HKUST Business Review

THE REAL COST OF SPACS n 2021, Special Purpose Acquisition Companies, or SPACs, raised US$162.5 billion. Endorsed by celebrities as wide- ranging as Shaquille O’Neal, Jay-Z, and Paul Ryan, SPACs were touted as a faster, more efficient way for innovative private companies to enter public markets—yet the data has shown that the majority of SPACs have in fact lost money. What can regulators do to ensure that investors and economies actually capture the potential of this new business structure? To answer this question, it is critical first to understand what a SPAC is and how it operates. At a high level, a SPAC is a type of shell company that raises money through an IPO with the intention of acquiring a privately held company. Investors are allowed to sell their shares back to the SPAC at any time if they don’t like a proposed acquisition, and shares typically come with warrants that give investors the right to buy future shares at a fixed price. It seems like a great deal for investors: All the upside of investing in a promising new company, with redemption rights that let them recoup their losses at any time. Nevertheless, a recent study found that while investors who cashed out before a SPAC merger earned annualized returns of nearly 24%, those who held their shares for at least a year post-merger suffered an average loss of over 11%. Another study found that for every US$10 of cash raised, the median SPAC held only US$6.67 by the time it merged with a target company. Common explanations for this persistent underperformance fall short. Some analysts have blamed SPACs’ lighter disclosure rules, but rational investors would simply demand a steeper discount for that increased risk, rather than accepting negative returns. Others have suggested that the SPAC structure is meant to reward long- term believers over shorter-term players, yet the data shows these are the very investors who lose out. In reality, my recent research suggests that this effect is largely driven by investor psychology. The unique structure of SPACs, which allows investors to redeem their shares at a future date, may EQUITY FINANCING Martin SZYDLOWSKI Authored by Most Special Purpose Acquisition Companies (SPACs) have failed to meet investors’ expectations. How can regulators address the risks while capturing the potential upside of this novel market structure? 34 HKUST Business Review Insight