The Avoidance of growing pains: Success factors for a healthy organizational development of young SME's going public.

Table of Contents

ACKNOWLEDGEMENTS

EXECUTIVE SUMMARY

LIST OF ABBREVIATIONS

LIST OF FIGURES

LIST OF TABLES

1 Introduction
1.1 Background and Problem Statement
1.2 State of Research
1.3 Aims and Objectives
1.4 Scope of research and limitations

2 Literature Review
2.1 The Concept of Growth
2.1.1 Introduction
2.1.2 Organizational growth
2.1.3 Organizational Life Cycle
2.1.4 Healthy growth vs. unhealthy growth
2.2 The Concept of the “New Institutional Economics”
2.2.1 Introduction
2.2.2 New Institutional Economics
2.2.2.1Property-Rights
2.2.2.2Principal Agent Theory
2.3 The Concept of Value-orientation
2.3.1 Introduction
2.3.2 Value-based management
2.3.2.1Financial value-drivers
2.3.2.2Operational value-drivers
2.3.2.3Value-based Communication as Value-driver
2.4 Summary

3 Research Framework
3.1 Conceptualization of findings
3.2 Development of research framework
3.2.1 Conducting the framework
3.2.1.1Organizational maturity
3.2.1.2Transparency
3.2.1.3Management quality

4 Research Method and Empirical data
4.1 Research Methodology
4.1.1 Archival data analysis
4.1.2 Sample
4.1.3 Data Collection - Secondary data
4.2 Empirical Data
4.3 Presentation of the sample
4.4 Analysis of the IPO-Prospectus
4.5 Archival Analysis
4.5.1 Performers
4.5.1.1SHW AG
4.5.1.2EVONIK INDUSTRIES AG
4.5.2 Non-Performers
4.5.2.1CONERGY AG
4.5.2.2INTICA SYSTEMS AG
4.5.2.3ASIAN BAMBOO AG
4.5.2.4EPIGENOMICS AG
4.5.2.5WILEX AG
4.5.2.6ESTAVIS AG
4.6 Benchmark of performers vs. non-performers
4.7 Summary of empirical data

5 Analyses
5.1 Comparison of transparency
5.1.1 Performers
5.1.2 Non-Performers
5.2 Comparison of organizational maturity
5.2.1 Performers
5.2.2 Non-Performers
5.3 Comparison of management quality
5.3.1 Performers
5.3.2 Non-Performers
5.4 Summary of Analyses

6 Conclusions
6.1 Findings and Conclusion
6.2 Recommendations
6.3 Implications
6.4 Further Research
6.5 Concluding Comment

Appendix 1: IPO Prospektus - Analysis

Appendix 2: SHW AG - Calculation of EVA

Appendix 3: Conergy AG - Calculation of EVA

Appendix 4: Inctica Systems AG - Calculation of EVA

Appendix 5: Asian Bamboo AG - Calculation of EVA

Appendix 6: Epigenomics AG - Calculation of EVA

Appendix 7: Wilex AG - Calculation of EVA

Appendix 8: Estavis AG - Calculation of EVA

References

ACKNOWLEDGEMENTS

I would like to express my gratitude to my supervisor Dr. Axel Steudle for the useful comments, remarks and engagement through the learning process of this master thesis. Furthermore, I would like to thank my loved ones, who have supported me throughout the entire process. So, I would like to thank my mother for all her endless love and sup- port as well as all her sacrifices. Furthermore, I would like to thank my sister which is a really special person in my life. Special thanks also go to my wife, Raouia, for her love, kindness and support she has shown during the past two years it has taken me to finalize this program.

I will be grateful forever.

EXECUTIVE SUMMARY

In order to take advantage of growth opportunities and to avoid growth pains, SMEs must be equipped with necessary funds. An appropriate way to raise funds is represented by the public stock exchange.

The objective of the present paper is to elaborate success factors that might be of assis- tance for SMEs when going public in order to avoid growth pains. In particular, SMEs have an immense backlog regarding their financial controlling, strategy, management quality, transparency and internal structure in general related to the “standard” level that has to be considered as generic requirement for a publicly held company. Thus, the starting hypothesis of the present paper is: In case an SME does not deal with such chal- lenges in due time and appropriate manner, it will not be able to realize the growth in- tended with an IPO. Such discrepancies would rather lead to sustained destruction of value with the consequence of massive growth pains at the post-IPO stage.

Therefore the present paper aims to analyze the relevant differences between the aforementioned areas that, after all, could have a direct impact on the performance of the organizational development of the company, in order to deduce crucial success factors for a successful initial public offering (IPO) and to avoid growth pains.

This shall be achieved by analyzing the relevant literature through systematic research review, in order to capture information on the current state of research. Then, in a se- cond step it will be aimed to conduct a theoretical analysis of different scientific con- cepts based on the captured discrepancies in oeder to identify parameters and measures that ought to be observed as success factors in the preparation of an SME for a forth- coming IPO.

As a last step, the identified success factors (“best practice”) will be assessed by a sys- tematic analysis of recent IPOs within the last ten years, based on random samples, for the purpose of examining whether such factors gained from theoretical analysis are sub- sequently applied in practice. This analysis shall consider whether the performance with respect to profitability, growth and evaluation of the companies applying those success factors differ from the performance of companies evidently not applying the identified success factors.

This work concludes that essential problems do not arise from asymmetric information flow but poor management quality. While different levels of detail-depth concerning the aims and objectives stated in the IPO prospectus had no impact on the initial investment behavior, post-IPO-performance is though strongly dependent on the existence of a management system and in particular a clearly defined approach related thereto in the strategic management. In other words: It is easy for SMEs to obtain capital through an IPO - but differences in success by means of the avoidance of growing pains are re- flected by growth strategies that are clearly elaborated up-front and implemented by a management system.

