Finding an Alternative Disclosure Path: IPO Business Model Targets

Key Observations

·         Nearly 40% of IPO firms provide quantitative forward-looking financial information in their IPO roadshows that is not included in the firm’s S-1 filings.

·         In contrast to seasoned public firms who generally provide next-year or next-quarter earnings forecasts, forward-looking metrics in the IPO roadshow – often called “targets” – most often describe the firm’s expected equilibrium business model at an unspecified time in the future.

·         Firms typically provide targets that improve their current financial position: increased profit ratios and reduced expense ratios.

·         Analyst forecasts are less dispersed for firms providing more targets, suggesting analyst use the targets. However, analysts’ forecasted values are generally more pessimistic than firm-provided targets, although analysts typically only forecast about 3 years ahead.

·         Firms frequently do not meet their disclosed targets. Even using the low-end of the target range, a minority of firms ever meet or exceed the target during any of their post-IPO years.

·         Stock returns increase (decrease) as firms’ realized profit (expense) margins grow relative to the IPO targets, suggesting that the targets were used to form expectations of firm value and investors adjust their estimates when realizations deviate from these expectations.

·         Firms that present targets during their IPO roadshow are nearly three times more likely to also issue next-year or next-quarter earnings forecasts after going public.

·         Firms do not continue to disclose targets after their IPO. Thus, target disclosure appears to be part of a broader strategy to provide investors with forward-looking information, with firms using the IPO roadshow as an initial platform before transitioning to more conventional guidance mechanisms once public.

The inclusion of forward-looking projections in Securities and Exchange Commission (“SEC”) filings has a long and varied history. Dating back to the Securities Act of 1933, the SEC initially prohibited the inclusion of such information in SEC filings. The SEC later reversed this prohibition through a series of regulations. Safe harbor rules released in 1979 (Rule 175 under the Securities Act of 1933 and Rule 3b-6 under the Securities Exchange Act of 1934) attempted to insulate financial projections from liability. Then, US Congress adopted the Private Securities Litigation Reform Act (PSLRA) in 1995 that, among other things, provided firms more protection when making forward-looking statements in an effort to reassure firms nervous about litigation risk.

However, IPO communications are explicitly excluded from PSLRA protections. Thus, issuers are exposed to significant liability if forward-looking statements prove inaccurate, and lawyers strongly caution firms against providing such information while marketing the IPO. Although IPO firms are technically allowed to provide forecasts when going public, Rose (2021) writes that issuers “uniformly choose not to.” In a review of IPO filings over the prior three years, Feldman (2021) similarly concludes that “no IPO company has actually provided financial projections, other than vague narrative disclosure.” In contrast, Coates (2023) raises the possibility that firms do provide such information, but through the roadshow presentation rather than in the SEC filing. In light of the debate, and motivated by increased discussion about IPO disclosure rules, we ask whether IPO firms use the roadshow as an alternative disclosure channel to meet the market demand for forward-looking information.

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