Financial regulation and IPOs: Evidence from the history of the Italian stock market

AbstractIn different conditions, financial regulation has different impacts on the development of

public equity markets. By covering the population of 879 IPOs from the unification of

Italy (1861) to today, this is the first paper that examine the effects of different

regulatory regimes on the survival of IPOs in a long run perspective. We find that when

the demand for investor protection is high, the stricter listing requirements increase IPO

survival. In presence of a high demand for easier capital formation on the financial

markets, survival of newly listed firms is shorter, but the number of firms going public

does not grow.

Key words: IPOs; Regulation; Survival; Investor protection; Italy

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1. Introduction

The number of firms going public has declined over the last decade. This has generated

an intense debate, involving academics, as well as policy-makers and stock exchange

officials. The drop in number of IPOs has been attributed to a regulatory overreach, in

which regulatory changes, such as the Sarbanes-Oxley Act of 2002 (SOX) and SOX-

like provisions in Europe, are blamed responsible. The increased compliance costs that

these tighter regulations imposed on publicly traded firms, meant to prevent the repeat

of corporate scandals (e.g. Enron, WorldCom, Parmalat), reduced the attractiveness of

being public*. Gao, Ritter and Zhu (2013) propose a different explanation. In recent

years, the number of IPOs declined as a private firm is much more likely to be acquired

than to go public, due to the higher importance of fast time-to-market and to the higher

economies of scope that can be achieved through a merger with a strategic, established

acquirer. However, they also agree that regulatory changes could help in restoring a

higher number of IPOs. On the other side, the financial crisis comes with an increased

demand for regulation, meant to counteract the destruction of trust which stops trades

and investments (Sapienza and Zingales 2012). In financial critical conditions, indeed,

regulatory interventions could be a way to curb widespread distrust among investors

and foster the functioning of the financial markets (Glaeser and Shleifer 2003).

The effectiveness of regulation is controversial (Shleifer 2005; Zingales 2009). Recent

IPO studies find that the level of uncertainty is lower for IPOs issued after tightening

regulatory changes (Johnston and Madura 2009; Ekkayokkaya and Pengniti 2012; Shi et

al. 2012). Akyol at al. (2012) show that the effects of SOX-like provisions adopted by

EU Member States have been effective in reducing the uncertainty surrounding

valuations in regulated markets. In contrast, the average level of underpricing of IPOs

on the exchange-regulated markets, primarily the London Stock Exchange’s Alternative

Investment Market (AIM), which were not affected by the new rules, did not decline

after the adoption of the corporate governance codes. From an historical perspective,

Chambers and Dimson (2009) highlight that regulations has been less effective than

market forces at reducing information asymmetry in UK IPOs. Two studies investigate

the relationship between of regulation and IPO survival. Simon (1989) finds that the US

* See , for instance, the article “The Demise of the IPO Market--and Ideas on How to Revive It” by J. Zweig in the Wall Street Journal, June 25, 2010.

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Securities Act of 1933 did not the failure rate of firms listed NYSE. Burhop et al.

(2012) find that the IPO failure rate was similar on the Berlin and the London financial

markets at the beginning of the twentieth century, even if they were characterized by

two different levels of regulation. However, these studies refer to concise periods of

time, up to 15 years). Our paper is the first to evaluate the impact on IPO survival of the

evolution of the regulatory framework on financial markets over time.

We contribute to the debate drawing upon the political economy of finance to study the

consequences of regulatory interventions occurring under dissimilar market conditions

on financial development. This theory offers a clue to identify when and why one can

expect financial regulation to change over time, evaluating financial reforms and their

feasibility (Pagano and Volpin 2001). Specifically, through the guidance of the public

and private interest theories, we entail explaining the effects of regulatory changes

taking place in different conditions. Examining the extent to which public and private

interests may influence the design of new regulatory interventions, we analyze the

implications of regulation for financial development.

Rules typically need complementary enforcement to be effective (Leuz and Wysocki

2008) and their effects should be evaluated as a whole. A long-run perspective is

therefore required to consistently evaluate the effects of regulation on the capital

markets (Levine 2011). With reference to the entire population of IPOs in Italy since its

unification in 1861, we investigate the impact of major changes in regulation on the

number of firms going public per year and on their survival profile. IPO-firms’ survival

is often considered a measure of capital market development (Fama and French 2004;

Burhop et al. 2012) and laws have been intended to ensure its growth (La Porta et al.

2002). As suggesting by the “law and finance literature”, better regulated capital market

develops corrective mechanisms and remedies to address information asymmetries

increasing the survival of firms going public (La Porta et al. 1997a, 1998).

The population 879 IPOs in the period 1861-2011 offers the opportunity to examine the

evolution of the Italian regulatory framework along the political and economic changes

occurred over a long time period. The Italian context here represents an ideal framework

to investigate the evolution of regulation, because Italy has been characterized for a long

time by a weak protection for both shareholders and creditors (La Porta et al. 1998), and

recently evolved into one of the developed countries in terms of shareholder protection

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(Enriques 2003). We investigate the effects of the long-run evolution of regulation

occurred in Italy, focusing on the impact of four different regulatory regimes (1861-

1935, 1936-1973, 1974-1997, and 1998-2011) that we identified adapting the

classification of the Italian legal framework provided by Aganin and Volpin (2005).

We find a significant increase in the IPO survival when regulatory interventions occur

in periods of higher demand for investor protection, while a decrease is registered when

a demand for regulation aimed to enhance capital formation. The aim of capital

formation are not reached, if measured in terms of number of firms going public.