LIST OF ABBREVIATIONS

illustration not visible in this excerpt

LIST OF FIGURES

Figure 1: Financial performance in the different stages of OLC

Figure 2: Structural model of a company and possible value-drivers

Figure 3: Research framework - the „Avoidance of growing pains - framework”

Figure 4: Methodological Framework

Figure 5: Value-orientation of the sample

Figure 6: EVA 2011-2012 SHW AG

Figure 7: SHW AG - Management effectiveness - profitability

Figure 8: EVA 2011-2012 EVONIK Industries AG

Figure 9: Evonik Industries AG - Management effectiveness

Figure 10: CONERGY AG - management effectiveness

Figure 11: EVA 2011-2012 CONERGY AG

Figure 12: EVA 2011-2012 INTICA Systems AG

Figure 13: INTICA Systems AG - management effectiveness - profitability

Figure 14: EVA 2011-2012 ASIAN BAMBOO AG

Figure 15: ASIAN BAMBOO AG - Management effectiveness - profitability

Figure 16: EVA 2011-2012 EPIGENOMICS AG

Figure 17: EPIGENOMICS AG - Management effectiveness - profitability

Figure 18: EVA 2011-2012 WILEX AG

Figure 19: WILEX AG - Management effectiveness - profitability

Figure 20: ESTAVIS AG - EVA

Figure 23: ESTAVIS AG - Management effectiveness - profitability

Figure 22: Return on Invested Capital and the assumed costs of capital (WACC) of the "Non-Performers"

Figure 23: Return on invested capital and the costs of capital (WACC) of the performers

Figure 24: P/E ratio of Non-Performers and the S&P 500

Figure 25: P/CF ratio of Non-Performers and the S&P500

Figure 26: P/E and P/CF ratios of SHW AG vs. S&P500

Figure 27: Key analyses of case companies, edited by author

LIST OF TABLES

Table 1: Improvements for companies situated in the growth stage of OLC

Table 2: Overwiew - financial value-drivers

Table 3: Sample

Table 4: No IPO-Prospectus available

Table 5: Evonik Industries AG - Company information

Table 6: Performer of value-based management

Table 7: Relationship ROIC and NOPLAT in million EUR

Table 8: Non-Performers: Development of share price/number of share/market capitalization

Table 9: SHW AG: Development of share price/number of shares/market capitalization

Table 10: Key findings of the empirical data

Table 11: Value-based content in the IPO-prospectus

1 Introduction

1.1 Background and Problem Statement

Especially for young SMEs with an unfavorable equity base associated with high risk that needs venture capital to finance the growth, the conditions of the credit market are very unfavorable. Therefore, the stock market is an interesting alternative source to raise capital for financing the organizational development.¹ According to Pagano, Panetta, and Zingales, “the conventional wisdom is that going public is simply a stage in the growth process of a company”.² So, it is observed that more and more young SMEs seek to go public in order to obtain the funds needed.³

When going public, a privately held company is supported by a consortium consisting of banks, tax advisers, legal adviser, and lawyers. Thereby, the consortium guides the firm through the IPO-process and adjusts its structures in accordance to the requirements of the capital market. However, many companies end up performing poor after entering the public stock exchange and suffer great losses.⁴

The initial public offering, or IPO, stands for the first-time issue of a company’s shares to investors on an organized capital market - the public stock exchange, in connection with its stock exchange introduction.

In this context the first-time aspect is crucial, as it distinguishes an IPO from other capital market transactions such as the so-called “secondary offering”. The following definition by Anderson, Beard, and Born is to be used for this thesis:

„An Initial Public Offering (IPO) comprises a private firm’s accessing the public capital through the sale of securities.“⁵

From the view of an entity, an IPO is a unique, limited in time and complicated project which is branded by complex planning- and controlling duties. Most IPO-candidates need know-how which originally does not exist in the own organization. IPOs are marked by a high complexity which is generated, among others, by the fact that with the initial public offering of an enterprise basically three parties (emitter, issue syndicate and investor) are involved which do not only have different interests, but also show dif- ferent states of information.⁶

Thus, motives for going public play an important role in order to justify this decision. The fundamental motive for going public can be derived from its existence, namely the inclusion of capital to finance growth targets. This is confirmed by the following statement of J. Arkebauer:⁷

„ the primary objective for raising capital is to support and sustain growth “

So, raising capital with going public, is associated with the internal and external growth.⁸ Moreover, the facilitation of M&A activity due to the stock as acquisition currency and low costs of capital are mentioned by literature as further motives.⁹

As business-related motives, also facilitated staff acquisition and retention with the implementation of stock option programs and a general improvement of brand recognition and image are mentioned.¹⁰

Scholars explain the poor performance of SMEs at the public stock exchange due poor financial management¹¹, immature systems and routines¹², a poor organizational maturity because of the young age¹³, and a higher pressure for economic growth.¹⁴

Out of this, it can be said that growing SMEs need sufficient management systems for different reasons; (1) for providing enough information to the investor in order to be recognized as good investment opportunity, (2) to provide the own organization with an sophisticated management system in order to perform efficiently with the aim to en- hance the company’s value, and (3) to know if future growth expectations are realistic and IPO-worthy.

1.2 State of Research

The state of research provides many studies investigating the banking business administration, concerning pricing mechanisms, stock performance,¹⁵ and and financial differ¬ences between large and small firms¹⁶ Further studies are concerned with investiga-tions of internal corporate success factors such as HR and IPO management.¹⁷ However, the stage of research misses to offer answers on how firms, which are according to the organizational life-cycle models situated in the growing phase, can master the challenge of going public successfully and continue to grow profitable. The concept of growth explained in chapter 2.1 can deliver valuable information about the growth process of young enterprises and uncover specific requirements enterprises must met in order to realize a healthy development especially when going public. Furthermore, the concept of the “ new institutional economics ” (chapter 2.2) seems to be of great importance for the purpose of this paper since this concept is assessed state-of-the-art regarding the possibilities for an efficient design of institutions and the interrelations between eco- nomic actors. The last basic concept, important for the purpose of this paper, is the con- cept of value-orientation (chapter 2.3) since its ultimate aim is to create value and thus foster growth.

1.3 Aims and Objectives

The aim of this paper is to identify factors, which contribute to a healthy organizational development and the avoidance of growing pains at young SMEs after going public.

Thus, die basic hypothesis of this paper is the following:

H: In case an SME does not deal with such challenges in due time and appropriate manner, it will not be able to realize the growth intended with an IPO. Such discrepan cies would rather lead to sustained destruction of value with the consequence of mas sive growth pains at the post-IPO stage.

In order to accomplish this aim, the following objectives will be taken:

- Potential literature will be reviewed in order to identify factors which enhance the performance of a company.
- The identified factors will be proofed in form of case studies. In doing so, a sample will defined on the basis of representative companies.
- The findings will be analyzed in order to make recommendations to improve the operational effectiveness in order to maximize the growth opportunities of young SMEs going public.

