WHY DO FIRMS GO PUBLIC?

Forthcoming in the Oxford Handbook of Entrepreneurial Finance

James C. Brau, PhD, CFA Professor of Finance Editor, Journal of Entrepreneurial Finance

July 1, 2010

Department of Finance Marriott School Brigham Young University 640 Tanner Building Provo, Utah 84602 Phone: 801.318.7919 Fax: 801.422.0741

WHY DO FIRMS GO PUBLIC?

Six months after he founded Netscape, Clark agitated for the company to go public. The company had few revenues, no profits, and a lot of new employees. No one else inside the company thought it should do anything but keep its head down and try to become a viable enterprise. "Jim was pressing for us to go public way before anyone else," recalls Marc Andreessen. It turned out there was a reason for this. He'd seen a boat called Juliet. He wanted one just like it, only bigger. To get it, he needed more money. By then the decision was not Clark's alone to make. The company had hired a big-name CEO, Jim Barksdale, and had a proper board of directors. Barksdale didn't want to go public. He thought the company had enough problems trying to figure out how to turn a profit without having to explain itself to irate shareholders. But this time Clark had power, through his equity stake. He called a meeting to discuss the initial public offering (IPO), and stacked it with lawyers and bankers who stood to reap big fees from a public share offering and who were, as a result, enthusiastic about his initiative. At that meeting Barksdale finally capitulated. Eighteen months after Netscape was created, and before it had made a dime, Netscape sold shares in itself to the public. On the first day of trading the price of those shares rose from $12 apiece to $48. Three months later it was at $140. It was one of the most successful share offerings in the history of the US stock markets, and possibly the most famous. There was only one explanation for its success: the market now saw the future through Clark's eyes. "People started drinking my KoolAid," says Clark What the IPO did was give anarchy credibility. Lewis (2001)

INTRODUCTION Why entrepreneurs choose to conduct an IPO has received relatively little attention when compared to other IPO topics such as initial underpricing and the long-run performance of IPOs. In this chapter, I summarize, analyze, and expand the current discussion on why firms go public. I begin by discussing the theoretical underpinnings and testable hypotheses offered thus far in the academic literature. I then discuss the empirical evidence for (and against) each of these potential explanations after presenting the intuition behind them. I focus on two types of empirical research: a) large-sample publicly-available financial and stock data and b) proprietary survey

data. When dealing with the topic of why firms go public, both approaches to research contain their own challenges. Publicly available data sources typically do not contain detailed information on private firms (particularly in the US). Without private firm data, it is difficult to compare private and public firms to isolate the factors determining why firms go public. In addition, it is problematic to ascertain motives for the factors observed in these types of studies. Survey data, on the other hand, has not been widely accepted in the Finance discipline and has its own challenges in collecting. After discussing the theories and traditional empirical research on why firms go public, I discuss four surveys that have either indirectly or directly addressed the motives for going public. After reviewing and discussing the existing evidence, I provide an in-depth analysis of the Brau and Fawcett (2006a) survey question, How important were/are the following motivations for conducting an IPO? In the conclusion, I attempt to pull all of the theories together and argue that all of them are valid, in certain instances, for certain entrepreneurs. In some samples, specific theories have greater efficacy. In other samples, these same theories have weak explanatory power.

THEORIES OF WHY FIRMS GO PUBLIC If entrepreneurs were asked why they took their firms public, they may not be as open as Jim Clark was in the opening quote. A typical reply might be, We needed money. The problem with such a non-discriminate reply is that it does not allow for the separation of a number of theories that have been advanced in the academic literature to explain why firms go public. On the other hand, if an empiricist finds correlation between firms that go public, and say post-IPO growth, they may conclude that the motive for the IPO was to finance that future growth. Take for example, Mikkelson, Partch, and Shah (1997) who document that US IPOs typically experience a large growth in assets after the IPO. The broad explanation that the reason for IPOs

is to fund growth does not really answer the question of why the entrepreneurs chose an IPO to fund that growth. Why didnt management choose to issue debt, presumably a cheaper source of financing than external equity? Surely cash from debt can buy assets as well as cash from equity. Or, why didnt the entrepreneurs choose to solicit private equity investment to fund its growth? Had the firm already tapped out venture capital (VC) money? Was the firm conducting an IPO according to an optimal capital structure theory or a pecking order of financing theory (both discussed below)? It soon becomes apparent that when trying to ascertain the motives of issuing entrepreneurs, we must peel back several layers of the onion. In many cases, researchers studying the IPO hot market phenomenon (a.k.a. IPO waves of Ibbotson and Jaffe (1975) and Ritter (1984)) discuss motives for going public as determinants of waves. For example, Lowry and Schwert (2002), studying IPO market cycles, conclude that more firms go public after periods of high underpricing because positive information has been revealed through the previous IPOs; and, subsequent IPOs can raise more money than they had previously thought. Although a solid job of documenting the relationship between initial returns and IPO volume, this explanation for IPO clustering falls short of addressing the motives of insiders on why they are considering an IPO in the first place. Have they run out of cheaper debt financing? Do their VCs want to cash out? Do they think the high underpricing is a signal that the market is overvalued and they have a window of opportunity to exploit? Does the founder want to buy a yacht? The same questions can be raised for virtually all of the hot market empirical papers (as in this example of Lowry and Schwert (2002)) and the theoretical hot market papers, such as Pastor and Veronesi (2005) who find that insiders tend to go public after observing improving market conditions. Thus, the timing of IPOs and the motives of IPOs, though related, are separate questions.

I have found through surveys of, and interviews with CFOs, that questions must be carefully crafted to pinpoint the sometimes fine differences in academic theory. To help the reader identify these differences among theories, below, I detail the leading theories on why firms go public. Each of the theories begins with a bold heading. Within each heading, I discuss the intuition behind each theory, several leading studies in that thread of the literature, and the extant non-survey empirical evidence pertaining to that specific hypothesis. I choose this structure because most of the finance literature focuses on one explanation and then primarily tests that specific explanation. A notable exception is Pagano, Panetta, and Zingales (1998) who are able to test eight of the hypotheses in one paper (see their Table II, pg. 37) by using a sample of Italian IPOs. Specifically, Pagano et al. (1998) study 2,181 firms from 1982-1992, of which, 69 are IPOs (40 new listings and 29 carve-outs). The findings of Pagano et al. (1998) are therefore sprinkled through the 12 groups of theories that follow.

