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Academic year: 2022



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Simon Iversen Schach

Student number 92932

A thesis presented for the degree of

Master of Science in Accounting, Strategy & Control (Cand.Merc.ASC)

Copenhagen Business School Supervisor: Thomas Ryttersgaard

15September 2021

No. of pages (characters): 80 (181.798)


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Based on empirical evidence from 191 initial public offerings on First North Growth Market in Sweden, Finland, and Denmark in the years 2012 to 2020, it is found that the initial public offerings are underpriced at an average and hence provide investors with an initial return.

The findings are based on a P/S and P/E multiple valuation comparison of the First North Growth Market companies and their respective sector and industry. They are furthermore based on an analysis of the underwriters performing the initial public offerings with regards to the valuation and pricing process culminating in an analysis of the initial returns provided by the First North Growth Market companies.

It is, furthermore, found that First North Growth Market companies provide a sub-optimal risk- adjusted return in the short run. The findings are based on a CAPM construction for each individual initial public offering along with the analysis an evaluation of Jensen’s Alpha, Sharpe ratios and Sortino ratios.


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Table of Contents


1.1 First North Growth Market ... 6

1.2 Problem Formulation ... 7

1.2.1 Research Question ... 8

1.3 Development of Hypotheses ... 8

1.4 Delimitations ... 10

1.5 Disposition ... 10


2.1 Going Public ... 11

2.1.1 Reasons for Going Public ... 11

2.1.2 The Process of Going Public ... 11

2.2 Theoretical Framework ... 12

2.2.1 Valuation and Pricing Process ... 12

2.2.2 Over- and Underpricing of IPOs ... 14


3.1 Clarification of the Research Topic ... 18

3.2 Measures of Initial Public Offerings ... 18

3.2.1 Valuation Process ... 19

3.2.2 Pricing Process ... 20

3.2.3 The Offer Period ... 21

3.2.4 The Initial Performance of IPOs ... 22

3.2.5 Short Run Performance ... 23

3.3 Limitations of the Research ... 28

3.4 Methodology for Testing the Hypotheses ... 29

3.4.1 Hypothesis One ... 29

3.4.2 Hypothesis Two ... 29


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3.4.3 Hypothesis Three ... 30

3.4.4 Hypothesis Four ... 31

4. DATA ... 33

4.1 Selection Criteria for IPOs ... 33

4.1.1 Time Period ... 33

4.1.2 Type of Listing ... 33

4.2 Data Availability and Collection ... 33

4.2.1 General IPO Information ... 34

4.2.2 Financial Data ... 34

4.2.3 Industry and Sector Information ... 35

4.2.4 Return Data ... 35

4.3 Data Suitability ... 36

4.3.1 Reliability ... 36

4.3.2 Validity ... 36

4.4 Sample Description ... 37

5. ANALYSIS ... 40

5.1 Hypothesis One ... 40

5.1.1 Sector Valuation Level Analysis ... 40

5.1.2 Industry Valuation Level Analysis ... 46

5.1.3 Summary of Hypothesis One ... 48

5.2 Hypothesis Two ... 48

5.2.1 Subscription Commitments ... 48

5.2.2 Subscription Ratio ... 50

5.2.3 Summary of Hypothesis Two ... 53

5.3 Hypothesis Three ... 54

5.3.1 Initial Returns across Countries ... 55

5.3.2 Initial Returns over Time ... 56


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5.3.3 Initial Returns across Sectors ... 58

5.3.4 Summary of Hypothesis Three ... 60

5.4 Hypothesis Four ... 60

5.4.1 Return Performance across Countries ... 61

5.4.2 Return Performance over Time ... 62

5.4.3 Return Performance across Sectors ... 65

5.4.4 Summary of Hypothesis Four ... 68

6. DISCUSSION ... 69

6.1 The Underwriters’ Part in IPOs ... 69

6.2 The Pricing of First North IPOs ... 69

6.3 The Return Performance of First North IPOs ... 71

6.4 Future Research ... 72

7. CONCLUSION ... 73


9. APPENDIX ... 79

9.1 Appendix A... 79

9.2 Appendix B ... 84

9.3 Appendix C ... 85

9.4 Appendix D ... 87

9.5 Appendix E ... 89


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1.1 First North Growth Market

Initial public offerings (‘IPOs’) on First North Growth Market (‘First North’, or simply ‘FN’) are similar to other IPOs on other markets. The entire process of valuing, pricing, and offering the shares of an IPO is similar. What differentiates First North Growth Market and main market IPOs is the quality and life cycle status of the companies going public. The main market is reserved for companies with a proven business model and proven earnings, which naturally leads to higher valuations. This is another important difference between the choice of market. First North Growth Market is, indeed, a growth market. Investing in companies listed on First North has been frequently compared to venture investing. The companies are, more often than not, in the early stages of their life cycle and might not even have proof of concept or even registered sales. Investing in First North companies is therefore considered riskier compared to investments in main market companies. This very statement regarding risk is required by Nasdaq, who operates First North, to be explicitly stated on the very first page of the prospectus/company description. The legally required disclaimer is as follows:

“Nasdaq First North Growth Market is a registered SME growth market ... Issuers on Nasdaq First North Growth Market are not subject to all the same rules as issuers on a regulated main market, as defined in EU legislation (as implemented in national law). Instead, they are subject to a less extensive set of rules and regulations adjusted to small growth companies. The risk in investing in an issuer on Nasdaq First North Growth Market may therefore be higher than investing in an issuer on the main market. All issuers with shares admitted to trading on Nasdaq First North Growth Market have a Certified Adviser who monitors that the rules are followed. The respective Nasdaq exchange approves the application for admission to trading.” (Nasdaq, 2019, p. 47)

As clearly stated in the disclaimer, the regulations, and rules to follow are less extensive for First North companies compared to the regulations on main markets. Adding to this, the companies are required to have a Certified Adviser, who is tasked with making sure that the companies are in line with applicable regulations and legislation. The task of a Certified Adviser e.g., entails making sure that the IPO company complies with the requirements regarding company announcements. In the current market, First North Certified Advisers are also often contracted to take on the responsibility of investor relations for the IPO company. More often than not, on First North, the Certified Adviser is also the financial adviser performing the valuation and pricing process.

The market for underwriters on First North is substantially different compared to main market underwriters. Underwriters performing First North IPOs are, more often than not, significantly smaller


Page 7 of 90 organisations with a larger dependency on a successful IPO compared to main market underwriters, who might only have one division assigned to perform IPOs and are hence less dependent on the income provided by performing IPOs.

