Going private as a solution to public market confusion

Abstract

Information asymmetry exists between companies and investors in public equity markets. A public firm’s choice of long-term and continuous forms of investments, such as R&D, may be unique and complex, and often uncertain. Naturally, companies’ strategies that are incomprehensible or intolerable by investors in terms of risk levels and durations are generally penalized in the form of valuation discounts. Intermediaries, such as analysts, attempt to alleviate some level of information asymmetry, but their limitations may hamper companies’ efforts to radically innovate. Of note, investors’ expectations are often associated with the industry in which the firm operates. As such, deviations from optimal standards or institutional expectations about corporate investments may further aggravate the level of confusion about the company in the public equity market. The public markets’ lack of understanding of a firm’s strategy results in distraction by short-term oriented goals, and the forgoing of high quality/less- transparent investment opportunities to avoid valuation discounts. I argue that companies facing inefficiencies, such as lack of flexibility in financial resources, opt for an alternative form of financial governance, i.e., privatization. Through a parametric test of maximum likelihood model, I find empirical support from data on domestically listed companies in the US during 1997-2014 that show higher likelihood of privatization outcomes for those with higher industry-relative R&D investments, with mediation by public market confusion.