, a fear that the firm will be devalued by investors or analysts (Higgins & Diffenbach, 1989) if a credible strategy and strategic fit are not demonstrated (Doty et al., 1993; Miles & Snow, 1978).

Phase 2 of the research used regression analysis and examined the effect of corporate strategy communication on the initial returns at the 1st day and 30 days after an IPO event. After examining the value of [IR.sub.1] and [IR.sub.30], this study selected only companies with positive initial returns for the regression analysis (i.e., underpricing as opposed to overpricing because of the focus of this research). As a result, the research included 49 cases for [IR.sub.1] analysis and 40 cases for [IR.sub.30] analysis. The authors are aware that a relatively small number of observations in the above regression analysis is usually discouraged but note that Type II error was constrained and estimated and also note that the data represented a census of underpriced biotechnology IPOs within this stock market over this study period.

The F statistic for [IR.sub.1], model (3) above, at 0.41, was not significant at the .05 level (with an associated p value of .80). There was no support in this study for significant relationships to exist between any of the predictor variables (i.e., the clarity, intensity, and consistency of strategic signals), represented in a parsimonious and noncollinear way by their principal components, and [IR.sub.1]. Thus, there was no evidence to support Hypotheses la through 1c, and so this research cannot conclude that effective communication of corporate strategy signal plays a role in reducing information asymmetry at the 1st day of an IPO event and therefore reducing underpricing.

Model F statistics for [IR.sub.30], Models (4), at 0.16 (p value = .97), and (5), at 4.25 (p value = .02), show support for the statement that the consistency of defender and prospector signals significantly impacts the 30-day initial returns, with an [R.sup.2] statistic of 0.18 (see Table 3). Clarity and intensity of strategic signals impacts on [IR.sub.30] were not supported. Hypotheses 2a and 2b are therefore rejected. In addition, no support for the prediction by any control variables of firm size, firm age, the presence of a venture capital, and the reputation of the underwriter was found in this study for the 30-day underpricing response, [IR.sub.30]. Subsequent Type II error analysis indicates that the overall Type II error of the sequential inferences reported from the F statistics of Models (3), (4), and (5) and the t statistics for the prospector and defender consistency signals in Table 3 was limited to less than 0.44 at the .05 significance level for the F and t tests, based on 200 random resamples.

Note that, in this study, due to the need for model specification parsimony to control for Type II errors, the significance of control variables on the 1-day underpricing response, [IR.sub.1], was not explored, as their exclusion from Model (3) above does not contribute to model misspecification bias if none of the effects of interest are significant, as was the case in this study.

It is interesting that Table 3 shows that a consistent signal of a prospector strategy had a negative impact on the 30-day initial returns and this result supported Hypothesis 2c, whereas consistent signals for a defender strategy had a positive impact on the 30-day returns, and so we partially rejected Hypothesis 2c. One possible explanation is that biotechnology firms are expected to be prospectors (Weisenfeld-Schenk, 1994). Therefore, the consistent communication of prospector intentions successfully reduces the knowledge gap about the IPO firm between informed investors and uninformed investors. However, because biotechnology firms are expected to be prospectors, the consistent communication of defender intentions will increase the value differences between informed and uninformed investors.

Summarizing the above results, Hypotheses la through 1c were rejected in this study. The failure to identify the relationships between strategy-based signals and the 1st-day initial returns may be attributed to (a) faddish behaviors of the 1st-day investors who may pay less attention to the strategic information, and (b) strategic information needs time to be well distributed and digested. Further on, this study did not find support for Hypothesis 2a and 2b but partially supported Hypothesis 2c. This study demonstrates that if a firm consistently communicates its strategy type from its IPO documentation, the initial returns in the short term (e.g., 30 days) after-IPO market will be affected. In the biotechnology industry, consistent communication of prospector signals reduces the knowledge gap between informed investors and uninformed investors in the 30-day after-IPO market; however, consistent communication of defender signals enhances the expectation differences among investors. The main reason for this difference can be attributed to IPO firms favoring prospector intentions.