Giudici roosenboom the rise and fall of europes new stock markets (2004)

Giancarlo Giudici and Peter Roosenboom 1PRICING INITIAL PUBLIC OFFERINGS ON EUROPE’S NEW STOCK MARKETS Giancarlo Giudici and Peter Roosenboom 25 FINANCING GROWTH AND INNOVATION THROUGH N

ADVANCES IN FINANCIAL ECONOMICS VOLUME 10

THE RISE AND FALL OF EUROPE’S NEW STOCK

THE RISE AND FALL OF EUROPE’S

NEW STOCK MARKETS

ADVANCES IN FINANCIAL

ECONOMICS

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Giancarlo Giudici and Peter Roosenboom 1

PRICING INITIAL PUBLIC OFFERINGS ON EUROPE’S NEW STOCK MARKETS

Giancarlo Giudici and Peter Roosenboom 25

FINANCING GROWTH AND INNOVATION THROUGH NEW

STOCK MARKETS: THE CASE OF EUROPEAN

BIOTECHNOLOGY FIRMS

Fabio Bertoni and Pier Andrea Randone 61

MANAGERIAL INCENTIVES AT THE INITIAL PUBLIC

OFFERING: AN EMPIRICAL ANALYSIS OF THE

ALTERNATIVE INVESTMENT MARKET

THE VALUATION OF FIRMS LISTED ON THE NUOVO

MERCATO: THE PEER COMPARABLES APPROACH

Lucio Cassia, Stefano Paleari and Silvio Vismara 113

VALUING INTERNET STOCKS AT THE INITIAL PUBLIC

OFFERING

Michiel Botman, Peter Roosenboom and

v

THE ROLE OF ACCOUNTING DATA AND WEB-TRAFFIC IN THE PRICING OF GERMAN INTERNET STOCKS

Andreas Trautwein and Sven Vorstius 157

THE EXPIRATION OF MANDATORY AND VOLUNTARY IPO LOCK-UP PROVISIONS – EMPIRICAL EVIDENCE FROM

GERMANY’S NEUER MARKT

UNDERPRICING OF VENTURE-BACKED AND NON

VENTURE-BACKED IPOS: GERMANY’S NEUER MARKT

THE PERFORMANCE OF VENTURE-BACKED IPOS ON

EUROPE’S NEW STOCK MARKETS: EVIDENCE FROM

FRANCE, GERMANY AND THE U.K.

THE NEUER MARKT: AN (OVERLY) RISKY ASSET OF

GERMANY’S FINANCIAL SYSTEM

Hans-Peter Burghof and Adrian Hunger 295

THE LONG-TERM PERFORMANCE OF INITIAL PUBLIC

OFFERINGS ON EUROPE’S NEW STOCK MARKETS

Giancarlo Giudici and Peter Roosenboom 329

LIST OF CONTRIBUTORS

Fabio Bertoni Politecnico di Milano, Milan, Italy

Michiel Botman University of Amsterdam, Amsterdam,

The Netherlands

Hans-Peter Burghof University of Hohenheim, Stuttgart, Germany

Lucio Cassia University of Bergamo, Dalmine, Italy

Stefanie A Franzke Center for Financial Studies and J W.

Goethe-University, Frankfurt am Main, Germany

Giancarlo Giudici Politecnico di Milano, Milan, Italy

Adrian Hunger University of Munich and Dresdner Bank AG,

Munich, Germany

Eric Nowak University of Lugano, Lugano, Switzerland

Stefano Paleari University of Bergamo, Dalmine, Italy

Pier Andrea Randone Politecnico di Milano, Milan, Italy

Georg Rindermann Allianz Group, Munich, Germany

Peter Roosenboom Rotterdam School of Management, Erasmus

University, Rotterdam, The Netherlands

Andreas Trautwein WHU Otto Beisheim Graduate School of

Management, Vallendar, Germany

Tjalling van der Goot University of Amsterdam, Amsterdam,

The Netherlands

Silvio Vismara University of Bergamo, Dalmine, Italy

Sven Vorstius WHU Otto Beisheim Graduate School of

Management, Vallendar, Germany

vii

With the opening of the Nouveau March´e in France in 1996, followed by theNeuer Markt in Germany in 1997 and the Nuovo Mercato in Italy in 1999, theopportunities for small companies to obtain a listing on European exchangeswere growing rapidly Other European countries with new stock markets includedBelgium, Denmark, Finland, Greece, Ireland, the Netherlands, Poland, Portugal,Spain, Sweden and Switzerland These stock markets had one common aim – toattract early stage, innovative and high-growth firms that would not have beenviable candidates for public equity financing on the main markets of Europeanstock exchanges Of these new markets, the Neuer Markt emerged as Europe’sanswer to NASDAQ

However, Europe’s new markets met with only limited success Many marketswere unable to attract sufficient numbers of listings to sustain market interest,while others suffered from inadequate rules or poor liquidity In addition, Europe’snew stock markets were hard-hit by the bursting of the Internet bubble The marketcapitalisation of new markets fell to record lows in 2001 and 2002 Insider tradingscandals and accounting frauds tarnished the reputation of new markets As aresult, investor confidence quickly disappeared The most painful consequencehas been the closure of EuroNM Belgium in 2001, the German Neuer Markt in

2003 and NASDAQ Europe in 2004

What went wrong? On the one hand, markets for high-growth companieswere inherently volatile The overoptimistic valuations of the Internet bubblehad to be corrected On the other hand, there were more specific reasons forthe failure of Europe’s new stock markets These lightly regulated markets werelocated at the juncture between private venture capital and main stock exchanges.They could be viewed as “public” venture capital that partially substituted fordeficient private venture capital markets in Europe However, stock marketfinancing lacked the typical provisions such as active monitoring and convenantsthat are implemented by venture capitalists to protect their investments againstinformation asymmetries and entrepreneurs’ opportunism

At the same time, listing requirements imposed by the new stock markets didnot protect investors from scandals and frauds On paper, the Neuer Markt had themost stringent listing requirements in Europe Companies had to report quarterlyearnings under U.S or international accounting standards within two months of

ix

x PREFACE

them being available and could issue only common, as opposed to preference,shares Moreover, insiders had to agree to a six-month lock-up period followingthe IPO before they could sell their shares However, the enforcement of theserules was mostly lacking For example, insiders of some companies listed on theNeuer Markt circumvented the lock-up rules and several companies reported falseannual and quarterly reports In addition, the Neuer Markt did not have kick-outclauses comparable to NASDAQ that allowed it to strike penny stocks from listing.Although many of the Neuer Markt companies became insolvent, it was relativelydifficult for these companies to be expelled from the market until October 2001.This meant that these companies continued to tarnish the reputation of theNeuer Markt

This book discusses the rise and fall of Europe’s new stock markets The bookconsists of 12 chapters We will briefly discuss each chapter in turn Chapter

1, co-authored by Giancarlo Giudici and Peter Roosenboom, describes thedevelopment of venture capital and new stock markets in Europe Markets forhigh-growth stocks offer venture capitalists a valuable exit opportunity for theirinvestments This allows them to re-invest their money in other start-up companiesand may spur new business creation and technological innovation They show thatthe private equity market in Europe today is as large as it was just before the advent

of new stock markets in 1997–1999 As such, the need for stock markets thatallow private equity investors to divest their equity stakes in growth companies didnot disappear

In Chapter 2, Giancarlo Giudici and Peter Roosenboom examine the differences

in pricing Initial Public Offerings (IPOs) on Europe’s new stock markets and onthe main stock markets of European exchanges Analyzing a large sample of 1,120European IPOs, they find that companies that went public on new markets aresignificantly smaller, younger and riskier than companies that listed on the mainmarkets They report a 22.3 percentage point difference in the average first-dayreturn of 578 companies that went public on new markets (34.3%) and the averagefirst-day return of 542 companies that went public on main markets (12%) Theyattempt to explain this difference Their results show that reduced incentives tocontrol wealth losses and differences in firm and offer characteristics partiallyexplain higher first-day returns on new markets Their results also show that theopportunity to bundle IPO deals has been important to control underpricing costs

on new stock markets However, a large part of the difference in average first-dayreturn cannot be explained by differences in sample characteristics

