CORPORATE GOVERNANCE AND INVESTORS’ PERCEPTIONS … · This article investigates stock market...

CORPORATE GOVERNANCE AND INVESTORS’ PERCEPTIONSOF FOREIGN IPO VALUE: AN INSTITUTIONAL PERSPECTIVE

R. GREG BELLUniversity of Dallas

IGOR FILATOTCHEVCity University London and Vienna University of Economics and Business

RUTH V. AGUILERAUniversity of Illinois at Urbana-Champaign and Ramon Llull University

This article investigates stock market responses to different constellations of firm-levelcorporate governance mechanisms by focusing on foreign initial public offerings (IPOs)in the United States. We build on sociology-grounded research on financial marketbehavior and use a “nested” legitimacy framework to explore US investor perceptionsof foreign IPO value. Using a fuzzy set theoretic methodology, we demonstrate howdifferent combinations of monitoring and incentive-based corporate governance mech-anisms lead to the same level of investor valuation of firms. Moreover, institutionalfactors related to the strength of minority shareholder protection in a foreign IPO’shome country represent a boundary condition that affects the number of governancemechanisms required to achieve high value perceptions among US investors. Ourfindings contribute to the sociological perspective on comparative corporate gover-nance and the dependencies between organizations and institutions.

The rapid globalization of financial markets inrecent years has been accompanied by a growingnumber of companies raising capital abroad. Sincethe late 1990s, foreign initial public offerings(IPOs)—wherein private firms bypass stock ex-changes in their country of origin to “go public” ona foreign stock exchange (Hursti & Maula, 2007)—have become a significant class of companies, par-ticularly in the United States. These foreign firmsseek equity financing not only to achieve financialgoals, but also to achieve marketing, political, andemployee relations benefits (Saudagaran, 1988).However, foreign IPOs may suffer from various “li-abilities of foreignness” and have less legitimacyamong investors than domestic listings (Bell, Fila-totchev, & Rasheed, 2012). Although foreign firmsmay try to increase their appeal to US investors by

complying with their expectations about corporategovernance, a growing number of finance and man-agement studies (Bruner, Chaplinsky, & Ramchand,2006; Francis, Hasan, Lothian, & Sun, 2010; Moore,Bell, Filatotchev, & Rasheed, 2012) demonstratethat home country institutional environments sig-nificantly affect foreign firms’ valuations and, ulti-mately, the success of their IPOs. At present, thereis a dearth of research on how governance factorsinfluence host county investors’ perceptions of for-eign IPO value and how these perceptions are af-fected by a firm’s home country institutionalenvironments.

Finance and management researchers have tradi-tionally relied on the agency perspective to under-stand the complex relationships between IPO cor-porate governance and stock market performance.An assumption in these studies is that an IPO firmmay rationally use multiple governance mecha-nisms to mitigate agency conflicts between its in-siders and public market investors to optimize thestock market valuations (Francis et al., 2010). Agency-theory-grounded governance studies often conceptual-ize and operationalize monitoring, managerialincentives, and other types of governance mecha-nisms as independent, as each having a unique

We would like to thank Associate Editor Tim Pollockand three AMJ reviewers for their significant contribu-tion to improvement of this article. For constructive con-versations and comments on this research we are alsograteful to Abdul Rasheed, Charles Baden-Fuller,Thomas Greckhamer, Peer Fiss, and Mason Carpenter.An earlier version of this research was presented at the2010 Annual Meeting of the Academy of Management.

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� Academy of Management Journal2014, Vol. 57, No. 1, 301–320.http://dx.doi.org/10.5465/amj.2011.0146

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ability to impact the behaviors of stock market par-ticipants (Beatty & Zajac, 1994; Sanders & Boivie,2004). In combination, these governance mecha-nisms are expected to have a positive, additiveeffect on investors’ valuation of an IPO firm.

More recently, sociological approaches to finan-cial market behavior have suggested that marketvalues and stock market reactions to firm-level fac-tors are socially constructed (Zajac & Westphal,1995, 2004). As a result, stock market valuationsare an outcome of investors’ perceptions of firms’legitimacy rather than rational, efficiency-centeredinvestor decisions. Legitimacy is defined as a “gen-eralized perception or assumption that the actionsof an entity are desirable, proper, or appropriate,within some socially constructed system of norms,values, beliefs, and definitions” (Suchman, 1995:574). When faced with uncertainty associated withthe process of IPO, investors are more likely tofocus on institutionalized rules when evaluatingthe quality of IPO firms (Pollock, Fund, & Baker,2009). This process of legitimation frames inves-tors’ assessment of various firm-level governancemechanisms because they are perceived as stan-dard and useful, and are legitimated in large part bytheir presumed efficacy in the highly uncertain IPOmarket environment. Yet the overall legitimacy im-pact of corporate governance mechanisms is morecomplex than previously assumed. Indeed, re-search has shown that scholars should not considercorporate governance mechanisms in isolationfrom each other, but should instead look at them in“bundles” when determining their overall legiti-macy impact, because mechanisms can be func-tionally equivalent (Aguilera, Filatotchev, Gospel,& Jackson, 2008). It is unclear, however, what in-stitutional mechanisms link adherence to a specificconstellation of governance factors and investors’perceptions in the specific case of IPO firms thatchoose to bypass their home country capital mar-kets and make their first public equity offers on USexchanges.

In addition, when seeking to exploit overseascapital markets, foreign IPO firms are exposed topotentially different institutional logics, or sets of“beliefs and rules that shape the cognitions andbehaviors of actors” (Dunn & Jones, 2010: 114), intheir home and host countries. Because the processof legitimation involves the interaction of bothcountry-level institutions and firm-level practices(Moore et al., 2012), there is a need to better under-stand how differences in home and host countryinstitutional logics impact investors’ perceptions of

firm governance. Foreign IPOs listing in the USrepresent a unique laboratory for theory buildingrelated to the multifaceted interplay between regu-latory institutions and firm-level governance, sincethese firms often originate in countries with differ-ent governance regulations than the US. Little re-search investigates whether dissimilarities inhome/host country institutional logics impact theprocess of legitimation through adoption of variouspractices in a firm’s overall governance bundle.

These theoretical arguments lead to two relatedquestions not addressed in previous studies of IPOgovernance. First, given that a firm’s governancemechanisms are important for managing investorperceptions, can different bundles of governancemechanisms in foreign IPO firms lead to the sameperceived valuation outcomes? Second, how dodifferences between a foreign IPO firm’s home andhost country institutional contexts affect this pro-cess of gaining legitimacy through governancemechanisms? By answering these questions, wemake a number of theoretical and empirical contri-butions to existing sociological understanding ofboth financial markets in general and corporategovernance in particular. First, although gover-nance mechanisms underpin the process of legiti-mation of foreign IPOs in the US investor commu-nity, unintended outcomes can occur when firmsadhere to multiple, and perhaps redundant, gover-nance mechanisms (Aguilera et al., 2008; Pollock,Chen, Jackson, & Hambrick, 2010). Hence, our fo-cus is on the boundary conditions that determinehow different combinations, or bundles, of gover-nance mechanisms in foreign IPO firms might leadto similar investors’ perceptions of their value. Sec-ond, we offer a nested model of legitimacy in whichinvestor perceptions of a foreign IPO firm’s overalllegitimacy fall at the intersection of the cognitiveand regulatory institutional domains. We sustainthe view that IPO firms can have flexibility in ob-taining legitimacy from their governance bundlesonly when they meet a minimal regulatory legiti-macy threshold—that is, they come from jurisdic-tion in which governance is strong. Conversely,IPO firms originating from countries with institu-tional environments granting weak minority share-holder protections will have to adopt a larger num-ber of governance mechanisms to gain the samelevel of legitimacy as IPOs from strong governancejurisdictions. Our research, therefore, providesan important extension to previous sociology-grounded studies of financial markets by show-ing how the complex interplay of multilevel le-

302 FebruaryAcademy of Management Journal

gitimation factors affects investor perceptions offirm value.

