Trade credit and IPO underpricing

Abstract

Firms may acquire financing through their suppliers rather than through financial intermediaries such as banks. By offering trade credits in the form of account receivables in lieu of requiring immediate cash payments when goods are delivered, a supplier plays an important financier role similar to that of a financial institution. The amount of trade credit for a buyer is a significant indicator of the firm's credit-worthiness to the market participants especially when the firm is about to go public. In this paper, we examine how a substantial fraction of pre-IPO trade credit affects firms' IPO underpricing phenomenon using a unique data set from a sample of 363 IPOs from January 2001 to December 2003 in the KOSDAQ stock market. We empirically explore why industrial firms prefer trade credit to financing from financial institutions such as banks. Our study is based on the presumption for the existence of significant information content from pre-IPO trade credit activities. Our paper is organized as follows. In Chapter 1, we provide the motivation and the goal of this research. Chapter 2 reviews the existing literature on trade credit and develops hypotheses by integrating the predictions of the extant work. In Chapter 3, we provide the descriptions of data with the emphasis on the uniqueness of our data resource. We also discuss the methodology employed in our study. Chapter 4 presents results of empirical analysis. Finally, the concluding remarks and implications of our research are given in Chapter 5. We find that there is a significant negative relationship between pre-IPO trade credit activities and IPO underpricing. This suggests that firms with higher fraction of trade credit before IPO are accompanied by the favorable market reactions due to the decrease in information asymmetry problems. In addition, we find that firms in the information technology with pre-IPO trade credit activities are more likely to have lower IPO underpricing. This further suggests that the value of pre-IPO trade credit activities is especially useful in this particular industry where reduction in information asymmetry problems is likely to increase firm value. For the robustness check, we employ the methodology proposed by Van Ness, Van Ness and Warr (2001) to measure whether pre-IPO trade credit activities are indeed a good measure of information on IPO firms. We find that pre-IPO trade credit activities are positively related to proxies for information asymmetry such as R&D to sales ratio, sales volume, and leverage. Also, firms with chaebol or listed firms' clients are more likely to have a portion of trade credit. We further find that proxies for information asymmetry from the market microstructure research framework such as spreads or trading volume are also related to the pre-IPO trade credit activities. Spreads are negatively related to the ratio of account payable to total assets, while trading volume is positively related to the ratio of account payable to total assets. This indicates that these IPO firms tend to have low information asymmetry problems. It appears that the greater presence of pre-IPO trade credit activities functions as a credible signal to encourage higher IPO pricing. Finally, we find that the pre-IPO financing relationship with suppliers in the form of trade credit will allow participants of the primary equity markets to suffer especially less from information asymmetry problems for technology-driven young firms. Overall, our results suggest that active pre-IPO trade credit activities will add value to IPO firms. This will allow them to experience both smaller IPO underpricing and cheaper borrowing costs due to less informational opaqueness of IPO firms.