Minimize cost of capital/Optimal capital structure Perhaps the earliest literature to address why firms go public (at least indirectly) begins with the seminal capital structure literature of Modigliani and Miller (M&M 1958, 1963). M&Ms famous Proposition I states that [t]he market value of any firm is independent of its capital structure (M&M 1958, p. 268). When corporate taxes are introduced, the tax shield of debt results in an optimal capital structure of 100% debt (M&M 1963). M&M lay the ground work for the theory of optimal capital structure in their 1958 and 1963 papers; but, it is the introduction of primarily bankruptcy costs that result in an optimal structure other than irrelevance or 100% debt. The work of Baxter (1967) and Stiglitz (1969) argues that if a firm obtains too much financing from debt, the increased bankruptcy (i.e., financial distress) costs begin to hurt the value of the firm. Thus, the introduction of bankruptcy costs results in an optimal mix of debt-to-equity to

minimize the weighted average cost of capital (WACC). In a discounted cash flow context, minimizing the WACC, ceteris paribus, maximizes the value of the firm. The crucial development of a theoretical optimal capital structure begins the debate on whether, and why, managers issue public equity. The early capital structure literature (e.g., Kraus and Litzenberger (1973) and Kim (1978)) offers the trade-off hypothesis that financial managers will issue equity when it will minimize their WACC, thus maximizing the value of the firm. Williamson (1988) extends this literature arguing that sometimes external equity is the cheapest option for financing certain assets. The WACC argument offers the hypothesis that managers issue public equity (i.e., go public) when the influx of IPO proceeds will decrease the overall company cost of capital, thereby maximizing firm value. The difficulty in testing this hypothesis directly is that the WACC is typically an internal measure computed within firms. Most firms have their own in-house method for computing the WACC. Although, Graham and Harvey (2001) find that 73.5% of the CFOs they survey use the capital asset pricing model (CAPM) to estimate the cost of equity, we do not know what these firms use for their inputs. Over how long of a period do they estimate beta for the CAPM? What do they use for their risk-free rate? Where do they get their market risk premium estimate? Although data availability of firm WACC inhibits direct tests of the optimal cost of capital hypothesis, researchers have been able to test if the cost of debt has declined via an IPO. Because a decrease in the cost of debt does not necessarily indicate a decrease in firm-level WACC, the next section does not explicitly test the WACC hypothesis. Although the survey approach to research is discussed towards the end of this paper, it is possible to test the WACC question by asking IPO participants directly. Analysis of this hypothesis (and all of the others) will be included in the survey section.

To overcome borrowing constraints/Increase bargaining power with banks Pagano et al. (1998) argue that gaining access to a source of finance other than banks or venture capital is probably the most cited benefit of going public, which is explicitly or implicitly present in most models (pg. 38). Citing Basile (1988), Pagano et al. (1998) argue that access to public equity markets may reduce the cost of credit. Pagano et al. (1998) then argue that increased bargaining power can also help firms lower their cost of debt (Rajan (1992)). In turn, firms can increase their bargaining power by gaining access to public equity markets and increasing firm transparency with investors. To test the borrowing constraint hypothesis, Pagano et al. (1998) argue that firms with large current investments (PPE capital expenditure, CAPEX), future investments (industry market-to-book), high leverage (lagged value of total debt plus equity), and high growth (rate of sales growth) should be positively related to conducting an IPO. Pagano et al. (1998) Table III (pg. 44) reports that growth and industry market-to-book are both positively related to the probability of conducting an IPO for their overall sample, as predicted. CAPEX and leverage are not significantly related to the choice of IPO. Examining independent IPOs, CAPEX, growth, and industry market-to-book are all significantly related to going public. Here, the increase in new investment is consistent with the model of Chemmanur and Fulghieri (1999). For carve-outs, only industry market-to-book is significantly related to going public. Data from after the IPO (i.e., ex post data) allow for two additional predictions to test the borrowing constraint hypothesis in Pagano et al. (1998). First, new IPO firms should increase their investment or reduce debt. Second, new IPO firms should not increase their payout ratio. Their Table IV (pg. 48) shows mixed evidence for these two predictions. Post-IPO investment for independent firms actually decreases and is persistent. On the other hand, carve-outs show a short-

term increase in investment, but the increase does not persist. As for leverage, independent firms reduce their leverage immediately with persistence. On the other hand, carve-outs do not immediately reduce leverage, but do so in the long-run. For payout, no significant changes are detected after the IPO, in accordance with the prediction. Overall, Pagano et al (1998) provide mixed evidence for the borrowing constraint hypothesis. As we will see going forward, this mixed evidence conclusion will apply to all of the going public theories. The question soon becomes, which theories apply to which subsets of firms? To test the bank bargaining power hypothesis, Pagano et al. (1998) posit that firms facing higher interest rates and more concentrated credit sources should be more likely to go public. Credit cost is approximated with the ratio of the firms interest rate scaled by an average interest factor. Credit concentration is measured with a Herfindahl index of the lines of credit by all of its lenders. With post-IPO data, credit should become cheaper and more available for the newly public firm. Pagano et al. (1998) Table III (pg. 44) reports that neither the bank rate nor the credit concentration is a determining factor for the decision to go public. Using post-IPO data however, indicates that the cost of credit decreases for independent IPOs and the concentration of credit is reduced (particularly for independent IPOs). Thus, the IPO offering data does not support the bargaining power hypothesis; but the post-IPO data does.

Asymmetric information/Pecking order of financing Based on asymmetric information between managers and investors and possible stock price misvaluation, Myers and Majluf (1984) and Myers (1984) argue for a pecking order of financing: internal equity, debt financing, and then external equity. This line of logic asserts that outside investors take the issuance of external equity as a negative signal, that management feels

the firm is over-valued. Anticipating investor negative sentiment, management will do their best to grow the firm with internal equity (i.e., retained earnings) first, and then debt, and then with external equity as a last resort. The pecking order offers the hypothesis that managers will issue equity only after exhausting retained earnings and debt capacity. The inherent assumption of the pecking order theory is that the firm needs more financing. The signaling literature (e.g., Leland and Pyle (1977)) and the market timing literature (e.g., Schultz (2003) and Alti (2005)) both suggest validity for the asymmetric information underpinnings of the pecking order. However, the literature on IPO underpricing (e.g., Stoll and Curley (1970), Logue (1973)) suggests IPOs are often in high demand (priced above investment bank estimates of fair value) and the IPO long-run performance literature (e.g., Ritter (1991)) suggests that equity is often overvalued at issue. Both of these observations are contrary to the pecking order underlying logic. Admittedly, these inferences from other literature threads are not direct tests of the pecking order hypothesis; however, as with the WACC hypothesis, direct non-survey empirical tests here are very difficult.

