Special purposes acquisition corporations (also known as SPACs or blank check companies) have received a lot of attention recently – and for good reason. SPACs accounted for more than half of U.S. IPOs in 2020, raising over $70 billion in total and over $300 million each on average, with their numbers increasing over 300 percent since 2019 (Goldman Sachs, 2020). Further, there were more SPAC IPOs in the first quarter of 2021 than in all of 2020.
SPACs raise capital through an IPO with the same filing and disclosure obligations as any other firm, however, they have no operations and virtually no assets or liabilities. The funds raised in the IPO are put in a trust after which the entity has a set time to identify a private target and complete a merger or acquisition. If a successful acquisition occurs, the combined public company continues the target’s operations. If there is no transaction, the money in the trust is returned to investors. Acquisition by a SPAC presents clear benefits to the acquired company in the form of access to public markets without the burdens or uncertainty of a traditional IPO.
It is less clear, however, why investors would choose to invest in SPACs or how they choose among different SPACs. Coupled with the extreme uncertainty and lack of operational history, prior studies have found that SPACs underperform other investments such as traditional IPOs. Our new study addresses this question, examining the roles of disclosure and manager reputation in raising capital by studying SPACs, where the information underlying the disclosure is minimal and the firm lacks an operational history.
The vast literature evaluating the role of disclosure in raising capital generally relies on extensive underlying information. For a traditional IPO, there are audited financial statements, assets and liabilities, and non-financial information. Like traditional firms, SPACs are required to file a prospectus (S-1) with the SEC prior to an IPO. For traditional firms, the prospectus can reduce information asymmetry between managers and investors by shedding light on the firm’s prior performance and assets and obligations. However, for a SPAC, there is substantially less information available – and sometimes for good reason. If the SPAC disclosed its potential acquisition targets, for example, other companies might step in and bid up the prices. What’s more, the SPAC’s claims about its superior ability to manage the acquired company might lack credibility because the SPAC has no relevant history. These issues make it unclear how much investors would value SPAC disclosures.
In place of, or to supplement, disclosures and to make up for the lack of operational history, investors may consider the reputation of the sponsors, including the managers, directors, and advisers, in assessing the likelihood a SPAC will execute a profitable acquisition. Some sponsors have extensive business reputations (e.g., former CEOs, individuals with prior SPAC experience, or private equity investors) who may provide experience relevant to a successful acquisition. Other sponsors are celebrities with extensive public followings (e.g., athletes, musicians, and politicians). The SEC has expressed concern that celebrity involvement may be attracting investment by unsophisticated investors who do not fully understand the risks associated with SPACs. It is not clear which type of reputation investors might consider most valuable when allocating their capital.
We examine SPACs that had IPOs in 2019-2021 with sufficient data to measure our key variables. To examine the role of disclosure in the IPO, we calculate text-based measures for the entire prospectus and from specific subsections. Our measures of sponsor reputation capture whether the management team has SPAC, private equity or venture capital, or CEO experience, as well as whether a celebrity (measured by number of Twitter followers) is sponsoring the SPAC.
When evaluating the overall prospectus, we find that disclosure and sponsor characteristics are associated with trust value. More forward-looking and widespread language and less negative and uncertain language are associated with more funds raised. These findings are consistent with disclosure having significant influence on the amount of capital raised in a SPAC IPO. Having a celebrity, former CEO, or sponsor with SPAC experience is also positively associated with amount of capital raised, consistent with the importance of reputation to investors when information asymmetry is high and the firm going public has no track record. This is also consistent with the SEC’s concerns that investors may be overly influenced by celebrity affiliations. Given the length of the S-1, we consider specific subsections that are likely relevant to investors. Perhaps not surprisingly, our findings from the subsection analyses suggest investors have varying expectations from, or interpretations of, the Risk Factor and Proposed Business sections of the prospectus.
Finally, we provide some initial evidence of a trade-off between disclosure and reputation in the presence of extreme uncertainty. When SPACs have a manager with relevant (i.e., prior SPAC) experience, investors appear to rely more on the disclosure and are less dissuaded by litigious and uncertain language. However, we do not find similar results when sponsors have less relevant experience (e.g., celebrity). This is consistent with manager reputation having significant influence on how investors use disclosures.
Our study has implications for our understanding of disclosure in capital markets. First, even unverifiable or less informative disclosure can be useful to investors. Second, how disclosure is used by investors can be influenced by the characteristics or reputation of management. In addition, our results suggest managers’ reputations are associated with their ability to raise capital, even when (and in some cases, especially when) there is very little information available about the related project. Finally, our findings speak to recent regulatory concerns about SPACs, especially concerns about potentially misaligned incentives and the role of celebrity sponsors.
This post comes to us from professors Andrea Pawliczek at the University of Colorado at Boulder, A. Nicole Skinner at the University of Georgia, and Sarah Zechman at the University of Colorado at Boulder. It is based on their recent paper, “Signing blank checks: The roles of reputation and disclosure in the face of limited information,” available here.