Controlling for macroeconomic variables, the shorter survival profile of firms going

public after restricting regulatory changes is not accompanied by an increase in the

number of IPOs per year, scaled by GDP.

This paper is organized as follow. Section 2 develops the testable hypotheses. Section 3

describes the evolution of the Italian regulatory framework identifying different

regulatory regimes over time. Section 4 presents the data, the sample and the

methodology. Section 5 reports the results and Section 6 concludes.

2. Literature review and testable hypotheses

Regulators face indeed difficulties to strike the right balance between investors

protection and an effective capital raising strategy (Ritter 2013). IPO markets offer an

interesting setting in which to calibrate the effectiveness of financial regulation, testing

whether new regulatory interventions are able to explain IPO market development.

Regulation is an inevitably dynamic issue and is driven by external conditions. In

practice, how regulation evolves in time and its effects on the financial markets is still

an unexplored issue. We aim to address this issue considering the impact of regulatory

regimes that develop when different conditions and interests are in place. According to

two competing views, the public and the private interest motives for regulation, we elaborate two sets of hypotheses explaining how the demands for regulation arises.The need to correct market failures and protect investors from harm is one of the basic

fundamentals of government regulatory interventions (Joskow and Noll 1981). The

literature on political economy of finance suggests that in these cases regulation calls in

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“public interest”, law interventions are meant to provide more stability to the financial

system as a whole (Pagano and Volpin 2001). However, interventions cannot occur

without costs, such as the amount of resources to comply with new laws, and the burden

imposed to firms that should not have been regulated, but nevertheless, are subject to it

(Zingales 2004). This is why regulation is expected to come when its benefits outweigh

the costs of implementation.

In periods of corporate scandals or financial crises, regulatory intervention could

represent a way to curb and prevent distrust, coherent with a higher demand for

regulation to protect investors. An increase in the demand for regulation is indeed

expected when people perceive unfairness of existing social order (Glaeser and Shleifer

2003, Djankov et al. 2003). Distrust, defined as a poor propensity of players to

cooperate for socially optimal solutions (La Porta et al. 1997b), represents the real

source of such disorder (Aghion et al. 2010). In critical economic conditions, the more

stringent interventions of regulators aim to reduce problems of distrust that grips

potential investors and undermines the efficient functioning of the capital markets.

Regulation might be a successful screening device to select firms entering the markets,

although it does not always represents the optimal solution.

In the IPO setting, regulation can be effective in limiting agency problems. Information

asymmetry would ideally disappear if regulation required insiders to fully disclose their

private information. In practice, by introducing more stringent listing requirements a

tighter regulation should discourage and limit the access to the capital markets to

“lemon” firms. We therefore expect that firms going public in compliance with stronger

regulations aimed to restore investor protection might be of higher quality, increasing

their survivability on the financial markets.

At the same time, tighter regulations might limit the number of firms going public.

Recently, there has been an increase in the number of foreign firms delistings from US

markets to list elsewhere. Doidge et al. (2010) argue that this happens also because of

the passage of the SOX, with firms escaping the newly imposed obligations. Firms can

indeed avoid the constraints of their home country’s rules and regulations. This has

generated a debate in the US (Gao et al. 2013, Doidge et al. 2013), which led to a new

law in 2012, the Jumpstart Our Business Startups (JOBS) Act, designed to stimulate

economic growth by improving access to the public capital markets for emerging

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growth companies. The undesired consequence of restricting laws aimed to restore

investor protection is indeed a reduction in the attractiveness of listing avenues, and

therefore a drop in IPO volumes.

Hypothesis 1a. Regulatory interventions occurring in periods of higher demand for

investors protection lead to an increase in the survival of firms going public

Hypothesis 1b. Regulatory interventions occurring in periods of higher demand for investors protection lead to a decrease of the IPO activity.

Regulatory interventions have different aims when taking place in favorable conditions.

In these periods, regulatory changes are typically aimed to increase the possibilities of

capital formation, making it easier to go public and, in general, lowering the restrictions

in raising funds. For instance, the “financial accelerator” effect (Bernanke et al. 1999),

that arises when collateral values increase and firms are able to gain easier access to

external financial sources, can amplify and propagate economic and financial cycles.

However, it might also lead to a socially suboptimal outcome, that of financial

instability. Indeed, while risk is overestimated in recessions, leading to a prudential

behavior, it is often underestimated in economic booms (Borio et al. 2001). Among the

numerous side effects, this contributes to excessive rapid credit growth, inflated

collateral values, artificially low lending spreads, and to financial institutions holding

relatively low capital and provisions. In the meanwhile, few investors care about the

transparency of firms when capital markets grow (Wagenhofer 2011).

In expansion periods, regulators are affected by a reduced demand for regulation, as a

diffuse pressure exerted by financial markets’ agents to implement less restrictive

interventions and increase as much as possible capital formation. The private interest

theory of regulation (Stigler 1971), also called the economic theory of regulation,

predicts that regulators cannot work independently from the existing forces operating on

the financial markets. While pressure can take different forms, from the coercive power

of the state used by groups to achieve their own interests (Becker 1983; Peltzman 1989;

Rajan and Zingales 2003), to the widespread sentiment of agents demanding more

financial openness to promote markets’ growth by reducing the cost of capital and

increasing its availability for the borrowers (Chinn and Ito 2006), governments are

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inevitably influenced when designing law interventions. Decreasing the compliance

costs firms have to bear, the regulators’ aloof behavior may increase the probability that

lemon firms enter the capital markets. In this case, the development of financial markets

is negatively influenced by the expected lower survivability of firms joining it.

