In 2021, 359 SPACs have raised $95 billion, surpassing the $74 billion raised by 254 SPACs in 2020. The growth in this market might mean that sophisticated investors are using a regulatory loophole to avoid IPO disclosure regulations in taking firms public and hyping their shares. It could also mean that IPO disclosure regulations are preventing small companies with scant performance history from raising money in public markets. Either way, it’s time to reconsider disclosure regulations related to IPO. With that in mind, we examine the extent of forecasting by SPACs and its relation to transaction outcomes.
SPACs are blank check companies that raise capital in the public market (i.e., the SPAC IPO). They then search for a private target and announce the planned acquisition. Three to five months after the announcement, the SPAC holds a shareholder vote and, in effect, takes the acquired firm public, marking the start of the “deSPAC” period. Shareholders have the option to redeem the pre-merger shares before the merger announcement. Because the acquisition of the private company and the deSPAC transaction are generally considered a merger rather than an IPO transaction, Section 10 of the 1934 Exchange Act and the PSLRA safe harbor for forward-looking statements govern disclosure liability for the deSPAC transaction. In contrast, traditional IPOs represent securities offerings, which are subject to the Securities Act (1933) Section 12(a) (2), which limits a firm’s communication during the quiet period, also called gun-jumping rules.
Using SPACs that announced a merger transaction over 2015-2020, we find investor presentations have the most detailed and comprehensive set of forward-looking information relevant to the future performance of the merged firm. The press release announcing the merger target is often filed simultaneously with the investor presentation and typically provides a less detailed summary of the information contained in the investor presentation. The presentation format is idiosyncratic, with custom graphs, charts, and other images that would render any attempt to infer forward-looking information highly imprecise. Therefore, we read each investor presentation and categorize into three dimensions the various aspects of the information contained in it. The first dimension is disclosure sentiment, which is often useed to gauge management exuberance (Lee, Jiang, Martin, and Zhou 2018). The second dimension is the breadth of forward-looking information, which looks at, for example, whether the SPAC investor presentation contained forecasts of revenue, net income, EBITDA, profit margin, or capital expenditures. The third dimension is the intensity of forward-looking information, which looks at, for example, whether firms provide a pro forma valuation of the combined firm using a forecast and, if so, the number of years for which the forecast is provided.
We find that, unlike in traditional IPOs, SPAC firms that go public frequently provide forward-looking information (e.g., earnings forecasts). Out of 236 SPACs that provided investor presentations around merger announcements, 220 issued a future performance forecast. Importantly, we find that forward-looking disclosure in SPAC merger announcements, on average, do not mislead small investors. Disclosures containing forecasts are associated with positive returns at the announcement, and they are not associated with subsequent return reversals or redemption rates. Furthermore, a higher number of forecasts relates positively to subsequent return drift, lower redemption rates and bid-ask spreads, and less (more) retail (institutional) buying. Lastly, we find no correlation between outcomes and disclosure tone, suggesting that hype, if present, does not sway investors.
Our study does not support the concern that SPAC firms take advantage of their apparent exemption from liability under the 1933 Act to hype forward-looking disclosure to deceive shareholders. Our findings highlight the possibility that regulation prohibiting forward-looking disclosure in traditional IPOs can inhibit price discovery,capital formation, and thus innovation.
This post comes to us from professors Kimball Chapman, Richard M. Frankel, and Xiumin Martin at Washington University in Saint Louis’ Olin School of Business. It is based on their recent article, “SPACs and Forward-Looking Disclosure: Hype or Information?” available here.