Research Questions:

According to the interest of the study, the following research question can be defined:

What are the factors accountable for a healthy organizational development of young SMEs going public?

What are the differences in the IPO success, which can be explained by asymmetric information?

How important are management systems for the success of the entire IPO process?

1.4 Scope of research and limitations

According to the aims and objectives of this paper, it is important to define a demarca- tion of the analytical framework in order to cope with the defined problem of this study.

For this purpose, a delineation of the scope of research is necessary. So, definitions of the type of companies analyzed, and an overview about the underlying concepts, reviewed in chapter 2, will be given.

The companies examined in the present paper are young SMEs that have completed their IPO in Germany at the Frankfurt Stock Exchange and can be classified as SME by means of number of employees and turnover. SME is a collective term for companies that move within a defined corridor of employment, turnover, and balance sheet total. The European Commission defines small enterprises as companies employing 10 to 50 employees and a turnover or a balance sheet total of 10 million EUR. Furthermore, mid- sized enterprises are companies employing up to 250 employees and having a turnover greater than 50 million or a balance sheet total greater 43 million EUR.¹⁸ The IFM (Center for Small and Medium Sized Business Research) goes further and defines small enterprises as companies employing a minimum of ten employees and generate a turno- ver greater 1 million EUR. Furthermore, mid-sized enterprises employ up to 500 em- ployees and generate turnover up to 50 million EUR.¹⁹ Additionally, B. Venohr contrib- utes a further definition on SME mentioning that larger and more sophisticated medi- um-sized companies generate turnovers from 50 million EUR up to 1 billion EUR.²⁰

That this definition is justified, confirms a study of Eekhoff and Malshe from 2012 whereas 1.2 % companies belong to this segment. These companies employ 34.5% of all workers and generate 32.5% of the total revenues generated from the SME sector.²¹ According to this definition, SME are separated from large enterprises on the basis of the quantitative dimensions employment rate, turnover, and balance sheet total. Addi- tionally to these quantitative dimensions, qualitative dimensions characterize SMEs, also. Thus, SMEs are mostly owned by the founder, who also bears the entire entrepre-neurial responsibility. A unified statistical definition on qualitative dimensions does not exist.²²

So, for the purpose of this paper, SMEs are understood as companies generating turnover from 30 million EUR up to 1 billion EUR. Furthermore, these companies are not traded on any stock exchange or their free float ratio is beyond 50%, which therefore are not subject to shareholder value interests.

2 Literature Review

In the following, the relevance of the single concepts reviewed in the following sections, will be illustrated.

The concept of growth can deliver valuable information about the growth process of young enterprises and uncover specific requirements enterprises must met in order to realize a healthy development especially when going public.

Furthermore, the concept of the “ new institutional economics ” seems to be of great importance for the purpose of this paper since it is assessed to be state-of-the-art regarding the possibilities for an efficient design of institutions and influences of interrelation of economic actors to the organizational performance.

Since, healthy growth is robustly correlated to the financial development, physical capital accumulation, and economic efficiency improvements in order to enhance the company’s ability to create value;²³ the last basic concept, important for the purpose of this paper is the concept of value-orientation.

In the following the basic concepts will be further analyzed in order set the fundamental understanding of the concepts and to derive the further structure of the present work.

2.1 The Concept of Growth

2.1.1 Introduction

Since this paper is about organizational development, the concept of growth shall here- after set a fundamental understanding on this subject. Thus, a definition will be given, followed by a short review of literature on organizational development. Furthermore, a stage model by means of life-cycle stages will be presented in order to outline the spe- cific nature of young company’s organizational status. Finally, this section will outline the difference between healthy and unhealthy growth in order to clearify the formation of growing pains.

To sum up, the concept of growth shall deliver valuable information on factors influencing the organizational development in order to derive potential factors contributing to a healthy organizational development.

2.1.2 Organizational growth

Growth is one of the most used but yet least well-defined words in the business diction- ary. In this context, a big variety of definitions exist in the fields of financial economics, internationalization and enterprise growth.²⁴ The fundamental formal feature of growth in terms of organizational development is given by the definition “Growth is a process, size is a state”, after which the organizational growth is a period-based process by which the organization shows a bigger size at the end of the period as at the beginning.²⁵ Furthermore, Penrose added that growth can only happen if resources needed exist in abundance and management is able to use them.²⁶ Schumpeter added that growth can be stimulated through actions that enhance the corporate performance and performance is dependent on resources available.²⁷

Literature on growth theory shall hereafter give an overview about which screws companies need to adjust in order to master the organizational development in the process of growth. In order to present the findings in a clear and comprehensible manner, the author decided to present them in table-form.

illustration not visible in this excerpt

Sources: Compiled from Maussner, A. and Klump, R. Wachstumstheorie. (Berlin: Springer, 1996), p. 18, Penrose, E. The theory of the growth of the firm. (Ox- ford: Oxford University Press, 1959), p. 88, Chandler, A., “Organizational Capabilities and the Economic History of the Industrial Enterprise.” The Journal of Economic Perspectives, Vol. 6, Issue 3 (1992), pp. 98-99, Flam- holtz, R. and Randle, Y., “How to avoid choking on Growth.” Management Review, Vol. 76, Issue 5 (1987), p. 25, Greiner, L., “Evolution and Revolution as Organizations grow.” Harvard Business Review, (May-June 1972), p. 40, Jain, B. and Kini, O., “The post-issue operating performance of IPO firms.” Journal of Finance, Vol. 49 (1994), p. 1699; and Schneck, O. Handbuch al- ternative Finanzierungsformen. (Weinheim: WILEY-VCH., 2006), p. 22.

Table 1: Improvements for companies situated in the growth stage of OLC

The essence of the above, in table 1, summarized recommendations for a healthy organizational development refer to an improvement of the organizations performance by means of efficient resource allocation, an improvement of the market performance by means of organic growth, and the ability of resource planning by means of resource allocation and costs planning.

