Special Purpose Acquisition Company (SPAC) IPO volumes have surged in recent years (Figure 1). In 2020-2021, SPAC’s IPO volume reached more than $200 billion. Merging with a SPAC has become an important mechanism for private companies to go public. Since 2010, 417 SPACs have merged or announced a merger with private firms. These mergers created public firms with an aggregate pre-money valuation of $743 billion. At the end of 2021, 534 SPACs were still searching for a target. If all of them merge, the aggregate pre-money valuation is expected to be another $950 billion.
This exponential growth in SPAC IPO volume and mergers has not escaped the attention of financial regulators. The question is, what are the risks to investors in investing in SPACs, and what regulation, if any, is needed to protect investors? We argue that a conflict of interest exists when SPAC directors sit on multiple SPAC boards. This conflict of interest generates a significant cost to retail investors and results in an inefficient matching between SPACs and target companies. Financial regulators should reexamine the costs and benefits of allowing a SPAC director to sit on more than one board to provide stronger legal protection to investors and improve mergers’ efficiency.
SPAC directors play a critical role in a SPAC’s success. The primary function of a SPAC’s director is to find a private company to merge with within two years from the IPO date. If a SPAC does not find a target, it liquidates, and the directors’ shares are worth nothing. For successful mergers, directors receive $1.3M on average.
About 50% of SPAC target companies are unicorns (private companies with above $1B in valuation). Thus, SPAC directors are better described as unicorn hunters than directors of a traditional company. In many cases, the same director hunts for unicorns for multiple SPACs simultaneously. SPACs are thus connected through the common board members. To empirically study the SPAC’s corporate board network, we collect the identities of each SPAC’s directors by web-scraping SEC filings 424-B4 and 424-B3 for all SPACs that IPOed from 2010 to 2021. We further collect the director’s biographical information, past work experience, and educational background to control for heterogeneity at the director level. Using the SPAC-director level panel data, we construct a corporate board network (see Figure 2). Each node in this network is a SPAC. A link between two SPACs means that they share a common director. This network helps us to study the conflict of interest between SPAC investors and directors.
We run a panel regression with fixed effects at the quarter level to study the effect of the director’s conflict of interest on the SPAC’s performance. A conflict of interest exists when directors sit on the board of more than one SPAC. Sitting on the board of two SPACs, a conflicted director might inefficiently allocate a prospective target to the younger SPAC even though the older SPAC faces a higher liquidation risk. With limited time left, the older SPAC can be forced to merge with a lower-quality target. Our panel-data regression result shows that the older SPAC’s investors react negatively to the misallocations caused by conflicted directors.
Specifically, we document that more investors redeem shares when connected SPACs IPO after and merge earlier than the current SPAC. When such a situation emerges, investors who do not redeem their shares and hold them until the merger is completed, suffer significant losses. Quantitively, the older SPAC’s redemption rate increases by 6.09 percentage points (13.14% of the sample mean), and post-merger return decreases by 12.42 percentage points (67.87% of the sample mean) when there is a one standard deviation increase in the number of younger SPACs that found targets before the older SPAC. These results only hold when the two SPACs are connected through common directors. In addition, investors have no significant negative reaction when connected directors allocate targets to SPACs according to the order of their IPOs. These two facts provide strong evidence that investors react negatively only when conflicted directors allocate targets inefficiently.
Next, we show that a conflicted director’s “skin in the game” plays an essential role in allocating targets. SPAC directors are compensated with founder shares from SPAC sponsors. We complement our analysis by collecting data on the number of shares each conflicted director receives from both the new SPAC and the existing SPAC. We then directly model the director’s choice in allocating targets and compare it to the optimal allocation in which a target is allocated to the older SPAC because it has less time until liquidation. Our logistic regression results show that a conflicted director is more likely to assign a target to the younger SPAC if she holds more shares in it. In contrast, such misallocation is less likely if the older SPAC pays more shares to the director. In addition, the relative liquidation risk of the two SPACs can also bias the director’s decision. The higher the relative liquidation risk of the older SPAC, the less willing the director is to misallocate a target to the younger SPAC. This result provides evidence that directors are not acting in the best interest of the shareholders and put their own interests ahead of the interests of the investors.