Finally, because our theoretical approach ad-dresses the intersection between bundles of firm-level governance mechanisms and country-level in-stitutional factors, the traditional methods used inthe majority of IPO studies have limited capabilityto tackle our research questions. Therefore, we alsomake a methodological contribution to IPO gover-nance research by testing our conceptual modelusing fuzzy set qualitative comparative analysis (fs/QCA; Ragin, 2008). Fs/QCA is intended not to iso-late the net, independent effects of single explana-tory factors on a particular outcome, but rather toidentify the combinations of factors that bringabout the particular outcome (Ragin, 2008). Thismethodological advance allows us to probe deeperempirically and theoretically into the factors thataffect stock market legitimation processes. Morespecifically, we can demonstrate that a firm’s legiti-macy can be captured not only by the relationshipsbetween governance practices and macro institu-tions, but also by other organizational and third-partycontingencies associated with the IPO process.

THEORY AND HYPOTHESES

IPO Corporate Governance Mechanismsand Legitimacy

IPO studies within financial economics and man-agement fields have developed a substantial bodyof research intended to link stock market perfor-mance with governance characteristics of an IPOfirm. Grounded in agency theory, these studies em-phasize rational adaptation of IPO firms to a set ofexternal market conditions and contractual rela-tionships between insiders, early stage investors,underwriters. and public market investors that areassociated with potential agency costs of moralhazard and adverse selection (Certo, Daily, & Dal-ton, 2001; Filatotchev & Bishop, 2002; Sanders &Boivie, 2004). They also argue that, facing thesecosts, an IPO firm should rationally respond byenhancing its governance mechanisms, such asboard monitoring and executive incentives, to re-duce informational asymmetries and convey itsquality to investors and ultimately improve itsstock market value.

However, the results of a large body of empiricalstudies of the agency-grounded governance predic-tors of IPO performance are inconclusive. This par-ticularly extends to the three most salient gover-

nance mechanisms identified in IPO research:board independence (compare Arthurs, Hoskins-son, Busenitz, and Johnson [2008] with Certo et al.[2001]); equity-based compensation (compare Elluland Pagano [2006] with Filatotchev and Bishop[2002] and Lowry and Murphy [2007]); and moni-toring by venture capital (VC) firms (see Bruton,Filatotchev, Chahine, & Wright, 2010). These mixedresults are further confirmed by Daily, Certo, Dalton,and Roengpitya’s (2003) meta-analysis of IPO re-search uncovering considerable empirical ambigu-ity in the hypothesized governance-performancerelationships.

A number of organizational theorists have putforward a sociological perspective on corporate andinvestor behavior questioning the rather simple,rational assumptions of agency-driven research.These studies’ argument is that dominant gover-nance beliefs based on the agency model of corpo-rate control have become an institutional logic thatunderpins the process of firm legitimation amonginvestors (Zajac & Westphal, 2004). For example,scholars maintain that “considerable uncertaintyinherent in valuations, which is compounded bythe social nature of investing, gives special urgencyto the need for legitimacy” (Zuckerman, 1999:1401). Within this line of analysis, research showsthat in the face of increasing uncertainty, such aswithin the IPO process, firms are more likely tofollow institutionalized rules that are taken forgranted in organizational decision making (Pollocket al., 2009). Yet little is known about how differentconstellations of governance mechanisms affect in-vestor perceptions of firm value.

Drawing on neoinstitutional theory (Kraatz & Za-jac, 1996; Meyer & Rowan, 1977; Scott, 2001), wesuggest that the governance mechanisms of IPOfirms are a product not only of coordinative de-mands imposed by market efficiency concerns, butalso of rationalized norms legitimizing the adop-tion of appropriate governance practices (Zajac &Westphal, 2004). The neoinstitutional perspectiveenables our analysis to focus less attention on theindividual efficiency outcomes of different gover-nance mechanisms at the core of an agency per-spective and instead center our theoretical effortson understanding how governance mechanisms af-fect a firm’s legitimacy through perceptions of ex-ternal assessors of organizational legitimacy—thestock market audience (Deephouse & Suchman,2008; Zuckerman, 1999), or investor community.Capital markets represent a particularly useful set-ting for studying social processes that capture le-

2014 303Bell, Filatotchev, and Aguilera

gitimation and, hence, investors’ valuation of IPOfirms (Higgins & Gulati, 2006; Pollock, Rindova, &Maggitti, 2008).

In addition, an institutional approach to corpo-rate governance research maintains that “corporategovernance systems themselves are embedded inlarger institutional and legal frameworks” (Fiss,2008: 390; see also Aguilera & Jackson, 2003, 2010).Thus, the process of legitimation may be contingenton the institutional environment within which afirm operates (Chung & Luo, 2008), in particular theextent of protection of minority investors (Bruton etal., 2010). Importantly, Berger, Ridgeway, Fisek,and Norman claimed that “legitimation is inher-ently a multilevel process” requiring a theory thatinvolves analysis of factors at “both the local levelof the object of legitimation and the level of encom-passing social framework” (1998: 379). Governanceresearchers are increasingly recognizing that firm-level governance should be analyzed in conjunctionwith institutional factors, such as laws and regula-tions (Aguilera et al., 2008; Bruno & Claessens,2007). However, extant IPO research neglects theimportance of the effects of firms’ home countryinstitutional environments on investors’ percep-tions of overall IPO governance bundles. In thefollowing section, we discuss IPO firms’ legitima-tion based on firm governance and IPO firms’ homecountry institutions.

Nested Legitimacy: Home Country Institutionsand Firm-Level Corporate Governance

Our previous discussion suggests US investors’perceptions of foreign IPO firm value may be basedon what sociology-grounded research describes as anested legitimacy framework (Deephouse & Such-man, 2008; Holm, 1995). In this framework, “theinstitutional arrangements at one level constitutethe subject matter of an institutional system at ahigher level” (Holm, 1995: 400). In the context offoreign firms making their capital market debut onUS stock exchanges, “perceptions of organizationallegitimacy shape investor behavior” (Tost, 2011:686) when investors evaluate how well the foreignIPO firms comply with their perceptions of “goodgovernance.” A good governance bundle in a for-eign IPO brings cognitive legitimacy (Scott, 2001)because it is “understood, recognizable, and lo-cated within the set of the widely held cognitivestructures of its institutional environment” (Sand-ers & Tuschke, 2007: 33). However, this process ofgaining legitimacy through governance does not

develop in isolation from investors’ perceptions ofa foreign IPO firm’s home country regulatory insti-tutional environment. The foreign IPO firm’s over-all legitimacy, therefore, falls at the intersection ofthe cognitive and regulatory institutional domainsassociated with its governance bundle and homecountry legal environment, in line with more re-cent research on social judgments of organizations(Bitektine, 2011; Tost, 2011).

Although foreign IPOs consider the US as a pri-mary equity market, these firms’ production anddistribution systems, business networks, and otherkey characteristics are significantly embedded intheir home countries (Bell et al., 2012). Foreign IPOfirms are exposed to a different institutional logicbefore listing in the US, which might have a signif-icant impact on investors’ perceptions of theirvalue because “multiple logics . . . may make agree-ment difficult and consensus impossible” (Dunn &Jones, 2010: 115). Greenwood, Raynard, Kodeih,Micelotta, and Lounsbury (2011) argue that thehigher the number of logics, the greater will be thecomplexity facing an organization and its audience.These authors emphasize the importance of formal-ized rules for dealing with this increase in com-plexity, in particular in organizations that are at ajuncture of multiple institutional logics, such asforeign IPOs whose primary audience includes USinvestors.

This suggests that legitimation should be ana-lyzed at multiple levels, including possible inter-actions among the levels (Deephouse & Suchman,2008: 68–69). Hence, the process of legitimationthrough governance may be nested in a broadercontext of investors’ perceptions of the legitimacyof institutions associated with a foreign IPO’s homecountry. The nesting of firm-level governance withcountry-level institutions and the associated com-plexity it creates represent an important boundarycondition that affects foreign IPO legitimation inthe eyes of US investors through firm-level gover-nance. Although some recent studies emphasizethis nested nature of cognitive and regulatory insti-tutional factors (e.g., Bitektine, 2011; Fiss, 2008;Greenwood, Diaz, Li, & Lorente, 2010), little re-search exists on their intersection in the context ofcapital markets.

