Pre-IPO Cash Flow Volatility and Aftermarket Valuation

Abstract

This paper studies the impact that pre-IPO cash flow volatility has on the initial and long-term value of a publicly traded firm. From the perspective of corporate risk management theory, higher cash flow volatility should reduce value in the form of higher borrowing costs, reduced investment, and lower firm value. However, if going public moderates these effects, then firms with high pre-IPO cash flow volatility should stand to benefit more in going public since it reduces their cost of capital and ensures future investment. I find that firms with higher levels of pre-IPO cash flow volatility are associated with higher post-IPO valuations. Likewise, I find that these types of firms experience greater underpricing due to the uncertainty aspect of their cash flows. These findings confirm that prior cash flow levels serve as a measure of uncertainty. Overall, this paper provides support for the access-to-capital hypothesis, which suggest firms go public to obtain capital to fund future investment and increase firm value.