The Jumpstart Our Business Startups (JOBS) Act, enacted in April 2012, was designed to make it cheaper for emerging growth companies (EGCs) to access capital and, by weakening disclosure requirements, easier for them to conduct initial public offerings (IPOs). Its impact on EGCs has been a focus of academic literature in accounting and finance, with Chaplinsky et al. (2017) showing that the act increases indirect costs for some EGC IPOs because of increased information asymmetry between the firm and potential shareholders. The upshot is that small private firms may prefer to be directly acquired rather than engage in an IPO.
In a new paper, we identify the benefits and costs to targets and acquirers of the JOBS Act and the introduction of weaker IPO disclosure requirements for EGC private targets. The JOBS Act aims to reduce direct costs of going public by lowering the required disclosure standards for private EGCs, and this, in turn, improves the exit options for EGC private targets – especially if the reduction in direct costs is more than the increase (if any) in the indirect costs of going public. These benefits to an EGC private target enhance its relative bargaining position during the M&A negotiation process, thereby lowering potential gains for acquirers and increasing returns for private targets.
We find a positive spillover effect on the valuations (measured as deal value by sales) of EGC private targets after the act, and this limits the wealth gains (three-day cumulative abnormal returns (CAR)) of acquirers. It also demonstrates an indirect and significant impact of a regulation aimed at IPOs on M&A activity. We show that the alternative exit strategies became more attractive after the JOBS act for EGC private firms. The spillover effect on M&A activity and valuations perhaps muted the overall objective of the JOBS act to increase the EGC IPO activity.
All our results are robust after controlling for industry characteristics, market timing, demand for funds, mode of payment, and whether the merger or acquisition is a leveraged buyout (LBO) or strategic acquisition. We also find that after the JOBS Act, firm valuations for venture capitalist (VC)-backed private EGC targets increase more than for private EGC targets with no VC backing. Additionally, the JOBS Act affects the mode of payment in M&A deals. The number of stock deals (cash deals) for private EGC targets decreased (increased) after the JOBS Act.
To check the robustness of our results, we use falsification tests, employing international deals as a placebo test and shifting the JOBS Act passage year to 2005. Because the JOBS Act only applies to private EGCs that go public in the United States, it should not affect exit decisions and outcomes for international EGC targets. Thus, we should see no change in valuations for global M&A targets. We find results consistent with the argument that the JOBS Act does not affect international target valuations and related acquirer CARs.
To analyze the relative impact of bargaining power and self-selection, we perform a matching analysis. Based on observed characteristics of EGC private targets, we match the relevant counterparts from the IPO sample both before and after the JOBS Act. We observe that the relative valuation premium, measured as the ratio of deal value over sales to IPO proceeds over sales, is higher in a matched sample in the post-JOBS Act period even after controlling for the cost of exit decision (IPO or M&A), and this further strengthens our hypotheses. In addition, we conduct a battery of other robustness checks.
A related explanation of this increase in valuation involves the change in the quality of the IPOs post JOBS act. As documented by Agarwal et al. (2017) and Chaplinsky et al. (2017), the JOBS Act led to an increase in underpricing of EGC IPOs and hence increased the indirect costs of going public. High quality EGC private targets may choose to take the alternate exit route of doing a merger or acquisition to avoid this increased indirect cost. The managers of the acquirer, through its due diligence and experience, may value the target more accurately and , therefore, offer a higher value for the EGC private targets leading to a higher valuation.
In a related paper, Ewens and Farre-Mensa (2019) documented that the National Securities Markets Improvement Act (NSMIA) of 1996 had increased the supply of private capital, prompting firms to stay private longer. While their paper highlights the impact of private capital on possible delays in the going public decision of private firms, our article focuses on the effects of the change in laws that made doing an IPO easier for private firms ((JOBS act, 2012) in the takeover market.
Overall, our research shows the spillover of IPO-related regulation in the M&A market. The JOBS Act leads to higher valuation in the M&A market, and this negatively affects acquirer’s shareholder wealth. These findings are more prominent for VC backed targets. We also find that, after the act, the number of stock deals (cash deals) for private EGC targets decreases (increases) after the JOBS Act.
This post comes to us from Jitendra Aswani, Sudip Gupta, and Iftekhar Hasan at Fordham University and Anthony Saunders at New York University’s Stern School of Business. It is based on their recent paper, “The Impact of JOBS Act on M&As,” available here.