FirstPreviousNextLast

Initial Public Offerings: Status, Flaws and Dysfunctions

Introduction

Access to public financing is a key factor in the development and growth of businesses. This stage enables a business to benefit from a permanent source of capital to finance its expansion. Moreover, by eliminating the risk associated with its securities' lack of liquidity, a business that takes advantage of this type of financing reduces its equity costs. This is especially important in a knowledge economy where the intangible nature of major assets limits the use of debt financing. The development of a method of exit for venture capital investors and a dynamic stock market are other arguments favouring the stimulation of primary issues. As Riding (1998) emphasizes, an efficient IPO mechanism offers the prospect of a profitable exit for early-stage investors and therefore encourages risk taking. The primary issues market is thus essential for businesses mature enough to make use of it, but also for more junior ones because it helps to improve early-stage financing conditions. Over the past two decades, various initiatives have been launched by governments and self-regulating agencies to promote public financing for new businesses in Canada. The Quebec Stock Saving Plan, stimulation of the venture capital supply, the gradual relaxing of minimum standards for stock market listings and the Capital Pool Companies^{Footnote 1} program all flow from this desire to facilitate the public financing of growth businesses.

Despite the importance of this type of financing for businesses and the efforts made to develop it, there are very few recent studies on the various forms of access to public financing in Canada, and what research there is, is limited to share offerings followed by listings on the Toronto Stock Exchange. This makes it difficult to gauge the outcomes of the various initiatives and redirect public policy in this area. To partly fill this gap, this study offers a complete picture of primary issues in Canada by operating companies and CPCs from 1991 to 2000, based on the identification and analysis of 1,891 share issues. The short- and medium-term behaviour of the securities and the issuing costs are evaluated for traditional issues. We draw a comparison with the activity in this area in the US and attempt to establish the connection between venture capital and primary issues. This work is consistent with the priorities of the federal government, which feels it should have "more and better statistics on and analysis of small and medium-sized business financing to provide a better understanding of their needs"^{Footnote 2} and thus better develop the Canadian financial system.

The main thrusts, which are covered in separate parts of the study, are as follows.

Part I comprises an overview, followed by a breakdown of the topic, along with a comparative analysis of Canadian and US issues, mainly in the technology sector, and observations about measurement and tracking problems.

Part 2 looks at direct and indirect issuing costs, including initial underpricing. Here again, comparative data are presented.

Part 3 contains a medium-term analysis of the performance of issues.

Finally, in Part 4, we get into the implications of our observations in terms of government action and market regulation, as the study reveals major dysfunctions in the primary issues market for small businesses, especially in the technology sector. Share offerings under CPC programs are listed and briefly discussed, although we stop short of an in-depth analysis, as these issues are part of a very special world that is particularly hard to analyze given the lack of reliable data.

^{Footnote 1} Created initially as "junior capital pools," these firms became "venture capital pools" and then "capital pool companies" when the program was approved by the CDNX and are now authorized in Quebec as "sociétés de capital de démarrage" (SCDs). We use the abbr CPC to identify them, although the regulations governing successive versions of this program have changed with time and jurisdictions.

^{Footnote 2} Finance Canada: Reforming Canada's Financial Services Sector – A Framework for the Future, 2001.

FirstPreviousNextLast