Chapter 3, written by Fabio Bertoni and Pierandrea Randone, analyses howcapital is raised and employed by a sample of 28 European biotechnologycompanies listed on Europe’s new stock markets from 1996 to 2000 The authorsanalyse the financing and the investment policy of these companies, and make a

Preface xi

comparison with a sample of U.S biotechnology companies listed on NASDAQ.Their results show different growth patterns among European and U.S firms.European companies primarily rely on capital raised at the time of the IPO, whileU.S companies also raise a significant fraction of capital in seasoned equity issuesafter the IPO Moreover, European companies are more aggressive in investingshortly after the IPO, especially in marketing and operating expenses, thanU.S companies

In Chapter 4, Peter Roosenboom examines the role of managerial incentives

in 188 small and entrepreneurial companies that went public on the AlternativeInvestment Market of the London Stock Exchange Managerial incentives aremeasured as the increase in the amount of executive wealth (composed of share-holdings, option holdings and human capital) per £1,000 increase in shareholderwealth He shows that managerial incentives are higher if the manager co-foundedthe firm, chairs the board of directors, and has been employed by the firm for

a larger number of years In addition, he identifies a trade-off relation betweenboard monitoring and incentives that is specific to CEOs He finds that managerswith large pre-IPO shareholdings may use the IPO as a wealth diversificationopportunity These managers receive smaller stock options grants and sell moreshares in the IPO than other managers

Chapter 5 is written by Lucio Cassia, Stefano Paleari and Silvio Vismara.They study the peer comparable approach used for the valuation of companiesthat went public on the Italian Nuovo Mercato during 1999–2002 In Italy, IPOprospectuses often report the valuation methods used by investment banks Thisallows them to analyze the accuracy of “real-world” valuation estimates Theyshow that underwriters rely on price-to-book and price-earnings multiples Thevaluation estimates generated by these multiples are closest to offer prices.Conversely, when using enterprise value ratios, comparable firms’ multiples aretypically higher than those of the firms going public They argue that underwritershave the possibility to select comparables that make their valuations lookconservative

Chapter 6 is devoted to an analysis of Internet-stock IPOs written by MichielBotman, Peter Roosenboom and Tjalling van der Goot They investigate therelevance of accounting and other information to valuing Internet IPOs during theyears 1998–2000 in Europe and the United States The authors compare EuropeanInternet companies to U.S Internet firms at the time of the IPO They find thatEuropean firms tend to report a smaller amount of loss in the year before the IPO,sell more shares to the public, have more concentrated ownership by the largestowner and experience lower first-day returns than comparable U.S Internet firms.They show that market value is negatively related to net income in the Internetbubble period before April 1, 2000 in both European and U.S IPO markets This

to buy Internet IPO shares.

Chapter 7 is written by Andreas Trautwein and Sven Vorstius This chapterlooks at the value-relevance of accounting data and measures of web-traffic forInternet firms listed on the Neuer Markt at the height of the stock market bubblefrom October 1999 to May 2000 In doing so, the chapter contributes to theunderstanding of the investment behavior of market participants during that time.They show that earnings and cash flow cannot explain the valuation of Internetcompanies, while there is a positive association between total sales and marketcapitalization In addition, sales and marketing expenses as well as research anddevelopment costs are relevant value-drivers Furthermore, they find a positiverelation between market values and a number of web-metrics such as customerloyalty, reach, page impressions, and unique visitors The authors conclude thatduring the Internet bubble measures of web-traffic were at least as relevant asfinancial data when explaining market values of Internet companies

In Chapter 8, Eric Nowak explores the stock price impact of expirations

of lock-up provisions that prevent insiders from selling their shares after theIPO He examines 172 lock-up expirations of 142 IPOs on Germany’s NeuerMarkt He reports statistically significant negative abnormal returns and a 25%increase in trading volume surrounding lock-up expiration He is the first todifferentiate between the stock price effects of mandatory lock-up provisions andthe U.S.-type private lock-up agreements between issuers and underwriters Herefers to the latter as “voluntary” lock-up agreements He shows that the averagenegative price reaction is significantly stronger for the expiration of voluntarylock-up agreements than for mandatory prohibitions of disposal He finds thatthe negative abnormal returns are larger for firms with high volatility, superiorperformance after the IPO, low free float and venture capital financed firms.Chapter 9 is authored by Stefanie Franzke This chapter sheds further light

on the role of venture capitalists and underwriters in certifying the quality of

a company She finds that many financial intermediaries are involved in IPOs

at the Neuer Markt: 104 underwriters and 148 venture capitalists In addition,she reports that venture-backed companies are less profitable compared to nonventure-backed companies The pre-IPO owners of venture-backed firms sellsignificantly more existing shares at the time of the IPO compared to the owners

of non venture-backed firms She finds no evidence for a trade-off between underwriting costs and IPO underpricing There is no support for the hypothesizedcertification role of underwriters and/or venture capitalists It does not seem to pay

non-Preface xiii

to hire a prestigious intermediary, at least as far as underpricing is concerned Onthe contrary, the involvement of a prestigious venture capitalist is associated withhigher underpricing

Chapter 10, written by Georg Rindermann, presents one of the first comparativeempirical assessments of the role of venture capitalists in the going public processand their impact on the long-term performance of IPOs in France, Germany and theUnited Kingdom His findings suggest that that there are substantial variations inthe experience and sophistication of venture capitalists In particular, internationalventure capitalists are on average older than national ones, back a larger number ofIPOs in the sample, are more often represented on the board, invest with a highernumber of syndication partners, and hold larger equity positions in portfoliofirms He reports that venture-backed IPOs do not generally outperform nonventure-backed issues Instead, only a subset of international venture capitalistsappears to have positive effects on both the operating and market performance

of portfolio firms The result that venture-backed issues do not commonlyoutperform non venture-backed ones has an important implication for research

on venture capital finance It indicates that the findings of previous studies onthe role of venture capitalists in the U.S and their influence on the operating andlong run market performance of IPO firms can generally not be transferred toEuropean countries

In Chapter 11, Hans-Peter Burghof and Adrian Hunger present a clinicalanalysis of the German Neuer Markt The authors document the initial enthusiasm

of investors for the Neuer Markt The deep crisis of the Neuer Markt is attributed

to investors’ delusion, to the burst of the Internet bubble and to the numerous cases

of frauds and defaults, that sank the image of the growth exchange and caused itsclosing The closing of the Neuer Markt and the rebranding and restructuring ofthe entire Frankfurt stock market indicate the seriousness of the crisis of Germanpublic equity markets

Chapter 12 is written by Giancarlo Giudici and Peter Roosenboom This chapterdocuments the long-run stock price performance of companies listed on Europe’snew stock markets They report that the average company that went public onthese markets has been a very poor long-term investment Investors would be leftwith an average of only 68 cents (72 cents) compared to one euro invested in thelocal market index (NASDAQ Composite index) The authors test the divergence

of opinion hypothesis of Miller (1977) as one possible explanation for why theaverage company performs so poorly This hypothesis states that overoptimisticinvestors initially set market prices above fundamental values (resulting in highfirst-day returns) and that prices gradually decline to fundamental values over time

as more pessimistic investors enter the market Their results provide some supportfor the divergence of opinion hypothesis of Miller (1977) In particular, they find

xiv PREFACE

that IPO underpricing is negatively related to long-run stock price performance.This suggests that investor overoptimism on the first trading day has a transitoryeffect on prices

Giancarlo Giudici and Peter Roosenboom

Editors

VENTURE CAPITAL AND NEW STOCK MARKETS IN EUROPE

Giancarlo Giudici and Peter Roosenboom

ABSTRACT

In this chapter we describe the development of venture capital and new stock markets in Europe We argue that markets for high-growth stocks offer venture capitalists a valuable exit opportunity for their investments This allows them to re-invest their money in other start-up companies and may spur the rate of new business creation and technological innovation The private equity market in Europe today is as large as it was just before the advent of new stock markets in 1997–1999 As such, the need for stock markets that allow private equity investors to divest their equity stakes in growth companies did not disappear.