Returning to the business model and earnings of the companies listed on First North, it is important to note that very few companies are fully established and have consistent positive earnings. The companies often, but not always, have a proof of concept and choose to do an IPO in order to receive financing to build the required structure in the company to achieve a positive bottom line. Other companies are still in the development phase e.g., tech, biotech, and medical companies, and require financing in order to fully develop or scale their given product or solution. The valuations of the companies reflect this early life cycle status. No required level of valuation exists on First North Growth Market, which provides a unique opportunity for companies seeking financing. An extension, or a big brother, exists for First North Growth Market called First North Growth Market Premier, which requires listed companies to, on a continuous basis, have a market value of at least EUR 10 million (Nasdaq, 2019). In comparison, the lowest tier main market, Nasdaq Capital Market, requires companies to, on a continuous basis, have a market value of at least EUR 50 million (Nasdaq, 2021).

First North companies are, in other words, substantially different from main market IPOs, less established, and hence a riskier investment for the average investor.

1.2 Problem Formulation

Researchers have, through the decades, scrutinised all aspects of IPOs and every step of the process has been mapped and analysed. Renowned is the research regarding the initial return of an IPO and the pricing of the share prior to said return. Ibbotson (1975) concluded in his study that the average IPO had an initial return i.e., the return measured from the offer price of the share to the price on the first day of trading, of 11,4 % and following his study Loughran & Ritter (2004) came to a similar conclusion that IPOs were still underpriced in the period from the 1980s and up until 2003.

Extant research investigates and explores the concept of underpricing, but very little evidence suggests that overpricing is similarly present in IPOs. Similarly, most researchers have focused on blue-chip IPOs and very few, if any, have had their focus on lower valued companies such as those listed on First North. Furthermore, recent publications from financial press have indicated that the price of companies on First North are too high, and that they do not live up to their own expectations (Kirketerp & Pedersen, 2021). The aim of this thesis is to provide evidence, as inspired by Ibbotson (1975) and Loughran & Ritter (2004), to the concept of IPO pricing along with evidence to the short run performance of IPO companies following their IPO.


Page 8 of 90 1.2.1 Research Question

“How are First North Growth Market initial public offerings priced, and how do they perform following the IPO?”

1.3 Development of Hypotheses

Extant literature has focused on ordinary IPOs, but whether or not the pricing, and causes of, apply to First North IPOs, which are substantially different to ordinary main market IPOs, is still unclear. In order for the thesis to properly investigate the research question, the following hypotheses have been formulated:

Hypothesis 1: The valuation level of First North Growth Market IPOs is higher than that of the given sector and industry in which they operate

The valuation of an IPO is, more or less, the very first step to be taken in the entire process of going public and is of the outmost importance for both investors and existing owners. In a perfect world, the valuation of a company would be fixed and not up for interpretation or at the underwriter’s discretion. In such a world, the valuation would be set to perfectly represent the current state of the company along with its future potential. As such a perfect world does not exist, the valuation is subject to the underwriter’s discretion and is therefore imperfect. Hypothesis 1 has been developed with the intention of testing the valuation levels of First North IPOs in order to determine whether or not they follow or deviate from an industry and sector average. The hypothesis is set forth to test the initial step in an IPO process and is a precursor for the development of the remaining hypotheses.

The testing of Hypothesis 1 provides crucial information as to answering the first part of the research question, as the valuation level of a company is a highly significant determinant of the final price of the offer shares in an IPO.

Hypothesis 2: The choice of underwriter affects the demand for shares in an IPO.

Hypothesis 2 is developed with the intention of determining the role the underwriter plays in the sale of IPO shares, and whether or not certain underwriters affect the sale of shares more than others.

The underwriter is essential for a First North IPO company as they are more or less responsible for the entire process of taking the company public. A more detailed description of the role of the underwriter will be provided in section 2.1.2 and in 2.2.1. The hypothesis is developed to be an extension of Hypothesis 1, which seeks to test the valuation levels i.e., the valuation process conducted by an underwriter. The underwriter is responsible for the initial sale of shares to the public by offering shares in a pre-subscription period. This usually entails offering shares to larger and more established investors compared to the retail investors targeted in the actual IPO offering, hence a more experienced and well-connected underwriter should, all things equal, possess a larger pool of


Page 9 of 90 potential investors compared to a less connected one. With First North IPOs being substantially different from those performed on main markets, the underwriters are, more often than not, also substantially smaller than underwriters performing main market IPOs. The difference is assumed to also apply to the availability of potential investors in the pre-subscription period. The hypothesis is, therefore, set forth to test whether or not such aforementioned differences exist in the market of First North underwriters.

Hypothesis 3: First North Growth Market IPOs are underpriced and hence provide a positive initial return.

The valuation and pricing process culminates in a final price of the offer shares. The final price is, by far, the most significant determinant of whether or not an IPO provides an initial return on the first day of trading. An initial return is, by definition, the return an investor receives on the IPO shares’

first day of trading. When companies are underpriced, the initial return is positive, and vice versa.

Hypothesis 3 has been developed in order to test the pricing and hence initial return of an IPO, but also to, in part, help answer the second part of the research question. The hypothesis has been specifically formulated as to confirm or reject the fact that First North IPOs are underpriced, which is in line with extant literature and empirical evidence (Clarke et al., 2016; Ibbotson, 1975; Loughran &

Ritter, 2004). Such theoretical and empirical evidence will be further reviewed in section 2.2.2. The specific formulation could have been altered as to state the opposite i.e., overpriced, which would be in line with the latest reports from financial media regarding the entire First North (Kirketerp &

Pedersen, 2021). As financial media are currently reporting the opposite scenario of that of extant theoretical and empirical evidence, the hypothesis, and also first part of research question, is of great importance to the thesis.

Hypothesis 4: Investing in IPOs is a viable option for investors seeking short run returns compared to the risks involved.

The hypothesis above has been developed in order to fully be able to answer the second part of the research question regarding the short run performance of the First North IPO shares. The short run has been defined as the time period from the first day of trading to the trading day exactly a year later. Based on the previously mentioned reporting from financial press, the statement presented by the hypothesis is significantly relevant in general, and crucial to the answering of the research question. Testing the viability of the short run performance of First North IPOs provides useful information, not only to this thesis, but also to investors considering investments into First North IPOs. Furthermore, the hypothesis has been developed to account for the risks that are, as stated by Nasdaq, associated with investing in shares traded on First North (Nasdaq, 2019).


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1.4 Delimitations

The following section will briefly present the delimitation and the scope of the thesis.

The research in this thesis is delimited to only consider First North IPOs in the time period from 2012 until a year prior to the development of the study i.e., March 2020. Initially the delimitation was considered to only include First North IPOs in Denmark, but due to a limited number of IPOs, the delimitation was expanded to include all First North IPOs.

