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nal of Marketing Press Release: Increasing IPO Performance By Revealing Innovation Potential And Outlining Future Plans: How Firms can Mitigate the Negative Impact of Insider Selling

Researchers from the University of Denver, California State University Long Beach and Texas A&M University have published a new Journal of Marketing article. It examines how innovation potential can be used as a reliable signal to reduce adverse selection in IPO deals that involve insider sales.

The study is forthcoming in the Journal of Marketing and is titled ” innovation potential, insider sales and IPO performance: How firms can mitigate the negative effect of insider selling“. It was authored by Zixia, Reo Song and Ansley Chua.

In 2021, the U.S. raised $155 billion in IPOs. This was a record year for IPO valuations. In the United States, insiders also sold $35.5 billion worth of shares in companies that went public in 2021. Insider sales can be a negative indicator of quality and reduce the value for IPOs.

This study focuses on how innovation potential can be used as a signal to reduce the negative selection inherent in IPO deals that include insider sales. Research has shown that IPO firm managers have a tendency to hide information about future innovations from prospectuses in order to keep competitors from knowing about their plans. Managers seek to preserve their competitive edge by removing information about future products and markets that they might be entering in 40% of IPOs.

“Our research however shows a positive effect on IPO value from informing investors about future innovation plans. Cao says it allows managers to reduce information asymmetry and provides background information that helps investors gauge the impact of insiders sales. This ultimately increases the IPO’s value.”

The research team documented the indirect effect of insider shares on IPO valuation to establish that innovation potential is a reliable indicator of firm quality. The negative impact of insider sales on IPO performance has been well documented. Song says that insider shares are less popular in firms with high innovation potential. When these sales happen, the stock price penalty is lower.


Indirect and Direct Effects of Innovation Potential

Indirectly, innovation potential has an indirect impact on IPO first-day returns and also reduces the impact of insider sales upon IPO valuation. This study examines these relationships using data from 370 IPOs in the consumer-packaged and pharmaceutical industries. Innovation potential is measured using patents and new product preannouncements. Generic references to future innovation are also included in the IPO prospectus. Even if companies do not disclose details about new products, generic references to future innovation can be used as a reliable indicator of quality.

Certain innovation potential proxies are more effective than others at indicating the true quality and integrity of a firm’s business. Sorescu says that patents have a greater impact on insider sales that preannouncements or generic references to future innovation. This suggests that insiders seem to place more value on technological innovation than they do in corporate communications or strategic actions that focus on market-based innovations. Preannouncements also have the greatest impact on first-day IPO returns. This suggests that retail investors should focus on the innovation potential closest to commercialization.

“Our findings will help investors understand how insider sales happen,” says Chua. Chua says that insiders are more likely to sell their holdings when the company has a rich innovation pipeline. Insiders may sell because they need liquidity or because they believe the firm’s value will drop in the future. Investors may not be able to discern the motivations of insiders because of the significant information asymmetry at the time the IPO was conducted. Investors who believe the latter motive underlies the sale will be more inclined to pay a higher price for IPO shares. This is according to a study that suggests that a decrease in insider sales of 0 to 1% reduces IPO first-day return by 0.95%.


Managerial Implications

The following are some tips for managers who want to make their company public:

  1. Preannouncements of new products may be the best indicator of innovation potential. The total effect of preannouncements upon IPO first-day returns exceeds that of patents or generic references to innovation. It is seen by investors as the best indicator that an IPO company will be competitive. The IPO value increases by $34.88million when an additional product is announced. However, in the pharmaceutical industry, the preannouncements can be more valuable because of the longer life cycles that products have.
  2. Managers of IPO firms should not have a sufficiently developed product or feel uncomfortable promoting it. Generic references to future innovation can grab the attention both of underwriters as well as retail investors. The direct positive effect of generic references on IPO first day returns is greater than patents. Although product announcements are not as effective in increasing the value of an IPO company, communicating the general direction for future innovation is sufficient.

Full article and author contact information available at: https://doi.org/10.1177/00222429221134489

The Journal of Marketing

The Journal of Marketing creates and disseminates information about real-world marketing issues useful to scholars, educators and managers, policy makers and consumers around the globe. JM, published by the American Marketing Association, has been a key part in shaping the content of the discipline. Shrihari Sridhar (Joe Foster ’56 Chair in Business Leadership, Professor of Marketing at Mays Business School, Texas A&M University) serves as the current Editor in Chief.https://www.ama.org/jm

About American Marketing Association (AMA).

The AMA is the largest global chapter-based marketing organization. It is trusted by sales and marketing professionals to help them find the next big thing in their industry. The AMA has more than 70 chapters and 350 colleges campuses in North America. The AMA offers award-winning content, PCM (r) professional certification and premier academic journals. It also hosts industry-leading training events, conferences, and workshops.

https://www.ama.org

The post Marketing Press Release: Increasing IPO Performance By Revealing Innovation Potential and Outlining Future Plans. How Firms can Mitigate the Negative Impact of Insider Selling was originally published by American Marketing Association.

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Justin is a local marketing expert with over 15 years of experience creating brand recognition around digital strategies.

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