1 INTRODUCTION

For the first time in recent history, in 2000 more companies listed in continentalEurope than in the United States In particular, 727 companies listed on the NewYork Stock Exchange and on the NASDAQ while about 900 firms went public onEuropean exchanges.1These statistics are surprising, given that the depth of theU.S financial markets has been commonly set against the shallow capital markets

in continental Europe, dominated by large mature firms, privatising companiesand business groups with interlocking ownership (Faccio & Lang, 2002; Franks

& Mayer, 1997).Ritter (2003)has highlighted the fast and significant evolution of

The Rise and Fall of Europe’s New Stock Markets

Advances in Financial Economics, Volume 10, 1–24

Copyright © 2004 by Elsevier Ltd.

All rights of reproduction in any form reserved

ISSN: 1569-3732/doi:10.1016/S1569-3732(04)10001-7

1

2 GIANCARLO GIUDICI AND PETER ROOSENBOOM

the IPO market in Europe The reason of the high level of IPO activity in Europemay be related to three recent developments:

(i) the de-mutualization of European exchanges, that favoured an aggressivemarketing policy towards attracting more firms to the stock market than inthe past;

(ii) the growth of private equity investments, especially in technology start-ups.These start-up companies went public on stock exchanges, taking advantage

of the euphoria for high tech and dot.com stock;

(iii) the establishment of new stock markets for growth and technology companies(the Neuer Markt in Germany, the Nouveau March´e in France, the NuovoMercato in Italy, EASDAQ/NASDAQ Europe, only to cite the most importantnew stock markets)

Among these recent developments, the third represents the most intriguing one inEuropean financial markets New stock markets played a crucial role in the rapidexpansion between 1998 and 2000, as well as in the dramatic decline in 2001and 2002, when the market capitalisation of new markets fell to record lows Themost painful consequence has been the closure of the German Neuer Markt in

2003 and NASDAQ Europe in 2004

Why are stock markets for small and high-growth companies important? Severalstudies suggest that these stock markets help to foster a vibrant venture capitalindustry by providing a means for venture capitalists to exit their investments Forexample,Black and Gilson (1998)argue that the opportunity to exit investmentsthrough an Initial Public Offering (IPO) explains the greater vitality of venturecapital in the United States.Jeng and Wells (2000)find that IPO activity is thestrongest driver of venture capital investments

Increased venture capital investments may lead to a higher pace of ical innovation and business creation Kortum and Lerner (2000) find that theamount of venture capital activity in an industry significantly increases its rate

technolog-of patenting They show that venture capital accounts for about 15% technolog-of industrialinnovations Hellmann and Puri (2000) find that the presence of a venturecapitalist is associated with a significant reduction in the time taken to bring aproduct to market, especially for innovators.Michelacci and Suarez (2004)showthat the earlier young firms go public the quicker venture capital can be redirectedtowards new start-ups Hence a stock market for high-growth firms may encouragebusiness creation New business creation is in turn important for employmentgrowth (Audretsch, 2002)

Stock markets are also important for economic growth.Minier (2000)examinesthe effect of opening a first national stock exchange on economic growth She findsthat countries that opened stock markets grew faster than similar countries that did

Venture Capital and New Stock Markets in Europe 3

not open exchanges.Levine and Zervos (1998)show that for every ten percentagepoint increase in the value of share trading, economic growth increases by onepercentage point.Rajan and Zingales (1998)show that a high level of financialdevelopment increases the rate of new business creation Subrahmanyam andTitman (1999)argue that when a country’s stock market reaches a critical mass,the market can “snowball” with new firms deciding to list on the stock market,making the market more liquid and efficient, which in turn attracts more firms to

go public

Taken together, these studies suggest that stock market development andventure capital are important to economic growth, new business creation andtechnological innovation Markets for high-growth stocks offer venture capitalists

a valuable exit opportunity for their investments This allows them to re-investtheir money in other start-up companies and may increase the rate of new businesscreation and the pace of technological innovation Stock markets can thus serve

as catalysts for economic growth and the creation of jobs This chapter continues

as follows Section 2discusses the evolution of venture capital, private equityand stock exchanges in Europe This section also compares the venture capitalindustry in Europe to that in the United States InSection 3we discuss Europe’snew stock markets.Section 4presents some concluding remarks

2 THE EVOLUTION OF VENTURE

CAPITAL, PRIVATE EQUITY AND STOCK

EXCHANGES IN EUROPE

This section discusses the development of European financial markets in the1990s The statistics reported about investments in venture capital and privateequity in Europe will show that there are still strong arguments suggesting thatstock markets or exchange segments specifically designed for growth firms shouldexist In particular in Europe, the flow of investments in private equity is still largerthan in 1996–1998, i.e the period in which the major new markets started theiroperations Therefore, the availability of an exit for such investments, one being

an IPO, continues to be important A much different fate has been experienced

by new market indices, in many cases fallen to their record lows, as well as thenumber of companies seeking to list their shares on new markets that has come to

a standstill

European financial markets underwent a major change during the 1990s Theadvent of the common currency and the convergence towards homogeneous in-stitutional settings of financial markets contributed to overcome national barriers,

in particular in the field of banking and intermediation services Nonetheless,

4 GIANCARLO GIUDICI AND PETER ROOSENBOOM

no relevant progress towards a single pan-European stock exchange has beenobserved (European Commission, 2001) The steady increase in cross-borderfinancial investments increased the competition between national exchanges, ashighlighted by alliances and acquisitions, sometimes only announced (such as theproject of the iX exchange between the Frankfurt and the London stock markets,

or the acquisition of the London Stock Exchange by the Stockholm Exchange)and sometimes implemented (such as the Euronext and Norex alliances).The advent of new markets around Europe from 1995 to 2000 is probably themost striking evidence that, in a favourable market momentum, stock exchangespreferred to grow internally instead of going towards integration The development

of new markets coincided, not by chance, with an unprecedented growth of privateequity investments and in particular venture capital

Private equity is defined as the investment by professional investors (such

as investment banks, closed-end funds, and business angels) in equity capital

of private companies that are often owned by a small number of shareholders.Venture capital is a specific form of private equity investment, targeted at start-upcompanies, in particular in technology sectors Venture capital is by no meansthe main source of capital for companies in industrialised countries For example,from 1990 to 1999, $137 billion has been invested in venture capital activities

in the United States During that same period companies listed on the New YorkStock Exchange and NASDAQ raised $500 billion in equity capital (NASDAQ,

2003) In Europe, the venture capital industry is even less developed, to a largerextent if we consider that in the U.S venture capital statistics exclusively relate tostart-up financing (from the seed phase to late-stage development) while Europeanstatistics refer to a more general definition that includes buy-out and replacementcapital (i.e purchases of secondary shares) Having said this, in Europe from 1990

to 2000 d85 billion has been invested in venture capital financing, while nies raised more than d200 billion on stock exchanges (European Venture CapitalAssociation, 2003)

compa-Figure 1reports the annual flow of venture capital investments, compared toGDP, in the major European countries, and in the United States, from 2000 to