To establish a market price for subsequent sell-out The notion of a harvest or exit event for entrepreneurs has prompted several lines of literature addressing why firms go public. This first line argues that IPO insiders are interested in going public to establish a market price for their firm as a first step in cashing out. The second step would then be a sell-out selling the firm outright at the hopefully higher market value. This line of literature stems mainly from Zingales (1995) and Mello and Parsons (1998). This literature offers the hypothesis that IPO firms will become targets or insiders will transfer control fairly quickly after going public. The target hypothesis is based on risk-averse insiders having incentives to sell the firm shortly after establishing a market price. Studying 4,795

US IPOs from 1985-2003, Brau, Couch, and Sutton (2010) find that only 45 of the firms (3%) become targets within one year. Thus for 97% of the sample, this hypothesis is not supported (at least for the first year of being public). Using Italian data, Pagano et al. (1998) test the subsequent sell-out hypothesis by predicting a high incidence of control transfers after the firm goes public. They find that nearly 14% of their IPO sample sells out the controlling stake to an outsider in the three years after the IPO. They report that this frequency of sell-out is significantly greater than a sample of privatelyheld firms, providing evidence that the IPO facilitated a first step of a sell-out for 14% of the sample. In addition, Pagano, Panetta, and Zingales (1996) show for a larger sample of Italian firms that 16.4% of the IPOs sell controlling ownership stakes in the three years following the IPO. Of course, the Brau, Couch, and Sutton (2010) and Pagano et al. (1996, 1998) papers cannot detect if the entrepreneurs in those samples of 3%, 14%, and 16% had planned to divest at the time of the IPO or if they had decided to divest sometime in the one or three years after the IPO (i.e., cannot explicitly call their findings a motive). Taken together, the Brau, Couch, and Sutton (2010) and Pagano et al. (1996, 1998) papers provide indirect evidence that for a small subsample of firms, the IPO may be a first step in a total sell-out (or at least transfer of control). For the other 84% of Italian firms and 97% of US firms in their samples, one of the other hypotheses is most likely driving the IPO decision. (Although not a dominant motivation for an IPO, see Brau, Sutton, and Hatch (2010) for a study of firms that conduct an IPO and then are shortly sold off.)

As a tool to cash-out/Insider liquidity Continuing the idea of the IPO as a harvest, Black and Gilson (1998) argue that the IPO gives VCs the opportunity to exit, providing an attractive harvest strategy (see also Lerner (1994)).

Professional private equity investors such as VCs desire to generate returns for their investors by harvesting their investments. As discussed in Brau, Francis, and Kohers (2003) and in Brau, Sutton, and Hatch (2010) the IPO can provide such a cash-out for professional investors. Along with VCs, founders and other insiders can use the IPO to at least partially cash-out by selling secondary shares in the IPO (e.g., Ang and Brau (2003) and Brau, Li, and Shi (2007)). In the language of Pagano et al. (1998), the IPO provides original owner personal diversification (see also Pagano (1993)). The cash-out theory offers the hypothesis that VCs and other insiders will regularly sell personally-owned (i.e., secondary shares) in the IPO. This hypothesis is certainly consistent for a large portion of European IPOs in the 1980s and early 1990s. Jenkinson and Ljungqvist (2001) report that of IPOs in Germany, 23% contained all secondary shares. Furthermore, of IPOs in Portugal, a full 2/3 contained only secondary shares. When an issue contains only secondary shares, typically no new shares are created, and the raised proceeds go directly to existing, selling shareholders (and not for company investment). It seems to follow that for the 2/3 of Portuguese IPOs that sold only secondary shares, the motive was to allow insiders to cash out (at least partially). Parsing between firms that raise external equity (sell primary shares) and those that do not (sell secondary shares), Pagano et al. (1998) show that 41% of the time their sample firms sell primary shares and 41% of the time they sell secondary shares. Thus, they argue that for a subset of the firms, the insider liquidity hypothesis is supported. Kim and Weisbach (2005) examine nearly 17,000 IPOs from 1990-2003 for 38 countries and document that IPOs that include secondary shares seem to have varying motivations and are fundamentally different than IPOs that issue primary shares. Primary share-selling IPOs demonstrate a greater demand for new capital, increased investment, higher repayment of debt, increases in cash, and greater subsequent SEO activity. Kim and Weisbach find that 21% of the

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IPO proceeds from their sample are from secondary shares. Examination of their Table II, Panel A (pg. 25 of their 2005 working paper version at http://ssrn.com/abstract=610988) shows that from 1990-2003, nearly 31% of Argentinean IPOs, 30% of Portuguese IPOs, and 23% of Spanish IPOs consisted of all secondary shares. In these cases, it is clear that at least some insiders are cashing out. For other countries, such as Hong Kong (0.4%), Taiwan (0.4%), and Japan (0.6%), very few IPOs are all-secondary share issues. Interestingly however, Japan has the highest percentage of combined (primary and secondary shares offered) IPOs at 85.8%. The combined IPOs for Japan account for 53.4% of the primary proceeds and 34.3% of secondary proceeds (their Table II, Panel B) of all Japanese IPOs. As displayed nicely in Kim and Weisbach (2005) for a broad international panel of IPOs, the cash-out hypothesis is valid for some subsets and not for others.

