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Why do companies go public?

Why do companies go public?. Motivation: 1. Why do some large firms stay private? IPO seems to be a choice, not a necessary stage! 2. US data can not test it, but Italy can! Results:

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Why do companies go public?

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  1. Why do companies go public? • Motivation: 1. Why do some large firms stay private? IPO seems to be a choice, not a necessary stage! 2. US data can not test it, but Italy can! • Results: • Industry M/B and sales, followed by growth rate and profitability have strongest positive effect on the likelihood of going public. • Investment, leverage, profitability, interest rate, and credit concentration tend to decrease after listing. • Independent firms are more likely to go public after high sales, high industry M/B, high profitability, high growth and high investment, and to reduce their leverage, investment, profitability, interest rate, and credit concentration after IPO. • Carve-outs are more likely to go public after high industry M/B and high profitability only, and to reduce their profitability after IPO. • Controlling shareholders of independent firms do not divest significantly after IPO but carve-outs do. But in both cases controlling shareholders experience abnormal turnovers in three years after IPO.

  2. Why do companies go public? • Conclusions: • Evidence is inconsistent with high growth opportunity hypothesis. Firms do not go public to finance future investment and growth. • Independent firms go public to rebalance their balance sheet accounts and capital structure after high growth and investment. Carve-outs choose best listing time to maximize proceeds. Carve-outs are driven by financial rather than real factors. • Evidence on bank credit suggests stronger bargaining power and increased information for borrowers after IPO. • Evidence on changes in ownership of controlling group does not support the portfolio diversification hypothesis. • Evidence on reallocation of control suggests IPO as a stage in the eventual sale of a company.

  3. Why do companies go public? • Data: • All firms must satisfy the minimum listing requirements, which may change during sampling period. Once listed, the firm is taken out of sample. • For carve-outs, the fixed flotation cost may be born (sunk cost) by their parent firms, ie, no economies of scale. Besides before carve-outs, they may have access to bank credit through their parent firms. Therefore they must be separately considered. • After screening, only 40 independent firms and 29 carve-outs get listed during 1982 and 1992. • Table 1 reports summary statistics. Compared to firms eligible to go public but did not, IPO firms appear to be larger, older, more leveraged, have lower loan rate, have higher investment, borrow from more banks, and rely more on external financing . • Why are IPO firms in Italy or other Continental European countries much larger and older than US firms? • high agency cost due to lack of enforcement of minority property rights • implicit fixed cost of a higher visibility to the tax and legal authorities • absence of VC or liquid stock market dedicated to small cap firms

  4. Why do companies go public? • Methodology: probit model Pr(IPOi,t=1) = F(α1SIZEi,t-1 + α2CAPEXi,t-1 + α3GROWTHi,t + α4ROAi,t-1 + α5LEVERAGEi,t-1 + α6MTBi,t + α7RCCi,t-1 + α8HERFINDAHLi,t-1 + ∑γtYEARt) F(z) is the standard normal cumulative distribution function (cdf), F(z) →0 as z → -∞, F(z) →1 as z →+∞ and is non-linear, F(z) = ∫-∞zφ(v) dv where φ(z) is the standard normal density, φ(z) = (2π)-0.5exp(-z2/2) The partial effect of SIZE on the probability of IPO is obtained from partial derivative: ∂F(z)/∂SIZE = α1[dF(z)/dz] where dF(z)/dz = φ(z) 1. F is the cdf of a continuous random variable, φ is a probability density function. F is a strictly increasing cdf, and so φ(z)>0 for all z. Therefore the partial effect always has the same sign as α1 2. However g(z) depends on the level of each variable! So there is no easy answer for the scale of any partial effect! So p. 43 is incorrect! 3. But relative partial effect is certain. The ratio of the partial effects for SIZE and ROA is α1/α4 4. The largest partial effect of SIZE occurs when z=0. When z=o, φ(z) reaches the maximum = (2π)-0.5 = 0.4 or so.

  5. Why do companies go public? • Tax law makes IPO easier in year 1984 through 1986. Expect the coefficients of these three year dummies to be positive. • Some unobservable firm-specific effect may be correlated with regressors. For example, entrepreneurs of traditional business are likely to resist IPO for the cultural bias and these firms are more likely to have low M/B. Therefore also estimate the linear probability model with firm-specific effects. • Why report standard error for each coefficient? • Why is the SIZE insignificant for carve-outs? • Fixed flotation cost is partly sunk for subsidiaries • Size may proxy reputation

  6. Why do companies go public? • Yit = α + ∑j=03βjIPOi,t-j + β4IPOi,t-n + ∑j=03γjQUOTi,t-j + ui + dt + eit ui is firm-specific effect and dt iscalendar year specific effect. • Include QUOT to capture the effect of meeting the listing requirement. This will correct the sample selection bias: more profitable firms will be qualified for listing. • To deal with the endogenous selection bias: firms that went public have chosen to do so, should run the two-stage regression. Should first estimate equation 1 and then include this estimated probability of listing into equation 2. • Also include lagged values of dependent variable and other lagged dependent variables into equation 2. • What are the meanings of β0 throughβ4?

  7. Why do companies go public? • Why do ROA declines after IPO? • Statistical coincidence - mean reversion: so include the first lag of ROA and ROA in the year before IPO into the equation 2 but results remain the same • Window dressing: public firms tend to inflate asset and profit but private firms tend to deflate asset and profit. High inflation rate in Italy makes government encourage firms to step up the book value of asset. • Cash raised in IPO is temporarily invested in interest earning financial assets • Moral hazard and adverse selection: change of the incumbent’s stake at IPO is positively related to change in post IPO ROA • Time the IPO

  8. Why do companies go public? • Why do bank credit interest rate falls after IPO? • Improvement in credit quality: leverage reduced and firms become safer. So include ROA, Leverage, and Size to control for risk. Results remain the same! • More information about borrowers • More outside financing options to weaken bank bargaining power • Initial owners divest very little of their holdings. This is true even if we factor in how much the new equity raised at IPO or in subsequent years was purchased by initial owners. • In 40.6% of cases, control group does not sell its equity and demands new funds from outside investors. In another 40.6% of cases, control group divests and does not raise new equity. • In the three years after the IPO, control group sells out the controlling stake to an outsider in 13.6% of cases. This may be due to (1) ease of transferring control of a public firm, (2) bad post IPO performance , or (3) IPO as a step for controlling group to sell the firm eventually.

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