metadata: authors: 0: author: Aggarwal, Reena
1: author: Klapper, Leora
count: India
docna: 0: docna: Ownership structure and initial public offerings
docty: Policy Research Working Paper
subtopic: Multinational & Corporate Governance,Corporate Governance,Legal Institutions of the Market Economy,Capital Markets and Capital Flows,Non Bank Financial Institutions,Capital Flows,International Trade and Trade Rules,Mutual Funds,Civic Participation and Corporate Governance,Financial Sector Policy
teratopic: Industry,Finance and Financial Sector Development,Conflict and Development,Macroeconomics and Economic Growth
abstracts: cdata!: The authors study the relationship
            between ownership structure, corporate governance, and the
            initial public offering (IPO) process. They examine equity
            ownership by different institutions, such as foreign and
            domestic financial institutions, banks with and without
            lending relationships, venture capitalists, and corporations
            prior to an IPO. The authors also analyze the relationship
            between ownership structure and corporate governance. They
            use a unique dataset of 152 Indian IPOs during the period
            1999-2001 to analyze ownership of shares by main groups of
            shareholders. The authors find a relationship between
            ownership structure and firm-specific factors such as sales,
            leverage, and profitability, and IPO characteristics such as
            percentage of equity locked up, gross proceeds, and exchange
            of listing. There is also a strong relationship between
            ownership by different types of institutions. Ownership is
            also tied to bank lending relationships. Finally, the
            authors find strong relationships between ownership types
            and corporate governance. For example, firms with foreign
            investors are more likely to have an outside chief executive
            officer and offer an employee stock option plan.
geo_reg_key: 517198,517212,517191
repnme: repnme: Ownership structure and initial public offerings
display_title: Ownership structure and initial
            public offerings
listing_relative_url: /research/2003/07/2483261/ownership-structure-initial-public-offerings
topicv3: Trade m1326924 698,Corporate Governance m1326968 417,Mutual Funds m1326970 2180,Financial Sector Development m1327681 1920,Financial Institutions m1505015 3797
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Industry,Finance and Financial Sector Development,Conflict and Development,Macroeconomics and Economic Growth
origu: Development Research Group (DECRG)
no_of_pages: 32
model_extractions: **POLIcy RESEARCH WORKING PAPER** 3103

# Abstract

Aggarwal and Klapper study the relationship between ownership structure, corporate governance, and the initial public offering (IPO) process. They examine equity ownership by different institutions, such as foreign and domestic financial institutions, banks with and without lending relationships, venture capitalists, and corporations prior to an IPO. The authors also analyze the relationship between ownership structure and corporate governance. They use a unique dataset of 152 Indian IPOs during the period 1999-2001 to analyze ownership of shares by main groups of shareholders. The authors find a relationship between ownership structure and firm-specific factors such as sales, leverage, and profitability, and IPO characteristics such as percentage of equity locked up, gross proceeds, and exchange of listing. There is also a strong relationship between ownership by different types of institutions. Ownership is also tied to bank lending relationships. Finally, the authors find strong relationships between ownership types and corporate governance. For example, firms with foreign investors are more likely to have an outside chief executive officer and offer an employee stock option plan.

This paper-a product of Finance, Development Research Group-is part of a larger effort in the group to study international corporate governance. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Agnes Yaptenco, room MC3-446, telephone 202-473-1823, fax 202-522-1155, email address ayaptenco@worldbank.org. Policy Research Working Papers are also posted on the Web at http:// econ.worldbank.org. The authors may be contacted at aggarwal@georgetown.edu or Iklapper@worldbank.org.<sup>July 2003.</sup> (27 pages)

> _The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objectiveof the series is toget thefindingsoutquickly, even if the presentationsare less than fuilly polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent._

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# **Ownership Structure and Initial Public Offerings**

Reena Aggarwal McDonough School of Business Georgetown University Washington D.C. 20057 (202) 687-3784 aggarwal(georgetown.edu www.msb.edu/faculty/aggarwal/ Leora Klapper The World Bank 1818 H Street, NW Washington D.C. 20433 (202) 473-8738 lklapper@worldbank.org Wethank Prem Jain, Saumitra Chaudhuri, Tom Glaessner,<sup>Jeppe Ladekarl, Pietra Rivoli, AjayShahand participants</sup> at Fortis-Georgia Tech Eighth Annual Conference on<sup>InternationalFinance, FinancialManagement Association</sup> Annual Meetings, and Georgetown University Summer<sup>seminarseriesfor helpful commentsand VictorSullafor</sup> research assistance. We also thank Anurag Garg and IndiaCapital.com<sup>for their assistance with thedata.</sup>
# **Ownership Structure and Initial Public Offerings**