Hypothesis 2a. Regulatory interventions occurring in periods of higher demand of

reduced requirements for capital formation lead to an decrease in the survival of firms

going public.

Hypothesis 2b. Regulatory interventions occurring in periods of higher demand of

reduced requirements for capital formation lead to an increase of the IPO activity.

3. The regulatory framework and the evolution of the IPO market

in ItalyThe first IPO on the Milan Stock Exchange, the railway company Società delle Strade

Ferrate Lombardo Veneto, took place in the year of the unification of Italy, 1861.

Examining the evolution of the IPO market from its foundation makes possible to

uncover long-term patters in the effectiveness of regulatory interventions in fostering

the development of the financial markets. We identify specific regulatory regimes, each

of them characterized by several law interventions, but with a common design in terms

of principles, shareholders’ rights, and requirement for access to the market. The set of

regulations provide the structure, while the period in which there are implemented

establishes the character of what can be labeled a regulatory regime (Hood et al. 2001).

We adopt the classification of the Italian legal framework provided by Aganin and

Volpin (2005), identifying four sub-periods, or regulatory regimes, in the evolution of

the Italian stock market: 1861-1935, 1936-1973, 1974-1997, and 1998-2011†.

1861-1935: Lack of financial market regulation

At the birth of the Reign of Italy, the Italian stock market was almost totally self-

regulated. In those years, firms could issue shares with multiple votes using cross-† We modified the first sub-period identified by Aganin and Volpin (2005) from 1861-1941 to 1861-1935. This choice is motivated by our focus on the evolution of the capital market, rather than on the development of the corporate law. In 1936, the Bank Law dramatically reshaped the banking sector. Since banks were directly responsible in defining the listing requirements for issuers, we argue that such date, rather than 1942, represents the starting point for the second regulatory regime.

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shareholdings with no limits, banks were often not concerned about the quality of

listings firms (Vivante 2003). Such loose existing legal framework did not formalize

any requirement in terms of information disclosure for listed firms.

1936-1973: Post-29 financial market reforms

As a response to the crisis of the 1929, a dramatic change in the Italian legal framework

occurred in 1936, when the Law 375/36 (Bank Law) was approved with the aim to

overcome the disorder and to restore trust among investors (Aganin and Volpin 2005).

Laws implemented primarily aimed to satisfy the existing demand for investor

protection imposing important innovations in disciplinating markets’ agents. The stock

market regulation improved dramatically, with the Bank Law establishing a clear

separation between short term and medium-to-long term financing and with the Civil

Code (Royal Decree 262/42) imposing that all shareholders acquired the right to vote at

the annual shareholder meetings.

1974-1997: Alignment to the international markets

The important legal improvements that occurred since 1974 allow to identify this year

as the beginning of a new regulatory regime. Specific disclosure requirements were set

to ensure the quality of issuers and, more importantly, the government delegated part of

the supervision of the financial markets to a commissions equivalent of the US SEC.

Notwithstanding the establishment of CONSOB (Commissione Nazionale per le Società

e la Borsa), the regulatory interventions in this period contained loopholes (Aganin and

Volpin 2005), and shareholders were more likely to be expropriated by controlling

blockholders (La Porta et al. 1998).

1998-today: Investor protection reforms

The latest major regulatory change took place in 1998. The Legislative Decree 58/98

(Draghi Reform) represented a “cornerstone” (Mallin 2011), because it explicitly

focused on strengthening minority shareholders’ protection. This law changed the

process of capital market offerings and takeovers, the functioning of audit firms, as well

as minority shareholders’ rights, increasing minority shareholders’ protection through a

wider application of the right to withdrawal from the company. Later, the EU Takeover

Directive (2004/25/EC), containing requirements for the bidders in M&As, and the

Savings Law (Law 262/05) signed a further progress in favor of a greater investor

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protection in avoiding corporate frauds. The regulatory regime starting in 1998 was

characterized by a conspicuous demand for investor protection.

4. Methodology and data4.1 Data and sources

In this paper, we analyse the population of 879 Italian IPOs that went public over the

full history of Italy since its foundation, in 1861, until December 2011, on the Milan

Stock Exchange. Different datasets were used to obtain the information. The listing and

delisting dates, the establishment and failure years, the industry identification, and the

delisting reasons were collected referring to three sources: a publication by Mediobanca

(2012), the historical collection of De Luca (2002), which integrates the primary source

of Mediobanca by punctually describing the history of each listed firm, and the

EURIPO database‡. Macroeconomic and financial variables are taken from the

publications of three institutions. We refer to Siciliano et al. (2011) for the data on the

market return index, to Mediobanca (2012) for the number of firms listed per year, and

to the national statistical agency (ISTAT) for the value of GDP, population and the

number of insolvency per year. Since our primary source of data contained the full

population of listings in the Milan stock exchange, our first task consisted in identifying

IPOs. Similarly to Chambers and Dimson (2009) we excluded introductions, new

listings by firms with a dispersed and broad prior stockholder base, transfers of listings

from other markets, the cross-listings of companies quoted on another exchange, IPOs

of closed-end-funds commonly known as investment trust. For each IPO firm we

assessed the survival time after the listing, defined as the time elapsed from the IPO up

to the suspension, liquidation or any other event leading to the delisting from a stock

exchange, with the exception of transfers to another market.