2002 Interestingly, in 2000 (although it has been a record year for venture capital)investments represented only a small fraction of the countries’ wealth, and only

in the U.S and in the U.K., and in some Nordic countries such as Sweden andFinland, they played a significant role The fraction has further decreased in 2001and 2002, reflecting the negative market momentum of financial markets.Although its limited relevance in quantitative terms, venture financing has sig-nificantly contributed to the creation of small successful enterprises, in particular

in technology sectors, in which the access to external finance is a necessary dition to promote innovation and R&D activity The European Venture Capital

con-Venture Capital and New Stock Markets in Europe 5

Fig 1 Venture Capital Investments in the United States and Europe Note: Comparison

between venture capital investments in the largest European countries and in the United

States, as a percentage of Gross Domestic Product (GDP) Source:European Venture Capital

Association (2003)andPricewaterhouseCoopers (2003)

Association (2003)underlines that between 1991 and 1995 European backed companies exhibited exceptional growth rates, if compared to the EUlargest 500 companies The sales of venture-backed firms grew at a mean an-nual rate equal to 25%, twice the rate computed for large companies The number

venture-of employees in venture-backed firms grew annually at a rate venture-of 15%, compared to2% for large companies Capital expenditures of venture-backed firms increasedevery year at a rate of 25% In 1995, R&D expenses represented 8.6% of sales

in venture-backed companies, and only 1.3% of sales in large companies In arecent survey of 351 companies in their seed, start-up or expansion stage, about90% have created new jobs (European Venture Capital Association, 2002) Over-all, these 351 companies created 16,143 new jobs (an average of 46 per company)

6 GIANCARLO GIUDICI AND PETER ROOSENBOOM

Fig 2 Annual Venture Capital Investments the United States and Europe Note:

Annual venture capital and private equity investments in Europe (data in d million)

and in the United States (data in US$ million) from 1995 to 2002 Source: EuropeanVenture Capital Association (2003), National Venture Capital Association (2003), and

PricewaterhouseCoopers (2003)

Companies that received seed or start-up capital between 1995 and 2001, have anannual growth rate of 125% over the first four years after venture capital invest-ment, whereas companies that received expansion financing grew by 33% per yearduring the four year period (European Venture Capital Association, 2002) For allcompanies, venture funding was followed by a sharp increase in spending on R&D(European Venture Capital Association, 2002)

Figure 2exhibits the annual flow of venture capital investments from 1995 to

2002, in Western Europe and in the United States For Europe, the total flow ofall private equity investments is also reported After a progressive growth duringthe 1990s, venture capital fundraising and investments reached record levels in

1999 and 2000 for both the United States and Europe The National VentureCapital Association (2003)reports that in the United States, $85 billion has beeninvested in technology start-ups in 2000, +91% with respect to 1999 The flow

of all venture capital investments totalled $106 billion The maximum level hasbeen recorded during the first six months of 2000 In Europe, during the sameyear, more than 10,000 new start-up companies have been financed with venturecapital, totalling about d35 billion (European Venture Capital Association, 2003),+39% compared to 1999, with d19.7 billion directly attributable to pure venturecapital financing (+84% compared to 1999)

A steady reversal can be observed in 2001 In the United States as well inEurope, during the first quarter of that year, investments declined by 60% withrespect to 2000 The halt of the venture capital industry has been confirmed

in 2002: in the United States the flow of investments fell below the level of

1998, −49% compared to 2001 In Europe, the trend has been similar for pure

Venture Capital and New Stock Markets in Europe 7

venture capital However, the total flow in 2002 has been above the level of

1998, and the total private equity investments even increased in 2002, compared

to 2001

The fall in funds raised by venture capitalists and private equity investorshas been more dramatic In the United States, in 2000 venture capitalists raisedresources for more than $106 billion, but only about $41 billion has been raised

in 2001 (−61%) and $7.3 billion in 2002 (−93% with respect to 2000, −82%compared to 2001)

In Europe, the capital raised by venture capitalists and private equity investorstotalled d48 billion in 2000 (more than the total capital effectively invested inthe same year, as shown inFig 2), while it reduced to about d38 billion in 2001(−20%), and d19 billion in 2002 (−50% compared to 2001, −60% compared to2000) Like the flow of investments, also the flow of fundraising has experienced

a less pronounced decrease in Europe than in the United States

Figure 3reports the evolution between 2000 and 2002 of the investments, bystage of firms’ life cycle, both in the United States (a) and in Europe (b) In theUnited States the distribution of investments remained rather stable, with a slightreduction in seed and start-up financing, compared to later-stage development InEurope statistics about venture capital, as mentioned previously, take into accountbuyout investments (i.e acquisitions of established firms) and replacement capital(i.e purchases of secondary shares without subscription of new shares) In 2000,19% of total investments have financed seed and start-up companies, compared

to 8% in 1999, while 27% has been channelled to later-stage investments and41% to buyouts In 2001, and to a lower degree in 2002, investments in matureenterprises have been preferred to new ventures

Figure 4compares the evolution of venture capital investments, by businesssector, from 2000 to 2002, in the U.S (a) and in Europe (b) The figure shows that

in addition to a decrease in the flow also a re-allocation of capital among severalbusiness sectors has occurred There is a strong reduction of funds allocated tothe Internet business, while both in Europe and in the United States an increase inthe investments in the biotechnology and life sciences business is observed Thissuggests that after the burst of the dot-com bubble venture capitalists turned theirattention to growth opportunities in the biotechnology sector

Figure 4 further highlights that the ratio between professional investments

in technology business and traditional sectors in Europe has been differentfrom the United States In the United States, on average, from 2000 to 2002,more than 65% of the investments were channelled to technology companies,while the opposite is true for Europe, where about 65% of the investments havefinanced traditional sectors (buildings, agriculture, services, transports, chemicals,mechanics, commerce)

8 GIANCARLO GIUDICI AND PETER ROOSENBOOM

Fig 3 Distribution of Venture Capital Investments in the United States and Europe Note:

Distribution of venture capital investments in the United States (a) and in Europe (b) from

2000 to 2002, by lifecycle stage of the financed company Source:European Venture Capital

Association (2003)and National Venture Capital Association (2003)

Venture Capital and New Stock Markets in Europe 9

Fig 4. Industry Composition of Private Equity Investments in the United States (a) and

in Europe (b) Comparison between 2000, 2001 and 2002

Source:European Venture Capital Association (2003)and National Venture Capital ciation (2003)

Asso-In Europe, technology enterprises absorbed financial resources (from venturecapital and other private equity sources) for d11.5 billion in 2000, +68% com-pared to 1999, but seven times lower than in the U.S (PricewaterhouseCoopers,

2003) Surprisingly, in a general scenario of decreasing investments, in 2001and 2002 the relative incidence of high-technology investments increased in theUnited States, while the opposite happened in Europe

10 GIANCARLO GIUDICI AND PETER ROOSENBOOM

The general tendency in 2001 and 2002 was to give priority to the consolidation

of investments in progress, and to select opportunities in the most promising ness, such as biotechnology The relative incidence of the biotechnology sector ontotal investments increased significantly both in the United States and in Europe.Finally, it is interesting to consider the evolution of the divestments flow In theUnited States the negative market momentum and the burst of the Internet bubbletwice penalized professional investors On the one hand, divestments throughIPOs on stock exchanges fell dramatically ($4 billion in 2001 and only $2.5 billion

busi-in 2002, compared to $25 billion busi-in 1999 and almost $28 billion busi-in 2000) On theother hand, the lack of profits in Internet and technology companies, forced profes-sional investors such as venture capitalists to write-off their portfolio investments

in these companies This generated sizeable losses for professional investors

In Europe in 2001 divestments totalled d12.5 billion, compared to d9.1 billion in