# **I. Introduction**

A recent survey paper on initial public offerings<sup>(IPOs)states,"the topicofshare</sup> allocations and subsequent ownership ranks among<sup>themostinterestingissuesinIPOresearch</sup> today" (Ritter and Welch, 2002). Researchers<sup>havecorrectlystartedpayingattentiontothese</sup> institutional issues. We believe that in order<sup>to exarnineallocationof IPO shares andsubsequent</sup> ownership, it is first important to understand<sup>the ownershipstructureofthe firm justpriorto</sup> going public. Firms deliberately attempt<sup>tochangetheir ownershipandcorporategovernance</sup> structure in preparation for going public. The<sup>structure createdprior to theoffering can influence</sup> the whole IPO process, the allocation process, and<sup>subsequent ownership.This paper attempts to</sup> partly fill this gap in the current literature.

We analyze the ownership structure of firms just<sup>priortogoing public.Thedifferent</sup> groups of owners examined include domestic<sup>andforeigninstitutions,bankswithandwithout</sup> lending relationships with the firm, venture capitalists<sup>(VCs)andcorporations.</sup> Ownership structure is also related to the corporate<sup>governancestructureof thefirm.</sup> Proxies used for corporate governance include ownership by insiders,<sup>theroleof the founder inmanagementof</sup> the firm, ownership by VCs, and the<sup>existenceofemployeestock optionplans (ESOPs).</sup> Empirical research examining ownership structure of<sup>IPOsis quitelimitedpartlydue tothelack</sup> of data. A unique dataset of Indian IPOs during<sup>the period1999-2001allowsus toexaminethe</sup> ownership and corporate governance structure of<sup>firms going public.Thedetaileddataon the</sup> number of shares held by the 10 largest shareholders<sup>allowsustostudytheroleoflarge</sup> shareholders. The analysis is also able to shed light on the<sup>roleof financial institutionsin</sup> corporate governance. India provides an interesting<sup>emergingmarkettoanalyzewith its hybrid</sup> 2
structure similar to market-based economies like the U.S. and U.K. and bank-based systems of Germany and Japan. We are also able to examine the role played by foreign investors in govemance and performance. For example, we find that firms with foreign shareholders have better corporate govemance, are more likely to have foreign lenders, and have greater access to financing. ' We also examine the characteristics of firms that have venture capital participation prior to an IPO. In the United States, venture capitalists (VCs) are found to take equity stakes in young firms that have large potential agency costs. The literature also finds that VCs provide financing and in addition are also likely to provide help in hiring management, serve on the board of directors, actively monitor the firm, and provide advisory services and reputation capital (Gompers, 1995 and Lerner, 1995). They therefore provide both financial and non-financial services. Previous literature also discusses that VCs are more sensitive to the corporate governance of the firm than the entrepreneur because of their need for repeated access to capital markets, which makes them concerned about their reputation (Baker and Gompers, 1999). It has also been suggested that venture capitalists play an important role in the professionalization of a firm in addition to their traditional role of a financial intermediary (for example, see Hellman and Puri, 2001). In the process of professionalization of the firm VCs may replace the original founder with an outside professional CEO. The role of the venture capitalist becomes even more important as a firm prepares for an IPO. The combination of the financial and non-financial contributions increases the credibility of the firm issuing new equity in the market and among investors. VCs will monitor the firm to ensure that benefits are not diverted to the managers of

> iThe unique ownership and governance of Indian firms is an example of the "new _firm"_ that Zingales (2000) recommends further study.

3
the firm. These issues become even more relevant in the Indian<sup>environment withweaklegal</sup> enforcement of shareholder protection laws.

