A Theory of the Going-Public Decision

Abstract

We address the question: At what stage in its life should a firm go public rather than undertake its projects using private equity financing? In our model a firm may raise external financing either by placing shares privately with a risk-averse venture capitalist or by selling shares in an IPO to numerous small investors. The entrepreneur has private information about his firm’s value, but outsiders can reduce this informational disadvantage by evaluating the firm at a cost. The equilibrium timing of the going-public decision is determined by the firm’s tradeoff between minimizing the duplication in information production by outsiders (unavoidable in the IPO market, but mitigated by a publicly observable share price) and avoiding the risk-premium demanded by venture capitalists. Testable implications are developed for the cross-sectional variations in the age of goingpublic across industries and countries. This article develops a model of the going-public decision of a firm and addresses the question, At what stage in its life should a firm go public rather than financing its projects through a private placement of equity (e.g., with a venture capitalist)? Beyond the fact that most firms start out as small private companies and at some point in their growth go public, we know relatively little about the trade-offs underlying a firm’s choice between remaining private or going public. Indeed, beyond a general idea that going public allows the firm’s shares to become more liquid, discussions of the goingpublic decision usually do not include a precise notion of the economic advantages or disadvantages of financing a firm’s projects by going public