2.1.3 Organizational Life Cycle

Organizational life cycle models are linked to the concept of growth and they are based on a biological metaphor of living organisms, which have a regular pattern of develop- ment: birth, growth, maturity, decline, and death.²⁸ The organizational life cycle (OLC) model propose that organizations, go through a more or less foreseeable order of devel- opmental stages during its lifetime. So, the OLC of a company is conceived of having four phases of development: start-up, growth, maturity, and decline. Four of the more popular models are that of Greiner,²⁹ Churchill and Lewis,³⁰ Scott and Bruce³¹ and Burns.³² Furthermore, Sihler, Crawford and Davis³³ came up with an OLC model which interprets the financial performance of a company measured by sales, profits, and cash flow. Figure 1 represents the different stages of an OLC. Additionally the financial de- velopment according to Sihler, Crawford and Davis is included:

illustration not visible in this excerpt

Sources: Compiled from Sihler, W., Crawford, R. and Davis, H. Smart financial man- agement. (New York: American Management Association, 2004), p. 4; Churchill, N. and Lewis, V., “The five stages of small business growth.” Har- vard Business Review, Vol. 61, Issue 3 (May-June 1983).

Figure 1: Financial performance in the different stages of OLC

The start-up stage is branded by chaotic and frenzied actions because no systems and routines have been established so far. At this early stage only few people are involved in the business and activity mostly revolves around problem solving.³⁴ The main strategic focus in this early stage lies in speed to market with one single product which is innova- tive. In this stage the business is primarily financed by the founder-manager and his intense passion for the mission. Sales start to grow slightly and the company starts to generate first profits. The cash flow from finances exceeds the cash flow from opera- tions which leads to negative net cash flow in this stage of the OLC. Towards the end of this stage, companies often begin to hire new employees rapidly, because business op- portunities exceed infrastructure and resources.³⁵

This expansion continues into the growth stage where control systems and recruitment of more skilled staff is necessary in order to adjust the organizations capacities to exter- nal growth.³⁶ The growth stage is extremely challenging as the organizational success strongly depends on the ability to grow as rapidly as the market opportunities, and this growth needs to be financed. Despite their expansion, companies often need additional funds which are difficult to be raised as the only financing source available in this stage is represented by the founder-manager and financial institutions, which perceive espe- cially young companies to be too small and risky.³⁷ The financing gap is also visualized in the figure 2. As a consequence, many enterprises experiencing growth decide to go public at this point as an IPO seems to be the only way to get additional funds needed.³⁸

If the company mastered the growth stage, it enters the maturity stage or stability stage of the OLC. The key issue for the firm is no longer survival, but rather amassed assets and solid profits, by becoming established in the market. The primary area of business has become a cash cow because it controls a sizable market share and continues to yield profits, but experiences slow or stagnant growth.³⁹ It is during this stage that a firm will have the advantages of size, financial resources and managerial talent.⁴⁰ After the rapid growth and expansion of the business in the preceding stage along with the increase in competition, this stage is characterized by stability.⁴¹

If a company fails to implement measures to improve growth, it will obviously enter the decline-stage of OLC. In this stage, the company experiences a drop in profitability. Furthermore, demand for a company’s products or services decreases. To compensate the decline, companies launch downsizing or reengineering campaigns, look for poten- tial mergers to achieve scale or realizing value for stakeholders or try to sell assets or profitable divisions. If these efforts do not succeed, companies shut down.⁴²

The illustration of the just mentioned OLC shows a direct linkage to the underlying concept of growth. Through all single stages it becomes clear that resources are needed to make growth possible. Especially, in the growth stage of the OLC financial resources represent a key resource for the organizational development of growing entities. Ac- cording to Jain & Kini, especially companies with negative cash flow look forward to go public since these young firms face large investment opportunities but are not suffi- ciently profitable to cover the financing needs required through internally-generated cash.⁴³ Especially, in the growth stage a solid equity base is fundamental for further growth.⁴⁴

2.1.4 Healthy growth vs. unhealthy growth

Growth is the fundamental requirement for a heathy organizational development. However, growth per se is not the source of value added. Rather, growth has to be realized within a corridor defined by upper growth boundaries and under growth boundaries. A company should calibrate her growth within this corridor in order to reach a stage of healthy growth development.⁴⁵

Under growth boundaries are represented by⁴⁶:

- Productivity: If the production capacities outperform the numbers of sales, the company is forced to carry out restructuring measures which costs lots of mon- ey.
- Growth expectations of investors: Stock ratings are influenced negatively when growth expectations are not met and wise versa.
- Market growth: Growth has to be at least at the level of the growth of the mar- ket the company is operating in. Otherwise, the products or services will be no more compatible and the market share will shrink.

Upper growth boundaries are represented by⁴⁷:

- Profitability: Market share may not be gained at the expense of profitability.

To sum up, companies need to adjust their growth strategy according to realistic market prospects and not trying to outperforme or underperforme the growth corridor given by the market growth.

Especially in the case of IPO, when a larg amount of money is available at once, efficient growth planning becomes necessary in order to reach a status of healthy growth. So, Besley & Brigham stated that “Businesses don’t plan to fail, they fail to plan”. The essence of this statement is that a sophisticated resource planning on the basis of realistic growth forecasts has to be developed in form of an investment strategy which then ca be used as ‘to-do list’ in order to guide the future growth.⁴⁸

2.2 The Concept of the “New Institutional Economics”

2.2.1 Introduction

Before going public, companies are in most cases owned by the founder or a group of private investors. Instead, a publicly held company is owned by shareholders. In other words, shareholders hold a part of the company’s asstes and profits. Thus, it is obvious that interrelations between the emitter and the extended stakeholder environment have an impact on the organizational development of puplic companies. Because of that, the Concept of the “New Institutional Economics” represents a valuable concept for the purpose of this paper as it illustrates potential factors affecting the organizational development of a public company.

2.2.2 New Institutional Economics

The new institutional economics deals with the impact of institutions on human behav- ior. It examines the possibilities for efficient design of institutions. An insight to this is that the creation of institutions and organizations and their daily users require the use of real resources. Property rights and contractual relationships in this context are basic ingredients, but do not form a unified theory picture. There are methodologically related approaches that overlap, complement and in some cases are interrelated with each other. There are broadly similar assumptions on human behavior that are grounded in individ- ual utility maximization and bounded rationality.⁴⁹ These two aspects define the actions of the actors. Especially in relation to the IPO and connected to the actions of the share- holders and the issuer provide the motivation to discuss this area of research with focus on the research question in more detail.