To allow more dispersion of ownership Chemmanur and Fulghieri (1999) argue that IPOs broaden the ownership base of the firm. In their model, the benefits of an IPO are contrasted with the lower information-production costs of being privately-held. Pagano et al. (1998) argue that the increased share liquidity of being public creates value for IPO insiders according to market microstructure literature. Benninga, Helmantel, and Sarig (2005) and Pastor, Taylor, and Veronesi (2009) present models in which the IPO decision is a balance of diversification benefits and private benefits. Bodnaruk, Kandel, Massa, and Simonov (2008) find empirical support for these models showing that firms with less diversified owners are more likely to go public. Pagano et al. (1998) test the dispersion hypotheses by arguing that riskier firms should be more likely to go public and that controlling shareholders should sell a large portion of their shares either in the IPO or shortly thereafter. (Note their second test also can apply to the cash-out hypothesis.) They find that controlling shareholders divest very little in the IPO (-3.2%) and

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actually increase their ownership in the three years after the IPO (+0.2%). These Italian firm shareholders retain an average of 69% ownership at the IPO and 64% three years after the IPO. Using US data, Mikkelson et al. (1997) report a 44% ownership retention, and using UK data, Brennan and Franks (1997) report a 35% ownership retention. Pagano et al. (1996) find in a larger set of Italian firms than their 1998 study that the controlling block shareholders retain an average of 60% ownership. Though not a direct test of ownership dispersion, and despite the highretained ownership in these samples, these samples typically do display a broadening of ownership at the IPO. Pagano et al. (1998) report that the ownership base (number of shareholders) increases dramatically for Italian firms when they go public (an average of three shareholders before the IPO to 3,325 shareholders at the IPO). Evidence is provided that ownership is dispersed, as measured by the number of shareholders; however, it is hard to determine from this data if dispersion was the motivation of the insiders to conduct the IPO. It is essentially a tautology that when a firm goes public, the number of shareholders will increase; however, this increase is a necessary, but not sufficient condition for this hypothesis.

Publicity/First-mover advantage Maksimovic and Pichler (2001) model that firms conduct IPOs in an attempt to capture a first-mover advantage and to increase the publicity or reputation of the firm. Their idea is that the IPO itself can serve to create buzz in the business community, increasing the reputation of the firm, and creating a first-mover advantage in the IPOs niche. Further, Demers and Lewellen (2003) argue that IPO underpricing can serve to create interest in the firm. Thus, IPOs may serve as strategic moves. Pagano et al. (1998) argue that an IPO may increase investor recognition and that listing on a major exchange may get the attention of portfolio managers. Graham and Harvey

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(2001) ask if issuing stock gives investors a better impression of the firms prospects than issuing debt. Finally, Aggarwal, Krigman, and Womack (2002) argue that extreme underpricing attracts greater media attention and generates publicity for the IPO firm. This line of logic offers the hypothesis that IPOs will experience an increase in name recognition/reputation or some other measure of popularity. Pagano et. al (1998) are unable to test this hypothesis with their data; but Demers and Lewellen (2003) use the clever metric of website traffic, as well as media reaction, to measure publicity. Their Table 2 (pg. 421) shows that both web traffic and media citations increase the month, of and the month after, an IPO. For example, average web traffic increases from 898 new visitors the month before the issue to 1,032 in the month of the IPO and then to 1,044 in the month after the IPO. Media articles increase from 2.7 the month prior to the IPO to 8.7 the month of the IPO and then to 3.4 the month after the IPO for the same firms. For a subset of business-toconsumer firms, the media coverage moves from 1.96 to 8.19 from the month before to the month of the IPO. Exploring not just the event of an IPO but the degree of underpricing, Demers and Lewellen (2003) find that underpricing is significantly correlated with website traffic for a set of internet IPOs. Specifically, they find that a one percent increase in underpricing generates 1,754 unique visitors on average. They compute that each unique visitor costs $450 of underpricing and then give examples of how this price is similar to banner ads and other forms of advertisement. Demers and Lewellen then go on to examine the number of media cites in the month of the IPO and find it also correlated with underpricing for a sample of internet and non-internet IPOs. They conclude that IPO underpricing, as well as the IPO itself, provides publicity to internet and noninternet firms.

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To create public market so the firm has the currency of shares for acquisitions Brau, Francis, and Kohers (2003) argue that IPOs may be important because they create public shares for a firm that may be used as currency in either acquiring other companies or in being acquired in a stock deal. The acquisition currency theory offers the hypothesis that M&A activity after the IPO should be brisk, particularly with stock deals. Note the overlap between this hypothesis and the Zingales (1995) and Mello and Parsons (1998) idea that an IPO is the first stage of a sell-out. The Brau, Francis, and Kohers (2003) notion of currency can be separated from the two-stage sell-out hypothesis if it were found that most IPOs become acquirers and not targets. As discussed above, Brau, Couch, and Sutton (2010) find that only 3% of the firms in their sample become targets within one year of the IPO. In addition, using non-survey data, Brau and Fawcett (2006a) find that 141 of their sample firms that went public between 2000 and 2002 became acquirers by July 2004; whereas only 18 of them became targets. In addition, they find that new IPO firms become acquirers significantly more frequently than a non-IPO matched benchmark sample. Finally, they find that the IPO sample did not become targets more frequently than a non-IPO matched benchmark sample. The overall evidence supports the acquisition hypothesis for a portion of IPOs (and the target hypothesis for a much smaller portion of IPOs).

To create an analyst following/Increase monitoring Bradley, Jordan, and Ritter (2003) argue that having an analyst following can increase the reputation of a firm and create shareholder value (e.g., with favorable analyst recommendations). Pagano et al. (1998) argue that an IPO increases the monitoring of executives vis--vis hostile takeovers and increased transparency of managerial decisions. The resulting hypothesis is that firms may go public to initiate analyst coverage and to increase monitoring. Pagano et al. (1998)

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are unable to test the monitoring hypothesis; however, Bradley et al. (2003) use US data to show that analysts typically offer very optimistic reports for newly-minted IPO firms. Examining 1,611 IPOs from 1996-2000, they find that 76% of their sample receives analyst coverage immediately after the quiet period ends, almost always consisting of a buy or strong buy recommendation. They find that these initiated firms experience a positive five-day abnormal return of 4.1%, compared with non-initiated firms which experience a 0.1% return. (See also Bradley, Jordan, and Ritter (2008) for a follow-on paper pertaining to analyst coverage after the IPO.) In addition to the work of Bradley et al. (2003), Rajan and Servaes (1997) study 2,725 US IPOs from 1975-1987 and show that more IPOs are completed during optimistic analyst periods and that analysts are generally overoptimistic about earning potential and long-term growth of recent IPOs. These empirical studies are compelling, yet once again, they do not actually answer whether analyst following was the motivation for the entrepreneurs to go public. If it were the motivation, then it must be the case that the entrepreneurs a) knew they would receive an analyst following, b) were confident their ratings would be favorable, and c) knew that favorable analyst following would create value for the firm (and them). For a subset of savvy entrepreneurs (or those who listen to their investment bankers), this may well be the case. At this point, however, we are left to wonder.