From the US investor perspective, an especiallyrelevant feature of foreign IPOs’ home environ-ments is the extent to which regulatory institutionsprotect minority investor rights. Neoinstitutionaltheorists argue that regulatory institutions hold apreeminent place in shaping organizational legiti-


mation (Deephouse & Suchman, 2008), chiefly inthe realm of corporate governance. This is because“the logic of shareholder value maximization be-came the dominant guiding principle informing topmanagement strategic decision making in listedfirms as well as . . . the way institutional sharehold-ers evaluated their performance” (Lok, 2010: 1305).Scott (1998) also highlights the importance of gov-ernmental organizations, legislation, and court de-cisions as “primary regulative agents” of the struc-ture and activities of organizations. The functionsof a regulatory system include establishing rules tohold managers accountable to shareholders, ensur-ing shareholder voting privilege, preventing self-dealing by managers, protecting creditors, and en-forcing these rules in practice. In countries withregulations lacking in these elements, US investorsmay suspect that, for example, insiders or control-ling shareholders may be diverting resources fromthe corporation to the detriment of minority inves-tors (Djankov, La Porta, Lopez-de-Silanes, & Shlei-fer, 2008; La Porta, Lopez-de-Silanes, Shleifer, &Vishny, 1998). Other things being equal, this wouldnegatively affect a firm’s legitimacy in the domi-nant logic of shareholder value maximization(Zajac & Westphal, 2004).

The nesting of firm-level governance with coun-try-level institutions securing protection of inves-tors in public markets has key implications for for-eign IPOs. During their evaluations, investorsattempt to gauge whether a firm will grow andsucceed as a public firm in US capital markets. Yeta cornerstone of their overall evaluation is the le-gitimacy US investors attach to the regulative insti-tutional environment from which the foreign IPOfirm originates. As Tost (2011: 692) emphasizes,“regulative legitimacy represents social cues indi-cating the validity of the entity.” This forms anintegral part of what Bitektine conceptualizes as amodel of the social judgment formation: “The eval-uator selects the most appropriate form of judg-ment, given the context and objectives of his or herevaluation, and then conducts a search for informa-tion on the organization’s features that may be rel-evant for the selected form of judgment” (2011:164).

In line with our nested legitimacy discussionabove, foreign IPOs will likely have different pathsto achieving legitimacy in the eyes of investorsavailable to them. What these paths are is contin-gent on the strengths of their home country regula-tive institutional environments. For example, IPOfirms coming from countries with strong investor

protection rules operate in a home institutionalenvironment with an agency-grounded institu-tional logic, similar to the US. Similarities betweena foreign IPO’s home and host markets’ regulatoryinstitutional logics reduce investor uncertaintiesand their need to rely on the firm’s compliancewith multiple governance mechanisms. The legiti-macy of firm-level governance mechanisms beingnested within home regulative institutions chal-lenges the agency framework’s assumption of thelinear additivity of governance practices (essen-tially, the idea that “more governance is better”) bysuggesting a scope for different bundles of gover-nance practices. In our context, this means thatwhen a firm has reached a certain level of thefirst-order, regulatory legitimacy, it may achieveequivalent levels of perceived IPO stock-marketevaluation via different and limited combinationsof governance mechanisms. For example, Zucker-man (1999) describes a social process that explainswhy US investors put a discount on companies thatwere not covered by the securities analysts special-izing in their industry. He argues that gaining in-vestor favor requires conformity with this audi-ence’s “minimal criteria” and that the analysts’coverage represents the main differentiation fromillegitimate offers. Companies that fit this minimalcriterion are not under pressure to use other meansto conform.

In the IPO context, a firm from a country withregulative institutions similar to those of the USmay gain a first-order, “minimal” legitimacy andthus have “the capacity to constitute itself bychoosing its identities and commitments from themenu of choices presented by its would-be constit-uencies” (Kraatz & Block, 2008: 255). This menumay be related to different monitoring and incen-tive-based governance practices that lead to thesecond-order, cognitive legitimacy. The nested le-gitimacy framework implies that the marginal ef-fect of additional governance practices on investorperceptions may be declining in foreign IPOs thatare over the regulatory legitimacy threshold. Bitek-tine (2011), for example, indicates that the legiti-mation process develops in an environment of“cognitive economy” and that evaluators may betempted to use “cognitive shortcuts.” Pollock et al.(2010) provide analysis of the potential redundan-cies of value signals associated with multiple cer-tifying affiliates of IPO firms, such as VCs andunderwriters. They discuss social mechanisms be-hind diminishing marginal legitimacy associatedwith these affiliates and suggest that the amount of


uncertainty that their certification can reduce maybe finite. As endorsements accumulate, each sub-sequent signal will have less impact than priorsignals. To put this argument into our context, be-cause they are required to adhere to regulatory stan-dards in their home country, foreign IPOs fromcountries with strong investor protection may carryless uncertainty from the US investors’ point ofview. As a result, they may need less governance.We build on these arguments and suggest:

Hypothesis 1. The effect of a foreign IPO’s gov-ernance mechanisms on investor value percep-tions is contingent on the legitimacy of its homecountry regulatory institutions, and the value ofmultiple mechanisms does not accumulate forforeign IPOs originating from countries withstrong legal protection for minority investors.

Given the importance of meeting the minimumthreshold of regulatory legitimacy, the question fac-ing foreign IPO firms from countries with less le-gitimate regulatory institutions, such as those asso-ciated with weak protection of minority investors,is this: What combinations of governance mecha-nisms are likely to enable firms from countries withweak regulatory institutions (e.g., China, Russia, orBrazil) to achieve comparable levels of valuation onUS exchanges as firms from countries with stronglegal institutions (e.g., Canada, UK)?

The sociological perspective on financial mar-kets offers three reasons why investors wouldlikely demand that firms originating from lesslegitimate regulative institutional environmentsadopt more governance practices to achieve thesame level of legitimacy as IPOs originating fromcountries with regulative institutions similar to USinstitutions. First, a regulatory void in the formalinstitutional environment in a foreign IPO’s homerepresents a missing minimal condition in a stockmarket’s nested social legitimacy framework. Fol-lowing Zuckerman’s (1999) arguments, firms com-ing from outside “accepted” countries are penal-ized not because they raise information costs for USinvestors, but because they threaten interpretiveframeworks that investors base their investmentevaluations upon. Hence, to achieve the same levelof investors’ value perception, foreign IPOs mayhave to rely on a broader range of governance prac-tices. Indeed, more firm-level governance would berequired to compensate for the legitimacy loss as-sociated with not surpassing a minimal thresholdof home regulatory institutions.

Second, Kraatz and Block (2008) argue that whenorganizations are situated in a pluralistic institu-tional context, their audiences may become suspi-cious about their priorities and commitment to therules. In addition, as Edelman, Uggen, and Erlangeremphasize, “legal rules are not self-enforcing . . .those subject to [them] must determine what con-stitute compliance and what actions they will taketo demonstrate compliance” (1999: 409). Therefore,in the context of a foreign IPO with heightenedinstitutional duality, investors are likely to rely onwhat Kraatz and Block call “second-order evalua-tive criteria in assessing its legitimacy” (2008: 249),and to achieve the high levels of legitimation andconsequently valuation, the IPO firm must deploy awider range of governance practices to reassure USinvestors that their interests are well protected.

Finally, a related argument is that foreign IPOsfrom countries with nonlegitimate regulatory insti-tutions are often exposed to divergent and conflict-ing institutional logics in their home and host mar-kets. The multiplicity of attention associated withinstitutional duality may result in conflicting de-mands and lack of consensus (Dunn & Jones, 2010),a result that increases the level of complexity anduncertainty surrounding these firms (Greenwood etal., 2010). When IPO firms are facing increasinguncertainty, the scope for redundancies in legiti-macy signals diminishes (Pollock et al., 2010), andinvestors become more likely to follow a widerrange of standard or institutionalized rules (Pollocket al., 2009). Together, these arguments suggest thatpositive US investor perceptions may still be asso-ciated with foreign IPO firms that originate fromcountries with weak legal protections to minorityinvestors, but only if these firms adopt a broaderrange of monitoring- and incentive-related mecha-nisms in their governance bundle.