We also study the affect of industry and founder on ownership structure,<sup>similar to Faccio</sup> and Lang (2002) who find that in Western Europe large firms and financial<sup>firmstend to be more</sup> widely held but small firms and non-financial firms are more closely<sup>held.If the firmisfamily-</sup> controlled then it is more likely to have top managers from the controlling<sup>family.They find that</sup> the largest controlling shareholder, on average, owns 38.48 percent of<sup>voting rights.Holdemess</sup> and Sheehan (1988) study the role of large-block shareholders and define<sup>majority shareholders</sup> as those who own 50 percent or more of the outstanding shares.<sup>Intheirsample,atleastone</sup> non-officer owned more than 10 percent of the stock and an officer<sup>owned morethan10percent</sup> of the stock in 15 percent of the sample firms. They conclude that<sup>majorityshareholdersare</sup> more involved in direct management and are present in both small<sup>and largefirms.Additionally,</sup> they find that the motivation of individual majority shareholders<sup>isdifferentfromthatof</sup> institutions. These studies, however, do not specifically examine<sup>IPOs.</sup> Demsetz and Lehn (1985) report that ownership -structure varies<sup>systematicallyin ways</sup> consistent with value maximization. The variation is based in factors such as firm size, instability of profit rate, and whether the industry is regulated or not. Brickley,<sup>Lease,and Smith</sup> (1988) argue that institutions such as mutual funds and pension<sup>fundsaremorelikely tooppose</sup> management than banks and insurance companies that derive<sup>business interestsfromthe firm.</sup> There is considerable literature that discusses the role of prestigious<sup>underwritersandex</sup> ante uncertainty and the effect of auditor quality (for example, Carter<sup>andManaster,1990,</sup> Megginson and Weiss, 1991, and Willenborg, 1999). Entrepreneurs also<sup>signalthe valueof the</sup> firm by retaining a large proportion' of ownership and not selling<sup>their shares at thetime of going</sup> 4
public. Brennan and Franks (1997) suggest that underpricing is needed to ensure that the offering is oversubscribed. Oversubscription gives managers the flexibility to discriminate in the allocation of shares thereby reducing the possibility of creating substantial outside blockholders. This becomes particularly important if the entrepreneur owns only a small proportion of the stock. Lock-up periods are seen as yet another mechanism by which the uncertainty is reduced (Field and Hanka, 2001, and Brav and Gompers, 2001). Different categories of equity holders perform different monitoring and control functions that can serve as signaling mechanisms. These may have a direct impact on the price performance of an IPO, including underpricing (Michaely and Shaw, 1994). However, prior to public listing is the time when it is crucial to signal firm value, and ownership structure can resolve some of the information asymmetry surrounding the IPO.

Our study is the first to examine the role of institutional investors when firms go public. There have been a few studies that have examined related corporate governance issues in India. Sarkar and Sarkar (2000) find that blockholdings by firm directors increases firm value after a certain threshold of ownership and that institutional investors, such as mutual funds, are not active in governance. They do find, however, that banks monitor companies effectively if they have a large equity stake and this monitoring is reinforced by debt holdings. Foreign equity ownership is also found to have a positive impact on firm value. Chhibber and Mazumdar (1999) specifically examine the relationship between foreign. ownership and accounting measures of performance. Khanna and Palepu (1999) study the role of institutions in governing group-affiliated companies.

_5_
The rest of the paper is organized<sup>as follows.SectionIIdescribesour unique datasetand</sup> some cross-sectional characteristics of<sup>oursample. SectionEIIreports the resultsof the empirical</sup> analysis. Section IV provides<sup>a summary and conclusions.</sup>

# II. Data

Our primary data is collected from<sup>IndianIPOfilingsbetweenJanuary1999andApril</sup> 2001.2 The sample includes all 152<sup>IPOs issued duringthe period.IPOsfromall majorsectors</sup> including financial, media, telecom,<sup>high-tech,andindustrialarerepresented.</sup> These filings include information on firm characteristics,<sup>IPO characteristics,and ownershipinformation.IPO</sup> characteristics include float percentage,<sup>number of days between opening and closing of the IPO,</sup> gross proceeds, initial return, exchange<sup>listing, and whethertheleadunderwriterwasforeignor</sup> domestic. Firm characteristics include<sup>balance sheetand incomestatementitems,suchas sales,</sup> leverage, earnings before income<sup>andtaxes(EBIT)andgrossmargin.</sup> Information is also included on the age of the firm,<sup>theexistenceof a bankingrelationshipwith a foreignbank,and</sup> the industry of the issuer. Since we<sup>havethenames of all shareholdersand lenders,wecanalso</sup> identify firms with equity and lending<sup>relationships with domesticand foreign banks.</sup> The main focus of our paper<sup>istoanalyzeownershipcharacteristicsthatinclude</sup> ownership by foreign and domestic<sup>institutionsand also ownershipbyinsidersof the firm.The</sup> institutions studied include corporations,<sup>financial institutions,andventure capitalists.</sup> The corporate governance proxies used<sup>intheanalysisaretheexistenceofanemployeestock</sup> ownership plan and whether the<sup>foundercontinuedas theCEOof thefirm.</sup> We also have information on whether the firm<sup>iscloselyheldandby whom.IndiaCapital,aprivateIndian</sup> financial information vendor, provided<sup>informationonthe nationalityand"type"of allequity</sup> 6
investors - whether the shareholder is classified as an individual, financial institution, venture capitalist, or corporation.<sup>3</sup> In addition, IndiaCapital identified whether the CEO was an original founder or an outsider at the time of the IPO and the nationality of lenders and IPO lead managers.