The research has furthermore been delimited to only investigate and examine the pricing and short run performance of First North IPOs. Initial public offerings contain information, subject to examination, that is beyond the scope of this thesis. The research question and hypotheses of this study have therefore been developed, and delimited, to address the current conditions and issues of the First North, and not to be a complete investigation of the entire IPO processes and companies.

1.5 Disposition

The following section seek to provide information regarding the structure and disposition of the thesis.

Chapter Two explores and reviews the theoretical and empirical framework that is to be the foundation of the research conducted in the thesis.

Chapter Three provides a presentation of the methodology to be applied in the study. The chapter concludes with a walkthrough of the methodology to be applied to each of the four hypotheses.

Chapter Four presents the data to be used in the thesis along with a description of the collection process. The availability and suitability of the data is furthermore reviewed. Finally, the chapter briefly describes the IPOs contained in the final data set.

Chapter Five presents the analysis of the data collected. The analysis is done chronologically and methodically for each hypothesis in order to positively confirm or reject them based on the analysed data.

Chapter Six presents a discussion of the findings of the thesis. The discussion focusses on the underwriters’ part in an IPO, the pricing of the IPOs, the performance of the IPO companies, and topics for future research.

Chapter Seven concludes the thesis summarizing the findings of the hypotheses and answering the research question.


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2.1 Going Public

The decision of going public is arguably one of, or perhaps the most important decision for a company to make. It is most often a once in a company lifetime event and subsequent financing will often stem from retained earnings and debt issues (Jenkinson & Ljungqvist, 2001).

2.1.1 Reasons for Going Public

An initial public offering entails an issuance and offering of company shares. The shares offered can either be solely new issues or be a combination of newly issued shares and existing shares. When existing shares are offered, it means that existing shareholders are using the IPO as an opportunity to sell their ownership stake or parts of it. No matter the combination of offer shares, the existing ownership stakes become diluted. Going public is therefore a trade-off between receiving financing and having ownership stakes diluted (Ibid.). it is however a trade-off that owners are willing to make, as raising new capital is thought to be one of the prime reasons for companies to go public (Ritter &

Welch, 2002). New capital provides new means for a company to use to grow or further establish their presence in the market (Huyghebaert & Van Hulle, 2006). Another important, and increasingly common, reason for companies to go public, are for existing owners to use it as an exit strategy (Zingales, 1995). Private equity firms, and especially venture capitalists are fond of using IPOs as a strategy to capitalise on their existing ownership stake and hereby exit the company (Black & Gilson, 1998).

2.1.2 The Process of Going Public

The following section shortly details the process of going public. The initial step to be taken in every IPO is to contract an underwriter. The decision of choosing the right underwriter should among other things consider aspects such as the underwriters experience, past IPOs, fee structure, and reputation. The issuing company should be very delicate in scrutinising every aspect of the available underwriters. However, the scrutiny goes both ways. It is equally important for underwriters to conduct their due diligence when accepting contracts from issuing companies (Jenkinson &

Ljungqvist, 2001). When an underwriter and the issuing company come to terms and agree to move forward, the actual process of going public can begin. The underwriter possesses the experience and knowledge of the process and the actors (lawyers, accountants, issuing bank, etc.) that need to be involved in order to satisfy the requirements of becoming a publicly traded company (Bancel &

Mittoo, 2009).

Analysts from the underwriter will then begin to prepare preliminary briefing documents to distribute to investors. Such documents typically contain information regarding the company, the financials,


Page 12 of 90 and an initial valuation of the company. Further details on the pricing of the company will be reviewed in section 2.2.1. The underwriter is responsible for producing the official prospectus wherein the final offer price is stated along with the number of shares offered. The prospectus has to contain enough information in order to satisfy the rules set by the exchange, who in the case of First North, is Nasdaq.

Nasdaq has put forth a rulebook that clearly states what information to include in the prospectus.

The company must, but is not limited to, include information regarding management, the board of directors, company financials for the past 2 years, market strategy, competitors, articles of association, ownership structure and business model (Nasdaq, 2019). The prospectus is made public by press release stating that the company aims to go public. Following this release, the subscription period starts for retail investors. When the subscription period ends, the underwriter and issuing bank, account for the number of shares subscribed to in order to determine whether or not the offering has been fully subscribed. In the event of an oversubscription, predetermined allocation rules stated in the prospectus will be applied in order to rightfully distribute the shares.

2.2 Theoretical Framework

In the following section different theories relevant to the thesis will be explained and reviewed. The theories mentioned provide different views and perspectives to the data found and analysed in the thesis.

2.2.1 Valuation and Pricing Process

The valuation and price setting of an IPO is based on both fair value estimations along with corrections based on the experience of the underwriter conducting the valuation (Roosenboom, 2012). The fair value estimate is comprised of multiples, different discount models along with any valuation techniques specifically desired by the underwriter. This valuation process provides the underwriter with a fair value which is then subject to corrections based on the underwriters’

experience and possibly current market conditions. The nature of and reasoning behind such corrections will be explained further in section 2.2.2.

In the current market, three major methods of valuation persist: Discounted Cash Flow (DCF) analysis, peer group analysis and precedent transactions (Petersen et al., 2017). The DCF is perhaps the most widespread valuation technique in the financial world, but the very basics of the analysis require input, that more often than not, is not available in First North IPOs. DCF models can be based on different accounting cash flows but are usually based on either Free Cash Flow to Firm (FCFF) or Free Cash Flow to Equity (FCFE) (Brealy et al., 2020). The analysis calculates the time value of future cash flows in order to value a company at a given time. The model and the calculations are expected to be known by the audience of this thesis and will therefore not be reviewed further.

Relevant to the thesis is, however, the input requirements, as briefly touched upon. First North IPOs


Page 13 of 90 are often unprofitable leading to negative cash. Such a limitation to the DCF model renders it less useful compared to alternative valuation methods (Hillier et al., 2014). A second method of valuation entails examining and investigating comparable companies to the one being valued i.e., a peer group valuation. This method is not limited to the accounting information available on the IPO company but simply requires the analyst to identify companies as similar to the IPO company as possible (De Franco et al., 2015). A certain level of discretion is available to the underwriter and its analysts when utilising this method, and in the case of First North IPOs, it is perhaps the most commonly utilised valuation method due to the limitations of DCF analysis (Paleari et al., 2014). Peer group valuation, more often than not, utilises multiples in order to compare the identified companies with the IPO company. Multiples are financial ratios that measure an aspect of a company’s financial state. The perhaps most common multiple is that of a price-to-earnings multiple (P/E). This specific multiple measures the ratio of the value (price) of the company, and the current earnings of the company. In the current market, blue-chip companies are traded at a P/E of about 20-30 (Frandsen & Ohmeyer, 2021). The utilisation of multiples is not without limitations when it comes to First North companies though. As the DCF analysis, multiples are most reliable when incorporating information about a company’s earnings i.e., when all costs and variables have been accounted for. The broader the financial metric used when calculation a ratio, the less reliable it is thought to be (De Franco et al., 2015) – especially in smaller unprofitable companies as those on First North. For unprofitable companies, the ratio of price-to-sales (P/S) is often utilised as it is possibly the only positive accounting metric available from the company’s income statement. Multiples rarely stand alone in a valuation process and are often combined with other ratios and valuation techniques, and the same is applicable to the use of preceding transactions, which, more often than not, are used as useful input in the valuation process rather than a direct peer.