In sum, while we do not claim that there is onlya single path for IPOs from countries with weakinvestor protection to achieve favorable investors’perceptions when going public on a US exchange,we argue that the benefits of adhering to multiplegovernance mechanisms are likely to be more valu-able to these firms in order to overcome perceivedlegitimacy concerns. Hence:

Hypothesis 2. To achieve high investor valueperceptions, foreign IPOs from countries withweak legal protection for minority investorsmust employ a larger number of mechanismsin their governance bundles than IPOs from


countries with strong protection for minorityinvestors.

SAMPLE AND METHODOLOGY

To construct our sample, we utilized the SecurityData Corporation (SDC) database New Issues toidentify all foreign firms that made first-time “firmcommitment” IPOs in the US between 1996 and2006. The SDC database defines foreign firms asthose incorporated and with primary executive of-fices outside of the US. As has prior IPO research,we excluded from our sample stock listings result-ing from mergers or acquisitions or from spin-offsof publicly listed firms. We also eliminated fromour analysis unit trusts, warrants, and rights offer-ings. We then followed the selection proceduresoutlined by Bruner et al. (2006) and removed allutilities from consideration and all firms incorpo-rated in Bermuda, Bahamas, or the Cayman Is-lands.1 We then acquired each firm’s initial S-1registration filing and final prospectus from theSecurities and Exchange Commission (SEC).

Tables 1 and 2 provide summary statistics of ourfinal sample, which is comprised of 198 firms from36 countries. Despite the slowdown in foreign list-ings after 2001, recent yearly totals suggest that thepopularity of US exchanges is gaining strength. Ta-ble 2 shows that most of the foreign firms that

choose to list on US exchanges originate from ei-ther Europe or from the Asia Pacific region.

To test our hypotheses, we utilized fs/QCA,which is based on set theory and in which causalclaims are developed by means of supersets andsubsets (Ragin, 2008). Fs/QCA is quite effective inevaluating both the number and complexity of al-ternative paths leading to a desired outcome (Fiss,2011; Greckhamer, Misangyi, Elms, & Lacey, 2008;Ragin, 2008). Given that our hypotheses are builton the premise that investors’ perceptions of highforeign IPO value can be achieved through multiplecombinations of governance features, the fs/QCAapproach is particularly useful.

In the following section, we identify our vari-ables and then calibrate them into crisp sets andfuzzy sets. Crisp sets define membership status aseither “fully in” or “fully out” of a given set. Incontrast, fuzzy sets allow researchers to account forthe varying degrees of membership of cases in a setby using the anchor 1 to designate “fully in” aparticular set, 0 for nonmembership, and .5 as thepoint of maximum ambiguity, neither in nor out ofa particular set. Ragin (2008) advised that bothsubstantive and theoretical knowledge be usedwhen calibrating measures and translating theminto set membership scores.

Outcome Condition: Price Premium

Price premium is a useful measure of investorIPO valuations because it represents the potentialvalue that investors perceive in an issuing firm’sshares that exceeds their book value (i.e., the valueof the firm’s equity as reported in its financial state-ments) (Rasheed, Datta, & Chinta, 1997; Welbourne& Andrews, 1996). We chose this measure to assessinvestor valuations because traditional IPO valua-tion measures that are based on determining issueprice relative to prevailing market price suffer threekey limitations (Rasheed et al., 1997). First, onlyafter trading has begun can a firm’s initial owners

1 While these firms technically conform to the “for-eign” criteria, they are often US or UK financial servicesfirms incorporated in these countries to reduce theirdomestic tax burdens.

TABLE 1Foreign IPO Yearly Statistics

IssueYear

IPOVolume

AverageAge

AverageOfferPrice

AverageShares

OfferedaNet

Proceedsa

2006 22 9.2 15.43 9.5 291.72005 23 5.78 14.19 7.9 150.52004 19 7.83 15.06 7.7 192.052003 3 2.33 15.95 5.6 460.52002 5 17.8 14.16 5.1 259.022001 6 19.67 12.4 19.54 50.652000 13 5.07 14.36 7.8 59.581999 7 5.42 14.51 10.65 55.981998 9 7.33 18.52 11.59 170.121997 42 10.09 14.63 10.27 85.771996 49 8.89 13.33 8.52 94.97Total 198

a In millions of dollors.

TABLE 2Foreign IPO Home Markets

Region IPOs

North America 24South America 12Europe 90Asia/Pacific 72BRIC countries 43


and underwriters determine whether a new issue isover- or underpriced, and the extent of the over- orunderpricing often varies with time. Second, initialincreases in prices may be the result of overvalu-ation, market fads, or intentional underwriter pricesupport. Finally, valuation assessments based onan initial return measure may overestimate the re-turn available to investors and the underpricingcosts to an issuer. Assessing a firm’s stock pricebeyond book value allows us to control for assets,and thus, enables us to provide a robust estimate ofinvestors’ perceived future value. Empirically, IPOpremium reflects investors’ intention of participationand offers a sense of their (the market’s) perceptionsof a firm’s competitiveness because underwriters setthe offer price after ascertaining the views of investorsthrough the book-building process (i.e., generating,capturing, and recording investor demand for sharesduring an IPO).

Following previous research, we calculated pricepremium using this formula: (offer price – bookvalue)/offer price. We then undertook two steps toarrive at our breakpoints to define membership inthe set of highly valued foreign IPOs. First, wereviewed prior studies from leading managementand entrepreneurship journals that incorporatedprice premium as the IPO valuation measure.2 Re-sults of these studies show that on average IPOfirms receive premiums of 66 percent. FollowingFiss (2011), we used this information and coded anissuing firm 0, or fully out of the set of highlyvalued foreign IPOs, if it did not receive a pricepremium of at least 66 percent.

Our second step involved defining the upperthreshold of our set of high-price-premium foreignIPOs. Since no prior literature has conceptualizedwhat price premium constitutes a high investorvaluation, we turned to similar measures thatscholars have relied upon to help define our break-point for full inclusion in the set. As for the pricepremium measure, numerous studies in financeand management have also relied on pre-IPO bookvalue to obtain similar proxies that researchers con-sider to capture investor perceptions of new issues.For example, a firm’s offer-to-book ratio can be seenas an indication of growth opportunities, wherebythe larger the offer-to-book ratio, the higher themarket’s perception of the firm’s growth opportu-

nity. Others have used Tobin’s Q (market price/book value per share) as a measure of perceivedmarket potential for an IPO (Welbourne & An-drews, 1996). Here, the higher the ratio, the morethe firm’s value because it means that investors aremore willing to “gamble” on the firm’s intangibleassets. Fama and French (2002), among others, uti-lized book-to-market values to gauge investor per-ceptions, defining high investor valuations to bethose in the upper quartile or even the highestdecile of their respective samples. Following Famaand French (2002), we define high investor valua-tions as valuation in the highest decile of firms inour study sample, which in our case refers to a 95percent price premium. This level agrees with re-search suggesting that investors are willing to pay apremium that far exceeds an issuing firm’s bookvalue when they perceive the issuing firm will cap-ture the growth opportunities available to it(Chung, Li, & Yu, 2005). We coded firms thatachieved 95 percent price premiums 1, or as fullyin the set of highly valued foreign IPO firms. Fol-lowing Fiss (2011), we defined the midpoint as theaverage of these two breakpoints.3

Predictor Conditions

In our analysis of governance bundles, we firstfocused on the three most important governancemechanisms used in previous IPO research: boardindependence, executive share options, and ven-ture capital backing (Arthurs et al., 2008; Beatty &Zajac, 1994; Certo et al., 2001). We have also addeda proxy for the strength of foreign IPO home coun-try investor protection. The following section ex-plains how we constructed these key variables.

Board independence. We approximated theextent of internal monitoring with board indepen-dence. We classified as independent (nonmanage-ment) directors only those with no prior profes-sional or personal ties to a firm or its management

2 See: Bruton et al. (2010), Lester et al. (2006), Daily etal. (2005), Certo et al. (2003), Nelson (2003), Rasheed etal. (1997), Welbourne and Andrews (1996).