In the following, the Property Rights and Principal-Agent-Theory as the two basic themes of the new Institutional Economics are considered to provide indications of a successful IPO and associated with identifying a successful growth.

2.2.2.1 Property-Rights

Property rights are focused on all enforceable behavioral relations between economic actors who result from the existence of goods and belong to their use. Out of these relations the action rights and the property rights can be opened up. There are four rights coming up from property rights:

(1) the right to use the good,
(2) the right to earn income from the good,
(3) the right to transfer the good to others, and
(4) the right to enforcement of property rights.

From an economical point of view property rights refer to ownership and control of a resource.⁵⁰

Against that background financing processes, as for example IPOs, can be interpreted as a transaction of property rights. With a publicly held company a dilution of property rights structure is given, because here a huge number of property rights holders (shareholders) exists and each of them bear comprehensive rights.⁵¹

The investors assess the actions of the emitter by purchasing the shares or refuse them. Therefore the management quality itself presents a success factor for a successful IPO, because investors are only willing to hold or buy the shares of a company if the management shows value-added performance.⁵²

2.2.2.2 Principal Agent Theory

Asymmetric information is covered in literature by a concept named the principal agent-theory as a part of the new institutional economics. The main interest of the principal-agent-theory is the design of the contractual relationship between a principal and an agent. The subjects of the theory are incentive- and control problems with asymmetric information (hidden information) and unobservable actions (hidden action) that result from the delegation of property rights from a principal to an agent.⁵³

Thus, the principal-agent-theory can be understood as a part of the property-rights approach by means of the delegation problem of property rights. Against this background, the separation of ownership and power in a publicly held company can be characterized as a typical principal-agent relationship:

“…the relationship between the stockholders and the managers of a corporation fits the definition of a pure agency relationship…”⁵⁴

However, this approach represents an extremely serious problem in the context of IPO, since asymmetric information between the IPO management and the investor results in a high degree of uncertainty for investors who fear that their investments are not matched by a corresponding equivalent.

These fears are justified, since it is common that privetly held companies usually try to hide their value from the tax authority wich can result in a high overvaluation of the company’s assets.⁵⁵ Other reasons are sourced out of the motivation for an IPO; many companies go public when profitability is about to decline (adverse selection) or the controlling shareholders want extract selfish benefits at the costs of the minority share- holder (moral hazard).⁵⁶ Representatives of the school of managerialsm go one step fur- ther and condemn the management of the IPO-candidate to take advantage of the asymmetric information in terms of selfish goals on the costs of the investors.⁵⁷

Because of these risks, investors will from all issuers the same returns on investment as equivalent to the expected risk. This means, especially for a company with above aver- age earnings prospects, the IPO is no longer worthwhile.⁵⁸ Thus, a reduction of asym- metric information flow in the IPO does not lie solely in the interest of the investor, but also in the interest of the IPO-candidate.⁵⁹ This agency problem is profound and will be taken up again and again by scholars investigating the principal-agency phenomenon therefore one can generally assume that “the agent will not always act in the best inter- ests of the principal”.⁶⁰ From this, the danger arises that investors’ sentiment towards an investment opportunity could probably develop negative. Especially for growing firms with negative cash flows, a shift of the investors’ sentiment because of asymmetric information flow could threaten their survival.⁶¹

Against that background, IPO-candidates must try to communicate their strengths as well as their weaknesses transparently in order to convince the investor about the man- agement, the growth potential of the business and its future prospects in order to mint- age its sceptism. Thus the principal-agent-theory offers additional hints to the im- portance of transparency.

2.3 The Concept of Value-orientation

2.3.1 Introduction

According to King & Levine, healthy growth is robustly correlated to the financial de- velopment, physical capital accumulation, and economic efficiency improvements.⁶² Thus, it can be said that a company which aims to grow healthy, has to act value creat- ing. Based on that, in the following the concept of value-orientation aims to illustrate a management concept, whose goal is to increase the company’s value in the short, medi- um and long term in order to promote a healthy organizational development.

2.3.2 Value-based management

According to Koller, value-orientation can be defined as an “approach to management that aligns a company’s overall aspirations, analytical techniques and management pro- cesses to focus management decision making on the key drivers of value”.⁶³ Value- based management (VBM) is a, consistently on the fundamental value of the company aligned, management concept that directs operating processes, financials, and the think- ing and behavior of employees in the right way in order to increase the company’s val- ue. Thus, VBM helps a company to maximize its value by generating a reasonable eco- nomic rent from the perspective of the shareholders.⁶⁴ The increase of corporate value,which is paramount for a healthy organizational development, is used for long-term livelihood of the company and as basis for the avoidance of growing pains.⁶⁵ A company’s value is determined on the basis of free cash flow which in turn is determined on the basis of profits generated by the company deducted by all investments. Finally the free cash flow is available to be distributed to the investors.⁶⁶

Value-based management experiences a growing popularity because of the increasing competition on the capital markets. Thereby, companies are more and more pushed by investors to focus on value orientation by means of allocating money ultimately to in- vestments which generate returns exceeding the capital cost of the investment.⁶⁷ Conse- quently, focus on value creation is equivalent to superior economic performance. Fur- thermore, value-based management offers systems to provide the own organization with sufficient information in order to develop its infrastructure according to the demand of external needs. In this regard, Dillerup & Stoi mentioned the following criteria VBM can be used by management in order to increase the value creation:⁶⁸

- Measurement of management performance: Which business divisions repre- sent the fundament of the internal corporate value? Which performance triggers have to be set in order to make a business division deliver a positive contribution towards the internal corporate value?
- Evaluation of strategies: Which strategies deliver the highest corporate value? How does a strategic option impact the corporate value?
- Evaluation of M&A’s and collaborations: How much is an acquisition candi- date worthy? What is the price we can afford? Which divisions deliver insuffi- cient performance and thus can be sold?
- Evaluation of investments: Which investments generate corporate value and which destroy it?
- Determination of critical success factors: Which factors influencing the corpo- rate value? How does the value behave to changes within these factors?