Having estimated a fair value and made corrections to this, the underwriter now has a preliminary offer price for the IPO. The preliminary offer price is pitched to institutional investors and specific investor networks in order to determine the demand of shares in the IPO at the set price – this process is called bookbuilding and will be further reviewed in section (Brealy et al., 2020).

Further corrections might incur given the outcome i.e., the demand from investors, and having accounted for such, the underwriter can set a final offer price, which will be the price mentioned in the company’s prospectus.

There has been a profound shift towards a preference for listing technology companies and companies with negative earnings, which prior to the internet-bubble in the early 2000s was not nearly as frequently occurring (Loughran & Ritter, 2004). This has changed the methods for valuing


Page 14 of 90 companies as certain techniques and models’ applicability is limited when dealing with unprofitable companies.

2.2.2 Over- and Underpricing of IPOs

As previously mentioned, an underwriter might deliberately discount the fair value estimate in the process of setting the preliminary offer price (Roosenboom, 2012). Empirical research has found that deliberate discounts occur as the underwriter wishes to either further establish or improve existing relationships with institutional investors and investor networks involved in the valuation process (Baron, 1982; Shiller, 1990) and to encourage investor participation (Rock, 1986).

Roosenboom (2012) made additional findings that the valuation process conducted by the underwriter was based on valuation methods that contain high degrees of bias and information asymmetry. The discretion available to underwriters in the valuation process allows them to carefully select discount model input and peer companies (Paleari et al., 2014). This available discretion in the valuation process might lead to a mispricing of the IPO company. Paleari et al. (2014) found that the prospectuses of companies doing an IPO had 13-18 % higher valuation multiples compared to similar companies found by sell-side analysts. The greater the bias exercised by the underwriter in the valuation process, the poorer performance of the share price (Ibid.). The empirical evidence provided by Paleari et al. (2014) does not stand alone in suggesting that IPO companies are just as likely to be overpriced as they are to be underpriced. An academic study from the start of the millennium found that IPOs may be overpriced in equilibrium as well as underpriced (Leite, 2000). Asymmetric Information Theory

Historically, research and studies have been carried out to confirm and document underpricing as a widespread phenomenon in IPOs. Overpricing has not received as much focus as its counterpart, and the theoretical framework surrounding these concepts are therefore mostly founded in underpricing. The theories do however apply to both phenomenon but with evidence clearly favouring the presence of underpricing. The following section explores and reviews theories of IPO pricing with regards to the presence of asymmetric information.

Signalling Theory

The valuation and pricing process of an IPO is similarly a process of different signals. Signalling theory examines communication between individuals, or in the case of an IPO, players involved in the process, e.g., the company, investors, and the underwriter. Signals in IPOs carry different values to the different players involved and can therefore be considered beneficial for some of the players involved while being costly for the counterpart. Underpricing an IPO sends a credible, albeit a costly, signal (show of strength) that the company is good to investors as only good companies are expected to regain the initial loss after their performance is realised (Allen & Faulhaber, 1989). In this


Page 15 of 90 theoretical example the cost of the signal i.e., underpricing the IPO, is carried by the initial owners of the company as they are ‘leaving money on the table’ (Loughran & Ritter, 2002) while investors are benefitting from the lower valuation of the company, i.e. a lower price per share. The exact same signal (underpricing) can be interpreted as a compensation to uninformed investors due to the presence of asymmetric information. When informed investors, typically institutional investors with thorough due diligence processes, refrain from participating in an IPO, it might be considered as a signal that the value or the quality of the company is too high. With the signal of weaker future earnings or fewer dividend payments, underpricing (show of weakness) can be utilized as a compensation method for investors (Michaely & Shaw, 1994).

Agency Theory

Agency theory concerns itself mainly with the misalignment of interests between agent and principal.

In the case of an IPO, this misalignment is between the issuing company and the underwriter. The issuing company has complete information regarding the company itself, but an instance of asymmetric information arises when the company contracts an underwriter to conduct the valuation and pricing process. The underwriter is assumed to get complete access to all information regarding the issuing company as this is required to correctly value the company. Furthermore, the underwriter is assumed to be more experienced and knowledgeable of the capital markets in which the issuing company seeks to do the IPO, hence the two players are unequally informed (Baron, 1982). Baron (1982) states that if both players are equally informed, the underwriter would only be contracted for the distribution services it could provide, and that this service would be at the first-best level. As the issuing company would only require the distribution services, no over- or underpricing would exist. If the underwriter and issuing company are unequally informed, an agency problem exists.

Baron’s (1982) model predicts that offer prices will be underpriced or overpriced less in the absence of asymmetric information. This statement has been challenged by examining the IPOs of certain underwriters, who are assumed by Baron (1982) to have superior information. In the examination of 38 underwriters in the period 1970-1987, it was found that the IPOs of the underwriter companies were underpriced at a level of about 7 % (Muscarella & Vetsuypens, 1989). In 17 of the IPOs, where the issuer acted as the lead manager, the average initial return was 13,23 %, which is evidence to support the fact that underwriters deliberately underpriced their own offerings (Ibid.). As underwriters are repeat players in the market for new IPOs, the incentive exists to provide investors with initial returns in order to foster demand for new issues (Roosenboom, 2012).

Agency theory regarding IPO pricing examines the relationship between agent and principle – in this case, underwriter and issuing company. It has been previously stated that in a perfect information scenario, no over- or underpricing would exist as both underwriter and issuing company possesses


Page 16 of 90 the same information on which to base the valuation on (Baron, 1982). Aspects of this statement has been challenged following the IPO of Facebook in 2012. Facebook went public with the highest- ever valuation of a U.S. company. The share price had an initial return of 0,61 % and was considered a major failure by the investor community (Krigman & Jeffus, 2016). No underpricing was present in the IPO, but investors were still unhappy with the result and the share price was almost halved after a month of trading. No other company went public 41 days after the IPO of Facebook, and when the IPO market restarted, an average underpricing of 27 % was seen in the share price of the companies going public (Ibid.). Krigman & Jeffus (2016) state that investors generally expect an underpricing of 15 % over time and such a conclusion is close to consistent with the findings of e.g., Ibbotson (1975) and Loughran & Ritter (2004).