3 Certo et al. (2003) suggested replacing a firm’s offerprice with the closing price on the first day the firm’sshares go public as a means to account for the premiumthat is determined by all investors, and not just thatdetermined by initial investors. Hence, in addition to theprice premium measure derived with the offer price, wealso evaluated governance configurations using the fol-lowing percentage price premium measure: ([first dayclosing price – book value]/first day closing price); usingthis measure controls for underpricing (Certo et al., 2003)and does not change our results.


on the basis of indicated in the firm’s prospectus(Certo et al., 2001). We do not include VC-relatedboard members as independent directors The 2010Spencer Stuart Board Index indicates that theboards of the largest and best-established US firmshad on average 70 percent independent membersduring our sample time frame (Spencer StuartBoard Services, 2010). Using this information, wecoded firms as 1, or fully in, this set if at least 70percent of their board members were independent.Surveys also show that board independence inUS firms may be as low as 20 –30 percent inde-pendent members (Davis, Polk, & Wardwell,2009). Using this information, we coded as 0, orfully out of the set, boards with 30 percent oftheir members independent. Following Fiss(2011), we defined the midpoint as the average ofthe two breakpoints.

Venture capital backing. Researchers have iden-tified private equity investors, such as VCs, as im-portant external monitors in IPO firms (Bruton etal., 2010). Previous studies have generally used adichotomous variable to indicate the importance ofVCs to IPOs (Certo, Daily, Cannella, & Dalton,2003). Thus, we generated a crisp set to indicate thepresence of VCs among a firm’s principal pre-IPOshareholders. Foreign IPOs backed by VCs prior tothe date the firms went public are considered fullyin the set, whereas those firms who were notbacked by VCs are coded as out of the set.

CEO stock. Stock options were used as a proxyfor executive incentives; they have become an im-portant element of CEOs’ compensation packagesbecause of the widespread belief that they are ef-fective in aligning executive and shareholder inter-ests. Drawing on previous IPO research (Beatty &Zajac, 1994; Certo et al., 2003), we built the execu-tive incentive set as a crisp set, coding a firm as 1(fully in this set) if stock options were offered to theissuing firm’s CEO prior to IPO and 0 otherwise.

Strong home country investor protection. Ournext step was evaluation of the extent to whichhome country institutional factors impacted thecombinations of governance conditions that lead tohigh premiums for foreign IPOs. We relied on twowidely recognized indexes to categorize firms as tothe degree to which their home country protects theinterests of minority investors. First, we utilized LaPorta et al.’s (1998) antidirector index, as revised byDjankov et al. (2008), which has six subindexescapturing the possibility of voting by mail and ofdepositing shares, aspects of cumulative voting, op-pressed minority, preemptive rights, and percent-

age of share capital needed to call a meeting. Thisindex covers aspects of de jure regulation since itdoes not control for the level of regulatory enforce-ment. Therefore, we also relied on the InternationalCountry Risk Guide “law and order index,” as itassesses both the legal system and the de facto lawand order tradition of a country. After standardiz-ing these indexes to a scale ranging from 0–1, wemultiplied values obtained from each to combinede jure and de facto aspects of investor protection(Bruno & Claessens, 2007; Durnev & Kim, 2005).Like earlier studies that have used these indexes(e.g., Leuz, Lins, & Warnock, 2009), we classifiedcountries with scores above the sample median asfully in the set of high minority investor protectioncountries and those below the median as out of theset. After performing these steps, we had a finalsample comprised of 97 firms from countries thatprovide weak investor protection to minority inves-tors and 101 firms from countries that providestrong investor protection. The weak investor pro-tection sample includes Argentina, Brazil, China,France, Greece, Mexico, Russia, and Venezuela.The strong investor protection sample includesAustralia, Canada, Hong Kong, Ireland, Israel, Ja-pan, New Zealand, Singapore, Spain, Taiwan, andthe United Kingdom.

Contextual Conditions

While the focus of our study is the importance ofcorporate governance to foreign IPOs’ perceivedvalues, we are acutely aware that contextual factorsbeyond governance can impact IPO valuations.However, including too many contextual factorsbeyond those most salient to IPO valuation assess-ments would add exponentially to the number ofconfigurations and cause limited diversity.4 There-fore, we constructed fuzzy and crisp sets in terms ofthe four contextual factors likely the most salient toinvestors evaluating foreign IPOs.

Prestigious underwriter. The Carter and Manas-ter (1990) index is the most widely recognizedmeans to capture the prestige of underwriters onthe basis of their position on “tombstone” an-nouncements. On the final index, 0 is the lowest,and 9 the highest, rating. Studies in leading strat-

4 Limited diversity is due to large numbers of logicalremainders—that is, combinations of causal conditionsthat are logically possible but not observed in the givendata (Ragin, 2008).


egy, entrepreneurship, and finance journals gener-ally agree that underwriters with rankings of 8 orhigher are prestigious (Loughran & Ritter, 2004;Pollock et al., 2010). Therefore, we coded firmsbacked by underwriters with rankings of 8 orhigher to be fully in the set of prestigious under-writers. Secondly, Loughran and Ritter (2004) con-sidered underwriters with rankings between 5 and7.9 to be “quality regional” or “niche underwrit-ers,” and underwriters lower than 5 to be “lowerquality” and most frequently associated withpenny stocks. Following these guidelines, we es-tablished the breakpoint for fully out of the set ofprestigious underwriters to be a Carter and Manas-ter index score lower than 5 and used the midpointbetween these breakpoints to establish the mid-point in the set.5

Mature IPO. Firm age is a frequently used con-trol variable in IPO research (Beatty & Zajac, 1994)and is one factor that investors use to gauge thegrowth prospects of a firm, both negatively andpositively. Megginson and Weiss (1991) showedthat the older a firm is upon listing, the lower itsgrowth prospects. This is because the older thefirm, the more firm-specific information there isavailable to the public. However, others suggestthat investors tend to perceive older firms as al-ready tested in their industry and as having estab-lished networks and routines that are vital for sur-vival (e.g., Stinchcombe, 1968). Some foreign IPOschoose to go public early in their lives, whereasothers choose a US listing after spending consider-able time as private firms in a foreign market.Hence, age may be particularly salient to investorsevaluating foreign IPOs. We accounted for the ageof firms at IPO by taking the difference in yearsbetween founding date and date of IPO. Firms werecoded 1 or fully in the set of mature IPOs if theyhad been in existence for at least 20 years sincetheir founding date. They were considered fully outof this set if they had been in existence for 1 year orless. We considered 5-year-old foreign IPO firms tobe at the crossover point, following Loughran andRitter (2004), who showed that IPO age can averageas low as 2 years, and others who have shown thatforeign firms listing in the US can exceed 20 yearsof age (Ejara & Ghosh, 2004).

High-tech industry. Researchers very often con-trol for industry effects when evaluating investorperceptions of IPOs. Industry is a particularly sa-lient control factor for foreign IPOs in light of thegrowing literature showing that industry does in-fluence foreign listing decisions, and more impor-tantly, an IPO market’s receptivity and understand-ing of a new issue can be contingent on the industrya firm competes in. One of the most common waysis to isolate whether an IPO firm operates in ahigh-tech industry or not, since technological ori-entation may also be a proxy for investors’ percep-tions of riskiness (Daily, Certo, & Dalton, 2005;Loughran & Ritter, 2004; Lowry & Murphy, 2007).We categorized all Internet-related, electronics, andsoftware firms as fully in the set of high-tech for-eign IPO firms.

Table 3 provides summary statistics of the gov-ernance and contextual conditions in our analysis.We then used fs/QCA’s truth table function to gen-erate the different combinations of our governanceand contextual conditions that are sufficient for aparticular outcome to occur (Ragin, 2008). Fs/QCA’s truth table algorithm enables researchers todeal with the issue of limited diversity by distin-guishing between parsimonious and intermediatesolutions based on both easy and difficult counter-factuals (Ragin, 2008).6 Truth table reduction re-

5 A complete list of IPO underwriter reputation rank-ings is available on Jay Ritter’s website: (http://bear.cba.ufl.edu/ritter/ipodata.htm).

6 Fiss (2011) points out that easy counterfactuals arethose situations where a redundant causal condition isadded to a set of causal conditions that by themselvesalready lead to the outcome in question. Difficult counter-factuals occur when a condition is removed from a set ofcausal conditions leading to the outcome on the assump-tion that this condition is redundant. Fs/QCA’s parsimoni-ous solution includes all simplifying assumptions regard-less of whether they are based on easy or difficultcounterfactuals. Alternatively, intermediate solutions re-

TABLE 3Descriptive Statistics

Variables Mean s.d.