2000 The most frequent exit route has been the trade-sale that accounted for d4.2billion, compared to d3 billion in 2000 Divestments through IPOs on stock ex-changes accounted for d250 million vs d570 million in the previous year In 2002divestments totalled d8.1 billion, of which 1% came from IPOs, 29.8% from trade-sales, and 28.5% from write-offs and capital losses (compared to 23.2% in 2001)

In sum, notwithstanding the negative cycle momentum following 2000, theprivate equity market in the United States and especially in Europe is as large

as it was just before the advent of new markets (1997–1999) As such, the needfor specialised exchanges that allow private equity investors to divest their equitystakes in growth companies did not disappear

3 EUROPE’S NEW STOCK MARKETS

The U.S economy has shown strong momentum in the 1990s Interestingly,much of the positive push derives from the contribution of small firms Ac-cording to the USA Small Business Administration,2 from 1990 to 1999 smallenterprises created 12 million new jobs, versus a reduction of 650,000 jobs inlarge enterprises The growth has been particularly strong in high-technologysectors (Audretsch, 2002) During the same period, continental European firms’growth rates have been significantly lower, and employment did not receivesignificant impulses

Several explanations have been suggested for the lower growth rates ofEuropean companies The less-developed capital markets in Europe can beviewed as one of the primary causes The scope of capital markets in Europe isthought to be limited because of the poor legal protection of shareholders thatreduces the willingness of investors to hold securities in European companies (La

Venture Capital and New Stock Markets in Europe 11Porta et al., 1997) From 1992 to 1995, more than 2,200 companies listed on U.S.exchanges, while in Europe only 800 firms went public during the same period.Moreover, firms listed in Europe during that period have been essentially largeand mature companies, with no need to raise capital, scarce growth opportunities,and seeking to reduce their debt burden (Pagano et al., 1998).

European technology firms seeking to raise equity capital preferred to list inthe United States.Pagano et al (2002)show that from 1986 to 1997 the number

of European companies listed in the U.S has been growing, while the number ofU.S firms listing in Europe has been decreasing In 1998, 135 EU companies had

a listing on the NASDAQ (52 from the U.K., 18 from the Netherlands, 15 fromSweden, 14 from Ireland, 3 from Germany and 2 from Italy)

The national governments and the European Commission quickly becameaware of the need to reform financial markets, and pointed to the poor development

of venture capital and equity investments as one the fundamental reasons for

Market Country Total Capitalisation/ Listed

Capitalisation a GDP(%) Companies TechMark/AIM b UK 391,395 27.52 914 Neuer Markt Germany 9,928 0.54 240 Nuevo Mercado Spain 9,576 1.64 13 Nouveau March´e/Euronext France 6,954 0.53 147 Nuovo Mercato Italy 6,438 0.59 45

Nieuwe Markt/Euronext The Netherlands 379 0.01 11 New market NEHA Greece 122 0.01 5 Euro-NM Belgium/Euronext Belgium 57 0.02 11 Novo Mercado/Euronext Portugal – – – NASDAQ United States 1,994,494 19.91 3,649

Source:Federation of European Stock Exchanges (2003) , NASDAQ (2003) , Internet URLs of exchanges.

a Data in d million.

b Statistics for AIM only are as follows: 704 listed companies, total capitalisation d15,760 million.

c The ratio is not significant, since the majority of listed companies are foreign firms.

d Nya Marknaden is not a regulated market of the Stockholm Exchange, although it shares the same trading platform.

12 GIANCARLO GIUDICI AND PETER ROOSENBOOM

the inferior competitiveness of EU companies in comparison to their U.S.counterparts (European Commission, 1993, 1995) The strategic priority ofdeveloping private equity investments has been repeated in the report written

by the Lamfalussy Committee (European Commission, 2001) and by the GreenPaper on entrepreneurship (European Commission, 2003)

The reform of stock exchanges has been one of the urgent topics in thereform agenda In a few years, ad hoc exchanges for small growing companies(the new markets) opened in most EU countries, targeted particularly at newtechnology-based small firms, that apparently could not find their way to existingestablished stock markets Some of these new markets attempted to join in apan-European network (Euro.NM) so as to provide cross-national visibility forlisted companies However, the Euro.NM network was disbanded in 2000.Table 1 lists all new markets established in Europe since 1995, and themost relevant statistics (capitalisation and listed companies) are reported (as atJanuary 1, 2003)

The main distinctive features of new markets, compared to the main boards ofthe exchanges are the listing requirements and the mechanisms in order to provideliquidity The two parts ofTable 2compare listing requirements of the major newmarkets in continental Europe, with those of the corresponding main boards.Generally, listing requirements of new markets are less tight than on main boards,both for company age and for profitability In fact, new markets are targeted atyoung small firms that are not profitable at the time of the IPO, but that have largegrowth opportunities that need to be financed In general, EU stock exchangesrequire a track record of three years to firms listing on main boards (two years

on the French Second March´e), while in new markets the minimum age is oneyear Only the German Neuer Markt and Euro.NM Belgium require three years.However, in many cases exceptions are tolerated by these two new markets andeven start-up companies (with a track record of less than one year) have beenadmitted to listing

As far as the company size is concerned the German, French, Dutch andItalian exchanges require a book value of the equity capital lager than d1.5million Euro.NM Belgium requires an expected market capitalisation largerthan d2 million NASDAQ Europe sets alternative rules, combining expectedcapitalisation, equity capital and sales On the main boards, requirements aremuch more diversified (the equity book value must be larger that d1.25 million

in Germany, but larger than d15 million in Belgium and France, and more thand17 million in Switzerland)

New markets belonging to the former Euro.NM network as well as the SwissSWX New Market require IPO companies to raise new equity with the issue of pri-mary shares (at least 50% of the offer proceeds, that must be larger than d5 million)

(a) Listing Requirements on Europe’s New Stock Markets (December, 2002)

Neuer Markt Germany Three years; equity book value larger

than d1.5 million

At least half of the IPO shares must be newly issued; IPO proceeds larger than d5 million

25% or 10% if IPO proceeds are larger than d5 million (with at least 100,000 shares)

Compulsory for 6 months

Nuovo Mercato Italy One year; equity book value larger

than d1.5 million

At least half of the IPO shares must be newly issued; IPO proceeds larger than d5 million

20% (with at least 100,000 voting shares)

Compulsory for 12 months on at least 80%

of the shares EASDAQ (NASDAQ

Europe)

Belgium Equity book value larger than d10

million and gross income equal to at least d1 million, or equity book value larger than d20 million, or market capitalisation larger that d20 million, with revenues larger than d50 million

No specific rule; dual offerings and listings on NASDAQ are welcome

20% owned by at least

100 different shareholders

Compulsory, for 6 months on at least 80%

20% (with at least 100,000 voting shares)

Compulsory for 12 months on at least 80%

of the shares Nieuwe Markt

(Euronext

Amsterdam)

The Netherlands

Equity book value larger than d1.5 million

At least half of the IPO shares must be newly issued; IPO proceeds larger than d5 million

20% (with at least 100,000 voting shares)

Not compulsory

Euro.NM Belgium

(Euronext Brussels)

Belgium Three years; expected market

capitalisation no lower than d2 million

At least half of the IPO shares must be newly issued; IPO proceeds larger than d5 million

25% (in some cases 10%) Compulsory for 12

months

SWX new market Switzerland One year; equity book value larger

than CHF 2.5 million (d1.7 million)

At least half of the IPO shares must be newly issued

20% (with at least 100,000 voting shares)

Compulsory for 6 months

(b) Listing Requirements on Europe’s Main Stock Market Segments (December, 2002)

Amtlicher Handel

Geregelter Markt

(Deutsche B¨orse)

Germany Three years (no constraint for

Geregelter Markt); expected capitalisation no lower than d1.25 million (minimum equity book value equal to d250,000 for Geregelter Markt)

No specific rule At least 25% (20% on

SMAX segment); no specific rule for the Geregelter Markt

Not compulsory

Mercato Telematico

Azionario

Italy Three years; expected capitalisation

larger than d5 million

No specific rule At least 25% (35% on

STAR segment)

Not compulsory Premier March´e

Second March´e

(Euronext Paris)

France Two years; recommended expected

capitalisation larger than d15 million

No specific rule At least 10% (25% on

Three years; equity book value larger than d5 million; the company must have reported profits at least three times during the last five years a

least 180 days) only if the company reports losses

Eerste Markt

(Euronext Brussels)

Belgium Three years; expected capitalisation

larger than d15 million

No specific rule No lower than 10% (25%

recommended) Floating capital must capitalise at least d5 million

Not compulsory

SWX Swiss Exchange Switzerland Three years; expected capitalisation

larger than CHF25 million (d17.2 million)

Source:Internet URLs of stock exchanges.

a The requirement about profitability does not apply if the firm’s expected capitalisation is larger than d150 million.