Winner’s Curse

As previously mentioned, Ibbotson (1975) initially examined the initial return and therefore underpricing of IPOs. He did not, however, conclude as to why the offerings were underpriced.

Following his research, Rock (1986) took up the mantle as to figuring out possible reasons behind the extant underpricing in the market for IPOs. His conclusion was a winner’s curse. The theory of adverse selection has its roots in the allocation of offer shares to different kinds of investors, and deduces that underpricing in IPOs could stem from a ‘lemons’ problem (Akerlof, 1970) given the circumstances of said allocation (Benveniste & Spindt, 1989). The issue with the allocation rests on the opportunity for informed investors to crowd out uninformed investors when an IPO is underpriced, and in the opposite scenario to withdraw from overpriced IPOs leaving more shares to the uninformed investors (Rock, 1986).

Using Rock’s (1986) framework it has been shown that the reputation of underwriters is essential to the reduction of information asymmetry (Michaely & Shaw, 1994). Prestigious underwriters utilize their information advantage to cherry pick the companies that they assist in going public. Doing so helps close the gap between informed and uninformed investors, as everyone is aware that certain underwriters do not assist companies of poor quality in going public. Such an underwriter strategy helps combat the winner’s curse set forth by Rock (1968) and evens out the asymmetry of information among investors.

Informational Cascades

It is not rare, that IPO shares are sold in a sequential manner in which certain investors, typically larger investors and institutions, are offered to commit to shares before the IPO is open to retail investors (Welch, 1992). Depending on the outcome of the ‘initial’ sale of shares, Welch (1992) argues that later investors choose to ignore or partially ignore their own information and base their decision on the purchasing decision of the early investors. Such a scenario creates informational


Page 17 of 90 cascades, which can be argued to reduce the applicability of Rock’s (1986) winner’s curse theory as issuers aim to price the IPO to early rather than later investors (Ibid.). Underpricing an IPO can be seen as a means for the underwriter to attempt to create a cascade of high demand with early investors, which then affects the purchasing decision of later investors positively (Amihud et al., 2003). Symmetric Information Theory

Book Building

The process has the purpose of providing the underwriter with crucial information regarding the offering and the possible implications that might occur from it (Petersen et al., 2017). Testing the demand with known larger investors and within established investor networks has, more often than not, become common practice amongst underwriters and for good reason. Entering into an agreement to perform the IPO process for a company naturally requires significant amounts of due diligence in order to determine whether the agreement will be profitable for the underwriter or not.

The underwriter might possess an indication of the level of demand for shares in a given IPO but will ultimately know for sure during the bookbuilding process (Ibid.). This process can, in other words, make or break the underwriter’s perceived profit margins regarding the IPO case.

In practice, underwriters tend to offer the IPO shares at a discount compared to their estimated fair value i.e., underpriced, in order for the targeted investors to reveal their own valuation levels. It is at these levels that they are willing to subscribe to IPO shares, which is what the entire process revolves around (Hanley, 1993). Given the level of interest from investors, underwriters might choose to explore an additional option in the bookbuilding process. Underwriters and IPO companies might choose to perform a pre-IPO process in which investors are offered shares at a certain discount (Derrien & Womack, 2003). The discount is similar to that of the normal bookbuilding process but investors subscribing in a pre-IPO are, as the name states, offered shares prior to the initial public offering and therefore possess ownership in the company when it is taken public. This particular process is also known as a private placement and is often used as an alternative to an IPO.


Page 18 of 90


The purpose of the following section is to provide an understanding of the considerations made when developing the thesis. The development of the thesis has been an ongoing process with ongoing reflection and revision of the research topic, theories, and empirical contents.

3.1 Clarification of the Research Topic

The initial thoughts behind the research topic stems from a personal interest in equity investing. More specifically, the interest was and is in investing in non-blue-chip companies that are traded on smaller and less regulated markets such as First North. These markets have, by the financial press, often been referred to as ‘mini exchanges’ insinuating that the markets are not the real deal (F. Jensen, 2021). Furthermore, the press has tended to shine a negative light on the companies and often with good reason. Recently, financial press published thorough research stating that within a sample of 13 Danish companies listed on First North Denmark, none lived up to their own expectations and were priced significantly higher compared to companies listed on the main markets (Kirketerp &

Pedersen, 2021). Given personal experience from investing in some of the named companies, it was a clear choice as the research topic for the thesis.

Extant literature and research exist on the topic of IPO pricing and the long run performance of returns. The majority of it focuses mainly on underpricing and the reasons for and consequences of such. Very little literature focuses on possible overpricing and reasons for and consequences hereof.

Given the recent stories of First North companies being priced high, it would be interesting to examine whether or not the pricing of First North IPOs and their short run return performance is consistent with the evidence provided by existing literature. Furthermore, the entire market is constantly reaching all time highs with investors having close to no alternative investments that can match the risk-return relationship of stocks. With this being the current scenario, an investigation of the pricing and short run performance of the First North IPOs could provide empirical evidence as to whether or not investing in said IPOs is a viable return to risk option in today’s market.

Having determined the final research topic, it was possible to further narrow down and formulate suitable and precise hypotheses. The arrival at the research questions has not been instantaneous but has, as the entire thesis, been subject to ongoing revision based on the increasing degree of available information.

3.2 Measures of Initial Public Offerings

The measures utilised in this thesis have mainly been selected due to their extant nature. They are and have been thoroughly used in the financial world and their use can therefore be considered to


Page 19 of 90 have been thoroughly tested (Brealy et al., 2020). The following section describes the measures utilised in the thesis along with their specific relevance for the hypotheses sought to be tested.

3.2.1 Valuation Process

As mentioned previously, the pricing of an IPO is a process involving a valuation stage and a pricing stage. The stages have been explained in a prior section but will be expanded upon in the following.

Both stages are controlled by the underwriter who then adapts the techniques used in the process based on feedback from other actors involved along with data as it becomes available. The valuation stage is more or less an isolated process wherein the underwriter performs their own valuation process, including and excluding models and techniques as they see fit. These techniques and models are relevant for the examination sought to be performed in this thesis.

The valuation method utilised often has its focus on multiples and peer companies when dealing with First North IPOs. The identification of peer companies is considered a tedious and time-consuming task for the underwriter and is therefore beyond the scope of this thesis. A relative valuation can, however, provide crucial information regarding the level of the valuation compared to the given sector a company operates in. The multiples to be considered are all based on the pre-money market capitalisation of the company. Pre-money market capitalisation is used rather than post-money market capitalisation as the pre-money value is the purest value of the two. A market capitalisation valuation multiple will be significantly affected if the post-money value is used, as this contains the cash proceeds received by the company from the IPO process. Such cash proceeds significantly increase the market capitalisation, and hence increase price valuation multiples. This thesis therefore considers pre-money market capitalisation as the true fair value of the company’s business.