Industry 0.58 0.49Age 8.71 12.71Market 33.64 20.17Executive incentives 0.78 0.41Venture capital 0.51 0.5Underwriter prestige 8.06 1.91Board independence 0.38 0.21Price premium: Pre-IPO book value 0.79 0.27Price premium: First day closing price 0.81 0.26


quires evaluating the consistency levels across con-figurations and establishing a frequency thresholdthat will be applied to the data listed. In this study,we adopted a consistency cutoff of .80 (Rihoux &Ragin, 2009). In addition, Ragin suggests that whenestablishing a frequency threshold, “the issue is notwhich combinations have instances, but whichcombinations have enough instances to warrantconducting as assessment of the subset relation-ship” (2008: 133). In general, frequency thresholdsshould be based on the number of cases included inan analysis, the knowledge of cases by researchers,the precision of calibration of fuzzy sets, and a goalof capturing at least 75–80 percent of the cases(Ragin, 2008). We adopted a threshold of two as thislevel allowed us to include 84 percent of the cases inthe analysis in Table 4. Tables 4, 5, and 6 (which wedescribe below) follow the format used by Crilly,Zollo, and Hansen (2012), Fiss (2011), Crilly (2011),

Greckhamer (2011), and Ragin and Fiss (2008) inthat they account for fs/QCA’s parsimonious andintermediate solutions. Overall solution coveragerefers to the joint importance of all causal paths(Schneider, Schulze-Bentrop, & Paunescu, 2010).Unique coverage is useful because it illustrates therelative weight of each path in leading to highforeign IPO perceived values by measuring the de-gree of empirical relevance of a certain cause orcausal combination to explain the outcome (Fiss,2011; Ragin, 2008).7

strict logical remainders to only those that are the mostplausible.

7 The notation for the presence and absence of condi-tions can be downloaded from Peer Fiss’s website. Inaddition, to reduce their size and complexity, the solu-tion tables only list configurations that consistently ledto our outcome of interest, high foreign IPO perceivedvalue. We include those solutions with unique coverageexceeding the value of 0 and those that include homecountry legal protection levels within the configuration.

TABLE 4Configurations for Achieving High Perceived Value for Foreign IPOs Listing in the US, 1996–2007a

Solution

Variables 1 2 3 4 5 6

Contextual ConditionsHigh-tech industry

Mature IPO firm

Prestigious underwriter

Country of Origin ConditionStrong home country legal protection

Governance ConditionsBoard independence

CEO stock

Venture capital

Consistency 0.86 0.89 0.99 0.87 0.89 0.87Raw coverage 0.16 0.11 0.01 0.08 0.05 0.03Unique coverage 0.06 0.03 0.01 0.08 0.03 0.02Overall Solution Consistency 0.88Overall Solution Coverage 0.54

a The outcome condition is a price premium. Full circles indicate the presence of a condition. Crossed-out circles indicate the absenceof a condition. Large circles indicate conditions that are part of both parsimonious and intermediate solutions. Small circles refer toconditions that only occur in intermediate solutions. Blank cells indicate that particular causal condition is not relevant within thatsolution configuration.


Results: Sufficient Conditions for High ForeignIPO Price Premiums

Table 4 shows that there are six solution config-urations with acceptable consistency levels (con-sistency � .80). The unique coverages for each so-lution configuration confirm that each of these sixcombinations offers a unique contribution to theexplanation of high foreign IPO perceived value.The combined solution configurations in Table 4account for about 54 percent of membership in theoutcome, high foreign IPO price premiums.8

Solutions 1–3 apply to firms originating fromcountries with strong legal protection of investors.A comparison of solution configurations 1–3 re-veals that these foreign IPOs can achieve high pricepremiums with only one governance mechanism.Solution 1 shows that the presence of incentivealignment and the absence of an independent boardlead to high perceived value for older firms com-peting in technology-related industries. Prestigiousunderwriters also contribute to the bundle of gov-ernance and contextual factors leading to high per-ceived value. Solution 2 provides similar evidencein that younger technology-based IPOs from stronginvestor protection countries can achieve high per-ceived values with just the external monitoring ofventure capital. Finally, solution 3 demonstratesthat IPOs competing in non-technology-related in-dustries can achieve high price premiums with justthe backing of an independent board. This is in linewith our first hypothesis, which suggests that sim-ilar levels of perceived IPO stock market evaluationmay be achieved by different and limited combina-tions of governance practices when a firm comeswith a certain level of regulatory legitimacy.

Solutions 4–6 in Table 4 apply to firms thatdo not originate from countries that offer stronglegal protection to investors and show that thesefirms need to adopt multiple governance mecha-nisms to achieve high perceived value at IPO. In-deed, the combination of incentive alignment andexternal monitoring via venture backing (solution4), the combination of incentive alignment and in-ternal monitoring via an independent board (solu-tion 5), and a combination of all three of thesegovernance mechanisms (solution 6) enable thesefirms to reach high premiums at IPO. A comparisonof solutions 1–3 with solutions 4–6 provides sup-port to our second hypothesis by demonstratingthat to attain comparably high perceived values,IPOs from countries that do not grant regulatorylegitimation must adopt more governance mecha-nisms than IPOs from countries with strong inves-tor protection.

Our results also reveal that the process of firmlegitimation among stock market investors dependsnot only on the interplay between a firm’s institu-tional context and governance mechanisms, but

8 We followed Helwege and Liang (2004) in definingthe IPO time period as a “hot IPO market” and usedthree-month-centered moving averages of the number ofIPOs for each month in the sample. These monthly aver-ages are then used to define the breakpoints for our targetset “hot market.” Our analysis indicated that a hot IPO

market was a necessary condition for high foreign IPOperceived value. Following Ragin (2008), we droppedthis condition from our final table, yet highlight thisfinding in our Discussion.

TABLE 5Configurations for Achieving Low Perceived Value for

Foreign IPOs Listing in the US, 1996–2007a

Solution

Variables 1 2 3

Contextual ConditionsHigh-tech industry

Mature IPO firm

Prestigious underwriter


Governance ConditionsBoard independence

CEO stock

Venture capital

Consistency 0.81 0.89 0.90Raw coverage 0.01 0.03 0.01Unique coverage 0.01 0.03 0.01Overall Solution Consistency 0.86Overall Solution Coverage 0.08

a The outcome condition is a price premium. Full circlesindicate the presence of a condition. Crossed-out circles indicatethe absence of a condition. Large circles indicate conditions thatare part of both parsimonious and intermediate solutions. Smallcircles refer to conditions that only occur in intermediate solu-tions. Blank cells indicate that particular causal condition is notrelevant within that solution configuration.


also on a number of important organizational con-tingencies, such a firm’s age, its technological ori-entation, and the presence of prestigious under-writers. Our hypotheses, therefore, may reflect onlya partial picture of a broader model of nested legit-imacy. It appears that, under the conditions of“cognitive economy” (Bitektine, 2011), investorsmay be equally satisfied with either strong externalmonitoring by VCs in young technology IPOs (so-lution 2) or with incentive alignment in mature(hence, less uncertain) technology listings (solution1), as long as these firms originate from countrieswith investor-friendly regulatory regimes. At thesame time, mature nontechnology firms need tohave independent boards in place if they want toachieve a similar level of legitimacy as technologyfirms (solution 3). Yet to achieve the same level ofinvestor valuation as technology firms (solution 1),both nontechnology companies and younger tech-nology firms need to secure the presence of a pres-

tigious underwriter, even when they are comingfrom countries with high investor protection (solu-tions 2 and 3). Likewise, nontechnology firms fromcountries with weak investor protection, in addi-tion to equipping themselves with more gover-nance, also need to secure prestigious underwriterscompared to technology firms (solutions 5 and 6).Therefore, a closer analysis of our results suggeststhat governance bundles should be considered inconjunction with other organizational factors, andwe will come back to this in the Discussion.