Windows of Opportunity

At times, the IPO market becomes frothy and strong investor demand may over-inflate the price of IPO shares. Ritter (1991), Loughran and Ritter (1995), Pagano et al. (1998), Baker and Wurgler (2002), and Lowry and Schwert (2002), among others, argue that such windows of opportunity exist, and IPO insiders take advantage of them to issue over-priced shares. Lucas and McDonald (1990) argue windows are driven by information asymmetry, and firms wait until a

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good news release so they do not sell at undervalued prices. If such windows do exist, the testable hypothesis is that IPOs that issue during these windows should underperform a riskmatched benchmark after the IPO. That is, the market will eventually realize the new public firm is overvalued and the price will adjust downward to reflect his revelation. Ritter (1991), in his seminal paper on the long-run performance of IPOs is among the first to show that IPOs average negative, risk-adjusted long-run returns. Ritter (1991) has spawned an entire literature attempting to a) document whether IPO firms actually do underperform and b) if they underperform, why? One of the primary explanations for the poor long-run IPO returns is that insiders (with the help of investment bankers and VCs) can time the market to exploit windows of opportunity. As further evidence, these over-priced IPOs typically experience a first-day underpricing jump caused by excess demand in the primary and secondary markets. Thus, the voluminous collection of IPO underpricing and long-run literature provides at least indirect evidence for the windows hypothesis. Non-long-run tests of the windows hypothesis include Pagano et al. (1998) and Rajan and Servaes (2003). Pagano et al. (1998) test the windows hypothesis by examining high market-tobook industry IPOs and their post-IPO behavior. They reason if new IPOs do not invest at an abnormal rate and do not earn large profits after the IPO, then this is evidence of exploiting windows. They find that profitability declines after the IPO and investment declines as well. Thus, the windows hypothesis receives empirical support from their Italian data. Using US data from 1975-1987, Rajan and Servaes (2003) find support for the windows hypothesis showing that more firms conduct IPOs when public same-industry firms are trading at high multiples. (They then show that these new IPOs underperform after the IPO.) Finally, the hot market phenomenon in which IPOs issue in volume and price waves (e.g., Ritter (1984), Lerner (1994)) also lends circumstantial evidence for the windows hypothesis.

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In contrast to the preceding research, Schiozer, Oliveira, and Saito (2010) show for Brazilian IPOs from 2005-2007, the decision to go public cannot be explained by a markettiming function. Instead, Schiozer et al. show that greater growth opportunities (relative to competitors) drives the decision to go public. Having discussed the windows hypothesis, it is important to note that it should actually be viewed, at least partly, as a timing issue, not a motive issue. Suppose entrepreneurs see the frothy market and they feel it is a great time to issue, so they do. Did they issue then so they would have overpriced equity to fuel growth? Did they issue then because the overpriced equity decreased their WACC? Did they issue then because they could cash-out amid the market frenzy and become deca-millionaires? Because the windows hypothesis can be thought of as a timing issue, Brau and Fawcett (2006a) includes the market timing question in the timing survey section and not the motive section. The responding CFOs top two reasons for the timing of their IPOs supports the windows hypothesis, with 83% agreeing overall market conditions were a factor in the timing and 70% agreeing industry conditions were a timing factor.

Create shares for compensation Holmstrom and Tirole (1993) and Schipper and Smith (1986) argue that publicly traded stock allows for efficient compensation programs. This hypothesis suggests that firms will offer more stock-based compensation schemes after the IPO. Because pre-IPO compensation data is very difficult to come by, the direct test of this hypothesis with non-survey data is nearly impossible. However, Graham and Harvey (2001) ask if issuing equity is motivated for providing shares to employee bonus/stock option plans in their survey, covered subsequently.

Because other firms in the same industry have gone/Are going public

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The IPO hot issues/cycles phenomenon literature (e.g., Ibbotson and Jaffe (1975), Ritter (1984) and Lowry and Schwert (2002)) provides evidence that firms herd when they issue new equity. In addition, the model of Maksimovic and Pichler (2001) predicts herding in IPOs in a subset of firms those where new-entry risk is significant. On the other hand, in industries with primarily technology risk, their model predicts non-herding in IPOs. As discussed previously, the motivation behind herding is unclear. Is it because the market is overvalued? Is it because there are more growth opportunities for the average firm than normal? Is it because credit markets have tightened and the average firm cant obtain more debt financing? Again, it is difficult to ascertain motivation without survey data. Subsequently, we will cover survey data by Pinegar and Wilbricht (1989), Graham and Harvey (2001), Brau, Ryan, and Degraw (2006), and Brau and Fawcett (2006a).

Summary of theories Having briefly discussed the leading theories on why firms go public, I now summarize here by listing each theory and the primary empirical predictions: Minimize cost of capital/Optimal capital structure: IPO firms will experience a decrease in their WACC after an IPO. To overcome borrowing constraints or increase bargaining power with banks: IPO firms will experience lower interest rates or less credit concentration after the IPO. Asymmetric Information/Pecking order of financing: IPO firms will offer public equity only after exhausting retained earnings and debt capacity. To establish a market price for subsequent sell-out: Frequent acquisitions of IPO firms will be observed in the after-market shortly after an IPO (e.g., 1-3 years).

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As a tool to cash-out: IPO firms, especially those with VCs, will frequently include secondary shares in the IPO.

To allow more dispersion of ownership: IPO firms will experience an increase in the ownership base after the IPO.

Publicity/First-Mover Advantage: IPO firms will experience a significant increase in press coverage or other publicity during and after the IPO process.

To create public market so the firm has the currency of shares for acquisitions: Many IPO firms will participate in the M&A market shortly after going public, especially as acquirers (to separate from the two-stage sell-out hypothesis).

To create an analyst following: IPO firms will experience a favorable analyst following, on average.

