On April 3, 2018, the Swedish online music company Spotify Technology disrupted the traditional initial public offering (IPO) marketplace when it directly listed its shares on the New York Stock Exchange (NYSE) under the ticker symbol “SPOT.” With a valuation of $26.5 billion at the end of the first day of trading, it was one of the largest technology listings for the NYSE since Facebook.  While seemingly just another tech venture IPO, this offering represented a watershed event.
The common motivations for firms listing on public stock exchanges such as the NASDAQ or the NYSE are to raise large amounts of capital, provide liquidity for their investors, and increase their visibility. As described previously on the CLS Blue Sky Blog,  to list its shares on a public market, an issuing firm usually hires an investment bank that acts as an underwriter. For a sizeable fee, the investment bank agrees to buy the shares of the firm and sell them to investors during the IPO.
What makes the Spotify listing unusual is that it did not hire an underwriter, create any new shares, or seek to raise any capital whatsoever from the transaction. Instead, the company simply listed its existing private float directly on the exchange. The so-called “direct listing” presented the opportunity for Spotify to save millions of dollars in underwriter fees (and possibly substantially more in underpricing) while also providing liquidity for its existing shareholders and increasing the prestige and reputation of the company.
This strategy provides a roadmap for other highly valuable startups such as Airbnb and Uber Technologies seeking to avoid using Wall Street investment banks.  Yet some fear that it opens the door for companies with risky financial and governance profiles to enter the public markets without the proper investor protections or underwriter certification by reputable investment banks. While the Spotify IPO represents one of the first direct listings of an industrial firm to the NYSE, there is another market where a similar practice already takes place: the public listings of non-listed Real Estate Investment Trusts (REITs).
Public non-listed REITs (commonly known as PNLRs) sell shares to public investors, but there generally is no active secondary market for the stock.  Hence, like those holding Spotify’s shares before their offering, PNLR shareholders have little liquidity. As with untested tech startups, scholarly work has shown that these are relatively risky ventures. PNLRs are poorly governed and tend to take advantage of unsophisticated retail investors.  However, some of these PNLRs choose to transition to public exchanges in a fashion similar to the Spotify transaction where they do not issue any new shares or engage an underwriter.
In our recent paper, we study the impact that public listings have on corporate governance by examining 504 observations of 123 unique PNLRs from 2002 to 2015. We pay particular attention to the 22 PNLRs that elect to list on a formal exchange during this sample period, a subsample we term “transitioning REITs.” We note that traditional exchange listings are accompanied by the firm’s initial public offering, whereby the company simultaneously lists its stock on the exchange and, for the first time, offers it for sale to the public. Thus, the effect of a public listing is confounded by the firm’s desire to raise capital. It is therefore unclear whether any changes in governance are attributable to the market’s demands for listed firm governance, the exchange listing itself, or both. Furthermore, a non-public industrial company’s governance is typically unobservable prior to listing, simply because the firm is not subject to the Securities and Exchange Commission (SEC) requirements for disclosure until the company elects to go public and files its prospectus.
In our unique sample firms, the PNLRs sell shares to investors without listing. However, unlike non-public industrial companies, regulatory filings for PNLRs are available prior to listing, making governance observable. This is true whether the companies intend to list on a formal exchange or not, because they are registered with the SEC. This allows us to compare characteristics of the PNLRs years prior to listing with those after the listing. It also allows us to examine the difference between firms that elect to list and those that elect to stay non-listed. In any other settings, this type of comparison would not be possible.
We first document the influence public market participants may have on various corporate governance mechanisms such as board structure, compensation, and institutional ownership. We find that following their listing, transitioning REITs modify their board structure by adding independent members to their boards of directors, creating independent nominating and compensation committees, and becoming professionally managed. Director and CEO compensation roughly triples following the listing, with most of this increase coming in the form of equity-based pay. Perhaps the most significant evolution following listing is the increased presence of institutional holders. In our sample, PNLRs do not exhibit substantial institutional ownership prior to listing, but institutions own an average of 25 percent of the shares three years after listing. These changes all suggest better governance following listing.
Additionally, we explore the signaling value of exchange listing. Most of the limited literature on PNLRs has given reason to question whether they are even viable investments.  Given the nature of the public perception of their market, higher quality PNLRs suffer from the poor reputation of this investment type given that it is very hard to identify good firms from bad firms. Indeed, they are pooled together with a large number of peer firms that choose to act opportunistically, and higher quality PNLRs thus have little way to distinguish themselves as legitimate enterprises.
We show that the listing process presents the opportunity for the higher quality PNLRs to distinguish themselves from their lower quality counterparts. Public exchanges have listing requirements that impose constraints on the corporate governance of the firms wishing to trade their shares on the exchange. The lower quality PNLRs may not wish to conform to these guidelines, because the reductions in entrenchment and improved shareholder monitoring would make it more difficult to expropriate unsophisticated investors. Thus, the listing requirements represent a costly signal that is difficult to imitate for lower quality firms.
Our results suggest that listing distinguishes the good from the bad. That is, firm quality is higher and the corporate governance shortcomings associated with PNLRs are less prominent among those transitioning to listed status. For example, 30.5 percent of transitioning REITs are compliant with exchange listing standards prior to listing, whereas only 13.4 percent of firms that do not transition are compliant. Transitioning REITs are larger, younger, more profitable, and pay higher dividends. We also find that they are more likely to be professionally managed rather than founder managed.
Overall our evidence suggests that listing is a signaling mechanism for REITs and that the quality of corporate governance improves following a listing. By extension, this research also illuminates the possible benefits for private firms like Spotify.
Our paper provides a meaningful contribution to our understanding of the value of public exchanges as a force for improving corporate governance. Although research exists on cross-listings of foreign firms, such evidence is confounded by the effects of differing legal origins, economic systems, etc. Scant attention has been given to the changes in governance of domestic firms around listings. By analyzing the motivations and governance consequences for the transitioning REITs, we hope to illuminate discussion about the prospects for industrial firms that intend to conduct direct listings like Spotify.
 Farrell, Maureen and Chelsey Dulaney. “Spotify’s Trading Slump Raises Questions About Listing Process.” The Wall Street Journal, April 4, 2018.
 Coffee Jr., John C. “The Spotify Listing: Can an “Underwriter-less” IPO Attract Other Unicorns?” The CLS Blue Sky Blog, January 16, 2018.
 Farrell, Maureen. “Spotify Disrupted the Music World, Now It’s Doing the Same to Wall Street.” The Wall Street Journal, January 15, 2018.
 Wiley, J., 2017, “Dividend Manipulation at Unlisted REITs,” Real Estate Economics 5, 1-49.
 Corgel, J.B., S. Gibson, 2008, “Real estate private equity: The case of U.S. unlisted REITs,” Journal of Property Investment and Finance 26, 132–150.
This post comes to us from professors Dan W. French, Andrew E. Kern, and Adam S. Yore at the University of Missouri, and Thibaut G. Morillon, who is a PhD candidate at the university. It is based on their recent paper, “The Impact of Exchange Listing on Corporate Governance: Evidence from Direct Listings,” available here.