What a Popular Hollywood Film Tells Us About the Symbiotic Link Between IPO Performance and Corporate Governance

By March 8, 2019 April 3rd, 2019 General
The wolf of wall street

Let’s take a trip down memory lane to the year 2013, when Hollywood released infamous film The Wolf of Wall Street.

Those who caught the movie would easily recall the questionable and audacious manner in which Jordan Belfort “conned” and separated everyday individuals from their hard-earned money.

Not as many, however, might remember Steve Madden’s cameo at the time Stratten Oakmont (Belfort’s company) took his female shoes firm public.

His character may have played a bit-part role in the film. But in reality, it was far from minor.

The severity of Madden’s involvement in Belfort’s ponzi operations came to full light when, in June 2000, US federal authorities arrested him on several counts of securities fraud and money laundering.

Prosecutors then alleged that in 22 IPO deals underwritten by two of Belfort’s companies between 1991 and 1997, Madden bought stocks at a predetermined price and sold them back at an agreed rate to artificially inflate their market value.

In return, he received a cut of the profits for services rendered as a “flipper”.

Madden had also deployed similar tactics to manipulate his own company’s share performance after it went public (Ticker: SHOO) in December 1993.

That SHOO’s stock ended up plunging nearly 15 percent the same day news of his arrest broke – nearly seven years after the IPO – shouldn’t have come as a shock.

Knee-Jerk Reactions

Shady practices, like those mentioned above, tend to draw the ire of shareholders as soon as they surface, resulting in sell-offs that send stock prices into a tailspin.

Even so, not all “shady” IPOs take years to unravel like SHOO’s.

Often the consequences of such illicit actions – should they be made known – are priced into stocks by the market within days, weeks, or at the longest, within months of going public.

Case Study: The Proof Is in the Data

In January this year, boutique research outfit Aequitas Research published a report on Smartkarma about IPO performance trends and their contributing factors based on deals analysed since 2015.

Part of the independent study aimed to showcase the positive correlation between good corporate governance and alpha generation – and that it did.

Aequitas filtered 209 past deals through 10 different parameters, which included related-party transactions, dividend/cash pull-outs before listing, partial asset listings, and legal disputes, among others.

True to their initial assumptions, the 55 percent of deals that scored positively for corporate governance outperformed those with a negative score across three time frames – on average.

Corporate Governance score impact on IPO price performance

“Deals with a positive score returned 7.4 percent on the first day, 6 percent by the end of the first month, and 8 percent by the end of three months,” wrote Sumeet Singh, Head of Research at Aequitas.

“In contrast, returns for the deals with a negative score were 1.4 percent, -0.4 percent, and 1.9 percent, respectively.”

The landmark revelation here, however, is not so much in proving how the presence of strong corporate governance drives relatively stronger post-listing returns.

While true, the bigger, underlying point is that, absent objectivity, such revelations might not even see the light of day.

Nowhere is this invaluable quality more entrenched than in the realm of independent investment research.

Why Research Independence Matters

Several characteristics underpin the strengths of independent research, but these three are most relevant in the context of Aequitas’s study:

  1. No Conflicts of Interest – Unlike analysts that work for the sell-side, their independent counterparts are not constrained by the high-value relationships a bank must preserve.
  2. Trust – For the buy-side, placing wagers in the millions (or billions) is no game. As such, asset managers frequently demand transparency and accuracy in the research they consume and on which they act. Unbiased reports produced by independent analysts provide this reassurance. 
  3. Transparency – Similar to how the free press serves as the watchdogs of society, independent analysts function as the gatekeepers of corporate governance for the companies they cover.

Karma (Always) Has the Final Word

So, what’s the key takeaway?

At the crux, companies with weak corporate governance set themselves up for relative IPO underperformance.

And for those, like Steve Madden, that get away initially, karma eventually finds its way over, no matter the time frame.

Now how’s this for an ironic conclusion: Money stolen from embattled Malaysian state fund, 1MDB, actually helped fund the production of The Wolf of Wall Street.

Subscribe to Our Blog