Venture Capital and New Stock Markets in Europe 15

As on main markets, companies that go public on new stock markets mustappoint a sponsor that supports the company in its communications with thefinancial community The liquidity is provided by market makers and brokers thatare appointed by the companies Their role is to continuously display bid and askprices for the shares

The recommended floating capital, that may be potentially traded on the market,varies from 20 to 25% (in some cases, for large capitalisation companies, 10%

is enough) With respect to this requirement, there are no significant differencesbetween main and new markets In order to reduce information asymmetries withinvestors, firms and sponsors are often requested to maintain a regular flow ofinformation towards the market by organizing regular meetings with analysts and

by providing research coverage

A further guarantee is provided through lock-up contracts, in which pre-IPOshareholders refrain from selling (part of) their shares after the listing, for a givennumber of months The provision aims at avoiding excess in the supply of shares

in the aftermarket (that could depress the share price) and above all at preventinginsider trading In fact, inside investors could be tempted to take their firm publicand sell shares in order to take advantage of temporarily overoptimistic valuations

By committing to hold their shares, they signal their favourable expectationsabout the firm’s value in the future

Lock-up provisions are compulsory on almost all new markets, for a periodvarying from 6 to 12 months, on a fraction of shares held by pre-IPO ownersvarying from 80 to 100% In none of the counterpart main boards lock-ups arecompulsory (the only exception is the Dutch stock exchange, that requires alock-up provision for unprofitable firms)

In the following sections the main characteristics of the major European newmarkets will be described in detail

3.1 AIM and the TechMark Segment (United Kingdom)

In Europe the first successful stock market for small and medium size companies,albeit not necessarily technology companies, has been the AIM (AlternativeInvestment Market), established in 1995 by the London Stock Exchange Thespecial feature of AIM companies is the size, sometimes very small In fact, nominimum capitalisation and floating capital are requested to list on this exchange.The only listing requirement is the adoption of accounting standards in accordancewith the international generally accepted rules Listing companies have to appoint

an advisor, guaranteeing the quality of the company to investors, and a broker

16 GIANCARLO GIUDICI AND PETER ROOSENBOOM

Fig 5. AIM (Alternative Investment Market) and TechMark Segment

providing liquidity with bid and ask prices Shareholders are requested to lock-uptheir shares for at least 12 months from the listing

The AIM took the place of the Unlisted Securities Market (USM), an ulated market that was set up in 1980.Figure 5shows that new listings on AIMhave been numerous, not only up to 2000, but also in the following months,despite the negative market momentum, described by the FTSE AIM marketindex performance, reported in the same figure

unreg-In 1999 the London Stock Exchange opened TechMark, a specific segment ofthe main board targeted at high-technology companies This segment has beenjoined by companies in the following businesses: computer hardware, computerservices, Internet, semiconductors, software, and telecommunications The listing

on the main board of the London Stock Exchange precedes the admission at theTechMark segment As a rule, companies must therefore be at least three yearsold However, high growth companies with an expected market capitalisation of

at least £50 million and offer proceeds of at least £20 million may be exemptedfrom this listing requirement

3.2 Nouveau March´e (France), Euro.NM Belgium and

Nieuwe Markt (the Netherlands)

The Nouveau March´e started its activity in France in March 1996, alongside themain market (Premier March´e) and the second market (Second March´e) Candidatefirms should exhibit a book equity value no lower than d1.5 million The IPOproceeds should be no lower than d5 million, of which at least 50% from primarynewly issued shares The floating capital must be equal to at least 20% (divided

Venture Capital and New Stock Markets in Europe 17

in at least 100,000 shares) Pre-IPO shareholders must comply with a lock-upprovision on at least 80% of their shares for a period of 12 months

Euro.NM Belgium opened in January 1997 Firms going public on thisexchange must be at least three years old, and capitalise at least d2 million Inthe Netherlands, the Nieuwe Markt (NMAX) opened in February 1997 Listingrequirements are the same imposed by the Nouveau March´e in Paris, althoughlock-up provisions are not compulsory for all the listing companies

The three new markets joined to form the Euro.NM alliance in 1997, with theaim to “improve the cooperation between EU exchanges in order to create anddevelop a pan-European stock market for growth companies.” Afterwards, thenetwork has been joined also by the German and Italian new markets, but thesubstantial failure of the objective to establish a pan-European exchange causedits abandonment, leaving full autonomy to single national new markets A furtherobstacle towards the integration has been the establishment of the Euronextalliance in September 2000, grouping the exchanges in Paris, Amsterdam andBrussels, and later Lisbon

In the context of the restructuring plan of the merged exchanges, the largestcompanies listed on the respective new markets from January 2002 have beenincluded in the NextEconomy segment (designed for high-tech companies) and inthe NextPrime segment (designed for growth companies in traditional business).Figure 6describes the evolution of the number of listed companies from 1996

to 2002 on the three Euronext new markets, and the market performance of thelargest one, the Nouveau March´e While the Dutch and Belgian exchanges did notflourish, the French Nouveau March´e progressively grew up to the level of 160listed companies, although in 2002 the number has been reduced by the transfers

of some companies to the main boards of the Paris Bourse

Fig 6. Nouveau March´e, EuroNM Belgium and Nieuwe Markt

18 GIANCARLO GIUDICI AND PETER ROOSENBOOM

3.3 NASDAQ Europe (EASDAQ)

EASDAQ (European Association of Securities Dealers Automated Quotation) wasfounded in 1996 by a group of financial and banking intermediates, supported bythe European Venture Capital Association (EVCA), with the aim to “promote theeconomic development and the innovating activity of young technology firms,looking forward to financing their growth.”

Listing requirements are significantly different from other European newmarkets In detail, it is necessary that the firm complies with one among thefollowing criteria: (i) accounting value of the total assets no lower than d5 million,and gross income no lower than d1 million; or (ii) equity book value larger thand20 million, or (iii) expected capitalisation no lower than d20 million with sales

no lower than d50 million In some respects, the admission requirements aretighter than on other European new markets The floating capital must be nolower than 20%, owned by at least 100 different investors Lock-up provisionsare compulsory on 80% of the shares owned by pre-IPO shareholders, for at least

6 months No particular conditions for the public offerings are imposed A specialfeature of EASDAQ is that at least two market makers should compete in order

to provide liquidity Dual listing on the U.S NASDAQ is encouraged

Figure 7describes the progress of the number of companies listed on EASDAQfrom 1996 onwards and of the index market performance In 2000, after an initialexpansion, the exchange experienced a continued reduction in the number of listedfirms, due to the competition with national new markets Several firms abandonedthe market, because of takeovers or defaults, while only a few new companies wereadmitted to trading In March 2001, with the aim to boost its activity, the market hasbeen acquired by NASDAQ, and changed its name in NASDAQ Europe The mar-ket index performance has been one of the worst among all European new markets