# **III. Empirical Results**

# _A._ **_IPO and Firm Characteristics_**

Table 1 reports characteristics of the IPO, the issuing firm, and the ownership structure for the full sample. The sample includes 152 Indian IPOs between January 1999 and April 4 2001. The proportion of shares floated in an IPO on average is 30 percent. Insider shares are not allowed to trade during the mandatory lock-up period of 36 months. Both the float percentage and the lock-up period is much higher than that observed in the U.S. The Securities and Exchange Board of India (SEBI) lays out detailed guidelines on lock-up provisions that require the lock-up period to be three years. The lock-up period starts from the date of allotment in the public issue or from the date of commencement of commercial production, whichever is later. SEBI's guidelines also require that the minimum float be at least 25 percentage of the issue size - which we find to be the median float percentage - although SEBI gradually relaxed the min float requirement to 10% on July 21, 2001.5 In the U.S. regulators do not set the minimum float or lock-up requirements. The minimum float is decided by the issuer and investment banker, based on funding requirements, demand for shares, and to allow for sufficient

> 2 Prior to 1999, IPOs were not filed electronically and did not have as extensive disclosure requirements.

> 3 In general, "corporations" are investment vehicles for non-financial firms.

> 4 Our sample excludes five firms that issued IPO prospectuses but did not list because they were unable to receive the mandatory 90% subscription.

> _5_ We exclude float from the proceeding summary tables comparing averages across samples because of the little variation across firms. In all cases, float is insignificant.

7
aftermarket liquidity. The lock-up<sup>periodin the U.S.is typically180days andisdetermined by</sup> the investment bank and not the regulators.

The median number of days between<sup>openingandclosingof the IPOisfive daysandis</sup> the time period during which allotment<sup>takes place.The averageIPO offeringsize in our sample</sup> is 291 million rupees and the median<sup>sizeis 49 million rupees.The size variationis quitelarge,</sup> ranging from over 8 billion rupees<sup>toabout 8 millionrupees.Firmsin our samplelisted either on</sup> a national exchange, the National<sup>Stock Exchange(NSE)or the BombayStockExchange (BSE),</sup> or on only one of the 21 regional<sup>exchanges(forexample,theCalcutta,Bangalore,or Hyderabad</sup> Exchange.) Indian law requires<sup>firmstoliston atleastone regionalexchangeinaddition toa</sup> national exchange and therefore<sup>Indian firmsfrequentlylistsimultaneouslyon morethanone</sup> exchange. About half the firms<sup>inour samplelisted ona nationalexchange,whichaccountfor</sup> almost 90 percent of the total proceeds<sup>raised.</sup> We measure IPO market performance<sup>bythe1-dayreturn (percentagechange) fromthe</sup> offering price to the closing price<sup>on thefirst dayof trading.6Theaverageinitialreturnof firms</sup> (not shown) is 99 percent and the<sup>median returnis38 percent.Returnsrangefrom-60percent</sup> to over 900 percent, with 70 percent<sup>of first dayreturnsbeingpositive.Thisisconsistentwith</sup> Shah (1995) who finds a first<sup>dayreturnof 105.6%forfirmsthatcommencedtrading between</sup> January 1991 and April 1995.<sup>Inaddition, wereportmarket-adjustedreturnsusingtheIndian</sup> Nifty index in Table 1. The<sup>meanand medianmarket-adjusted returnsare74percentand35</sup> percent, respectively. We also<sup>findthat13percentof firms haveaforeignlead IPO manager,-</sup> which may suggest a greater<sup>ability to attract foreign investorsandgreater returns.</sup>

> 6 We exclude one firn with 1-day<sup>returnequal to 3200.</sup>

8
The age of the firms varies from less than a year to over 70 years, with a median age of seven years.<sup>7</sup> The mean and median sales are 326 million rupees and 33 million rupees, respectively. The mean and median gross margin is 0.23 and 0.19, respectively. This low profitability may reflect the young age of firms and concentration in the technology sector, which often have high start-up costs and initial losses.