As the above list shows, VBM is a concept which allows the management by using evaluation methods to adjust both the organizational environment and the strategic deci- sion-making towards the status needed - which is to increase the company’s value. In other words, there has to exist one in consistent business-management anchored strategy which is aligned with the lasting increase of value. Businesses aiming to increase value can express this by implementing strategic business management.⁶⁹ In doing so, a mis- sion statement and a vision statement have to be developed on the basis of a strategic analysis. Finally, the repective strategies can be formulated out of this in detail.⁷⁰ For the determination of the economic success of the chosen strategy, the measurement of the value added can be applied. To reach the aim of creating long lasting company val- ue, it is necessary to produce continued value added. Thus, the implementation of value- based management supports the strategy assessment as well as the strategic control through the operationalization of the strategic objectives with the help key drivers of val- ue.⁷¹ Those, key drivers of value can be divided into financial value-drivers, operational value-drivers, and value-based communication.⁷²

2.3.2.1 Financial value-drivers

Financial value-drivers are financial outcome variables such as return on sales, sales growth, investment, cost of capital or income taxes whereas the Economic Value Added (EVA), trademarked by Stern Steward & Co., and the Return on Capital Employed (ROCE), developed by McKinsey & Co., represent the key financial value-drivers since they show if the company is growing.⁷³ Conducting these metrics as performance measures, results in the ultimate aim to generate shareholder value. Thus, these measures belong to the concept of residual profit, which assumes that only profit higher than the cost of capital creates added value.⁷⁴ Furthermore, the metrics of Return on Investment (ROI) as performance measure of value-based management is confirmed for the purpose to create additional value through growth strategies⁷⁵. Return on Investment is the ratio of the divided measure of return by the measure of investment. Thereby, various ways to measure ROI exist, for example the Return on Assets (ROA), and the Return on Equity (ROE). The ROA shows how efficiently the management allocates assets in order to make profits; the fewer assets are invested, the more value-creating the profits are. The ROE gives a clear picture of the company’s health in showing the return generated to common stockholders. The metrics ROI helps the management in the in- vestment or divestment decision since management is able to suggest if the expected returns are worth it.⁷⁶ One further metrics, established by Standard & Poor’s, is the measure of return on invested capital (ROIC). Standard & Poor’s claim that ROIC is the appropriate measure of profitability for strategy formulation, since it accounts for the capital required to compete in the industry and delivers the true value a company pro- duces.⁷⁷ The following table (table 2) shall give an brief overview about the just de- scribed financial measures:

illustration not visible in this excerpt

Source: Compiled from Sihler, W., Crawford, R. and Davis, H. Smart financial man- agement. (New York: American Management Association, 2004).

Table 2: Overwiew - financial value-drivers

Financial value-drivers help the leading management to react early to failures and ena- ble them to avert the negative economic consequences from the company at least par- tially. All these measures have the target to create value and are therefore linked to val- ue drivers. With capturing the real value which is the only performance measure that uses complete information, the measures can help management make valuable deci- sions.⁷⁸

2.3.2.2 Operational value-drivers

Operational value-drivers by means of critical performance measures need to be out- lined and translated into milestones which have to be incorporated into the management strategic planning. In doing so, operational value-drivers help understanding better the development of the operational structure and value-generation of the company. With re- organizing the organization along the necessary infrastructure for the implementation of VBM, the IPO-candidate brings itself into the position to compete better after going public. The following structural model in figure 2 shows the possible value-drivers (1-7) a company can translate into strategic milestones in order to improve its performance:⁷⁹

illustration not visible in this excerpt

Source: Schweickart, N. and Töpfer, A. Wertorientiertes Management. (Berlin: Sprin- ger, 2006), p. 41

Figure 2: Structural model of a company and possible value-drivers

As visible in this figure, value-drivers can have two objectives, first to lower costs, and second to improve revenues. Translating those value-drivers into strategy would result in actions for (1) sales growth, (2) increase the return on sales as a ratio of revenues and costs, (3) increase the assets by extending investment in intangible and tangible assets,(4) reduce costs, (5) improve relation between equity and debt in order to reduce the interest burden, (6) improve cash-flow timing, and (7) active tax policy in order to ex- ploit legal elbow rooms in decision making by means of financial, balancing, and loca- tion criteria.

2.3.2.3 Value-based Communication as Value-driver

Value-based communication has an essential influence on the organizational success since active communication with the shareholders generates trust; thus, it should be used as value-driver of VBM.⁸⁰

From the viewpoint of value-based management, particularly the adequate communica- tion of such soft facts and hard facts as part of the corporate strategy becomes very im- portant since they can contribute to value-creation. Thereby, communication takes place twice, within the company and between the company and the relevant capital market actors.

Investors determine their investment decision for or against an investment in a company specifically according to the answer of the question: In what value - in terms of equity - do I invest?⁸¹ Value-based businesses are able to provide a lot more information about the internal value than profit-oriented companies; thereby the information asymmetry is less given. Investors can better assess their investment and thus determine their profit expectations a better way. Additionally, value-based businesses are able to provide in- formation about the future profitability from which the investor can derive the potential corporate value and if the business is expected to deliver growth in value over the long- term.⁸²

Furthermore, VBM enables the IPO candidate to communicate its strengths through performance indicators that help the own management and the potential investors to assess the value of the company and its economic success.⁸³

2.4 Summary

In the following, a short summary of each concept presented in this chapter will be given. Additionally, the surplus of the reviewed concepts towards answering the research question will be outlined.

- The concept of growth: The concept of growth is linked to the metaphor of liv-

ing organisms, which have a regular pattern of development. Likewise organiza- tions show the same pattern, or in other words, stages of development. Accord- ing to literature, companies situated in the growth stage of OLC, experience a set of conditions they have to improve in order to get into the next stage of devel- opment. With developing the organization, the company becomes bigger and more powerful.

The concept of growth offers valuable insights for the purpose of this paper, since it provides information about the organizational conditions of relatively young companies. Furthermore, it illustrates that SMEs situated in the growth stage of OLC need to prepare their own organization to necessary maturity re- garding to internal processes, infrastructure, and management quality. So, espe- cially young companies are branded with relatively lax organizational structures, immature controlling systems, and a management team that has no great experi- ence in how capital markets function.

- The concept of the “New Institutional Economics”: The concept of the “New Institutional Economics” deals with the impact of institutions on human behavior and the efficient design of institutions. The two, relevant concepts of the “New Institutional Economics” for this paper are the Property-Rights and the Principal-Agent-Theory.

In the case of an IPO, the concept of the “New Institutional Economics” is of high relevant since with going public, different parties (emitter, issue syndicate and investor) are involved in the process of preparation, an interest clash and asymmetric information of those parties arises.