4.2. Sample

Figure 1 reports the number of IPOs, the number of delisting and the number of listed

companies from 1861 to 2011. The y-axis reports IPOs above zero, and the number of

delisted firms below zero, highlighting voluntary delistings. The classification of

regulatory regimes is also represented. ‡ See Vismara et al. (2012) for a description of the database.

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[INSERT SOMEWHERE HERE FIGURE 1]

Table 1 provides a description of the population of IPOs and delistings on the Milan

Stock Exchange, classified by regulatory regime and by industry. This disaggregation

shows how the different IPO waves were characterized by different industries over time.

For instance, in the first sub-period there was a large percentage of IPOs in the

Consumer Goods industry (31%, 119 IPOs out of 385). The Financial industry was

leading in the period following the Second World War (26%, 30 IPOs out of 114), while

Industrial IPOs were the most frequent in the last two sub-periods. In Italy, the

Technological industry increased its weight over time (from 0% between 1861-1935 up

to 14% in 1998-2011). With respect to firms exiting the financial markets, the total

number of delistings decreased in time (from 43% between 1861-1935 to 19% in the

period 1998-2011), with a contemporaneous decrease in the percentage of voluntary

delistings. Data show that almost half of firms going public in the first regulatory

regime were delisted in the same period, with the exception of the Utilities that

registered only a 14% (6 delistings on 43 IPOs) of failures. During the following

periods, delistings rates decreased to large an extent especially for Industrials (from

45% to 18%), Consumer Services (from 46% to 17%) and Financials (from 58% to

17%).

[INSERT SOMEWHERE HERE TABLE 1]

4.3 Methodology

This section describes the methodologies employed for the analysis of how the long-run evolution of financial regulation impacts on the survival

of IPO firms and the IPO activity in time.

The first test of hypotheses (1a – 2a) investigates the effects of regulation on the survival of IPO firms. M&A delistings are considered as not negative delistings and, specifically, as right censored cases, since, often, one of the reasons to go public is to take advantage of

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the market for facilitating valuation and divestment (Högholm and Rydqvist 1995)§. By using a Cox proportional hazards models we firstly

regress the survival time of our sample of IPOs considering all types of delistings;

second, we exclude voluntary delistings, namely cases where a firm is in compliance with an exchange’s listing standards and voluntarily takes steps to delist its shares. In fact, voluntary delistings are not necessarily negative cases. In all regressions, observations that survive at the end of the analysis are treated as right censored. In particular, IPOs are considered as censored observations if they were not delisted on 31 December 2011.The impact of the financial regulation on IPO survival is investigated including a set of

three dummy variables, Post 1935, Post 1973 and Post 1997, which identify the

changes of regulatory regimes according to the classification we presented in section 3.

Each dummy equals 1 after the change in regulation. For instance, the dummy variable

Post 1935 equals 0 for IPOs in the period 1861-1935 and value 1 in the period 1936-

2011. The first sub-period, 1861-1942, is the reference case in our analysis. Hypothesis

1a is validated if dummies Post 1935 and Post 1997 assume a negative estimated

coefficient which means that regulation occurred in period of high demand for investor

protection decrease the hazard and thus resulting in a higher IPO survival. On the

contrary, hypothesis 2a is verified when the coefficient of variable Post 1973 is

negative.

The second set of hypotheses (1b – 2b) examine whether the development of regulation in time is a determinant in IPO activity changes. We investigate the time series of IPO volume in Italy, and we test whether the changes in regulation had a positive (or negative) impact on the number of companies going public. A yearly time series regression is estimated with a first-order autoregressive error term, employing the number of IPOs in each year divided by yearly real GDP (measured in € billions) as the dependent variable.

§ In previous literature on IPO survival there is no shared consensus on this issue: companies delisted for M&As are considered as non-survivors (Carpentier and Suret 2011, they are completely excluded from the analysis (Hensler et al. 1997) or treated as censored survivors (Jain and Kini 2000) as in our case.

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4.4 Control Variables

IPO survival and IPO activity are however not only determined by the regulatory

regime, as they are likely to be affected by several other determinants that we consider

through a comprehensive set of explanatory variables.

4.4.1 IPO survival controls

Previous contributions generally control for different firm-level characteristics, such as

firm’s age, size and ownership (e.g. Demers and Joos 2007). However, in a very long

run analysis, the state of the financial markets and that of the economy take on even

more importance since they determine the conditions reducing (increasing) the

probability that lemon firms have access to the market. In addition to the main firm-

level characteristics at the IPO, considered in former literature we add different controls

for contextual conditions to distinguish the impact of the financial development from

the overall economic development (Tsoukas 2011) and capture the impact of socio-

political exogenous events occurred over the past 150 years in Italy.

Firm-level controls

Firm age: According to prior studies dealing with IPO failure risk (e.g. Demers and

Joos 2007), younger firms may suffer from greater uncertainty because of higher

managerial inexperience and a lack of record of past performances (Jain and Kini 1999).

Age at IPO is defined as the number of years from the firm’s incorporation date to the

IPO date.

Firm size: Information asymmetry tends to be negatively correlated with firm size.

Larger firms have greater visibility, and information that prospective investors can use

to evaluate issuers is more readily available for larger firms. On the contrary, smaller

firms are likely to face more severe problems of asymmetric information. We therefore

expect a negative relation between firm size and IPO survival. Because of lack of

punctual data on the size of Italian IPOs (e.g. total sales) when relying on a very long-

run perspective, we proxy the firm size classifying all IPOs in three classes: large,

medium and small-size firms with respect to the ICB (Industry Classification

Benchmark) classification. Large firms refer to the Oil and Gas, Basic Materials,

Utilities and Telecommunications sectors. Medium firms belong to the Industrials,

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Consumer and Goods, Consumer and Services and Financials sectors. Firms in Health

Care and Technology are considered as small. We report in our regressions the value for

the top (large firms) and the bottom (small firms) groups considering the medium-firm

class as the reference case.