The price valuation multiples will further be based on the sales and earnings from the income statement, hence providing the following multiples: Price-to-Sales (P/S) and Price-to-Earnings (P/E).

The multiples indicate and provide information as to how much an investor has to pay for 1 unit of sales and earnings, respectively, in the company.

As mentioned previously, an individual peer comparison would be time-consuming, but in order for the multiples to provide the necessary data for the thesis and the further analysis, they have to be used in some sort of comparison. The comparison relies on sector- and industrywide multiples in order to determine the level of the individual company valuation. The specific sectors and industries will be described in section 4.2.3.


Page 20 of 90 Applicability of Valuation Models

As briefly mentioned in section 2.2.1, the different valuation methods described vary significantly in applicability when it comes to First North companies. First North Growth Market is considered a

“mini” exchange wherein less established companies are traded. The companies do, more often than not, not have any bottom-line earnings and are therefore businesswise far from the companies traded on main markets. Investment in First North companies has been compared to venture investing as the financials of the companies are very similar and comparable to those of venture companies. Such financial states naturally affect the applicability of valuation methods. The renowned and often applied discount models are rendered useless in such an environment. The vast majority of cash flow valuations are made based on either the free cash flow to the firm (FCFF) or the free cash flow to equity (FCFE), which both require the given company to have cash available after covering all expenses, reinvestments, and debts. Fulfillment of such a requirement is a rarity with First North companies. Even though cash flow models can be modified to be based on EBIT or EBITDA, such financial levels are not a given in the First North environment. Some companies are even in a pre-sale life cycle state and therefore have no revenue, or perhaps even no proof of concept. The discount valuation models are hence not applicable to companies in this very market.

A peer group is more common in this given environment. The process of identifying eligible peers can however prove tedious, and its applicability in this thesis is therefore limited. Companies listed on First North often have a unique, non-comparable, business model, which makes a peer comparison difficult, but not entirely impossible. Directly comparable companies are generally very few, and even more so on the level of First North companies.

The applicability issues of the abovementioned valuation methods leave the method of multiples as the most viable option. When addressing the viability and applicability of multiples as a valuation method, it is crucial to mention, that the method is not without faults. In the case of this thesis, the comparison of sector and industry multiples with those of the First North companies, relies on average ratios. Such averages might consider significantly different size companies with significantly different financial positions. The issues related to that of sector and industry averages will be further touched upon in section 3.3. Even with the issues related to multiples, the applicability of the method far outweighs the applicability of the cast flow models and the peer group method.

3.2.2 Pricing Process

The pricing process is centred around the concept of bookbuilding, which involves pitching the IPO company to outside investors to determine the level of demand and price for shares in the company (Brealy et al., 2020). As the name suggests, the process is used to build the orderbook for the IPO shares and acquire subscription commitments from investors (Hanley, 1993). These commitments


Page 21 of 90 are confirmed orders of a given amount of IPO shares at the final offer price, but they are not guaranteed. In the event of an oversubscription, a reduction plan will be followed that will allow the underwriter, in cooperation with the IPO company, to reduce orders for shares in order to satisfy e.g., the requirements set by Nasdaq regarding number of qualified shareholders (Nasdaq, 2019). The reduction plan is required to be a part of the official prospectus published in relation to the IPO and can allow for subscription commitments to be allocated completely but is ultimately at the discretion of the underwriter and the issuing company.

Subscription commitments are required by Nasdaq to be listed in the prospectus by name of the investor and the number of shares subscribed to. The commitments are a fixed amount but make up a certain percentage of the total offering. That percentage will be determined as follows:

𝐶𝑜𝑚𝑚𝑖𝑡𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝑆𝑢𝑏𝑠𝑐𝑟𝑖𝑝𝑡𝑖𝑜𝑛 𝐶𝑜𝑚𝑚𝑖𝑡𝑚𝑒𝑛𝑡𝑠 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝐼𝑠𝑠𝑢𝑎𝑛𝑐𝑒 𝐴𝑚𝑜𝑢𝑛𝑡

The ratio is simple but seeks to illustrate the number of shares already committed to by larger investors. An important sidenote regarding the commitments is that in Denmark and Finland, but not Sweden, underwriters and their friends and family, are prohibited from investing in companies that they are contracted to help go public and can therefore not partake in the IPOs. This is partly due to the level of asymmetric information present (Baron, 1982). The ratio, furthermore, and perhaps most importantly, provides information of the number of shares available to public retail investors not included in the pricing process. These are then subject to the reduction plan in the case of an oversubscription.

The commitment ratio can, furthermore, provide information asserting to the issue and presence of a winner’s curse (Rock, 1986). An IPO having a high degree of subscription commitments could indicate a high level of information asymmetry benefiting investors who are participating in the offering prior to the offering being available to the general public.

3.2.3 The Offer Period

During the offer period, very little, if any, new information is released from the IPO company and the underwriter. The valuation and pricing processes are completed, and the remaining parts of the offering is left to the public. An offer period usually stretches over 10 trading days and allow for retail investors to subscribe to offer shares until the very last minute of the last trading day.

The offer period is perhaps the most crucial stage in the entire IPO process, as the demand for the offer shares is finally revealed. In an ideal world, companies would seek to receive subscription applications in excess of the number of shares offered i.e., an oversubscription.


Page 22 of 90 Oversubscriptions can occur due to the demand of the IPO shares being very high and therefore be an indicator of the quality of the IPO company and its prospects. There is, however, also the possibility of an offering being oversubscribed due to a very limited supply of offer shares. A limited supply of offer shares can be the result of decisions made by the IPO company prior to the offering.

If management of the IPO company decides to maintain a high level of ownership in the company, the number of offer shares will naturally be low as existing ownership will hereby not become as diluted as in the event of a high number of offer shares. With the IPO having a low supply of offer shares, the possibility of the offering being over-subscripted at the end of the offer period is, all things equal, higher.

The subscriptions of First North IPOs will, in this thesis, be measured as a ratio. The ratio will be as follows:

𝑆𝑢𝑏𝑠𝑐𝑟𝑖𝑝𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑖𝑜 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑢𝑏𝑠𝑐𝑟𝑖𝑏𝑒𝑑 𝑆ℎ𝑎𝑟𝑒𝑠 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑂𝑓𝑓𝑒𝑟 𝑆ℎ𝑎𝑟𝑒𝑠

As shown, a fully subscribed IPO will have a subscription ratio of 100 %. If the ratio is above 100 %, the IPO is considered oversubscribed, and the subscribing investors will have their subscriptions be subject to a reduction. If the ratio is below 100 %, the IPO is considered undersubscribed, and the IPO company will therefore not receive the full intended proceeds from the offering.

