why do firms go public? - Marriott School

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is to fund growth does not really answer the question of why the entrepreneurs chose an IPO to fund that growth. Why didn’t management choose to issue debt, presumably a cheaper source of financing than external equity Surely cash from debt can buy assets as well as cash from equity. Or, why didn’t the entrepreneurs choose to solicit private equity investment to fund its growth Had the firm already tapped out venture capital (VC) money Was the firm conducting an IPO according to an optimal capital structure theory or a pecking order of financing theory (both discussed below) It soon becomes apparent that when trying to ascertain the motives of issuing entrepreneurs, we must peel back several layers of the onion. In many cases, researchers studying the IPO hot market phenomenon (a.k.a. IPO waves of Ibbotson and Jaffe (1975) and Ritter (1984)) discuss motives for going public as determinants of waves. For example, Lowry and Schwert (2002), studying IPO market cycles, conclude that more firms go public after periods of high underpricing because positive information has been revealed through the previous IPOs; and, subsequent IPOs can raise more money than they had previously thought. Although a solid job of documenting the relationship between initial returns and IPO volume, this explanation for IPO clustering falls short of addressing the motives of insiders on why they are considering an IPO in the first place. Have they run out of cheaper debt financing Do their VCs want to cash out Do they think the high underpricing is a signal that the market is overvalued and they have a window of opportunity to exploit Does the founder want to buy a yacht The same questions can be raised for virtually all of the hot market empirical papers (as in this example of Lowry and Schwert (2002)) and the theoretical hot market papers, such as Pastor and Veronesi (2005) who find that insiders tend to go public after observing improving market conditions. Thus, the timing of IPOs and the motives of IPOs, though related, are separate questions. 3
I have found through surveys of, and interviews with CFOs, that questions must be carefully crafted to pinpoint the sometimes fine differences in academic theory. To help the reader identify these differences among theories, below, I detail the leading theories on why firms go public. Each of the theories begins with a bold heading. Within each heading, I discuss the intuition behind each theory, several leading studies in that thread of the literature, and the extant non-survey empirical evidence pertaining to that specific hypothesis. I choose this structure because most of the finance literature focuses on one explanation and then primarily tests that specific explanation. A notable exception is Pagano, Panetta, and Zingales (1998) who are able to test eight of the hypotheses in one paper (see their Table II, pg. 37) by using a sample of Italian IPOs. Specifically, Pagano et al. (1998) study 2,181 firms from 1982-1992, of which, 69 are IPOs (40 new listings and 29 carve-outs). The findings of Pagano et al. (1998) are therefore sprinkled through the 12 groups of theories that follow. Minimize cost of capital/Optimal capital structure Perhaps the earliest literature to address why firms go public (at least indirectly) begins with the seminal capital structure literature of Modigliani and Miller (M&M 1958, 1963). M&M’s famous Proposition I states that “[t]he market value of any firm is independent of its capital structure …” (M&M 1958, p. 268). When corporate taxes are introduced, the tax shield of debt results in an optimal capital structure of 100% debt (M&M 1963). M&M lay the ground work for the theory of optimal capital structure in their 1958 and 1963 papers; but, it is the introduction of primarily bankruptcy costs that result in an optimal structure other than irrelevance or 100% debt. The work of Baxter (1967) and Stiglitz (1969) argues that if a firm obtains too much financing from debt, the increased bankruptcy (i.e., financial distress) costs begin to hurt the value of the firm. Thus, the introduction of bankruptcy costs results in an optimal mix of debt-to-equity to 4
Page 1 and 2: WHY DO FIRMS GO PUBLIC Forthcoming
Page 3: data. When dealing with the topic o
Page 7 and 8: To overcome borrowing constraints/I
Page 9 and 10: the firm is over-valued. Anticipati
Page 11 and 12: Professional private equity investo
Page 13 and 14: actually increase their ownership i
Page 15 and 16: To create public market so the firm
Page 17 and 18: good news release so they do not se
Page 19 and 20: The IPO hot issues/cycles phenomeno
Page 21 and 22: discussed above. As an example of t
Page 23 and 24: (Brau et al. (2004)) and a follow-o
Page 25 and 26: firms. Of the 392 firms that replie
Page 27 and 28: firms that indicate they plan to is
Page 29 and 30: [Insert Table 2 about here.] Table
Page 31 and 32: Because other chapters in this text
Page 33 and 34: REFERENCES Aggarwal, R., L. Krigman
Page 35 and 36: Brau, J. C., N. Sutton, and N. Hatc
Page 37 and 38: Lowry, M, and G. W. Schwert. 2002.
Page 39 and 40: Schultz, P. 2003. “Pseudo Market
Page 41 and 42: Panel F. Optimal Dispersion A benef
Page 43 and 44: Panel C. Withdrawn IPOs How importa
Page 45: Panel G. VC-Backing Very Not Import

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