[...]

---

¹ Schnell, C. “Kapitalmarkt: Börsengang wird für Mittelständler wieder zur Alternative,“Handelsblatt, December 27, 2009.

² Pagano, M., Panetta, F. and Zingales, L., “Why do companies go public? An empirical analysis.” Journal of Finance, Vol. 53 (1998), p. 1.

³ Onpulson. “Der Börsengang eines Unternehmens,“ http://www.onpulson.de/themen/79/der- boersengang-eines-unternehmens/, accessed March 2, 2013.

⁴ Jain, B. and Kini, O., “The post-issue operating performance of IPO firms.” Journal of Finance, Vol.49 (1994); Pagano, M., Panetta, F. and Zingales, L., “Why do companies go public?, Chan, K., Wang,J. and Wei, K., “Underpricing and long-term performance of IPOs in China.” Journal of Corporate Finance, Vol. 10 (2004), Ahmad, Z. and Lim, S., “Operating performance of initial public offerings in Malaysia.” Capital Market Review, Vol. 13 (2005), Wang, C., “Ownership and operating performance of Chinese IPOs.” Journal of Banking and Finance, Vol. 29 (2005).

⁵ Anderson, S., Beard, T. and Born, J. Initial public offerings. (Boston: Kluwer Academic Publishers, 1995), p. 1.

⁶ Neus, W. Zur Theorie der Finanzierung kleinerer Unternehmungen. (Wiesbaden: Gabler, 1995) p. 138

⁷ Arkebauer, J. Going Public (Chicago: Dearborn, 1998), p. 4.

⁸ Bösl, K. Praxis des Börsengangs (Munich: Vahlen, F., 2004), p. 13.

⁹ PricewaterhouseCoopers “PwC's Autofacts Forecasts 2013 Global Automotive Light Vehicle Assem- bly to Exceed 83 Million Units and Top 107 Million by 2019,” http://www.pwc.com/us/en/press- releases/2013/pwc-autofacts-forecasts-2013.jhtml, accessed August 16, 2013.

¹⁰ Arkebauer, J. Going Public, p. 7.

¹¹ Sicking, M. 2013. “Schlechte Noten für mittelständisches Finanzmanagement,“Heise, January, 18,2013, http://www.heise.de/resale/artikel/Schlechte-Noten-fuer-mittelstaendisches-Finanzmanagement- 1784257.html, accessed February 26, 2013.

¹² Maussner, A. and Klump, R. Wachstumstheorie. (Berlin: Springer, 1996), p. 18.

¹³ Flamholtz, R. and Randle, Y., “How to avoid choking on Growth.” Management Review, Vol. 76, Issue 5 (1987), p. 25.

¹⁴ Schneck, O. Handbuch alternative Finanzierungsformen. (Weinheim: WILEY-VCH., 2006), p. 15.

¹⁵ Jain, B. and Kini, O., “The post-issue operating performance of IPO firms.” Journal of Finance, Vol.49 (1994), p. 1700.

¹⁶ Ronstadt, R. Entrepreneurship. Dover, Mass.: Lord Pub., 1984, p 701.

¹⁷ Baumback, C. and Mancuso, J., Entrepreneurship and venture management. Englewood Cliffs, N.J.: Prentice-Hall, 1975), p. 314.

¹⁸ European Commission, European Commission, „Die neue KMU-Definition: Benutzerhandbuch und Mustererklärung“ (PDF file), downloaded from European Commission website, http://ec.europa.eu/enterprise/policies/sme/files/sme_definition/sme_user_guide_de.pdf, accessed March 4, 2013, pp. 36-41.

¹⁹ Ifm Bonn, “Mittelstandsdefinition,” http://www.ifm-bonn.org/mittelstandsdefinition/, accessed Febru- ary 24, 2013.

²⁰ Venohr, B. Erfolgsmodell Deutscher Mittelstand (Berlin School of Economics, 2009), PDF,http://www.berndvenohr.de/download/veroeffentlichungen/sonstige/05_2009/Roedl_Erfolgsmodell_D eutscherMittelstand.pdf, accessed March 15, 2013., p. 3.

²¹ Eekhoff, J. and Malshe. A., “GE Capital Mittelstand Summit 2012 - Triebwerk des Erfolgs - der deut- sche Mittelstand im Fokus.“, PDF file, downloaded from GE Capital website,http://www.gecapital.de/de/docs/120611_GE_Brochure_2.pdf, accessed March 3, 2013.

²² Ifm Bonn, “Definition KMU des IfM Bonn,” http://www.ifm-bonn.org/mittelstandsdefinition/definition-kmu-des-ifm-bonn/, accessed February 24, 2013.

²³ King, R.G. and Levine, R. (1993). “Finance and Growth: Schumpeter Might Be Right.” The Quarterly Journal of Economics, Vol. 108, Issue 3 (1993), p. 717.

²⁴ Chandler, A. Strategy and structure. (Cambridge, Mass.: M.I.T. Press, 1990); Maussner, A. and Klump, R. Wachstumstheorie; Penrose, E. The theory of the growth of the firm. (Oxford: Oxford University Press, 1959).

²⁵ Penrose, E. The theory of the growth of the firm. (Oxford: Oxford University Press, 1959), p. 88.

²⁶ Ibid, p. 88.

²⁷ Maussner, A. and Klaus, J. Grundz ü ge der mikro- und makro ö konomischen Theorie. (München: Vah- len, 1986), p. 18.

²⁸ Sihler, W., Crawford, R. and Davis, H. Smart financial management. (New York: American Manage- ment Association, 2004), p. 3.

²⁹ Greiner, L., “Evolution and Revolution as Organizations grow.” Harvard Business Review, (May-June 1972).

³⁰ Churchill, N. and Lewis, V., “The five stages of small business growth.” Harvard Business Review, Vol. 61, Issue 3 (May-June 1983).

³¹ Scott, M. and Bruce, R., “Five Stages of Growth in Small Business.” Long Range Planning, Vol. 20 (1987).

³² Burns, P. and Dewhurst, J. Small business and entrepreneurship. (Basingstoke, Hampshire [England]: Macmilan, 1996).

³³ Sihler, W., Crawford, R. and Davis, H. Smart financial management, p. 4.

