Initial public offerings (IPOs) and direct listings (DLs) offer two different mechanisms for a firm to obtain a listing in the public capital markets. Historically, DLs have been rare in the U.S., but that has changed in recent years, starting with Spotify’s listing through a DL in 2018. Since then the number of DLs in the U.S. has increased rapidly. There are two key differences between IPOs and DLs: (1) IPO firms raise fresh capital, whereas traditionally, DLs have not, and (2) DLs do not employ an underwriter.
The listing process for a DL is quite simple: The firm’s outstanding shares are simply listed on a stock exchange without a primary or secondary offering to raise fresh capital. The firm’s existing shareholders are then free to sell their shares in the public market. Prior to listing, the DL firm hires an investment bank to counsel the firm on filing its registration statement with the Securities and Exchange Commission (SEC) and preparing presentations to investors. Because DLs do not employ an underwriter, they are much cheaper than IPOs.
The rising prevalence of DLs in the U.S. capital markets is driven, in part, by the growth in size and sophistication of the private capital markets over the last 20 years. Increasingly, new firms can raise much larger sums of capital in the private capital markets with the result that private firms can delay going public, and when they do eventually go public, they do not need to raise new equity capital to fund their investment plans. For such firms, DLs provide an attractive and much cheaper means of going public.
However, regulators, including some SEC commissioners (see Lee and Crenshaw 2020) have expressed concerns that, because they lack an underwriter, DLs might expose investors to more risk than similar IPOs do. This is because underwriters engage in a number of services in both the pre- (due diligence, book building, hosting roadshows) and post-listing (lockup periods, price stabilization, i.e., Greenshoe option) periods that aid price discovery and, thus, ensure an orderly listing process. Absent an underwriter performing these services, in a DL, investor uncertainty has to be resolved via the price discovery process in the immediate post-listing process. Hence, we might expect to see that DLs have higher price volatility than IPOs in the immediate post-listing period. While some regulators have mentioned this possibility, to date, there has been no empirical evidence that examines it.
Because DLs have historically been quite rare in the U.S., for this study we use a sample of 362 IPOs and 69 DLs on the EU-regulated markets of the three largest stock exchanges in Europe, i.e., the London, Frankfurt, and Euronext stock exchanges, from 2008 to 2019. For our sample period, all three of these markets were subject to the same regulatory framework, i.e., the EU’s Prospective Directive regime, which mandates minimum prospectus disclosures for all firms admitted to trading on EU-regulated markets and the enforcement of these disclosure requirements. We undertake a comparison of IPOs and DLs on these three markets and examine two research questions. First, whether there are differences in the types of firms that list via DLs and IPOs. Second, whether DLs are riskier, i.e., have higher price volatility, than IPOs in the immediate post-listing period, and, if so, how long any such excess volatility lasts.
The first significant finding is that, on average, DL firms are significantly larger, more profitable, and less leveraged than IPO firms – all of which suggest that, on average, DL firms are less risky than IPO firms. Our second significant finding is that, when we compare the post-listing price volatility of DLs with similar IPOs, consistent with some regulators’ suspicions, we find that DLs are riskier than IPOs in the immediate post-listing period: DLs have higher price volatility than similar IPOs in the immediate post-listing period. However, we find that this excess price volatility dissipates rather quickly: On average, it lasts for only 20 trading days. We also find that, in industries with a richer “industry information environment” – i.e., where the existing listed firms in that industry already provide relatively high-quality public disclosures – there is no difference in post-listing price volatility across DLs and IPOs.
Our study provides a number of new insights regarding DLs that may be of interest to managers of firms seeking a public listing, investors, and regulators such as the SEC. First, we provide the first empirical evidence confirming that the types of firms that list via DLs are larger and more mature than IPO firms, on average. Second, our analysis confirms the suspicion of some regulators that, because of the absence of an underwriter, DLs are riskier, i.e., have higher price volatility, than similar IPOs in the immediate post-listing period. However, while our results confirm this suspicion (providing evidence that underwriters’ services in the pre-listing period do indeed serve to ensure an orderly listing process), our results also show that this excess price volatility is quite short-lived, i.e., it last for approximately 20 trading days, on average. Our analysis also identifies settings where DL firms are less likely to experience excess price volatility in the immediate post-listing period and point to strategies managers of DL firms can take to mitigate the potential for heightened post-listing price volatility.
 Lee, A., and C. Crenshaw (2020). Statement on Primary Direct Listings. Securities and Exchange Commission. https://www.sec.gov/news/public-statement/lee-crenshaw-listings-2020-12-23
This post comes to us from Anna Bergman Brown at Clarkson University, Donal Byard at Baruch College – City University of New York (CUNY), and Jangwon Suh at Queens College – CUNY. It is based on their article, “A Comparison of Direct Listings and Initial Public Offerings,” forthcoming in Contemporary Accounting Research and available here.