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Market Liquidity, Investor Participation and Managerial Autonomy: Why Do Firms Go Private?

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  • Boot, Arnoud W A
  • Gopalan, Radhakrishnan
  • Thakor, Anjan

Abstract

We analyze a publicly-traded firm’s decision to stay public or go private when managerial autonomy from shareholder intervention affects the supply of productive inputs by management. We show that both the advantage and the disadvantage of public ownership relative to private ownership lie in the liquidity of public ownership. While the liquidity of public ownership lets shareholders trade easily and supply capital at a lower cost, the liquidity-engendered trading also results in stochastic shocks to a firm’s shareholder base. This exposes management to uncertainty regarding the identity of future shareholders and their extent of intervention in management decisions and in turn curtails managerial incentives. By contrast, because of its illiquidity, private ownership provides a stable shareholder base and improves these input provision incentives but results in a higher cost of capital. Thus, capital market liquidity, while being a principal advantage of public ownership, also has a surprising 'dark side' that discourages public ownership. Our model takes seriously a key difference between private and public equity markets in that, unlike the private market, the firm’s shareholder base, namely the extent of investor participation, is stochastic in the public market. This allows us to extract predictions about the effects of investor participation on the stock price level and volatility and on the public firm’s incentives to go private, thereby providing a link between investor participation and firm participation in public markets. Lesser investor participation induces lower and more volatile stock prices, encouraging public firms to go private, whereas greater investor participation encourages younger firms to go public. Moreover, IPO underpricing is optimal because it is shown to lead to a higher and less volatile post-IPO stock price, greater autonomy for the manager and a higher supply of privately-costly managerial inputs.

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  • Boot, Arnoud W A & Gopalan, Radhakrishnan & Thakor, Anjan, 2006. "Market Liquidity, Investor Participation and Managerial Autonomy: Why Do Firms Go Private?," CEPR Discussion Papers 5510, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:5510
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    Cited by:

    1. Thakor, Anjan V., 2012. "Incentives to innovate and financial crises," Journal of Financial Economics, Elsevier, vol. 103(1), pages 130-148.
    2. repec:ers:ijebaa:v:v:y:2017:i:4:p:104-132 is not listed on IDEAS
    3. Astudillo, Alfonso & Braun, Matías & Castañeda, Pablo, 2011. "The going public decision and the structure of equity markets," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1451-1470.
    4. Arnoud W.A. Boot & Matej Marinč, 2012. "Financial Innovations, Marketability and Stability in Banking," Chapters,in: Research Handbook on International Banking and Governance, chapter 22 Edward Elgar Publishing.
    5. Dicks, David & Fulghieri, Paolo, 2015. "Ambiguity, Disagreement, and Allocation of Control in Firms," CEPR Discussion Papers 10400, C.E.P.R. Discussion Papers.
    6. repec:spt:fininv:v:7:y:2018:i:3:f:7_3_3 is not listed on IDEAS
    7. Klein, Paul-Olivier & Weill, Laurent, 2016. "Why do companies issue sukuk?," Review of Financial Economics, Elsevier, vol. 31(C), pages 26-33.
    8. Stuart, Toby E. & Yim, Soojin, 2010. "Board interlocks and the propensity to be targeted in private equity transactions," Journal of Financial Economics, Elsevier, vol. 97(1), pages 174-189, July.
    9. Eric Van den Steen, 2011. "Overconfidence by Bayesian-Rational Agents," Management Science, INFORMS, vol. 57(5), pages 884-896, May.
    10. Helwege, Jean & Packer, Frank, 2009. "Private matters," Journal of Financial Intermediation, Elsevier, vol. 18(3), pages 362-383, July.
    11. Thakor, Anjan V., 2015. "Strategic information disclosure when there is fundamental disagreement," Journal of Financial Intermediation, Elsevier, vol. 24(2), pages 131-153.
    12. Acharya, Viral V. & Thakor, Anjan V., 2016. "The dark side of liquidity creation: Leverage and systemic risk," Journal of Financial Intermediation, Elsevier, vol. 28(C), pages 4-21.
    13. James Brau & J. Carpenter & Mauricio Rodriguez & C. Sirmans, 2013. "REIT Going Private Decisions," The Journal of Real Estate Finance and Economics, Springer, vol. 46(1), pages 24-43, January.
    14. Kamoto, Shinsuke, 2017. "Managerial innovation incentives, management buyouts, and shareholders' intolerance of failure," Journal of Corporate Finance, Elsevier, vol. 42(C), pages 55-74.
    15. Kevin Levillain & Blanche Segrestin, 2016. "Entrepreneur’s Wealth vs. Firm’s Welfare: Exploring an “evergreen” governance for firm succession," Post-Print hal-01292956, HAL.

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    Keywords

    corporate finance;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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