Last, we build a theoretical model to study how SPACs compete for directors’ loyalty. Our model generates several empirical predictions that we test using network-level data where each observation is represented by a triplet of two SPACs and a director who connects them. The model predicts that younger SPACs strategically compensate directors sitting on the boards of other SPACs to compete with the older SPAC and endogenously create the conflict of interest problem. A new SPAC faces a trade-off. The more shares it provides to a director of the existing SPAC, the higher the probability that the director will prefer to give the target to the new SPAC despite the higher liquidation risk of the existing SPAC. On the other side, the more shares are allocated to the director, the fewer shares are left to the new SPAC’s sponsors. The competition becomes too costly if the existing SPAC already aggressively compensates the director, or when it faces a much higher liquidation risk. Empirically, we use a triple-interaction regression and show evidence supporting our model’s predictions. Specifically, we find that when a new SPAC tries to “steal” the future target (competition mode), its compensation is highly sensitive to changes in the existing SPAC, especially when the existing SPAC faces a higher liquidation risk than the new one. In contrast, the sensitivity is much lower and not related to the relative liquidation risk when the new SPAC chooses to wait for a target until the existing SPAC merges or liquidates (waiting mode). Quantitatively, in the competition mode (80% of cases), the new SPAC pays the director 1.71 shares for each share she receives from the existing SPAC, given an average relative liquidation risk (90 days difference, meaning that the existing SPAC is 90 days closer to the liquidation date than the new SPAC). If we look at a one-standard-deviation-above-average relative liquidation risk (90+169=259 days), then the new SPAC needs to pay 4.55 shares for each share the director receives from the existing SPAC to compensate for her loss from the existing SPAC’s liquidation. In the waiting mode (20% of cases), we find that the new SPAC pays only 0.5 shares for each share the existing SPAC pays, and this relationship does not depend on the liquidation risk. Figure 3 plots the sensitivity of the new SPAC’s compensation to the existing SPAC, holding the two SPACs’ relative liquidation risk at different levels. The red line shows that in the competition mode, the sensitivity increases with the relative liquidation risk for new SPACs. The blue line shows that in the waiting mode, the sensitivity stays constant at 0.5.
Overall, we show that investors redeem more shares when the SPAC has conflicted directors who allocated better targets to competitor SPACs. Directors are more likely to do it when the competitor SPAC compensates them better. Younger SPACs compensate some directors better than older SPACs to generate a conflict of interest while compensating the remaining directors poorly because it is too expensive to compete and better to wait until after the older SPAC finds a target.
These results have an important policy implication. Regulators should reconsider allowing board members to sit concurrently on multiple SPACs’ boards. Board connections between SPACs hurt unsophisticated investors who do not redeem their shares on time. With a lack of market discipline, conflicted directors act in their own interests which can result in an inefficient matching between SPACs and target firms.
SPACs are unique because they usually do not introduce any synergy from the merger. Therefore, the competition between them is more severe, and as such, the conflict of interest is especially strong. In the same way that it would be unreasonable for a general partner of a late-stage venture capital firm to be also a general partner in another late-stage VC firm, it is unreasonable for SPAC directors to serve simultaneously on two or more SPAC boards.
Michael Gofman is a Senior Lecturer at the Hebrew University Business School in Jerusalem.
Yuchi Yao is a PhD candidate at Simon Business School, University of Rochester.
This post is adapted from their paper, “SPACs’ Directors Network: Conflicts of Interest, Compensation, and Competition,” available on SSRN.
The views expressed in this post are those of the author and do not represent the views of the Global Financial Markets Center or Duke Law.