State control: A crucial determinant in IPO survival concerns the type of ownership. In

terms of long-run performance, state ownership can be more detrimental than private

ownership because of the “grabbing hand” of the government, which tries to perceive its

own interests (Shleifer and Vishny 1998). However, when considering the access to the

capital markets, state-controlled IPOs may be viewed as “too big to fail”. This may be

for both an economic and a political reason. First, these firms are generally peculiar

cases, so well-interconnected that their failure may lead to the failure of others. Second,

politicians cannot resist in protecting their interest avoiding the collapse of a company

in the short term. Therefore, we include a dummy variable equals to 1 for state-

controlled IPOs (State-controlled).

Contextual level controls

GDP per capita: Firms that are able to go public in periods of recessions (i.e. decline in

real GDP (Gross Domestic Product) per capita) may be of higher quality and stronger

since there are lesser opportunities to raise public capital in such periods. Investors

indeed perceive a greater risk of financial distress. We measure the real GDP scaled by

the Italian population at the time of each IPO.

Number of insolvencies: Firms attempting to go public might face a higher risk of

bankruptcy when the rate of firms’ insolvency is high. This might be due to an increase

in risk aversion of investors, reducing the availability of public capital. In these periods,

IPOs should be more financially sound to raise public capital in order to convince

investors that they are not selling junk stocks. We therefore include the rate of firms’

insolvency in our regressions, measured as the number of fallimenti** per year at the

time of each IPO collected in Di Martino and Vasta (2010).

Market capitalization to GDP: The more developed is the capital market structure of a

country, the more are the services and facilities for listed firms and the tools for

** The Aglo-Saxon legal jargon generally use different names for insolvency. It refers to bankruptcy to indicate personal cases and insolvency for companies. According to Di Martino and Vasta (2010) we adopt the Continental European jargon and use insolvency and bankruptcy as synonyms. In Italy the word fallimento applies to both cases.

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investors to evaluate the quality of firms going public. Coherently, we measure the

importance of the equity market relative to the economy, as the total market

capitalization to GDP (Beck et al. 2002). This indicator is measure of the weight of the

equity market, allowing the comparisons across time periods because of its relative

stability (Rajan and Zingales 2003).

Number of UK IPOs: Additionally, we also include the extent to which European IPO

markets have been developed over time. As a proxy we consider the number of UK

IPOs per year aggregating data from different sources: Chambers and Dimson (2009),

Burhop et al. (2012) and Ritter’s IPO database††.

Market return index: Consistent with the window-of-opportunity theory (Ritter 1991),

investors can become over-optimistic in poor-quality firms and less discriminating

during hot markets periods. Specifically, the high initial returns firms may acquire in

hot periods lead lower quality issuers to take advantage of investors sentiment. Our

measure relies on the total return of the Italian index including reinvested dividends, in

the one year before each IPO.

Historical trend: By means of a trend variable, running from 0 (for IPOs in 1861) to 150

(for IPOs in 2011), we also control whether the change in IPO survival has simply

followed a constant trend over time. Specifically, we compare regressions including

dummies for different regulatory regimes with a specification including only a time

trend variable.

Furthermore, dummy variables to capture the effects of the dramatic political and social

conditions occurred during the First and the Second World Wars (World Wars I & II)

and for firms going public on the Italian New Market (Nuovo Mercato) as a

distinguishing case of hot market period in the Italian markets history are included.

4.4.2 IPO activity controls

The effects of the different regulatory regimes in increasing or decreasing IPO volume

over time is assessed after controlling for both economic and financial conditions, and

other exogenous events.

First, we capture the effects of economic conditions including both the percentage

growth in real GDP adjusted for inflation using 2011 purchasing power from year (t-1) †† http://bear.warrington.ufl.edu/ritter/ipodata.htm

14

to year (t) (Real GDP growth [t-1, t]) and the number of IPOs in the UK to control for

the development of financial markets in Europe. On the other side, financial conditions

are included relying on the percentage value of the total return of the Italian index

including reinvested dividends adjusted for inflation using 2011 purchasing power in

year (t-1) to (t) (Market return index [t-1, t]). A dummy for the First and the Second

World Wars contributes to control for the negative effects of the dramatic political and

social conditions occurred during those periods on markets development. A dummy for

firms that went public on the Nuovo Mercato captures the euphoria of hot periods on

IPO activity.

In the Appendix we report the correlation matrix including all variables.

5. Results

We first provide preliminary evidence on the investigated phenomena considering the

survival profile of IPOs by reporting their cumulative survival rates with respect to

different regulatory regimes. Table 2 reports the survival rates of the population of

Italian IPO firms, grouped by regulatory regime at the time of the listing (Panel A), and

by industry (Panel B), respectively one, three, five and ten years after the IPO. The

survival rates are calculated using the non-parametric Kaplan-Meier method‡‡.

