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Bypassing the Financial Growth Cycle: Evidence from Capital Pool Companies

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  • Cécile Carpentier

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  • Jean-Marc Suret

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    Abstract

    To close an asserted equity gap, the Canadian regulators implemented the Capital Pool Company program, which enables small firms to directly access the stock market, thus bypassing the conventional growth cycle. Similar to American Blind Pools/Blank-Checks, Capital Pool Companies have spawned more than half of the new issues on Canadian stock markets between 1995 and 2001. Underlying this program, along with several other governmental actions, are three postulates: 1) a significant number of profitable companies cannot be financed using conventional tools, 2) small firms can grow and succeed without the full set of services usually provided by the specialized intermediaries, and 3) individual investors are able to correctly price the stocks issued by small and generally young firms. Our analysis of close to 450 issuers resulting from this program fails to confirm any of these postulates. Companies that access the stock market through this program are of low quality, which is consistent with the adverse selection paradigm. Their abnormally low subsequent operating performance can be traced to the lack of incentive and monitoring tools, along with the “lemon” principle. Moreover, their market performance is also abnormally poor, confirming that individual investors cannot correctly assess the fair value of new ventures, in a strong asymmetric information context. In terms of public policy, development of mechanisms intended to facilitate the entry of emerging companies on the stock market apparently requires serious reexamination. Our results confirm the essential role played by financial intermediaries in small business finance. Pour remédier à une discontinuité de marché supposée, les autorités canadiennes des valeurs mobilières ont mis en place le programme des sociétés de capital de démarrage. Celui-ci permet aux petites entreprises d’accéder directement au marché boursier, sans avoir recours aux étapes traditionnelles de financement de la croissance. Comparables aux Blind Pools américaines, les sociétés de capital de démarrage représentent plus de la moitié des émissions publiques initiales au Canada entre 1995 et 2001. Les hypothèses sous jacentes à ce programme, ainsi qu’à d’autres initiatives gouvernementales, sont les suivantes : 1) un nombre significatif de projets rentables ne peuvent pas être financés en utilisant les moyens de financement conventionnels, 2) les petites entreprises peuvent croître et être rentables sans les services fournis habituellement par les intermédiaires traditionnels, 3) les investisseurs individuels sont capables d’évaluer correctement le prix d’émission des petites, et généralement jeunes, entreprises. Notre analyse de près de 450 émetteurs résultants de ce programme ne permet pas de confirmer ces hypothèses. Les entreprises qui accèdent au marché boursier au moyen de ce programme sont de mauvaise qualité, ce qui est cohérent avec le paradigme de l’anti-sélection. Leur performance opérationnelle subséquente est anormalement faible, ce qui peut être relié à un manque d’outils d’incitation et de surveillance, ainsi qu’au même paradigme de l’anti-sélection. En outre, leur performance boursière est également anormalement faible, ce qui tend à montrer que les investisseurs individuels ne sont pas en mesure d’évaluer correctement le prix de ces nouvelles émissions, dans un contexte d’asymétrie informationnelle forte. En termes de politiques publiques, le développement de mécanismes de marché visant à faciliter l’accès au marché boursier d’entreprises en démarrage requiert un sérieux réexamen. Nos résultats confirment le rôle crucial joué par les intermédiaires de financement traditionnels auprès des petites entreprises.

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    Bibliographic Info

    Paper provided by CIRANO in its series CIRANO Working Papers with number 2004s-48.

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    Date of creation: 01 Sep 2004
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    Handle: RePEc:cir:cirwor:2004s-48

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    Keywords: capital pool company; small business finance; initial public offering; société de capital de démarrage; financement de la PME; émission publique initiale;

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    1. Cumming, Douglas J., 2005. "Capital structure in venture finance," Journal of Corporate Finance, Elsevier, vol. 11(3), pages 550-585, June.
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    7. Allen N. Berger & Gregory F. Udell, 1998. "The economics of small business finance: the roles of private equity and debt markets in the financial growth cycle," Finance and Economics Discussion Series 1998-15, Board of Governors of the Federal Reserve System (U.S.).
    8. Brav, Alon & Gompers, Paul A, 1997. " Myth or Reality? The Long-Run Underperformance of Initial Public Offerings: Evidence from Venture and Nonventure Capital-Backed Companies," Journal of Finance, American Finance Association, vol. 52(5), pages 1791-1821, December.
    9. Fenn, George W. & Liang, Nellie, 1998. "New resources and new ideas: Private equity for small businesses1," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 1077-1084, August.
    10. Janney, Jay J. & Folta, Timothy B., 2003. "Signaling through private equity placements and its impact on the valuation of biotechnology firms," Journal of Business Venturing, Elsevier, vol. 18(3), pages 361-380, May.
    11. Jenkinson, Tim & Ljungqvist, Alexander, 2001. "Going Public: The Theory and Evidence on How Companies Raise Equity Finance," OUP Catalogue, Oxford University Press, edition 2, number 9780198295990.
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