> The mean debt-to-equity (D/E) ratio is 1.53 and the median is 0.14. The low median

> usage of debt reflects the large number of technology firms, which generally have few fixed

> assets and little debt.8 We identify 20 percent of firms in our sample to have a loan outstanding from a foreign bank, which reflects the strong presence of foreign banks in India. In addition, we

> find that 24% of firms in our sample have both lending and equity relationships with a bank. Our empirical analysis examines whether the ability to borrow from a foreign lender is related to

> a firm's shareholders. Finally, our sample of firms can be identified as 5% financial, 75% technology, and 20% other (Pharmaceuticals, Media, etc.)

# **_B. Ownership Structure_**

> We find that 67 percent of firms have an insider blockholder. Initially, we define blockholders as any shareholder that owns 5 percent or more of the stock. For robustness, we

> also use other ownership percentage cutoffs (10 and 15 percent) in defining blockholders. The

> large percentage of firms with inside block ownership is not surprising, because we would expect company founders to retain equity ownership at least until the time of the IPO. In addition, 38

> percent of the firms have at least one VC blockholder - defined as a venture capitalist or a

> corporate investment vehicle - 34 percent of firms have at least one domestic blockholder and 9

> 7 Our sample includes 16 firms that had not yet started commercial operation at the.time of the IPO.

> 8 On average, listed Indian firms in Worldscope have median debt to equity ratio in the range of 0.75-1.00.

9
percent of firms have a foreign<sup>blockholder.9</sup> Indian law permits banks to<sup>own equityin non-.</sup> financial firms. This allows<sup>us toexaminemore closelytheeffectof both bankloans andequity</sup> investment, and the interaction<sup>betweenthesetwotypesof investment.Wefind that12percent</sup> of the firms have bank<sup>shareholders-7percentoffirmshaveatleastoneIndianbank</sup> shareholder and 6 percent<sup>haveatleastoneforeignbankshareholder.Thisdatapresentsthe</sup> opportunity to study the relationship<sup>betweenfinancialinstitutions'lending relationship with the.</sup> firmn and equity ownership. These results clearly suggest<sup>thatbothindividualinsidersand</sup> institutions, such as banks<sup>and VCs, have significant equity stakes in firms going public.</sup> In addition, we find that foreign<sup>institutions -VCs and banks-own equityin13percent</sup> of our sample firms. As was<sup>previouslydiscussed, foreignbankshavealendingrelationship</sup> with 20 percent of the firms<sup>going public.In13percentof our firmsa foreigninvestment bank</sup> also takes the firm public.<sup>Theseinitial resultssuggestthatforeigninstitutionsareactively</sup> involved in lending money,<sup>owningequity,andinservingasinvestment banksto firmsgoing</sup> that<sup>22 percentof firmshaveat least one insidercontrollingmore than 20</sup> public. We also find percent of total equity.<sup>10Thesefirms,whereinsidemanagers arealsoconitrollingshareholders,</sup> may identify an environment<sup>of poorcorporategovernance.Inaddition, we find that13percent</sup> of firms have a VC as a<sup>controllingshareholder that owns morethan 20 percentof totalequity.</sup> This ownership information<sup>allowsus toexamine therelationshipbetweenownershipstructure</sup> and corporate governance.

We also include information<sup>onownership structurethatmayrelatetothecorporate</sup> of firms at the<sup>timeof theirIPO.About30 percentof firms offeranESOP, which</sup> governance may provide incentives to<sup>managerstoactmoreon behalfof shareholders.Lessthan5 percent</sup>

> 9 Of the 39% of non-bank<sup>institutionalowners,12%or9 firnshaveinvestorsexplicitlyidentifiedasventure</sup> capitalists.

10
of firms have replaced their CEO with an outsider, the remaining firms have a founder as their CEO.

