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The Stock Market as a Screening Device and the Decision to Go Public

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Author Info

  • Ellingsen, Tore

    ()
    (Department of Economics)

  • Rydqvist, Kristian

    (Norwegian School of Management)

Abstract

We argue that many firms become publicly traded on a stock exchange as the first stage of a longer term divestment plan. Making a direct sale of unlisted stock may be associated with great adverse selection costs. The publicly listed stock price reduces adverse selection by aggregating the information of several investors, and this market valuation, rather than the cash infusion, could be the main benefit of an initial public offering. This theory provides a unified treatment of a whole range of empirical observations, in particular why initial owners frequently exit completely subsequent to an initial public offering (IPO) and why the number of stock market introductions increases with the stock price level. The model also reformulates the ”sweet taste” explanation of IPO underpricing in a way which is consistent with recent evidence. Finally, we argue that the number of firms which go public is inefficiently large.

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Bibliographic Info

Paper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 174.

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Length: 30 pages
Date of creation: May 1997
Date of revision:
Handle: RePEc:hhs:hastef:0174

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Related research

Keywords: IPOs; going public; seasoned offers; underpricing; adverse selection;

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References

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  1. Allen, Franklin & Faulhaber, Gerald R., 1989. "Signalling by underpricing in the IPO market," Journal of Financial Economics, Elsevier, Elsevier, vol. 23(2), pages 303-323, August.
  2. Ellingsen, Tore, 1997. "Price signals quality: The case of perfectly inelastic demand," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 16(1), pages 43-61, November.
  3. Michaely, Roni & Shaw, Wayne H, 1994. "The Pricing of Initial Public Offerings: Tests of Adverse-Selection and Signaling Theories," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 7(2), pages 279-319.
  4. Welch, Ivo, 1989. " Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings," Journal of Finance, American Finance Association, American Finance Association, vol. 44(2), pages 421-49, June.
  5. Noldeke, Georg & van Damme, Eric, 1990. "Signalling in a Dynamic Labour Market," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(1), pages 1-23, January.
  6. Marco Pagano & Ailsa Röell, 1998. "The Choice Of Stock Ownership Structure: Agency Costs, Monitoring, And The Decision To Go Public," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 113(1), pages 187-225, February.
  7. Mailath George J. & Okuno-Fujiwara Masahiro & Postlewaite Andrew, 1993. "Belief-Based Refinements in Signalling Games," Journal of Economic Theory, Elsevier, Elsevier, vol. 60(2), pages 241-276, August.
  8. Chemmanur, Thomas J, 1993. " The Pricing of Initial Public Offerings: A Dynamic Model with Information Production," Journal of Finance, American Finance Association, American Finance Association, vol. 48(1), pages 285-304, March.
  9. Roell, Ailsa, 1996. "The decision to go public: An overview," European Economic Review, Elsevier, Elsevier, vol. 40(3-5), pages 1071-1081, April.
  10. Chemmanur, Thomas J & Fulghieri, Paolo, 1999. "A Theory of the Going-Public Decision," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 12(2), pages 249-79.
  11. Loughran, Tim & Ritter, Jay R. & Rydqvist, Kristian, 1995. "Initial public offerings: International insights," Pacific-Basin Finance Journal, Elsevier, Elsevier, vol. 3(1), pages 139-140, May.
  12. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, Elsevier, vol. 22(3), pages 477-498, June.
  13. Timothy F. Bresnahan & Paul Milgrom & Jonathan Paul, 1992. "The Real Output of the Stock Exchange," NBER Chapters, National Bureau of Economic Research, Inc, in: Output Measurement in the Service Sectors, pages 195-216 National Bureau of Economic Research, Inc.
  14. Smith, Clifford Jr., 1986. "Investment banking and the capital acquisition process," Journal of Financial Economics, Elsevier, Elsevier, vol. 15(1-2), pages 3-29.
  15. Stoll, Hans R, 1989. " Inferring the Components of the Bid-Ask Spread: Theory and Empirical Tests," Journal of Finance, American Finance Association, American Finance Association, vol. 44(1), pages 115-34, March.
  16. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1315-35, November.
  17. Burkart, Mike & Gromb, Denis & Panunzi, Fausto, 1997. "Large Shareholders, Monitoring, and the Value of the Firm," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 112(3), pages 693-728, August.
  18. Ritter, Jay R., 1987. "The costs of going public," Journal of Financial Economics, Elsevier, Elsevier, vol. 19(2), pages 269-281, December.
  19. Lucas, Deborah J & McDonald, Robert L, 1990. " Equity Issues and Stock Price Dynamics," Journal of Finance, American Finance Association, American Finance Association, vol. 45(4), pages 1019-43, September.
  20. Zingales, Luigi, 1995. "Insider Ownership and the Decision to Go Public," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 62(3), pages 425-48, July.
  21. Jegadeesh, Narasimhan & Weinstein, Mark & Welch, Ivo, 1993. "An empirical investigation of IPO returns and subsequent equity offerings," Journal of Financial Economics, Elsevier, Elsevier, vol. 34(2), pages 153-175, October.
  22. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 101(4), pages 678-709, August.
  23. Grinblatt, Mark & Hwang, Chuan Yang, 1989. " Signalling and the Pricing of New Issues," Journal of Finance, American Finance Association, American Finance Association, vol. 44(2), pages 393-420, June.
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Citations

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Cited by:
  1. Damiano Bonardo & Stefano Paleari & Silvio Vismara, 2010. "The M&A dynamics of European science-based entrepreneurial firms," The Journal of Technology Transfer, Springer, Springer, vol. 35(1), pages 141-180, February.
  2. Reuer, Jeffrey J. & Shen, Jung-Chin, 2004. "Sequential divestiture through initial public offerings," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 54(2), pages 249-266, June.
  3. Thierry Foucault & Christine a Parlour, . "Competition for Listings," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 2000-E11, Carnegie Mellon University, Tepper School of Business.
  4. Ehrhardt, Olaf & Lahr, Henry, 2008. "Uncertain private benefits and the decision to go public," CEFS Working Paper Series 2008-02, Center for Entrepreneurial and Financial Studies (CEFS), Technische Universität München.
  5. Thorsten V. Braun & Sebastian Krispin & Erik E. Lehmann, 2009. "Entrepreneurial Human Capital, Complementary Assets, and Takeover Probability," Discussion Paper Series, Universitaet Augsburg, Institute for Economics 307, Universitaet Augsburg, Institute for Economics.
  6. Mantecon, Tomas, 2008. "An analysis of the implications of uncertainty and agency problems on the wealth effects to acquirers of private firms," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(5), pages 892-905, May.
  7. Johann Burgstaller, 2009. "When and why do Austrian companies issue shares?," Empirica, Springer, Springer, vol. 36(3), pages 229-244, August.
  8. Tomáš Meluzín & Marek Zinecker, 2009. "Analyses of Partial Decision Models for IPO Realization," Ekonomika a Management, University of Economics, Prague, University of Economics, Prague, vol. 2009(2).
  9. Wagner, W.B., 2002. "Divestment, Entrepreneurial Incentives and the Decision to go Public," Discussion Paper, Tilburg University, Center for Economic Research 2002-47, Tilburg University, Center for Economic Research.
  10. Tomas Mantecon & Paul Thistle, 2011. "The IPO market as a screening device and the going public decision: evidence from acquisitions of privately and publicly held firms," Review of Quantitative Finance and Accounting, Springer, Springer, vol. 37(3), pages 325-361, October.

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