We performed two additional analyses to test therobustness of our results. First, we evaluated theconfigurations of governance and contextual con-ditions that led to low price premiums. Causalasymmetry (Ragin, 2008) suggests that the condi-tions that lead to a foreign IPO’s high perceivedvalue may be different from those that lead to theabsence of high perceived value. The results inTable 5 are based on the inverse of the high price

TABLE 6Robust Configurations for Achieving High Perceived Value for Foreign IPOs Listing in the US, 1996–2007a

Solutions

Variables 1 2 3 4 5 6 7 8 9 10


IndustryHigh-tech firm

Founder StatusCEO is not a founder

Third PartyPrestigious auditor

Governance ConditionsHigh insider-retained ownership

Board independence

CEO stock

Venture capital

Consistency 0.99 1.00 0.99 1.00 1.00 0.96 0.92 0.86 0.98 0.91Raw coverage 0.04 0.04 0.02 0.01 0.01 0.03 0.04 0.02 0.01 0.01Unique coverage 0.02 0.02 0.02 0.01 0.01 0.01 0.04 0.02 0.01 0.01Overall Solution Consistency 0.94Overall Solution Coverage 0.33

a The outcome condition is a price premium. Full circles indicate the presence of a condition. Crossed-out circles indicate the absenceof a condition. Large circles indicate conditions that are part of both parsimonious and intermediate solutions. Small circles refer toconditions that only occur in intermediate solutions. Blank cells indicate that particular causal condition is not relevant within thatsolution configuration.


premium measure used in Table 4, a consistencycutoff of .80, and a frequency threshold of 1, whichcaptured 100 percent of the cases. Solution 1 inTable 5 complements our results found in solutions1–3 in Table 4, in that IPOs from countries withstrong protection of investors suffer low perceivedvalue when they adopt multiple governance mech-anisms. Similarly, solutions 2 and 3 in Table 5complement solutions 4–6 in Table 4 by demon-strating IPOs from countries that do not offer stronglegal protections to minority investors experiencepoor perceived value when they adopt very fewgovernance mechanisms. Again, in terms of thecontextual factors, the negative impact of too manygovernance practices is particularly prominent intechnology IPOs coming from countries with stronginvestor protection.

Our second robustness test includes a number ofother governance and contextual factors that previ-ous studies have also identified as drivers of inves-tors’ perceptions of IPO value (see Sanders andBoivie [2004] for a review). We followed Zajac andWestphal (1995) and included both CEO stock op-tions and retained ownership of company insidersto better capture the range of incentive alignmentpractices available to foreign IPO managers. Webuilt a fuzzy set to capture the ownership of insid-ers, defining low equity as 5 percent holdings,moderate as 25 percent, and high as 50 percent(Certo et al., 2003). Also, research has shown thatlarge international accounting firms play an impor-tant role in reducing IPO investor uncertainties. Wefollowed Beatty (1989) and built a crisp set withfirms backed by Big Five accountancy firms codedas fully in the set. Finally, Nelson (2003) found thatfirms managed by founder CEOs are likely to re-ceive a higher percentage price premium at IPO.Yet it is unclear whether this finding applies tofirms’ seeking equity resources outside their homecountry’s institutional context. Hence, we took intoconsideration whether the presence of a founder-CEO influenced our results and could be consid-ered a strong governance signal. Table 6 illustratesthe results of our analysis using a consistency cut-off value of .85 and reducing the truth table with athreshold of 2, which captured 78 percent ofthe cases.

Solutions 1–6 in Table 6 apply to firms originat-ing from countries with strong investor protection,whereas solutions 7–10 apply to firms from coun-tries that do not provide strong protection to inves-tors. Solutions 1–4 show that firms that are over theregulatory legitimacy threshold need only one gov-

ernance factor (e.g., CEO share options or high re-tained ownership of insiders, or venture backing) toachieve the same high level of valuations, in linewith our first hypothesis. Solutions 5 and 6 showthese firms can achieve high valuation levels bycombining high retained ownership levels withventure backing or with independent boards. Ad-ditional support for our second hypothesis comesfrom comparing solutions 1–6 against solutions7–10. It demonstrates that firms from countries thatdo not provide strong investor protection mustadopt more governance mechanisms than firmsthat originate from countries that do provide stronginvestor protection to achieve comparably highperceived values. Yet again our results show thatspecific governance configurations also depend onwhether a foreign IPO is a high-tech firm. Finally,these results demonstrate that the presence of aninternational auditor may be yet another potentlegitimation driver in that it is present in all thesolution configurations leading to high perceivedvalue for a foreign IPO. In sum, these results involv-ing a broader range of governance factors are in linewith our theoretical expectations and demonstratethat foreign IPOs that originate in countries thatdo not provide strong investor protection mustadopt more incentive alignment and monitoringpractices than IPOs from countries with strong pro-tection to achieve legitimacy with US investors.

DISCUSSION

Much of the previous research on the effects ofcorporate governance on the stock market perfor-mance of IPO firms is built on assumptions thatgovernance mechanisms act independently and cu-mulatively. The inconsistency of evidence fromprior studies suggests that the valuation implica-tions of a range of firm-level governance mecha-nisms associated with IPOs represent a signifi-cantly more complex phenomenon than previouslyunderstood. We challenge these basic assumptionsof past research grounded in the agency perspectiveboth by focusing on “the workings of legitimacy atmultiple levels of analysis” (Deephouse & Such-man, 2008: 67) and by proposing two importantextensions building on research within the field ofsociology of financial markets. First, we argue thatthe process of investors’ perceptions of a foreignIPO’s value may be based on its compliance withgovernance-related best practices as part of a moregeneral framework of nested legitimation. We sug-gest that the same levels of IPO stock market eval-


uation may be achieved via different combinationsof governance mechanisms. Second, we sustainthat the impact of governance practices on investorperceptions is contingent on the strength of firms’home country regulative, governance-related insti-tutions, and that these institutions shape the sizeand composition of governance bundles amongfirms seeking equity in foreign capital markets.

Contributions

Our study advances both corporate governanceresearch in general and IPO research in particularin a number of important ways. First, we show thatthere is no universal governance bundle leading tohigh levels of investors’ value perceptions. In fact,our findings clearly indicate that board indepen-dence does not seem to play as central a role inaffecting investor perceptions as executive incen-tives and VC monitoring in IPOs from countrieswith strong investor protection. This is in line withprevious empirical IPO studies that question thesignaling role of IPO boards (Arthurs et al., 2008;Filatotchev & Bishop, 2002). Second, our resultsdemonstrate that institutional factors have a criticalimpact on the composition of firm-level gover-nance bundles that lead to the same level of inves-tor valuations. Specifically, we uncover that IPOfirms that originate from a country with strong in-vestor protection can substitute monitoring and in-centive-related governance practices to achieve thesame high levels of stock-market investor valueperceptions. However, as our first robustness testclearly shows, having too many governance prac-tices may actually undermine IPO valuations. Thisfinding is in line with research on costs of overgov-ernance in the finance and management fields(Aguilera et al., 2008; Bruno & Claessens, 2007). Incontrast, foreign IPOs originating from countrieswith weak investor protection must deploy bothmonitoring and incentive-related governance tobolster US investor confidence in their governancequality and their potential to achieve high levels ofvaluations.

By using fuzzy set qualitative comparative anal-ysis (fs/QCA), we also make a methodological con-tribution that, in turn, helps our theoretical under-standing of the legitimation process associatedwith firm-level governance in general, and IPO val-uation in particular. We utilized fs/QCA because itsintent is not to isolate the net, independent effectsof single factors on a particular outcome, but toidentify the combinations of factors that bring

about the outcome (Ragin, 2008). By leveraging fs/QCA’s configurational approach, we relax some ofthe assumptions typically associated with thequantitative techniques inherent to most IPO re-search, such as permanent causality, additivity,and causal symmetry, and make three importantmethodological contributions. First, we demon-strate that investors take into account institutionalfactors, firm-level governance mechanisms, andcontextual factors simultaneously when evaluatingIPO firms. Second, more than one bundle of gover-nance practices can lead to high investor percep-tions. Finally, we provide evidence that high inves-tor perceptions can result from the presence of acondition (e.g., high levels of monitoring) or theabsence of a condition (e.g., absence of incentivealignment).