Venture Capital and New Stock Markets in Europe 19

NASDAQ Europe clearly failed its objective to build a cross-national exchange,and to provide visibility to foreign investors for their firms The success of thenational new markets demonstrated that a single pan-European exchange wouldremain a distant vision The most striking evidence is the number of listed firms thatchose to de-list from the NASDAQ Europe in 2001 and 2002 and to concentratethe trading in their national exchanges (for example, the companies AISoftw@re,Innogenetics, Ubizen, Melexis) In 2004 NASDAQ Europe closed its doors

3.4 The Neuer Markt (Germany)

The story of the German Neuer Markt, from its opening in January 1997 up to theannouncement of its closure in 2003, illustrates the rise and fall of all Europe’snew markets The Neuer Markt succeeded to attract hundreds of companies in afew years time, and became the largest new market in continental Europe At itsheight, in March 2000, the capitalisation exceeded d200 billion, equal to about10% of German GDP

Firms listing on the Neuer Markt must be three years old (but exceptions havebeen frequent), exhibit a book equity value larger than d1.5 million and a floatingcapital equal to 25% (10% if the company capitalisation is sufficiently large) Half

of the IPO shares must be newly issued Lock-up covenants on a 6-months basis arecompulsory The listing firm is requested to publish the IPO prospectus both in Ger-man and in English, and must commit to organise regular meetings with analysts

An advisor (Betreuer) and a broker acting as a market maker must be appointed.

Figure 8describes the growth of the market index performance and the increase

in the number of listed companies, that grew close to 350 companies, but soon

Fig 8. Neuer Markt

20 GIANCARLO GIUDICI AND PETER ROOSENBOOM

declined because of defaults and distressed firms expelled from listing for theirlow level of capitalisation

The scandals that lead to the collapse of the Neuer Markt are numerous.Its closure in 2003 and the consequent transfer of the listed companies to themain segments of the Deutsche B¨orse have been justified by the loss of investorconfidence

3.5 The Nuovo Mercato (Italy)

The debate about the incapability of the Milan Stock Exchange to attract firms,

in particular small and medium size enterprises, has been long-lived in Italy Thenumber of privately owned industrial companies that can be potentially admitted

to the listing is much larger than the number of companies actually floated on theItalian Exchange

The first initiative, with the opening of a second market (Mercato Ristretto)

in 1977, to attract small capitalisation companies substantially failed.Figure 9describes the evolution of the Mercato Ristretto, in terms of new listings, from

1995 to 2002, compared with numbers from the Nuovo Mercato

Figure 9 demonstrates the slow but consistent decline of the number ofcompanies listed on the Italian Mercato Ristretto The main reason of such failure

is a process of adverse selection The best companies listing on this secondmarket, after a period of seasoning, transferred to the main board of the exchange,while their mediocre counterparts remained, causing an impoverishment of themarket In fact, the image of the Mercato Ristretto has never been associated

to dynamic ambitious firms, but to small co-operative banks and local utilitiesstrongly influenced by public administrations

Fig 9. Mercato Ristretto and Nuovo Mercato

Venture Capital and New Stock Markets in Europe 21

Only in 1998, after the demutualization of the stock exchange, reformsgained new momentum Listing requirements (that admitted to the tradingonly companies with a three-years track of profits) have been relaxed In fact,

in the previous years several Italian technology companies (such as Algol,AISoftw@re, Union Technology, Gruppo Formula, Instrumentiation Laboratoryand Orthofix International) had decided to go public on foreign exchanges such

as the EASDAQ, the NASDAQ or the French Nouveau March´e, because theycould not find an appropriate listing venue on the Italian Exchange

The Nuovo Mercato opened in 1999, joining the Euro.NM network, after a bate about which choice should be better for the Italian Exchange (promote the pan-European market EASDAQ, or promote a national new market) The development

de-of the Nuovo Mercato coincided with the height de-of investors’ euphoria for Internetand high-tech stock, so that in a few months the Italian new market exceeded thecapitalisation of the French counterpart, born three years before From the secondhalf of 2000, the Nuovo Mercato suffered the world crisis of stock markets, so thatonly a handful of companies listed in 2001 and none in 2002 (seeFig 9).The admission requirements imposed by the Nuovo Mercato are equal to theones requested by the French Nouveau March´e However, the exchange alsoaccepted some start-up companies, less than one year old In this case, lock-upprovisions must be extended for one year on 100% of the equity capital owned bypre-IPO shareholders and on 80% for two years

The Italian new market, despite the significant fall of the market index, did notexperience cases of firms’ default However, in some cases relevant restructuringplans have been implemented because of financial distress In other cases,investors discovered that false information was given in the IPO prospectusesabout company sales

3.6 New Markets in Other European Countries

Between 1999 and 2000, several European exchanges opened market segmentsfor growth and technology companies, imitating the experience of the largest newmarkets In Spain, the Nuevo Mercado was established in April 2000 The first 10companies listed on the Nuevo Mercado transferred from the main board of theexchange, and were operating in high-tech sectors The largest company by far hasbeen Terra Networks (now Terra-Lycos) The Spanish Nuevo Mercado is the onlynew market, among the others, accepting the flotation only of profitable companies

In Portugal, the Bolsa Valores in Lisbon joined the Euronext alliance in 2001,opening a specific market for growth companies (the Novo Mercado), although

at the moment no companies are listed on this new market

22 GIANCARLO GIUDICI AND PETER ROOSENBOOM

In Nordic countries the Stockholm Exchange opened the Nya Marknaden in

1997, but differently from other new markets, it is an over-the-counter segmentexploiting the same trading platform of the official market In Finland there is astock market for small capitalisation firm (I-List) but in 1999 a new market forgrowth companies opened (NM-List) Denmark opened its own KVX GrowthMarket in September 2000 Ireland followed with the ITEQ market

In Switzerland, the SWX New Market started to operate in 1999, hosting severalforeign (and even large) companies especially in the biotech/pharmaceuticalsector In 2001, Greece opened the market NEHA (or NEXA) for innovativecompanies In Eastern Europe, Poland opened a segment in the Warsaw Exchangefor technology firms (SiTECH) in 2000

New markets have been established outside Europe as well In November 1999Japan established an exchange for entrepreneurial start-ups (Mothers) as well asSingapore (SESDAQ), Hong Kong (Growth Enterprise Market), Brazil (NovoMercado) and the Vancouver Exchange in Canada (Canadian Venture Exchange)

4 CONCLUDING REMARKS

In 1996, the lack of an early exit route for venture capitalists from technology based companies was described as the Achilles’ heel of Europe

young-(Financial Times, March 5 1996) In 1997, a survey of the European Venture

Capital Association showed that 70% of venture capitalists experienced culties in exiting their investments Many venture capitalists considered an IPO

diffi-as the ideal exit route because it wdiffi-as one of the most profitable exits for themand allowed incumbent management to stay in charge But at that time it wasconsidered not a viable option for many small companies (European VentureCapital Association, 1997) The new markets were a first attempt to offer venturecapitalists an attractive exit route for their investments in early stage companies.These markets are important from a policy perspective Previous research hasshown that well-developed stock markets lead to a vibrant venture capital industrythat in turn spurs technological innovation and new business creation (Black &Gilson, 1998; Michelacci & Suarez, 2004) In addition, a high level of financialdevelopment can act as a catalyst for economic growth (Levine & Zervos, 1998;Rajan & Zingales, 1998) It may also help to create new jobs For example,Seifert(2002)estimates that the Neuer Markt in Germany has helped to create a total of700,000 jobs

But how do you get sustainable markets for growth stocks? One possibleanswer may be to increase transparency and investor protection Increasing thelevel and scope of disclosure increases the accuracy of asset pricing and may

Venture Capital and New Stock Markets in Europe 23

restore investor confidence (Fox, 2000; La Porta et al., 1997) Although on paperEurope’s new stock markets had stringent disclosure regimes, the enforcement

of these rules left a lot to be desired Venture capitalists and investment banksbrought companies to the market without adequately informing investors aboutthe risks European stock exchanges have recognised the importance of effectivedisclosure For example, the Frankfurt Stock Exchange has established a PrimeStandard segment Companies that list on this stock market segment have to meetadditional disclosure requirements

The private equity market in Europe is as large as it was just before the advent

of new markets (1997–1999) As such, the need for stock markets that allowprivate equity investors to divest their equity stakes in growth companies didnot disappear A recent survey of Grant Thornton (2002) shows that 10% ofmedium sized companies in Europe prefer going public as an option for change

of ownership in the next three to five years Among medium sized companiesthe biggest impediment to an IPO is their company size Companies believe theyshould ideally have a value of d21–50 million before flotation This highlights thecontinued need for stock markets in Europe that allow small and medium sizedcompanies to go public

Black, B S., & Gilson, R J (1998) Venture capital and the structure of capital markets: Banks versus

stock markets Journal of Financial Economics, 47, 243–277.