Windows of Opportunity: IPOs that issue during opportunistic windows will underperform after the IPO (e.g., 1, 3, 5 years).

Create shares for compensation: IPO firms will offer more stock-based compensation schemes after the IPO.

Because other firms in the same industry have gone/Are going public: IPO firms will herd, particularly in industries.

In Netscapes case, to buy a boat: Jim Clark will be able to buy his yacht after the IPO.

SURVEY EVIDENCE OF GOING PUBLIC THEORIES As demonstrated above, the challenge of empirically testing the motives of why insiders in firms go public is the limitation of proxies to accurately measure motives. Researchers have thus worked hard to identify appropriate instruments in attempts to disentangle the theories

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discussed above. As an example of this challenge, suppose it is observed after an IPO that a) the firms WACC decreased, b) the firm had worked through the pecking order of financing prior to issuing, c) a sizable portion of the shares in the IPO were secondary shares, d) press coverage increased around the IPO, e) the IPO received preferable analyst treatment, f) the firm performed under a risk-matched benchmark for a year, and then finally g) the firm was acquired. These seven observations support at least seven of our hypotheses above. The researcher has been able to provide support for seven possible motivations, but she is left to wonder which of the seven, or which combination of the seven, actually motivated the entrepreneurs to conduct the IPO. This limitation of publicly available data is what motivates the use of survey-based methodology. Although not as widely accepted in Finance as in other disciplines, survey methods add a new dimension to exploring the question of why entrepreneurs choose to go public. Prior to discussing the extant survey data on the topic, and some new data that has not yet been published, a discussion of publicly available data in IPO research is appropriate (or at least an interesting aside).

PUBLICLY AVAILABLE DATA In the early days of IPO finance research, scholars were forced to hand-pick data from sources such as the Investment Dealers Digest (IDD) and the Dow Jones Broad Tape. As late as 1997, I had to drive over 150 miles to access IDD at a university library in a different town to extract secondary shares sold in IPOs for my dissertation. (It wouldnt have been too bad, but the Florida Gators managed to beat the Florida State Seminoles in football with only two minutes left in the game at the very time I was extracting data. With the win, the Gators stopped the Seminoles from going to the national championship game. The roars from the Swamp still haunt me.)

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Jay Ritter became one of the pioneers in IPO research by compiling a database of 2,609 IPOs from 1975-1984. He used a subset of 1,526 of these IPOs that were listed on CRSP for his seminal 1991 Journal of Finance article (Ritter (1991)). Professor Ritter now offers public access to the complete database on his webpage. In the mid to late 90s, Compact Disc Disclosure offered IPO prospectuses (SEC S-1 documents) for researchers to scour. Around the same time, Securities Data Company (SDC) was marketing its New Issues database in DOS-style format which streamed over the internet. The advent and expansion of SDC provided a catalyst for IPO researchers. Although errors have been documented in SDC along the way by scholars such as Alexander Ljungqvist and Jay Ritter (corrections available on their respective webpages), the easy access to IPO data via SDC has been a boon to researchers. Since SDC, various other data providers continue to provide richer and richer data on IPOs. The existence of these computer-readable data opened up a large literature testing IPO in the three IPO phenomena of underpricing, long-run returns, and hot markets along with newer discoveries as well. As a side note, the availability of IPO data also increased competition for new anomalies. For example, at one point in time, at least five teams of researchers were all working on the lockup expiry effect simultaneously (earliest known working paper dates: Brau, Carter, Christophe, and Key (1999), Brav and Gompers (1999), Bradley, Jordan, Roten, and Yi (1999), Field and Hanka (1999), Ofek and Richardson (2000)). Field and Hanka won the lockup expiry race with their article that was published in the Journal of Finance (Field and Hanka (2001)). The Bradley team focused their paper on VC-effects in lockups and published their paper in the Journal of Financial Research (Bradley et al. (2001)). Brav and Gompers focused on the front-end of the lockup paper and published their revised paper in the Review of Financial Studies (Brav and Gompers (2003)). The Brau et al. paper on lockup expiry was published in Managerial Finance

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(Brau et al. (2004)) and a follow-on analysis of the lockup front-end explanation was published in the Journal of Financial and Quantitative Analysis (Brau, Lambson, and McQueen (2005)). As can be seen, the availability of public IPO data, coupled with Compustat and CRSP, increases the possibility of competition and scooping among researchers. Although the existence of SDC and other IPO data providers has spurred brisk competition and increased volume studying many IPO issues, as mentioned previously, the topic of why firms go public has received relatively little empirical study. The obvious reason for this is lack of data. If researchers desire to determine the factors of going public empirically, they must not only have data on publicly traded firms but also on privately-held firms. One can envision modeling the choice of IPO as either a probit or logit model, with the binary dependent variable being either going public or staying private. The lack of financial data for private firms, particularly in the US, limits such empirical modeling. In fact, acknowledging the difficulty of using US data to test extant theories on why firms go public, Bharath and Dittmar (2006) use the novel approach of testing reverse predictions of the IPO decision by studying firms that go private. The study of Italian data by Pagano et al. (1998), which I cite profusely throughout the discussion above, is one of the few articles able to conduct such a binary model approach. It is this lack of data and difficulty in creating instruments to detect motivation that provides the catalyst for survey research.

SURVEY DATA Pinegar and Wilbricht (1989) were among the first to employ survey sampling techniques in Finance (and perhaps the first on the topic of capital structure). (For some predecessors, see Lintner (1956) on dividend policy, Gitman and Forrester (1977) on capital budgeting, and Baker, Farrelly, and Edelman (1985) on dividend policy.) Pinegar and Wilbricht (1989) survey the

