why do firms go public? - Marriott School

More documents

Recommendations

Info

minimize the weighted average cost of capital (WACC). In a discounted cash flow context, minimizing the WACC, ceteris paribus, maximizes the value of the firm. The crucial development of a theoretical optimal capital structure begins the debate on whether, and why, managers issue public equity. The early capital structure literature (e.g., Kraus and Litzenberger (1973) and Kim (1978)) offers the trade-off hypothesis that financial managers will issue equity when it will minimize their WACC, thus maximizing the value of the firm. Williamson (1988) extends this literature arguing that sometimes external equity is the cheapest option for financing certain assets. The WACC argument offers the hypothesis that managers issue public equity (i.e., go public) when the influx of IPO proceeds will decrease the overall company cost of capital, thereby maximizing firm value. The difficulty in testing this hypothesis directly is that the WACC is typically an internal measure computed within firms. Most firms have their own in-house method for computing the WACC. Although, Graham and Harvey (2001) find that 73.5% of the CFOs they survey use the capital asset pricing model (CAPM) to estimate the cost of equity, we do not know what these firms use for their inputs. Over how long of a period do they estimate beta for the CAPM What do they use for their risk-free rate Where do they get their market risk premium estimate Although data availability of firm WACC inhibits direct tests of the optimal cost of capital hypothesis, researchers have been able to test if the cost of debt has declined via an IPO. Because a decrease in the cost of debt does not necessarily indicate a decrease in firm-level WACC, the next section does not explicitly test the WACC hypothesis. Although the survey approach to research is discussed towards the end of this paper, it is possible to test the WACC question by asking IPO participants directly. Analysis of this hypothesis (and all of the others) will be included in the survey section. 5
To overcome borrowing constraints/Increase bargaining power with banks Pagano et al. (1998) argue that gaining access to a source of finance other than banks or venture capital “is probably the most cited benefit of going public, which is explicitly or implicitly present in most models” (pg. 38). Citing Basile (1988), Pagano et al. (1998) argue that access to public equity markets may reduce the cost of credit. Pagano et al. (1998) then argue that increased bargaining power can also help firms lower their cost of debt (Rajan (1992)). In turn, firms can increase their bargaining power by gaining access to public equity markets and increasing firm transparency with investors. To test the borrowing constraint hypothesis, Pagano et al. (1998) argue that firms with large current investments (PPE capital expenditure, CAPEX), future investments (industry market-to-book), high leverage (lagged value of total debt plus equity), and high growth (rate of sales growth) should be positively related to conducting an IPO. Pagano et al. (1998) Table III (pg. 44) reports that growth and industry market-to-book are both positively related to the probability of conducting an IPO for their overall sample, as predicted. CAPEX and leverage are not significantly related to the choice of IPO. Examining independent IPOs, CAPEX, growth, and industry market-to-book are all significantly related to going public. Here, the increase in new investment is consistent with the model of Chemmanur and Fulghieri (1999). For carve-outs, only industry market-to-book is significantly related to going public. Data from after the IPO (i.e., ex post data) allow for two additional predictions to test the borrowing constraint hypothesis in Pagano et al. (1998). First, new IPO firms should increase their investment or reduce debt. Second, new IPO firms should not increase their payout ratio. Their Table IV (pg. 48) shows mixed evidence for these two predictions. Post-IPO investment for independent firms actually decreases and is persistent. On the other hand, carve-outs show a short- 6
Page 1 and 2: WHY DO FIRMS GO PUBLIC Forthcoming
Page 3 and 4: data. When dealing with the topic o
Page 5: I have found through surveys of, an
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

why do firms go public? - Marriott School

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?