3.2.4 The Initial Performance of IPOs

As previously mentioned, the initial return was first introduced by Ibbotson (1975) in his study of IPOs on the American market. His conclusion was an average underpricing of 11,4 % in the period 1960-1969. The research furthermore concluded that an investor, investing in a random IPO, has a far higher likelihood of receiving large positive returns than correspondingly negative returns (Ibbotson, 1975). A similar study was performed from 1990-2003 in which it was concluded that initial returns had doubled from 7 % in the 1980s to 15 % in the period 1990-1998, and then back to 12 % in the years 2001-2003 (Loughran & Ritter, 2004). Lastly, a study conducted from 2003-2014 in India, found that the average underpricing of an IPO was 23 % (Clarke et al., 2016). More specifically, and relevant to this thesis, it was recently found that the average initial return in Denmark, Sweden &

Finland was 7,4 %, 25,9 % and 14,2 %, respectively (Loughran et al., 2021). The abovementioned studies show that IPOs have been underpriced on the average on a global scale throughout the past decades and still are.

As empirically proven by extant literature underpricing of IPOs is a significant issue in the market of IPOs. This thesis will attempt to explore the concept of IPO pricing and the evidence provided by extant literature on IPOs on First North. These IPOs are significantly different from the ones


Page 23 of 90 performed on the main market and the pricing and initial performance might therefore not follow the evidence provided by extant literature. As mentioned previously, the difference between First North IPOs and main market IPOs is due to a fundamental difference in the quality and life cycle stage of the companies going public.

In order to determine whether or not First North IPOs are subject to underpricing, the initial return of the IPOs has to be assessed (Ibbotson, 1975). Academics use the terms first-day positive returns and underpricing interchangeably, and the methodology surrounding this has varied depending on the authors performing the analysis but have mainly considered two viable options. The first option considers the closing price on the first trading day of the offer shares as an indicator of the initial return, whereas the second option considers the opening price. “The opening market price is close to an unbiased indicator of the closing market price on the first day, so results are insensitive to whether the opening or closing market price is used. The vast majority of empirical work has used the first closing price to measure the first-day return.” (Ritter & Welch, 2002, p. 8). As pointed out by Ritter & Welch (2002), results should be insensitive to the use of opening price and closing price, and the conclusion should therefore be the same. As the vast majority of previous empirical studies has used the first day closing price to calculate the initial return of an IPO, the author of this thesis has chosen to follow the same methodology. It is furthermore relevant for the thesis to follow the methodology applied by e.g., Ibbotson (1975) as to consider whether or not the initial return of IPO offer shares are affected by the state of the market in which they are now traded. Adjusting for the effect of the market will help isolate the initial return performance of the individual IPO. The initial return will be calculated as follows:

𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑅𝑒𝑡𝑢𝑟𝑛 =𝑂𝑝𝑒𝑛𝑖𝑛𝑔𝑃𝑟𝑖𝑐𝑒 − 𝐼𝑃𝑂 𝑃𝑟𝑖𝑐𝑒

𝐼𝑃𝑂 𝑃𝑟𝑖𝑐𝑒 −𝐵𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘𝑡− 𝐵𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘𝑡−1 𝐵𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘𝑡−1

The formula above adjusts the initial return of the IPO share by subtracting the corresponding daily return of a matching benchmark thus ensuring that the return effect found in the market is eliminated from the measure. Each IPO company has been matched with a specific index as a benchmark. The selection of benchmarks will be explained in section 3.2.5.

3.2.5 Short Run Performance

This thesis will utilise a modern portfolio theory and mean-variance approach in order to determine and evaluate the short run performance of the IPO company’s shares following their listing. Modern portfolio construction entails utilising the renowned capital asset pricing model to assess and compare assets or investments to determine the composition of risk and return in the portfolio (Markowitz, 1952).


Page 24 of 90 The short run performance of the offer shares will be measured over a period of exactly 1 year, or more specifically 253 trading days, hence providing every share in the sample with exactly 253 daily return data points. Having daily return data for each company, it is almost possible to calculate the components of the CAPM (Ibid). A benchmark is needed in order to calculate the necessary main component of the model i.e., the beta. Every company has therefore been paired a share index. All companies have been paired with the First North All Share Index from their respective country. The benchmarks contain all companies listed on First North in the respective countries and therefore serves as a viable benchmark from which to calculate the covariance to be used for the beta calculation (Eun, 1994).

The remaining components of CAPM are return data of the market or portfolio and return data on a risk-free asset. CAPM was developed with the intention of using portfolio data as a reference point, but has for long been interchangeably used with return data for a given market, which in the case of this thesis, is the benchmark that each company has been paired with (Murphy, 1977). The risk-free asset is required to be an asset that, with close to a 100 % guarantee, secures the return listed on the asset. In both theoretical and practical instances, the United States Treasury Bill (T-bill) has been used as the risk-free asset to include in the CAPM. As the focus of the thesis is on Scandinavian IPOs, a Swedish 1Y Government Bond will be used. The 1Y bond has been selected due to the time period being identical to that of the IPO share return data.

In order for the data to be comparable and useful in the model, the time periods have to align.

Misaligned data point would yield misinformative data points, which would lead to a skewed model.

All data to be used in the CAPM has therefore been carefully selected as to match the first trading day of each company in the sample ending exactly 253 trading days later.

Modern portfolio theory was first introduced in 1952 by Harry Markowitz (1952) in his paper ‘Portfolio Selection’. In this paper, Markowitz (1952) emphasized the importance of portfolios with regards to risk and the correlation between securities. Furthermore, diversification of risk through concepts such as variance and covariance were introduced into the world of investment. Risk and return were at the core of Markowitz’ (1952) theory and the optimal combination of the two (also known as ‘the Markowitz set’) would later become the framework from which the capital asset pricing model would be developed. Following the widespread use of modern portfolio theory, criticism arose claiming faults in the theory. A common denominator in the criticism was, and still is, the definition of risk, chosen by Markowitz and some of his co-authors, to be measured by volatility. It has been argued, that the relationship between risk and returns is far weaker than illustrated by modern portfolio theory (Murphy, 1977) and that there is no empirical evidence to support the statement, set forth by modern portfolio theory, that risk generates a special reward (Haugen & Heins, 1975).


Page 25 of 90 Mean-Variance Portfolio Construction

The capital asset pricing model (CAPM) has been widely used since its development and is to a large extent still relevant in todays’ portfolio management. The origin of the model stems, as mentioned, from the theories put forth by Markowitz (1952) regarding a risk-reward relationship, which was then further developed into the powerful and intuitive model known today. The purpose of the CAPM is to evaluate whether a given share or portfolio is fairly valued. The fair value is determined by comparing the risk of the stock and the time value of money with the expected return of the stock (Sharpe, 1966).