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Fortune 500 firms for 1986 as classified in April, 1987. They received 176 useable surveys, for a 35% response rate. Pinegar and Wilbrichts intent is to ask managers with which academic theories pertaining to capital structure they agree. (Their nine question survey is available at the back of their article.) Although they do not ask specifically why firms go public, they do ask, Rank the following sources of long-term funds in order of preference for financing new investments (1 = first choice, 6 = last choice). This specific question at least partially addresses the pecking order hypothesis of Myers and Majluf (1984), although the majority of these CFOs most likely have seasoned equity offerings (SEOs) in mind (and not IPOs) because they are predominantly public firms. Pinegar and Wilbricht report that nearly 69% of managers held a preference for the pecking order of financing, where 84% of respondents listed retained earnings as their most favored source of financing, and 72% listed straight debt as their second favored source. Next was convertible debt, followed by external common equity. Only preferred stock (straight and convertible) ranked lower than common stock. From these results, we can conclude that managers at least have preferences that align with the pecking order hypothesis. A second survey paper focusing on corporate finance in a broader sense is Graham and Harvey (2001). Graham and Harvey survey over 4,000 CFOs and receive 392 usable surveys (i.e., 9% response rate). Graham and Harvey construct a comprehensive survey that covers capital budgeting, cost of capital, and capital structure. Although they do not directly ask, What motivates firms to go public, they do ask, Has your firm seriously considered issuing common stock? If yes, what factors affect your firms decisions about issuing common stock? (see their Table 8, pg. 216 and Figure 7, pg. 230; also see Graham and Harvey (2002) Figure 5, pg. 16). Graham and Harvey have a column in their Table 8 which reports the survey replies for private

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firms. Of the 392 firms that replied to their survey, 37%, or 145 are privately-held. For these firms, their question can be interpreted as consideration for an IPO (since they are private firms). Ranked by the average response (0 = not important through 4 = very important), the first five reasons given for issuing equity (perhaps going public) by private firms are: providing shares for compensation (2.72), high stock price (1.83), sufficient profits to fund activities (1.80), misvaluation of stock (1.78), and maintaining target debt-to-equity (1.73). First, note that only one of the top five (and total 13 choices) is over a score of 2. So in the aggregate, none of the reasons for going public (i.e., issuing equity) is overly compelling to privately-held CFOs. Even with the low scores, the clear winner of this question for private firms is to provide shares for compensation schemes. The possible replies that deal with the classical arguments of optimal capital structure of cost of capital, rank no higher than the fifth most important reason. Related questions such as common stock is our cheapest source of funds (1.46) and inability to obtain funds using debt, convertibles, or other sources (1.42) receive much lower ratings. Thus, Graham and Harveys survey for their private-firm subset would suggest that the stock compensation theory is supported the most by practitioners. The next survey, one that gets closer to asking why firms go public, is Brau, Ryan, and DeGraw (2006). They survey 984 IPO firms from 1996-1998 and 2000-2002 in two rounds of surveys and receive 438 usable surveys for a response rate of 44.5%. In their Table 1 (pg. 487) Brau et al. (2006) list 12 possible theories on why firms go public, breaking them down into lifecycle and market-timing theories (following Ritter and Welch, 2002). As can be seen in the Brau et al. (2006) Table 3 (pp. 492-494), the surveyed CFOs were not asked directly why they went public, but were instead asked if certain aspects of the IPO were advantages or disadvantages or to answer yes or no to various statements. The construction of the going-public theories (their

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Table 1) was actually created after the survey data had been collected. As such, the authors were able to only get partially to the question, Why do firms go public?

[Insert Table 1 about here.]

A modified version of Brau et al. (2006) Table 3 is our Table 1. Only three survey questions received at least 75% agreement as an advantage of conducting an IPO: to gain financing for long-term growth (86.8%), to gain financing for immediate growth (86.8%), and to increase liquidity (82.5%). Note that although the two most popular questions are consistent with the empirical work of Mikkelson et al. (1997), they still do not directly address why the firm chose external equity for immediate and long-term growth and not some other cheaper financing source. Brau et al. (2006) Table 7 (pg. 506) shows that in regressions, firms that replied that immediate growth was a benefit were actually correlated with negative and significant 1-year abnormal returns. Perhaps the immediate growth response indicated strapped for cash which did not turn around over the year after the IPO. On the other end of the response ranking, only 3.8% of the CFOs agreed that a benefit of the IPO was that it allowed for the retirement of the original owner. The surprising low agreement to this question most likely points out one of the main criticisms of survey research. Even if the original founders used the IPO as a harvest strategy, the survey responder may feel a duty to cover for them. Perhaps, the worry is lawsuits. Perhaps, the worry is a negative signal. Critics of survey research have a valid point when they argue that survey participants may not always be truthful. Of course, if the survey data can be linked to insider sales data at the time of the IPO and in the following months, the survey replies could be cross-checked. For example, in the Brau, Ryan, and Degraw (2006) survey, SDC data is used to examine how many of the 181

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firms that indicate they plan to issue an SEO in the next two years following the IPO actually did. It turns out 21% of these firms actually completed an SEO in this time period. The fact that only one in five completed an SEO does not necessarily mean that the other 4/5 of the respondents were lying. These respondents may have intended to conduct an SEO, but were unable to do so based on market conditions or some other factor. The remainder of the data in Table 1 are left to the readers inspection. In sum, Brau et al. (2006) offer some tangential evidence on what motivates firms to go public; but it wasnt until Brau and Fawcett (2006a) that the direct question was asked of practitioners.

A CLOSER LOOK AT BRAU AND FAWCETT (2006a) The first survey to explicitly ask CFOs how important various motivations are for conducting an IPO is Brau and Fawcett (2006a). We tried our best to craft survey questions that could separate the main theories on why firms go public. For example, we did not provide a reply of to get money to their motive for going public question. Instead, we chose answers such as our company has run out of private equity, debt is becoming too expensive, or to minimize our cost of capital in an effort to test the pecking order (first two examples) and the WACC (third example). Inherently, if a CFO said the primary motive of the IPO (raising external equity) was because debt was becoming too expensive, it was understood that the firm needed more capital. I have received calls from other researchers asking why we didnt have a reply that simply stated, because we needed money. Each time, Ive offered the explanation above and it seems to have been adequate. I hope it is adequate here to explain why we chose the specific replies we did. In hindsight, especially after writing this chapter, Im sure some of the replies could have been better than they are in the 2006 survey; but at the time, they seemed like the best replies.