[INSERT SOMEWHERE HERE TABLE 2]

The values reported in Panel A show that IPO survival largely varies in the different

sub-periods, ranging from 66% to 84% for delisting within 10 years. The IPOs issued in

1935-1973 and 1998-2011 show a higher survival rate with respect to 1974-1998. The

differences of the survival curves across these different periods are statistically

significant according to the log rank test (chi-square: 18.03, p-value: 0.000). The

‡‡ The IPO survival rates are estimated non-parametrically using the Kaplan-Meier method:

S (t j )=( n j−d j

n j)S( t j−1)

where S(tj) is the probability of being listed at year tj, S(t j−1) is the probability of being listed at year t j-1, ni is the number of IPOs listed just before the year tj (the risk set at tj), dj is the number of IPOs delisted during the year tj. Firms that went public during the last decade and may consequently not have a compete survival profile at one, three, five and ten years, and are still listed on the financial markets are treated as right-censored cases.

15

survival rates in Panel B, on the contrary, show that differences among industries are

not statistically significant (chi-square: 22.56; p-value: 0.550). Nevertheless, we control

for industry fixed effects across all our econometric analyses that validate in a

multivariate setting these preliminary observations.

Table 3 reports the estimates for a Cox proportional hazard model. First, we regress

survival time considering all delistings (Models 1 – 3); second, we exclude voluntary

delistings as they may not be necessarily failures (Models 2 – 4). In both cases we

compare results obtained including dummy variables for different regimes (Post 1935,

Post 1973, Post 1997) with a specification including only a time trend variable. All

regressions treat M&As as right censored cases.

Firstly considering all delistings, Model (1) presents the time-trend specification

showing that the historical trend is significantly associated with a lower incidence of

delistings (at a 5% significant level). This is an evidence of an improvement in the IPO

survival over the full history of the Italian capital market. Concerning the control

variables, we find that being large or state-controlled firms decreases the hazard rate to

be delisted for negative reasons. This confirms that larger firms are seen as “too big to

fail”, and this causes a smaller probability to be delisted after going public. Results are

confirmed also when excluding voluntary delisting (Model 2).

In Model (3) we test our first set of hypotheses (1a and 2a) measuring the impact of

regulation by means of the three dummies corresponding to the changes in regulatory

regime after controlling for the historical trend. We predict that when the demand for

investor protection is high, IPO survival increases (Post 1935 and Post 1997), while in

presence of a high demand for easier capital formation on the financial markets, survival

of newly listed firms is shorter (Post 1973). Coherently to our expectations, the first

dummy shows a strongly significant negative coefficient (at a 1% significant level). The

second change is positive and significant (at a 5% significant level), indicating a

decrease in the survival time stating from 1974, while the Post 1998 dummy is an

evidence of a neat significant increase in the survival time after 1998 (at a 5%

significant level). Accordingly, when excluding voluntary delistings reasons results are

confirmed, and the dummy Post 1935 becomes more significant (at a 1% significant

level) (Model 4)§§.§§ In order to check for potential multicollinearity problems in our estimations, we calculate for each regression the mean Variance Inflator Index (VIF) of included variables. All regressions reported a mean

16

As a whole, the analysis shows that the improvement in the IPO survival found in

models (1 – 2) did not follow a monotonic trend in time. As expected, from 1974 to

1997, the regulation had a negative and significant effect on the survival profile of IPOs.

Our results confirm that, once acknowledged the need to implement new rules to fuel

the IPO market after the stagnation following the Second World War, the Italian

government tried to encourage firms’ capital raising and enlarge the capital markets, but

did not dedicate enough attention to the quality of the firms joining the market. This

result is coherent with the finding of Pagano et al. (1998), showing that firms going

public from 1982 to 1992 did not finance their growth and investments but, on the

contrary, used the proceeds to repay their debts.

Our results are also in accordance to La Porta et al. 1998, describing the level of

minority protection in Italy before 1994 to be very poor and unattractive to new

investors (La Porta et al. 1998). It is only with the following Draghi Reform, in 1998,

that minority protection becomes the ultimate aim of financial regulation in Italy, and

the positive outcome in terms of IPO quality is well documented by the increase in IPO

survival to delisting. Further, Dyck and Zingales (2004) show that after such regulatory

interventions the private benefits for the dominant blockholders decreased at the

expenses of minority shareholders interest.

[INSERT SOMEWHERE HERE TABLE 3]

Table 4 reports the results of the validation of the second sets of hypotheses (1b and 2b)

on the effects of different regulatory regimes on IPO volume. Consistent to our

hypothesis 1b, the Post 1935 dummy shows a significant (at a 5% significant level)

increase in the IPO activity after controlling for the effects of market conditions, which

are found to significantly influence IPO volumes. However, the coefficient related to the

last regulatory regime, although negatively associated to the propensity of firms in

accessing financial markets, is not statistically significant. Our hypothesis 1b is

therefore partially supported. By contrast, in presence of a high demand for easier

capital formation on the financial markets, although the survival of newly listed firms is

VIF lower than 4 indicating that multicollinearity does not seem to be severe.

17

shorter, the number of firms going public has not grown. We therefore do not find

statistical evidence supporting our hypothesis 2b.

