The fewer numbers of companies going public in recent years has raised many questions regarding the IPO process, in both academic and regulatory circles. As we all strive to understand these changes in the market, it is especially important to understand the dynamics behind the decision to go public. If the process of going public is too costly, if the process is unable to bridge the information gap between insiders and potential, or if the IPO mechanism is plagued by too many conflicts of interest among the various intermediaries, then private companies may rationally choose other methods of raising capital. In our paper, we review existing evidence related to these issues, highlight several debates within the literature, and suggest directions for future research.
One continuing debate in the literature concerns whether firms go public primarily to raise money for future investment or for other reasons such as market timing, ie, because they expect the market to value them higher than their ‘true’ value. Existing evidence suggests that both play a role, but there is no consensus regarding the relative importance of each. Importantly, a more in-depth understanding of such issues can potentially help us understand the dynamics behind the downturn in IPOs over the past 15 years. If raising money for future investment has traditionally been one of the drivers of IPOs, then the decreased number of IPOs raises the question of whether private companies are increasingly obtaining capital from other sources. Evidence suggests that this is the case. For example, an increasing number of companies are choosing to be acquired rather than to go public through an initial public offering, potentially due to increasing barriers to entry and diseconomies of scale for small standalone firms. At the same time, private firms are also increasingly raising money from entities such as mutual funds. Costs related to regulatory requirements and challenges for small firms to compete in today’s rapidly evolving global economy can both discourage companies from going public and encourage them to pursue these other avenues instead.
A second debate within the literature relates to the mechanism of going public and the effects of intermediaries. While bookbuilding with discretionary allocation of shares at the IPO represents the dominant mechanism of going public around the world, it is less clear that this mechanism is preferable to alternatives that may include an auction component. The fact that underwriters control both price and allocations in bookbuilding IPOs means that agency costs and conflicts of interest can have substantial negative impacts on the firms going public. Empirical evidence provides strong evidence regarding the ways in which agency costs within underwriter banks lead to suboptimal outcomes for the firms going public.
A third area of debate relates to the optimal governance structure of firms going public. IPO firms are increasingly likely to have classified boards, and a number of the recent high-profile IPOs (eg, Facebook, Alibaba, Snap, and more) have dual class share structures. Such structures enable greater decision making control by the management, who are often the original founders. While both academics and activists increasingly argue that such structures facilitate agency costs within mature firms, a growing body of literature suggests that the governance demands of newly public firms are unique, due, for example, to their high information asymmetry and to the relative inexperience of management. Governance structures designed to facilitate monitoring in mature firms can provide fewer advantages to newly public firms. Newly public firms are more likely to benefit from governance structures that facilitate advising to inexperienced management and that provide continuity to these high growth, high information asymmetry companies. It is imperative that new regulations not be based on research focusing solely on large, more mature firms.
To facilitate discussion on all of these issues, we provide an empirical overview of the key aspects of the IPO process over the past 45 years, ie, 1970–2015. In addition, we also provide a detailed discussion of the institutional details surrounding the IPO process, which are key to understanding this market.
Michelle Lowry is the TD Bank Endowed Professor in LeBow College of Business at Drexel University.
Roni Michaely the Rudd Family Professor of Management and Finance at Johnson@Cornell Tech, Cornell University.
Ekaterina Volkova is a PhD student at Samuel Curtis Johnson Graduate School of Management, Cornell University.