# _C. Ownership Types_

Table 2, Column 1 classifies issuers based on whether a Bank, VC or Insider is a blockholder, defined as a shareholder that owns more than 5 percent of equity. In 18 firms banks hold equity positions at the time of going public. Firms in which banks hold equity are much more likely to be older and larger. They also have higher leverage ratios, which may suggest that an equity relationship improves access to financing. 33 percent of bank-owned issuers use a foreign lead underwriter as compared to 10 percent for the non-banked owned group; 44 percent have a lending relationship with a foreign bank as compared to 17 percent for the non-bank group; and 56 percent of them have foreign ownership as compared to 8 percent for the non-bank owned group. All of these differences in means are statistically significant. Therefore, we can conclude that bank ownership and foreign participation go together. We also find that bank ownership results in higher underpricing. The mean initial return spreads are 116.99 percent for the bank-owned group and 67.95 percent for non-bank owned group with the difference in means being statistically significant. If banks have ownership then the firm is more likely to have an ESOP. In addition, firms with a bank blockholder are significantly more likely to have a VC investor that controls more than 20 percent of equity. This supports our prior assertion that banks and VCs invest jointly and by taking significant equity positions.

Table 2, Column 2 reports the results based on VC ownership. VCs own an equity stake in 57 firms with foreign VCs owning equity in 14 firms. VC ownership is associated with a greater likelihood of ESOPs. 40 percent of firms with VC ownership have ESOPs but only 23 percent of firms with no VC ownership have ESOPs. Our finding that firms with institutional ' Claessens, et al. (2000) identify controlling shareholders as those with greater than 20% equity stake.
investors - banks or VCs - are more likely<sup>tohave ESOPssuggeststhatinstitutionalinvestors</sup> help to professionalize the firm and improve<sup>governance.VCownershipalsoresultsin higher</sup> foreign participation. In 32 percent of<sup>VC owned firms, a foreign bank or a foreign VC holds an</sup> equity stake, versus 2 percent in firms<sup>without VC equity stakes,a significantdifference.In 32</sup> percent of firms there is a lending relationship<sup>with a foreign bank, whichis significantlylarger</sup> than the 14 percent of firms without<sup>VCblockholders.</sup> We also find that firms with VC blockholders are significantly older, have<sup>largerIPOproceeds, andaremore likely tolistona</sup> major Indian exchange. This may suggest<sup>that ex-anteVCsinvest in firmswith greaterlisting</sup> potential.

In Table 2, Column 3 we examine firms<sup>with insider blockholders.Thesefirmstend to</sup> be smaller, as measured by total sales<sup>and total IPO proceeds.In addition wefind thesefirms to</sup> be significantly less profitable (as measured<sup>bygrossmargin)and havelessinvestment(as</sup> measured as investment to sales). Interestingly,<sup>wefind that these firmsareless likelyto havea</sup> VC with ownership greater than 20 percent,<sup>suggesting that VCs may discourage large individual</sup> shareholdings.

# _D. Corporate Governance_

Next, in Table 3 we examine the characteristics<sup>of issuersbasedontheirgovemance</sup> structure. Three proxies are used for corporate<sup>governance:whetherthefirm has anESOPor</sup> not; whether the firm is closely held by<sup>VCsor not;and whether thefirmiscloselyheld by</sup> insiders or not. Closely held firms are<sup>definedasthosein which insidermanagers ownmore</sup> than 20 percent of the total common equity.<sup>It would havebeen useful tohave other proxiesfor</sup> corporate governance, such as* composition<sup>ofthe board andauditcommittee,butthis</sup> information was not available.

12
In Table 3, Column 1 the dummy variable for ESOP takes<sup>ona valueequalto oneif the</sup> issuer has an ESOP and zero otherwise. Firms that have<sup>ESOPs,on average,aremore likely to</sup> have a lending relationship with a foreign bank and both<sup>foreign banksand foreigncorporations</sup> are more likely to have an equity stake in the firm. The<sup>differencein means between the ESOP</sup> group of firms and non-ESOP group of firms is statistically<sup>significantfor thevariables foreign</sup> lender, foreign bank equity, and foreign VC equity (not<sup>shown).These resultssuggest that firms</sup> with ESOPs also have stronger relationships with foreign<sup>institutions,bothlenders and equity</sup> holders.