The model is as follows:

𝐸(𝑅𝑖) = 𝑅𝑓+ 𝛽𝑖∗ (𝑅𝑚− 𝑅𝑓)


𝐸(𝑅𝑖) = Expected return of the investment in question

𝑅𝑓 = Risk-free investment

𝛽𝑖 = Beta of the investment in question

𝑅𝑚 = The historic or expected return of the market (Return on portfolio can be used interchangeably) The model assumes that investors seek to be compensated for the time value of money as well as for adding risk to their portfolio (Lintner, 1969). The risk-free investment, usually depicted by government bonds, accounts for the time value of money as it is the return an investor could, with close to complete certainty, expect with out any risk. The model then uses the ‘beta’-measure to determine the risk of adding a given investment or asset to the a portfolio - assuming that the portfolio looks like the market (Fama & French, 2004). Beta is calculated as follows for investment A:

𝐵𝑒𝑡𝑎 (𝛽) =𝐶𝑜𝑣(𝐴, 𝐵) 𝜎(𝐵)2


𝐶𝑜𝑣(𝐴, 𝐵) = Covariance of investment A (The portfolio or market) and B (the investment) 𝜎(𝐵)2 = Variance of investment B


Page 26 of 90 The covariance is calculated as follows:

𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 1

𝑛 − 1∗ ∑((𝑅𝐴− 𝑅̅𝐴



) ∗ (𝑅𝐵− 𝑅̅𝐵))


𝑛 = Number of observations

𝑅𝐴 = Return of investment A

𝑅̅𝐴 = Average return of investment A 𝑅𝐵 = Return of investment B

𝑅̅𝐵 = Average return of investment B

With a certain beta assigned to the investment, the model can be used to calculate the expected return for that given level of risk. This is done by multiplying the beta value with a value consisting of the actual or expected market return subtracted the risk-free investment. The sum of the formula yields the return an investor could expect, in the given market, given the particular level of risk (Sharpe, 1966).

The capital asset pricing model provides very useful insights for investors trying to compare investments when determining which to include in a portfolio. The perhaps most used measure in this regard is the ‘Jensen’s Alpha’ – also known as ‘Jensen’s Measure’ or simply ‘Alpha’ (M. C.

Jensen, 1968). Alpha measures the difference between the expected return, as calculated using CAPM given a certain level of beta, and the actual return provided by a given investment. The measure therefore provides investors with a simple metric as to determine whether or not an investment or asset provides enough return compared to the level of risk (Ibid.).

Expanding on additional measures that have come from the mean-variance and modern portfolio theories, certain ratios are crucial to include. Critiques of the mean-variance and modern portfolio theories often state that volatility is not necessarily equal to risk. The Sharpe Ratio (Sharpe, 1966) sticks to the assumption while the Sortino Ratio (Sortino & van der Meer, 1991) tries to somewhat remedy the critique of the assumption.


Page 27 of 90 The ‘Sharpe Ratio’ was first presented by William F. Sharpe (1966) in his paper ‘Mutual Fund Performance’ and is based on the initial thoughts brought forth by Markowitz (1952) a decade or so earlier (Travers, 2012). The ratio is a measure of the average level of return earned in excess of the risk-free rate per unit of volatility:

𝑆ℎ𝑎𝑟𝑝𝑒 𝑅𝑎𝑡𝑖𝑜 =𝑅𝑖− 𝑅𝑓 𝜎𝑖


𝑅𝑖 = Return of the investment 𝑅𝑓 = Risk-free investment

𝜎𝑖 = Standard deviation of the investment

A rule of thumb, when it comes to the Sharpe Ratio, is that the higher it is, the better for the investor.

The higher the ratio, the better the risk-adjusted return of the investment (Lhabitant, 2006).

The ‘Sortino Ratio’ expands on the fundamentals presented by the Sharpe Ratio with a slight modification of the risk-free investment and the volatility of the investment (Rollinger & Hoffmann, 2013).

𝑆𝑜𝑟𝑡𝑖𝑛𝑜 𝑅𝑎𝑡𝑖𝑜 =𝑅𝑖− 𝑇 𝑇𝐷𝐷


𝑅𝑖 = Return of the investment 𝑇 = Target or required rate of return 𝑇𝐷𝐷 = Target downside deviation

Instead of using the risk-free investment as a target, the Sortino Ratio allows for the investor to set their own minimum acceptable return, but more often than not, the risk-free rate will be used (Sortino

& van der Meer, 1991). Furthermore, the Sortino Ratio modifies the volatility used in the calculation.

Instead of using the total volatility of the portfolio i.e., both up- and downside risk, the ratio only takes downside risk i.e., downside deviation into account (Rollinger & Hoffmann, 2013). It is calculated as follows:


Page 28 of 90 𝑇𝐷𝐷 = √1

𝑛∗ ∑ (𝑅𝑖− 𝑇)2



𝑛 = Number of observations

𝑅𝑖 = Return of the investment 𝑇 = Target or required rate of return

This exclusion of upside risk, which in most cases is considered beneficial, allows for the ratio to consider the fact that investors most often care more about their losses than they do their wins (Ackert & Deaves, 2010).

3.3 Limitations of the Research

Number of IPOs

The depth of the analysis will be limited due to the number of IPOs included in the data set. Individual analysis of each IPO will, in other words, not be possible, and the analysis will hence be performed on an average level as to include all the data, while still providing crucial information as to the testing of the hypotheses, and ultimately, the answering of the research question.

Industry Compatibility

The valuation level comparison on an industry level will be somewhat limited due to the compatibility of the industries provided by Damodaran and the industry classification by Morningstar. This compatibility will be further explained in section 4.2.3.

Multiple Selection

The thesis will utilise certain specified multiples in order to evaluate the valuation level of First North IPOs and in doing so, deliberately exclude other multiples in the process. Other valuation multiples e.g., enterprise value-based ones, could provide additional insights into the valuation level as such multiples take the debt level of the company going public into account, which a market capitalization multiple does not.

CAPM Construction

The choice of input in CAPM construction is subjective and certain benefits and consequences arise from every given choice. The author decided on benchmarks in which the very companies analysed are included and hereby capturing the very market conditions that apply to the companies. In general, a less volatile and more regulated market could have been chosen in order to provide the



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This study conducted a local sensitivity analysis of 30 indicators that affect the energy efficiency of public buildings during the operation phase and identified 12

1) Heat integration technology can decrease the energy and capital cost significantly, especially for S1b and S3b schemes. S3b with 17.16% reduction on TAC can