In the End, Only Retail Investors Got Burned... They Trusted 'Earnings,' but Stakeholders Joined Forces to Inflate 'Valuations' [Inflated KOSDAQ Listings] 3

The higher the offering price, the more lead underwriters, VCs and issuers profit
Offering prices set by inflating revenue and earnings to the maximum
Risk of post-listing share price declines shifted to ordinary investors

Behind inflated KOSDAQ listings is an ecosystem in which the key stakeholders driving an IPO can profit only by pushing the offering price as high as possible. Securities firms acting as lead underwriters, venture capital firms participating as financial investors (FIs), and issuers raising funds through the listing all have strong incentives to inflate corporate valuations, while the resulting losses are borne entirely by retail investors.

The structural acquiescence of lead underwriters, who should serve as gatekeepers, is considered a major cause of listing bubbles. In South Korea, IPO underwriting fees are generally success-based: underwriters receive a set percentage of the total offering proceeds only if the listing succeeds. For small and midsize companies listed on KOSDAQ, the rate is typically 3% to 5%.

Amid fierce competition to win underwriting mandates, securities firms find it difficult to reject the rosy earnings projections issuers present based on the discounted cash flow (DCF) method. Their earnings also rise as the offering size increases. Regulators sought to reduce incentives for excessive valuations by allowing lead underwriters to receive a "retainer fee" covering actual expenses even if a listing falls through. But the discussions effectively fizzled out amid industry opposition and questions about the measure's effectiveness.

The put option, or put-back option, introduced to protect investors, is also failing to serve its intended purpose. Rather than use the Tesla track, a special listing route for companies that have yet to turn a profit and which requires underwriters to buy back shares at 90% of the offering price if the stock plunges after listing, underwriters are using the technology-based special listing system as a workaround because it carries no put-back option requirement.

Even when a put-back option is granted, securities firms do not actively inform investors about it, leaving the rate at which retail investors actually exercise the right exceptionally low. According to the Korea Financial Investment Association, retail investors exercise put-back options in only about 16.3% of cases.

Pressure from venture capital firms to exit their pre-listing investments is another factor driving up valuations. FIs that invested at high valuations during the pre-IPO stage sometimes repeatedly urge issuers to inflate their valuations so they can recover their principal and maximize returns.

Moreover, the high valuations VC firms assign to companies in the over-the-counter market can serve as an "anchoring effect" when the offering price is set, providing grounds for raising the benchmark. This also aligns with the interests of lead underwriters seeking fee revenue. The calculation is that, if the offering price is set high, investors who came in during the pre-IPO stage can exit at a higher price even if the stock falls after listing.

Moral hazard on the part of issuers is another driver of inflated listings. Issuers, particularly their largest shareholders, can raise substantial funds while minimizing the dilution of their stakes if the offering price is set high. Some issuers are therefore exploiting the technology-based special listing system, which allows companies to enter the stock market on the strength of their future growth potential even if they are not yet profitable.

One recently listed issuer using the technology-based special listing route presented earnings projections based on the optimistic assumption that growth in its end market and rising customer demand would translate directly into profits. The projections ignored execution risks that would require internal capabilities, such as securing product competitiveness and expanding production facilities. In effect, it presented opaque projections based on the idea of "getting listed first and figuring out the rest later."

In addition to inflating earnings projections, issuers frequently resort to selecting companies of vastly different scales as peers to boost valuation multiples such as the price-to-earnings ratio (PER).

In the case of FADU, which became embroiled in a prominent controversy over an inflated listing, the company selected global top-tier semiconductor companies such as Broadcom and Microchip as peers, despite having recorded a large net loss in the year before its listing. At the time, the peer companies' average total assets and revenue were about 621 times and 323 times greater than FADU's, respectively. Nevertheless, FADU applied the peers' average PER to set its offering price, thereby assigning itself a high valuation.

"South Korea's IPO market has repeatedly seen overheated subscription demand driven by short-term profit seeking, followed by concentrated selling after listings, raising questions about the fairness of offering prices and trust in the market," said Park Sangyeon, a researcher at the Korea Capital Market Institute. "This is seen as an obstacle to building trust in the IPO market and fostering an investment culture focused on long-term corporate value."

This content was produced with the assistance of AI translation services.