In Column 2 the sample is classified based on whether<sup>aVChasacontrolling</sup> shareholding, defined as more than 20 percent of equity.<sup>Wefind thatthesefirms havelarger</sup> IPO proceeds and are more profitable, as measured by<sup>grossmargin.Wecannot implythe</sup> direction of causality between VC ownership and profitability,<sup>since it may be the case that VCs</sup> invest in more profitable firms. We also find a link with<sup>foreignlendersand foreignownership.</sup> Firms with controlling VC ownership may be more likely<sup>to accessforeignlenders becausethey</sup> are more profitable, or because the VC uses its bank<sup>relationshipstohelpthefirmaccess</sup> financing. Again, we find a strongly significant relationship<sup>between VC and bankinvestments</sup> - we find firms with more than 20 percent VC equity holdings<sup>significantlymore likely to have</sup> more than 20 percent bank equity stakes and significantly<sup>lesslikelyto haveinsider</sup> blockholders. This suggests that VC investors are unlikely<sup>to take a large equity stakein a firm</sup> that is controlled by insiders. These firms are also more<sup>likely toissue ESOPs. Column3 is</sup> classified by insider ownership, the insider dummy equals<sup>one if any Indian individualowns20</sup> percent or more of equity and zero otherwise. We find<sup>nosignificantdifferencesbetweenthe</sup> 13
samples, with the exception that as discussed<sup>above,firmswithinsidercontrolareless likely to</sup> also have large VC ownership.

To summarize the relationship between<sup>proxiesforgovemance and ownershipstructure,</sup> we find that firms with foreign bank and/or<sup>VCinvestmentaremorelikelytoofferESOPs.</sup> Furthermore, we find that firms with large<sup>VCandbankequitystakesarelesslikelyto have</sup> insider blockholders. These results suggest<sup>anaddedbenefitof increasedforeigninvestment</sup> abroad is potential improvements in local corporate<sup>governance.</sup> _E. Foreign Financial Firms_ In Table 4 we examine the differences<sup>inthe corporategovernanceandownership</sup> structure of firms that do and do not have<sup>aforeign lender,foreignlead banks,and foreign</sup> owner. This analysis and the results as reported<sup>in Table 4 overlapwith our earlier analysis.The</sup> conclusion is again that foreign lenders, foreign<sup>lead underwriters,andforeignequity investors</sup> (both banks and VCs) all participate in IPO<sup>dealstogether.Not only do theytend to bring each</sup> other to the table but it is likely that<sup>foreignequityinvestorsextend theirownbanking</sup> relationships to the firms in which they invest.<sup>Wefindalmostidenticalresults forsummary</sup> statistics by firms with and without foreign<sup>lenders andfirmswithand withoutforeign owners</sup> (Columns I and 2). Firms with foreign lenders<sup>or foreign ownersareon average older,larger,</sup> and more leveraged. Their IPO are larger in<sup>size and are more likely to list on a majorexchange.</sup> In addition, firms with foreign lenders and<sup>owners are more likely to offer ESOPs.</sup> Column 3 classifies firms based on whether<sup>thelead manager for theoffering wasa</sup> foreign bank or not. Foreign banks are more<sup>likely to be the lead managerfor larger offeringson</sup> a major exchange, of firms significantly<sup>characterizedas older,larger,andhavinghigher</sup> leverage. There is more likelihood of bank blockholder<sup>andcontrollingownership.</sup> It is 14
interesting to note that the mean initial return spread of 55.79 percent is significantly lower for foreign lead underwriters than 77.07 percent for Indian lead manager offerings. We know larger offerings have lower underpricing and these results might be driven by the size of the offering. It is also possible that foreign lead managers are better at pricing the offering.

# _F. Corporate Governance and Ownership in a Multivariate Framework_

Table 5 shows logit tests of the relationship between ownership types. Four different models are estimated with the type of ownership as the dependant variable. The dependent variables are equal to 1 in the case of ownership type (Bank, VC, VC_20, and Insiders). The independent variables are dummies equal to 1 if a foreign bank owns equity and 0 otherwise; a dummy equal to 1 if a domestic bank owns equity and 0 otherwise; dummy equal to 1 if a foreign VC owns equity and 0 otherwise; a dummy equal to 1 if a domestic VC owns equity and 0 otherwise; dummies for technology and financial sector IPOs; and the natural log of age." For example, Columns 1 and 2 shows a significant positive relationship between VC investments and bank investment. This symbiotic relationship between bank and VC ownbrship may suggest a method to approach information opaqueness in emerging markets - foreign non-financial investors may depend on the information gathering and relationship between local banks and firms in making investment decisions. Although we do not have information on the sequence of investors, we hypothesize that foreign VCs depend on the signal of local bank shareholders in making investment decisions. We also find that firms with institutional investors are significantly older.

Column 3 looks at the relationship between insider blockholders and other institutions. We do not find any significant relationship with institutional investors, but find a significantly

> 1 We estimated models including other firm-specific and IPO-specific variables but they were generally not statistically significant and are not reported here.
negative relationship with the financial sector dummy. This is consistent with expectations that whereas industries such as technology and services may be conceived with less start-up capital, financial firms require large capital infusions - and risk management and MIS expertise - that institutional investors (such as banks and other financial institutions) can offer. Column 4 supports our previous univariate result that firms with large VC investments are less likely to have insider blockholders. This may be explained by VCs reluctance to invest in firms controlled by local shareholders.

