Regulatory Arbitrage on Narrative Steroids: The Case of SPACs
40 Pages Posted: 20 Dec 2021
Date Written: December 15, 2021
Abstract
We review the historical emergence, recent boom, and functioning of Special Purpose Acquisition Companies (SPACs). SPACs are blank-check companies, raising money from investors to complete an acquisition (generally a private firm) within a limited period of time (generally two years). First, we describe the main features of SPACs and the considerable growth of such transactions, mostly in the US. Second, we examine the academic literature that has explored the financial performance of these investment vehicles. The overwhelming evidence from academic studies (that have mostly focused on US SPACs) indicates that these investment vehicles, while allowing their sponsors to earn substantial gains, did not on average create value for shareholders with a long-term horizon, that is investors that kept their shares after the merger with a target firm (the de-SPAC). Several factors can explain this underperformance: the dilutive nature of SPACs for investors, deferred payments to the underwriters only if a target is found, or the misalignment of incentives between sponsors and investors, the former receiving a large equity compensation only if the SPAC acquires or merges with a target firm. On average, SPACs have identified low quality target firms and underperformed following the de-SPAC. Third, drawing on Shiller’s work on narrative economics, we discuss the role played by another, perhaps underestimated factor, that is, the promotional narratives disseminated by SPACs in explaining their growth. Historically, traditional IPOs faced stricter disclosure regulations than SPACs, e.g., regarding forward-looking statements or the quantity of information. We provide an illustrative case study of disclosure by focusing on a US SPAC transaction in the online education area (i.e., Nerdy). Using content analysis, we find evidence consistent with promotional investment narratives in documents intended to inform potential investors. SPACs’ sponsors have engaged in this regulatory arbitrage regarding disclosures. Fourth, we examine the regulatory environments and prominent cases in the US and in Europe. After reviewing the US, we provide examples of SPACs in four major European market venues: Amsterdam, Frankfurt, London, and Paris. We show that the regulations differ significantly across European markets, influencing SPAC activities in these markets. Finally, we discuss the value and limitations of SPACs as an access to public capital markets. This report shows that the performance of SPACs has been largely disappointing, particularly for retail investors. The possibility for SPACs to disseminate positively biased narratives, among other factors, has in our view contributed to the boom in their activity. We think that the future of SPACs, as we know them, is currently uncertain due to several factors, including a reduction in the strength of underlying driving forces fueling the growth in SPAC activity (e.g., booming equity market, increase in trading activities of inexperienced investors), and an increasing regulatory oversight, notably by the SEC in the US, which may reduce the possibility to engage in a regulatory arbitrage in critical matters such as SPAC disclosures.
Keywords: SPAC, Narrative Economics, Mergers & Acquisitions, Transactions
JEL Classification: G32, G34
Suggested Citation: Suggested Citation