Conclusions

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4.2.4 The Problem of Endogeneity

Finally, this study addresses the issue of endogeneity. There might exist an endogeneity problem in determining the association between underpricing and risk factor disclosures. If firms purposefully choose their disclosure strategy considering the costs and benefits of increased disclosure of risk factors, the analysis of the above relationship might suffer from self-selection bias.

In addition, the decision of how much to disclose may be related to when to do an IPO. But if the balance between disclosure costs and benefits affects the firm’s timing of IPO, it is only one of several factors and probably not the controlling factor. (Guo et al. 2004) Besides, all of our sample firms are at the IPO stage. There is still a variation in extent of risk factor disclosures.

In order to control for potential self-selection bias, it needs more tests and assumptions to solve this problem such as the two equation approach utilizing two-stage least squares (2SLS). However, this study doesn’t consider the endogeneity in above models. This issue is very worthy to discuss in the future.

To further diminish potential distortions from endogeneity, future work should concentrate on a better understanding of a firm's voluntary disclosure behavior. Useful insights can also be expected from studying the change in disclosure of risk factors over time and its implications for a firm's risk position.

5. CONCLUSIONS AND DISCUSSION

5.1 Conclusions

This study examines whether the effect of strategic alliances and disclosure of risk factors will influence underpricing of the biotech firms.

Firstly, the empirical results show that there is a significantly negative relation between strategic alliances before IPO date and the initial return. This indicates that

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biotech IPOs with strategic alliances before IPO date will be likely to have lower underpricing and the result is consistent with the expectation. This study thinks that strategic alliances may play a role in reducing ex ante uncertainty and lead to lower the level of underpricing.

Secondly, in the light of prior studies that when an IPO with greater ex ante uncertainty about firm’s value, underpricing will be higher. This study uses risk factors to be a proxy for ex ante uncertainty according to past research (Beatty and Welch 1996; Arthurs et al. 2008 and Arnold et al. 2010). In addition, in order to measure the content of risk factors, two approaches are applied. The first approach is to calculate total items listed in the risk factors section considering the quantity of risk factors. The other approach focuses on the content of risk factors or its description by calculating the total disclosure score within the listed items. Through the result of empirical regression, this study finds that the sum of the disclosure score within the listed items has a significantly positive association with underpricing and the result is consistent with the expectation. This indicates that if a biotech IPO with higher disclosure score, it will experience greater underpricing. If the disclosure score in a biotech IPO is higher, this means that the content provides quantitative information or some specific information. Because of the characteristics of the biotech industry, biotech firms are very risky (Hand 2005). The disclosure of risk factors in the IPO prospectus implying the uncertainty about firm’s prospect would be important for investors to evaluate the value of biotech firms. Besides, if risk factors disclosed are greater, the ex ante uncertainty about the value of an IPO would be greater, because it is difficult for investors to value the stock. Therefore, the content or its description provided in the risk factors section would affect underpricing positively.

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Furthermore, the effect of strategic alliances before IPO date still negatively influences underpricing. Consequently, the overall effect of disclosure score and strategic alliances is significant as expected.

Lastly, taking different firm size into account to analyze the relation between underpricing and risk factors, two subsamples are classified by the median of original filing amount which is a proxy for firm size. The empirical result shows that the association between risk factors disclosed and underpricing is significantly positive in larger firms. It seems that in larger firms the greater are risk factors disclosed no matter the quantity or the content and its description, the higher is underpricing.

Therefore, the prospectus provided from larger firms would have some effect for investors to evaluate the value of biotech IPOs.

In conclusion, this study finds that a biotech IPO with greater disclosure of risk factors would experience higher underpricing. This result is consistent with previous studies that firms citing more risk factors must increase IPO underpricing (Beatty and Welch 1996; Arnold et al. 2010) and the greater is the ex ante uncertainty about the value of an issue, the greater is underpricing (Beatty and Ritter 1986). Moreover, the results show that there is a significantly negative association between strategic alliances before IPO date and underpricing. It seems that a biotech IPO with strategic alliances before IPO date would reduce ex ante uncertainty about the value of an issue and lead to lower the level of underpricing.

In the end, this study contributes to the literature in underpricing and disclosure of risk factors by showing that a biotech IPO with more quantitative information or some specific information of risk factors would experience higher underpricing. In other words, risk factor, a proxy for ex ante uncertainty, is positively associated with underpricing and it is consistent with previous research. In addition, prior literature

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suggests that strategic alliances provide a valuable market signal for investors and would mitigate investors’ concern. This study empirically demonstrates that strategic alliances would be an indicator to be negatively related to underpricing.