³⁴ Greiner, L. Evolution and Revolution, p. 7.

³⁵ Ward, A. The leadership lifecycle. (New York: Palgrave Macmillan, 2003), pp. 6-7.

³⁶ Ibid, p. 7.

³⁷ Berger, A.N., “A more complete conceptual framework for SME finance.” Journal of Banking & Fi- nance. Vol. 30, Issue 11 (2006), p. 2963.

³⁸ Onpulson.de (2009)

³⁹ Ward, A. The leadership lifecycle (2003), p. 8.

⁴⁰ Hall, W. Managing cultures. Chichester, England: Wiley, 1995), p. 115.

⁴¹ Churchill, N.C. and Lewis, V.L. (1983), p. 38.

⁴² Ward, A. The leadership lifecycle, pp. 15-16.

⁴³ Jain, B. and Kini, O. the post-issue operating, p. 460.

⁴⁴ Portisch, W. Theorie der Finanzierung. (München: Wolfang Portisch (Publisher), 2008), p. 441.

⁴⁵ Raisch, S., Probst, G. and Gomez, P. Wege zum Wachstum. (Wiesbaden: Gabler, 2010), p. 11.

⁴⁶ Ibid, p. 13.

⁴⁷ Ibid, p. 14.

⁴⁸ Besley, S. and Brigham, E.F. Principles of finance. (Mason, Ohio: South-Western/Cengage Learning, 2012), p. 251.

⁴⁹ Williamson, O.E., “The New Institutional Economics: Taking Stock, Looking Ahead.” Journal of Economics Literature, Vol. 38, Issue 3 (2000), p. 600.

⁵⁰ Ibid, p. 599.

⁵¹ La Porta, et al., “Investor protection and corporate governance.” Journal of Financial Economics, Vol.58 (2000), p. 7.

⁵² Salzer, E. Investor Relations-Management und IPO-Erfolg. (Wiesbaden: Dt. Univ.-Verl., 2004), p. 54

⁵³ Arrow, K. The Economics of Agency. The Economics Series. (Stanford: Institute for Mathematical Studies in the Social Sciences, Stanford University, 1984), p. 38.

⁵⁴ Jensen, M. and Meckling, H., “Theory of the Firm: Managerial Behaviour, Agency Costs and Owner- ship Structure.” Journal of Financial Economics, Vol. 3 (1976), p. 6.

⁵⁵ Pagano, M., Panetta, F. and Zingales, L., “Why do companies go public? An empirical analysis.” Journal of Finance, Vol. 53 (1998), p. 30.

⁵⁶ Jensen, M. and Meckling, H., Theory of the Firm, p. 6.

⁵⁷ Williamson, O., “Transaction Cost Economics Meets Posnerian Law and Economics.” Journal of Insti- tutional and Theoretical Economics, Vol. 149 (1993), p. 105.

⁵⁸ Neus, W. Zur Theorie der Finanzierung, p. 148.

⁵⁹ Fischer, M., et al., “Marketing und neuere ökonomische Theorie: Ansätze zu einer Systematisierung.“Betriebswirtschaftliche Forschung und Praxis (BFuP), Vol. 45, Issue 4 (1993), p. 448.

⁶⁰ Jensen, M. and Meckling, H. Theory of the Firm, p. 308.

⁶¹ Jain, B. and Kini, O., “The Impact of Strategic Investment Choices, p. 460.

⁶² King, R.G. and Levine, R. Finance and Growth, p. 717.

⁶³ Koller, T. (1994) in Bausch, A. and Schwenker, B. Handbook utility management. (Dordrecht: Sprin- ger, 2009), p. 16.

⁶⁴ Schweickart, N. and Töpfer, A. Wertorientiertes Management. (Berlin: Springer, 2006), p. 5.

⁶⁵ Rappaport, A. Shareholder-Value. 2nd ed. (Stuttgart: Schäffer-Poeschel, 1999), p. 23.

⁶⁶ Dillerup, R. and Stoi, R. Unternehmensf ü hrung. (München: Vahlen, 2008), p. 187.

⁶⁷ Bausch, A. and Schwenker, B. Handbook utility management. (Dordrecht: Springer, 2009), p. 16.

⁶⁸ Dillerup, R. and Stoi, R. Unternehmensf ü hrung, p. 188-189.

⁶⁹ Brunsmann, B., DeVore, S. and Houston, A., The corporate strategy function.” Journal of Business Strategy, Vol. 32, Issue 5 (2011), p. 45.

⁷⁰ Hart, S.L., “An Integrative Framework for Strategy-Making Processes.” The Academy of Management Review, Vol. 17, Issue 2 (1992), p. 327.

⁷¹ Schweickart, N. and Töpfer, A. Wertorientiertes Management, pp. 40-41.

⁷² Parres-Lopez, S. and Jäger, W. Wertorientiertes Kommunikationscontrolling in der Praxis. (Wiesba- den: Gabler, 2007), p. 2.

⁷³ Koller, T., Goedhart, M. and Wessels, D. Valuation, p. 17.

⁷⁴ Pilzecker, S. Konzepte der wertorientierten Unternehmensführung: die DAX 30 Unternehmen. (Ham- burg: Diplomica, 2011), p. 27.

⁷⁵ Whittington, R. and Delaney, P. Wiley CPA exam review 2013. Hoboken, N.J.: Wiley, 2013), p. 270.

⁷⁶ Ibid, p. 270.

⁷⁷ Porter, M. On competition. (Boston, MA: Harvard Business School Pub., 2008), p. 83.

⁷⁸ Koller, T., Goedhart, M. and Wessels, D. (2010), p. 14.

⁷⁹ Ibid, pp. 40-41.

⁸⁰ Parres-Lopez, S. and Jäger, W. Wertorientiertes Kommunikationscontrolling, p. 2.

⁸¹ Hilbert, S. “Wertorientierte Unternehmensführung,” (PDF-file), downloaded from DHBW-Mannheim website, http://www.dhbw-mannheim.de/fileadmin/ms/bwl-vs/Versicherung_1/Wertorientierte_Unternehmensfuehrung.pdf,accessed July 3, 2013, p. 2.

⁸² Dillerup, R. and Stoi, R. Unternehmensf ü hrung. (München: Vahlen, 2008), p. 190.

⁸³ Schweickart, N. and Töpfer, A. Wertorientiertes Management, p. 217.