European Commission (1993) White paper on growth, competitiveness and employment: The lenge and ways forward into the 21st century.

chal-European Commission (1995) Green paper on innovation.

European Commission (2001) Final report of the Committee of Wise Men on the regulation of european securities markets.

European Commission (2003) Green paper: Entrepreneurship in Europe http://europa.eu.int/comm European Venture Capital Association (1997) Better exits http://www.evca.com

European Venture Capital Association (2002) Survey of the economic and social impact of venture capital in Europe http://www.evca.com

24 GIANCARLO GIUDICI AND PETER ROOSENBOOM

European Venture Capital Association (2003) Yearbook http://www.evca.com

Faccio, M., & Lang, L H P (2002) The ultimate ownership of Western European corporations Journal

of Financial Economics , 65, 365–395.

Federation of European Stock Exchanges (2003) Information and statistics http://www.fese.be

Fox, M (2000) The securities globalization disclosure debate Washington University Law Quarterly,

78, 567–596.

Franks, J., & Mayer, C (1997) Corporate ownership and control in the UK, Germany, and France.

Journal of Applied Corporate Finance , 9, 30–45.

Grant Thornton (2002) European new markets guide 2002.

Hellmann, T., & Puri, M (2000) The interaction between product market and financing strategy: The

role of venture capital Review of Financial Studies, 13, 959–984.

Jeng, L A., & Wells, P C (2000) The determinants of venture capital funding: Evidence across

countries Journal of Corporate Finance, 6, 241–289.

Kortum, S., & Lerner, J (2000) Assessing the contribution of venture capital to innovation Rand

Journal of Economics , 31, 674–692.

La Porta, R., Lopez-De Silanes, F., Shleifer, A., & Vishny, R W (1997) Legal determinants of external

finance Journal of Finance, 52, 1131–1150.

Levine, R., & Zervos, S (1998) Stock markets, banks, and economic growth American Economic

Review , 88, 537–558.

Michelacci, C., & Suarez, J (2004) Business creation and the stock market Review of Economic

Studies , 71, 459–481.

Minier, J (2000) Opening a stock exchange Working Paper, University of Miami.

NASDAQ (2003) The NASDAQ-AMEX fact book & company directory.http://www.nasdaq.com

National Venture Capital Association (2003) Venture Capital Yearbook.http://www.nvca.com Pagano, M., Panetta, F., & Zingales, L (1998) Why do companies go public? An empirical analysis.

Journal of Finance , 53, 27–64.

Pagano, M., R¨oell, A A., & Zechner, J (2002) The geography of equity listing: Why do companies

list abroad? Journal of Finance, 57, 651–694.

PricewaterhouseCoopers (2003) Money for growth – Technology investment report.

Subrahmanyam, A., & Titman, S (1999) The going public decision and the development of financial

markets Journal of Finance, 54, 1045–1082.

PRICING INITIAL PUBLIC OFFERINGS

ON EUROPE’S NEW STOCK MARKETS

Giancarlo Giudici and Peter Roosenboom

ABSTRACT

In this chapter we investigate whether the pricing of IPOs on Europe’s new stock market differs from that of IPOs on main market segments We report a 22.3 percentage point difference in the average first-day return of new market IPOs (34.3%) and the average first-day return of main market IPOs (12%).

We show that reduced incentives to control wealth losses and different firm and offer characteristics partially explain the higher average first-day return

on new market segments We also find that the bundling of IPO deals has been more important to control underpricing costs on new market than on main market segments.

1 INTRODUCTION

During the latter half of the 1990s new stock markets designed for high-growthand high-tech fledgling companies have been established around Europe: theFrench Nouveau March´e (first listing March 20, 1996), the German NeuerMarkt (first listing March 10, 1997), Euro.NM Belgium (first listing April 11,1997), the Dutch Nieuwe Markt (first listing March 25, 1997), the Italian NuovoMercato (first listing June 17, 1999) and EASDAQ (now NASDAQ Europe, firstlisting November 27, 1996).1From 1996 to 2002, 675 companies listed on these

The Rise and Fall of Europe’s New Stock Markets

Advances in Financial Economics, Volume 10, 25–59

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ISSN: 1569-3732/doi:10.1016/S1569-3732(04)10002-9

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26 GIANCARLO GIUDICI AND PETER ROOSENBOOM

exchanges, mostly after an IPO (Initial Public Offering) The admission criteria ofnew market segments are different and generally less strict than that of main marketsegments (for example, start-up companies are allowed to list on new markets and

at least half of the shares sold in the IPO must be newly issued) These new marketsare therefore meant to appeal to a different type of company than main marketsegments

The purpose of this chapter is to investigate whether the pricing of IPOs onEurope’s new stock markets differs from that of pricing IPOs on main marketsegments We analyze 578 IPO firms listed on new stock markets and 542 IPOfirms listed on main stock markets (the French Second March´e, the GeregelterMarkt and Amtlicher Handel of the Frankfurt Stock Exchange, the Belgian EersteMarkt, the Dutch Offici¨ele Markt and the Italian Mercato Telematico Azionario)from January 1990 to December 2002

Our study contains three contributions to the literature First, we analyze acomprehensive sample of 1,120 European IPO firms on both new stock marketsand main stock markets Second, we investigate pre-IPO ownership structure andsecondary sales Pre-IPO ownership structure and secondary sales have not beenanalyzed in previous studies on IPO pricing in Europe (but see Ljungqvist &Wilhelm, 2003, for evidence from the United States) New stock markets imposerestrictions on companies regarding the composition of the IPO At least half ofthe shares sold to the public must be newly issued This implies that no morethan half of the IPO shares can be sold by pre-IPO owners In the United States,such rules regarding IPO composition do not exist Third, our paper builds on theemerging literature examining why IPO first-day returns have increased during the1996–2000 period in the United States (Ljungqvist & Wilhelm, 2003; Loughran

& Ritter, 2003) We take a similar approach to explore if the IPO pricing process

of new market IPOs differs from that of main market IPOs

We document that new market IPO firms are smaller, younger and riskier thanmain market IPO firms They more frequently report losses in the year beforethe IPO and a larger fraction of new market IPO firms are from the Internetand technology sector We report a 22.3 percentage point difference in theaverage first-day return of new market issues (34.3%) and the average first-dayreturn of main market issues (12%) We show that reduced incentives to controlwealth losses and differences in firm and offer characteristics partially explainhigher first-day returns on new markets We also show that the opportunity tobundle IPO deals has been important to reduce underpricing costs on new stockmarkets However, a large part of the difference in average first-day return cannot

be explained by differences in incentives to control wealth losses, bundling,firm and offer characteristics, post-pricing spillover variables or hot issuemarkets