[INSERT SOMEWHERE HERE TABLE 4]

5.1 Robustness checks

Following Christensen et al. (2011), we perform an additional test to check the robustness of tour results, both in terms of IPO survival (Table 3) and IPO activity (Table 4). In practice, since it is possible that the average level of IPO survival and IPO activity declined (increased) prior or after the entry-into-force of the regulatory changes we identified. To therefore investigate this possibility, and examine the IPO survival and IPO activity pattern around the entry-into-force dates of the changes in regulatory regimes by using dummy variables Change of the regulatory regime (t + N). This variable equals one if a change occurs after t + N, where t is the entry-into-force date of the regulatory change and N is number of years relative to year t; the variable equals zero otherwise. The value of N is an integer whose value ranges from -3 to +3. We perform seven regressions. The independent variables are the same as those in the Table 3 and Table 4 regressions, except for the differences noted above. To save space, we only report the coefficient estimate for the Regulatory regime (t + N) from each of the different regressions. Panel A confirms our previous finding showing the estimations for the effects of different regulatory regimes on IPO survival. The coefficients become significant after the breaks we identified across the history of the Italian regulatory framework. In regressions t+1, t+2 and t+3, coefficients of regulatory interventions are all statistically significant with respect to those associated to previous years, especially for the change occurred in 1936 (at 1% significant

18

level). Panel B presents the same analysis when considering the yearly time series regression on IPO activity. We find that only the first regulatory regime started in 1936 shows statistically significant coefficients in the different regressions presented, as suggested by the results of Table 5.

[INSERT SOMEWHERE HERE TABLE 5]

6. Conclusions

In this paper, we contribute to the literature examining the effects of financial regulation

by investigating the impact of different regulatory regimes on the survival and the

activity of IPOs, from the birth of the Reign of Italy, in 1861. The two major regulatory

changes that arose from a higher demand for investor protection, the introduction of the

Bank Law in 1936 and Draghi Law in 1998, determine a significant improvement in

IPO survival. By contrast, the major change characterized by an important demand of

capital formation, the establishment of CONSOB in 1974, leads to a lower IPO survival,

but the number of firms going public did not grow.

19

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23

Table. 1 Population of IPOs and delistings on the Milan Stock Exchange, classified by regulatory regime and by industryThe table reports the number of IPOs and the delistings across different regulatory regimes and industries. Data are relative to the number of delistings occurred in each period The industry classification is the ICB (Industry Classification Benchmark), officially adopted by the European Stock Exchanges. We rely on the one digit-level to classify firms.

Regulatory Regime 1861-1935 1936-1973

IPOs Delistings Excluding Voluntary IPOs Delistings Excluding Voluntary

Oil & Gas 2 0 0 6 1 1Basic Materials 49 20 12 10 3 1Industrials 75 34 20 20 9 4Consumer Goods 119 53 27 18 19 11Health care 2 2 2 3 0 0Consumer Services 26 12 7 5 3 1Telecommunications 4 0 0 1 0 0Utilities 43 6 3 18 1 0Financials 64 37 15 30 5 1Technology 1 1 1 3 0 0Tot. 385 165 87 114 41 19Regulatory Regime 1974-1997 1998-2011

IPOs Delistings Excluding Voluntary IPOs Delistings Excluding Voluntary

Oil & Gas 4 3 2 2 0 0Basic Materials 14 7 2 4 4 4Industrials 55 17 11 50 9 8Consumer Goods 31 16 10 34 9 8Health care 3 0 0 10 1 1Consumer Services 12 2 2 36 6 5Telecommunications 1 0 0 1 0 0Utilities 4 1 1 18 1 1Financials 42 7 5 29 5 5Technology 1 0 0 29 5 5Tot. 167 53 33 213 40 37

24

Table. 2 Cumulative survival ratesThe table reports the cumulative survival rates for the population of 879 IPOs listed during 1861-2011, classified by regulatory regime (Panel A) and by industry (Panel B), calculated with the Kaplan-Meier method (see footnote 13 for details), for one, three, five and ten years after the IPO. Firms that went public during the last decade and do not have a complete survival profile at one, three, five and ten years by being still listed on the financial markets are treated as right-censored cases. A log rank test is performed to assess the statistical significance of the differences among the survival curves. We show the chi-square value and the p-value in brackets.

Obs. 1 YR 3 YR 5 YR 10 YRPanel A: by period 1861-1935 385 100 92 82 66 1936-1973 114 100 98 96 79 1974-1997 167 99 96 91 70 1998-2011 213 100 98 92 84 Full sample (1861-2011) 879 100 95 87 72

Log Rank 18.03(0.000

)Panel B: by industry Oil & Gas 14 100 100 100 93 Basic Materials 77 99 92 86 74 Industrials 200 100 96 89 68 Consumer Goods 202 100 95 86 72 Health care 18 100 94 83 67 Consumer Services 79 100 92 90 77 Telecomunications 7 100 100 86 86 Utilities 83 100 96 90 78 Financials 165 99 95 83 64 Technology 34 100 97 94 82Log Rank 7.85

(0.550)

25

Table. 3 Survival profile of IPOsEstimated coefficients for the cox proportional hazard models wherein all delistings are firstly treated as failures and then the voluntary ones are excluded. Models (1 - 2) include the baseline specification and an historical trend. Model (3 - 4) show the effects of the changes in the regulatory regime. Robust standard errors are in parentheses. All regressions include control for World War I and World War II, and for IPOs listed on the Nuovo Mercato. Stars identify significance level at less than 1% (***), 5% (**), and 10% (*).