More importantly, fs/QCA enabled us to explorethe nature of equifinality (Fiss, 2011; Ragin, 2008)in terms of the impact of different configurations offirm-level characteristics and mechanisms jointlywith institutional factors on the overall process oflegitimation. In our context, equifinality means thatthe process of legitimation of foreign IPOs may bebased on different constellations of governancemechanisms and other organizational contingen-cies, such as a firm’s technological orientation, orits age, or the presence of prestigious third parties.For example, finance researchers indicate that tech-nology-intensive firms prefer to go public in devel-oped Western capital markets rather than in theirhome markets because the prevalence of knowledg-able analysts and investors offers a more efficientflow of information and a deeper understanding ofthe nuances of technology and innovation (Blass &Yafeh, 2001; Hursti & Maula, 2007). Our resultssuggest that being a high-tech firm might be anotherlegitimation driver for a foreign IPO in the US thatworks in conjunction with governance mechanismswhen affecting investor perceptions. In addition,the presence of prestigious underwriters and firmage also appear to work alongside governance bun-dles when affecting investor valuations.

A configurational perspective can also explainwhy specific governance practices are part of somesolutions and absent in others. For example, ouranalysis shows that CEO stock ownership addsvalue, but only in high-tech companies originatingfrom countries with strong investor protection.This may stem from the belief that incentive align-ment is more efficient than monitoring-related gov-ernance mechanisms, especially in IPO firms com-peting globally in the technology sector (Carpenter,


Pollock, & Leary, 2003). On the other hand, inves-tors seem to consider monitoring by independentboards a critical governance mechanism for matureIPO firms competing outside the technology sector.These findings are consistent with those of previ-ous research suggesting that incentive alignmentmay be a more potent governance mechanism thanboard monitoring when uncertainty surroundingan IPO firm is particularly high (Beatty & Zajac,1994). Interestingly, young technology IPOs fromstrong investor protection countries seem to be ableto achieve high premiums with VC backing ratherthan with independent boards or incentive align-ment mechanisms. In light of their strong homecountry legal environment, it is likely that inves-tors believe that VCs will deliver a sufficient bal-ance for these firms by providing both the strategicguidance a young technology venture needs toflourish as a public firm (Hellmann & Puri, 2002)and effective, highly engaged external monitoring(Barry, Muscarella, Peavy, & Vetsuypens, 1990).

In terms of prestigious underwriters, their impor-tance seems to be somewhat lower for technologyIPOs, perhaps, because media and analyst coveragetends to be generally high for technology firmslisting in the US (Francis, Hasan, & Zhou, 2005).This extensive coverage may reduce the impor-tance of third-party endorsement within the stockmarket legitimation process. Indeed, our results arein line with the growing body of research demon-strating how the presence of reputable underwrit-ers does not necessarily equate to better IPO valu-ation (Gulati & Higgins, 2003; Pollock, 2004).Finally, nontechnology IPOs from countries withweak investor protection need all governancemechanisms as well as support of prestigious un-derwriters to obtain a high level of legitimacy.

Our findings, therefore, echo a number of studiesthat advocate viewing corporate governance as partof a broader system of interrelated elements,wherein firm-level governance interacts with otherorganizational contingencies and country-level in-stitutions in determining organizational outcomes(Aguilera et al., 2008; Bell, Moore, & Al-Shammari,2008). Our analysis indicates that there is a need ofa more holistic approach to studying links betweengovernance factors and investor perceptions of firmvalue within a broader model of nested legitimacy.

Like other studies, our research suffers from anumber of limitations. First, fs/QCA is constrainedby the number of variables researchers can includein models, and our analysis does not utilize allpossible controls typically used in IPO research.

However, this apparent methodological constraintis not a theoretical limitation, since the governancemechanisms that we consider are the most salientones in IPO governance research. Second, in ouranalysis of institutional effects, we draw on inves-tor protection as a proxy for institutional differ-ences between foreign IPOs’ home countries. Insti-tutional research differentiates between formal(e.g., laws, regulation) and informal (e.g., networks,trust relationships) institutions. US investors mayalso take into account informal institutional char-acteristics of an IPO firm’s home country whenevaluating the effectiveness of the firm’s gover-nance bundle that are not captured by our opera-tionalization. Third, the perceived value we arecapturing through the price premium measure re-flects the commingling of the value perceived byinstitutional investors as well as underwriters.While we do not attempt to tease out how differentgroups of investors perceive foreign IPO quality, werecognize that underwriters, and in particular pres-tigious underwriters, offer a key point of referencefor investors, which encompasses informal institu-tions. Finally, normative legitimacy is a higherlevel of legitimacy and is derived when the valuesand norms of a new venture are congruent with thatof the wider society and industry (Scott, 1998). Oneimportant source of normative legitimacy is en-dorsement (Zimmerman & Zeitz, 2002). Pollock(2004) reports that, at the time of their IPO, firmshaving the endorsement of reputable underwritersobtain higher legitimacy. Future research shouldisolate what governance bundles are associatedwith prestigious underwriters and auditors, whatgovernance bundles attract “dedicated” institu-tional investors (Higgins & Gulati, 2006), andwhether institutional factors affect these bundles.

Our discussion indicates that the configurationalapproach is currently underutilized and that it canbe usefully applied in other research designs re-lated to IPOs. For example, our conceptual frame-work could be valuable in an IPO survival study,since the longer a foreign IPO survives, the moreinstitutionally embedded and legitimate it may be-come in the eyes of investors. Further, the institu-tional environments of other host capital marketsare often significantly different from that of the US.Hence, it would be logical to suggest that hostcountry institutions may also have an impact onlegitimacy through firm-level governance. Finally,a growing number of firms opt to list on two ormore national capital markets. Does this specificcontext of multiple listings change the process of


legitimation through governance practices? Andwhat effect would investor concern with institu-tional pluralism (Kraatz & Block, 2008) have on themenu of governance practices in this subsample offirms with international sources of equity finance?

Finally, our study points to opportunities to de-velop a broader theoretical approach to nested le-gitimacy, including its formative and boundaryconditions. This is in line with recent theoreticalresearch on legitimacy judgments (e.g., Bitektine,2011; Tost, 2011). Indeed, in addition to cognitiveand regulatory factors, normative and other institu-tional aspects of legitimation are also relevant, and“researchers might do well to attend more closelyto the workings of various sources of legitimacy”(Deephouse & Suchman, 2008: 68; emphasis inoriginal).

Conclusion

Although considerable empirical attention hasbeen paid to the study of domestic IPO firms, todate little research has addressed foreign IPOs andthe factors impacting the benefits of internationallistings. We adopt a configurational perspective toconsider the valuation outcomes associated withgovernance practices of foreign IPO firms goingpublic on US exchanges. Overall, our study pro-vides a more comprehensive picture of the gover-nance-performance relationship than traditionalagency-grounded research. We demonstrate thatforeign IPO firms may achieve legitimacy with re-gard to US investors by utilizing different combi-nations of governance practices. However, this pro-cess of legitimation is nested within a broaderinstitutional framework that takes into account afirm’s home country institutional environment,contingent on firm characteristics.

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R. Greg Bell ([email protected]) is as an assistant profes-sor at the University of Dallas College of Business. Hereceived his Ph.D. in strategic management from the Uni-versity of Texas at Arlington. His research interests includecorporate governance, international entrepreneurship, ven-ture capital strategy, and corporate sustainability.

Igor Filatotchev ([email protected]) is associatedean and professor of corporate governance and strategyat Cass Business School, City University London, andvisiting professor at Vienna University of Economics andBusiness. He earned his Ph.D. in economics from theInstitute of World Economy and International Relations(Moscow). His research interests are focused on corpo-rate governance effects on entrepreneurship develop-ment, strategic decisions, and organizational change. Keyresearch programs currently in progress include analysisof resource and strategy roles of corporate governance;corporate governance life cycle; and a knowledge-basedview of governance development in entrepreneurialfirms and IPOs.

Ruth V. Aguilera ([email protected]) is an associateprofessor and a fellow at the Center for ProfessionalResponsibility in Business and Society at the College ofBusiness at the University of Illinois at Urbana-Cham-paign. She also holds an appointment at ESADE BusinessSchool in Barcelona. She received her Ph.D. in sociologyfrom Harvard University. Aguilera’s research interestsfall at the intersection of economic sociology and inter-national business, specifically in the fields of global strat-egy and comparative corporate governance. More re-cently, she has been interested in comparative ownershipand the stakeholder perspective.


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