Table 6 uses logit regressions to test the relationship between ownership and foreign participation and between governance and foreign participation. Column 1 shows that firms with access to foreign debt are more likely to have foreign shareholders. This confirms our hypothesis that awsymbiotic relationship exists between foreign lenders and investors. Column 2 shows that firms with a foreign lead underwriter are more likely to have a bank blockholder, who may also lend to the firm. This may offer evidence of the benefit of universal banking to Indian firms. Column 3 shows no significant relationship between ESOPs and ownership types, although it is significantly and positively related to foreign blockholders. Column 4 shows that CEOs are more likely to be founders in firms with inside shareholders and less likely in firms with foreign blockholders. This supports our previous assertion that large insider ownership may delay improvements in governance and that foreign investors may introduce "best practices" of international corporate governance.

Table 7 uses OLS regressions to test the relationship between ownership and performance. We use two measures of ownership - at the 5 percent and 20 percent level - since non-controlling ownership stakes may not give blockholders enough power to make management and/or strategy decisions. Column 1 finds no relationship between ROA and ownership types at 16
5 percent. This may suggest that our previous findings<sup>of relationshipsbetweenownershipand</sup> firm characteristics is not driven by ex-ante differences<sup>infirmperformancethat endogenously</sup> determine investor types (i.e. VCs are more likely to<sup>investin more profitablefirms). However,</sup> in Column 2 we find a positive relationship between<sup>VCownershipat20percentandROA.</sup> Column 3 and 4 show that firms with insider blockholders<sup>havesignificantly lowergross margin</sup> and again offers evidence that large VC shareholding<sup>isrelatedtohigherperformance.These</sup> findings may reflect the ex-ante decision of VCs<sup>toinvestinbetterperformingfirms.</sup> Alternatively, we have shown that large VC ownership<sup>isassociated withbettercorporate</sup> governance (such as the issuance of ESOPs and the<sup>replacementof theinsideCEO)andthese</sup> findings may also be interpreted as additional<sup>supportforpreviousfindingsofapositive</sup> relationship between better corporate governance<sup>andperformance(KlapperandLove, 2002,</sup> Black, 2001, Gompers, Ishi, and Metrick, 2001).<sup>Finally,Columns5 and6testtherelationship</sup> between access to financing and ownership. We find<sup>that firmswith largeVCinvestmentshave</sup> lower debt ratios, but this may reflect their relatively greater<sup>access to equity.</sup>

# IV. **Summary and Conclusions**

This paper examines the ownership and corporate governance<sup>structureof firmspriorto</sup> going public using a sample of Indian IPOs. We believe it is the first time that ownership structure has been analyzed just before a firm goes<sup>public.FirmsdoingIPOsareparticularly</sup> motivated to have the "appropriate" ownership structure<sup>sothat it canserveasa signalingdevice</sup> to the market. This is also the point in time of a firm's<sup>history when informationasymmetrycan</sup> be high. Firms make major realignments to their<sup>ownershipand corporategovernance structure</sup> in preparation for going public. The ownership structure<sup>just prior totheIPO can affect theIPO</sup> 17
process including the marketing of the offering, allocation of the IPO, and subsequent ownership of the firm. Our paper relates to the literature that has examined the reputation of underwriters, auditors, insider holdings, and lock-up provisions in reducing ex ante uncertainty as well as ownership structure as a way to mitigate some of the information asymmetry. We also associate ownership with proxies for corporate governance in the Indian IPO market.

The paper has specifically attempted to answer three questions: 1) Who owns equity in firms just prior to going public and what is the role of domestic and foreign institutions, such as banks, VCs, and lenders? 2) What are the determinants of ownership? 3) Does institutional ownership have any affect on the corporate governance practices of the firm? First, we find that both foreign and domestic banks and VCs hold equity stakes in a large proportion of our sample. Institutions tend to invest as a group, therefore, if a VC holds an equity stake then a bank is also likely to hold an equity stake. Second, there is a strong positive relation between a foreign equity stake and a foreign bank lending relationship. Third, equity holding by institutions in general and foreign institutions in particular is positively related to the corporate governance practices of the firm, as measured by the existence of ESOPs and role of the founder in the firm.

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