(1) (2) (3) (4)Delistings Excluding voluntary Delistings Excluding voluntary

Age at IPO 0.000 0.002 0.003 0.003(0.003) (0.002) (0.002) (0.002)

Large size -0.304** -0.281** -0.284** -0.310**(0.122) (0.136) (0.137) (0.123)

Small size 0.085 0.143 0.119 0.074(0.353) (0.360) (0.375) (0.363)

State-controlled -0.827** -0.991** -1.090** -0.908**(0.356) (0.444) (0.458) (0.362)

No. of insolvencies -0.001 0.012 -0.035 -0.029(0.025) (0.027) (0.029) (0.027)

GDP per capita -2.742 -2.333 -1.726 -2.291(2.722) (1.738) (2.427) (2.346)

Mkt cap to GDP -1.250 -1.256 -0.036 0.569(1.088) (1.173) (1.205) (1.127)

Number of IPOs in UK 0.002 0.002 0.003 0.003(0.002) (0.002) (0.002) (0.002)

Market return index -0.000 0.001 -0.001 -0.004(0.002) (0.003) (0.003) (0.003)

Historical trend -0.499** -0.661** -0.468* -0.288(0.253) (0.263) (0.275) (0.264)

Post 1935 -0.705** -0.983***(0.296) (0.280)

Post 1973 0.634** 0.616**(0.322) (0.309)

Post 1997 -1.493** -1.460**(0.628) (0.622)

No of observations 879 879 879 879Pseudo R2 0.062 0.042 0.055 0.085Log pseudolikelihood -1,735 -1,413 -1,405 -1,725

26

Table. 4 The number of IPOs per yearEstimated coefficients for time-series regressions with residuals following an AR(1) process. The dependent variable is the number of IPOs in each year, all scaled by yearly real GDP, measured in € billions of 2011 purchasing power. Real GDP growth is the percentage growth in real GDP from year (t-1) to year (t). Market return index growth is the percentage value of the total return of the Italian index including reinvested dividends adjusted for inflation using 2011 purchasing power and in year (t-1) to (t). Stars identify significance level at less than 1% (***), 5% (**), and 10% (*).

Real GDP growth [t-1, t] 36.575(41.521)

Market return index [t-1, t] 19.130**

(7.489)New markets 1.527

(6.195)World War I & II -3.312

(12.875)Number of IPOs in UK 0.088

(0.102)Historical trend 0.041

(0.437)Post 1935 -52.607**

(25.988)Post 1973 -8.843

(14.954)Post 1997 -1.099

(10.060)AR(1) coefficient 0.560***

(0.174)Constant 56.943**

(25.773)Observations 149R-squared 0.66

27

Table. 5 Analysis of varying entry-into-force datesThis table reports results from COX proportional hazard regressions and yearly time-series with residuals following an AR(1) process that are variations of the second regression model in Table 3 and the regression in Table 4. In Panel A, we report the coefficient estimates of the interaction term Change of the regulatory regime (t + N). This variable equals one if a change occurs after t + N, where t is the entry-into-force date of the regulatory change and N is number of years relative to year t; the variable equals zero otherwise. The value of N is an integer whose value ranges from -3 to +3. Each coefficient estimate reported is from a separate regression. Panel B reports the same analysis re considering the yearly time series regression on IPO activity. Stars identify significance level at less than 1% (***), 5% (**), and 10% (*).

Panel A: COX proportional hazard regressions

Post 1935 Post 1973 Post1997

t-3 -0.528 0.202 -0.631(0.327) (0.293) (0.471)

t-2 -0.488 0.276 -0.631(0.328) (0.299) (0.471)

t-1 -0.457 0.315 -0.958(0.328) (0.293) (0.638)

t -0.983*** 0.616** -1.460**(0.280) (0.309) (0.622)

t+1 -0.966*** 0.634** -1.444**(0.283) (0.321) (0.619)

t+2 -0.896*** 0.671** -1.439**(0.282) (0.319) (0.732)

t+3 -0.848*** 0.568* -1.417*(0.279) (0.323) (0.734)

Number of observations 879 879 879Panel B: Time series regression on IPO activity

Post 1935 Post 1973 Post1997

t-3 -47.528 -6.540 1.831(35.262) (15.734) (10.101)

t-2 -54.921 -5.422 -3.020(36.291) (17.262) (9.055)

t-1 -60.064* -13.062 -2.720(30.823) (13.954) (8.571)

t -51.840** -9.379 -1.099(26.063) (14.791) (10.060)

t+1 -49.243** -10.119 -6.860(24.927) (13.578) (8.308)

t+2 -48.020* -11.114 -1.143(26.041) (13.559) (9.915)

t+3 -41.777* -9.300 -5.057(24.312) (14.207) (8.603)

Number of observations 149 149 149

28

A. 1 Correlation MatrixCorrelation coefficients. Significant correlations at less than 1% are identified with *.

Variables 1 2 3 4 5 6 7 8 91 Age at IPO 1.000

2 Large Size 0.089* 1.000

3 Small Size -0.051 -0.232* 1.000

4 State-controlled 0.222* 0.280* -0.065 1.000

5 No. of Insolvencies 0.229* -0.049 0.243

* 0.018 1.000

6 GDP per capita 0.279* -0.011 0.176

* 0.077 0.806* 1.000

7 Market cap to GDP 0.227* -0.055 0.317

* 0.06 0.807* 0.731* 1.000

8 Market return index 0.005 -0.108* 0.280* -0.003 0.583* 0.466* 0.781

* 1.000

9 Number of IPOs in UK 0.129* -0.004 0.226

* 0.018 0.621* 0.592* 0.608* 0.570* 1.000

29

Figure. 1. Number of IPOs and delistings in Italy during 1861-2011 X-axis represents years. Vertical bars below the X-axis identify the number of delisted companies per year (voluntary delistings are in grey), while bars above the X-axis describe IPOs per year (IPOs listed on the Nuovo Mercato are in black). The curve above the X-axis represents the number of listed firms per year.

30

III reg. changeII reg. changeI reg. change

1974-19971961-1935 1936-1973 1998-2011

No.

of l

iste

d fir

ms

No.

of I

POs -

de

listin

gs