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The replies, reported in Brau and Fawcett (2006a) Table II (pg. 407) surprised the authors. The number one motivation for an IPO revealed by CFOs (in the aggregate) was to create public shares for use in future acquisitions (nearly 60% agreeing) see also Brau and Fawcett (2006b) Figure 1 (pg. 108). This possibility was motivated by discussions with Professor James Ang when I was one of his students around 1997. I included it as a hypothesis in Brau, Francis, and Kohers (2003), which led to Brau and Fawcett (2006a), which in turn led to Brau, Couch, and Sutton (2010). (Just a note, Kohers and Sutton are the same coauthor, Ninons maiden name is Kohers.) Graham and Harvey (2001) do report that nine of their surveyed firms indicated that they issued common stock because it is the preferred currency for making acquisitions (pg. 210); however, this represents only 2.3% of their sample (of private and public firms). In the aggregate, Brau and Fawcett report that the following motivations for an IPO received low support: minimize cost of capital/optimal capital structure, pecking order of financing, and to create an analyst following (see their Appendix C). The following received moderate support: as a cash-out tool, to increase the publicity/reputation of the firm, and to allow more dispersion of ownership. Along with creating public shares for acquisitions, to establish a market value for the firm received strong support. These conclusions are all based on aggregate responses. Brau and Fawcett (2006a) also parse the data based on IPO status (withdrawn, successful, not tired), size of the firm (revenues), age of the firm, high-tech status of the firm, underwriter prestige, venture capital backing, insider ownership decrease, overhang, IPO demand, and initial return hotness. For the aggregate sample, Brau and Fawcett report the mean of each CFO response and the percentage of CFOs who reply either 4 or 5. For all of the subgroups, they report only the means.

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[Insert Table 2 about here.]

Table 2 (herein) reports the survey findings in greater detail than Brau and Fawcett (2006a,b) for the first time. Here, I include the complete frequency of replies to the why do firms go public question. Panels A and B detail these results. Panel A reports in the first column the possible responses to, How important were/are the following motivations for conducting an IPO? in the order they were given in the survey instrument. Actual counts are reported for each of the possible replies of one through five with the total number of replies summed in the last column. Panel B sorts the responses based on the highest to lowest mean reply and reports the percentage of CFO replies instead of counts as in Panel A. Again, the inspection of the details are left to the inquisitive reader. Here, I provide highlights. Note that the top selection, to create public shares for acquisitions, not only receives the most 5 rankings, but also is tied for the most 4 rankings. The top four replies experience a monotonic increase from ranking 1 through 4, but all of them have a 5 rating that is less than the 4 rating. The bottom two reasons, our company has run out of private equity and debt is becoming too expensive show a monotonically decreasing scaling. Panels C-E further break down the aggregate sample into the three sub-samples in Brau and Fawcett (2006a,b) firms that filed for an IPO and then withdrew prior to issue (Panel C), firms that filed for and completed an IPO (Panel D), and firms that have never filed for an IPO but are interested (Panel E). Panels C-E demonstrate that the IPO experience of the CFO results in differing motivations for going public. CFOs of withdrawn IPOs feel that the most important motivation for an IPO is to create public shares to use in future acquisitions (mean=4.00). Next, they feel an IPO enhances the reputation of the firm (mean=3.62). Establishing a market price for the firm (3.54), minimizing the cost of capital (3.30), and broadening the base of ownership

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(3.16) round out the top five reasons. The bottom two reasons for withdrawn IPOs are that the company has run out of private equity (2.41) and that debt is becoming too expensive (1.86). Note that not a single withdrawn CFO ranked creating public shares for acquisitions as not important (a rank of 1). On the other hand, over 50% reported that debt is becoming too expensive as a 1. Panel D reports that CFOs of successful IPO firms feel the top five motivations for an IPO are to allow VCs to cash-out (3.57), minimize cost of capital (3.48), attract analysts attention (3.44), the firm has run out of private equity (3.28), and to create public shares for future acquisitions (3.02). Interestingly, to establish a market price/value for the firm (40% rated 1), to allow principals to diversify (35%), and to enhance the firm reputation (32%) received very high percentages of 1 ratings. The fact that establishing a market price for the firm ranked second overall (Panel B) and last among the successful IPOs (Panel D) demonstrates that the motivations for IPOs differ across firms and CFOs. Note that the motivation second from the bottom is to let principals diversify personal holdings (i.e., at least a partial cash-out). This observation, along with the highest ranking of VCs to cash-out raises an interesting point. It suggests that CFOs view at least two classes of insiders founders and professional investors. Successful CFOs see the IPO as a tool for VCs to cash out but not founders. The relatively low frequency and volume of secondary shares in US IPOs is consistent with the latter point. Panel E consists of CFOs of firms who have not tried to go public but who expressed interest in doing so. Only three motivations obtained a mean greater than three: to broaden the base of ownership (3.43), minimize cost of capital (3.37), and create public shares for use in future acquisitions. Nearly 60% of the never-tried CFOs rank to allow one or more of the principals to diversify personal holdings as a 1.

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Because other chapters in this text cover the topic of VC financing, Ive included Panels F and G, which report survey results for firms without and with VC-backing, respectively. I do so to emphasize the point that different subsamples of IPOs have different motives for going public. (If I provided the full data (which is available upon request) cut on all of the demographic dimensions included in Brau and Fawcett (2006a), this conclusion would become overly redundant.) Panel F reports that the top two reasons for non-VC-backed IPOs are to create shares for acquisitions (3.47) and to establish a firm value (3.45). Note that the lowest motive, to allow VCs to cash-out has 60% of CFOs replying the reason is not important (1), which makes sense as they do not have VC backing. In contrast, Panel G reports that allowing VCs to cash-out has the second highest frequency for the 5 rating (very important), although overall it ranks as the fifth popular reason. Note also 1/3 of the non-VC IPOs state that debt is becoming too expensive is ranked 1 (not important), whereas over 1/2 of VC IPOs rank it as 1. The debt rating again highlights how different samples are driven by varying motives. In this case, it makes sense that IPOs that have tapped private equity markets are not as strained in the debt markets.

SUMMARY AND CONCLUSIONS Since my study of finance began in grad school in 1994, I have always been intrigued with how much academic theory actually jives with what practitioners do on a daily basis. As such, financial surveys have always been of personal interest. While I was a doctoral student working on my dissertation, the idea of an IPO survey constantly nagged me. Graham and Harvey (2001) proved to me that it could be done, and Brau and Fawcett (2006a) was the result. Brau and Fawcett (2006a) has helped us to understand the motives of a sample of CFOs for conducting an IPO (among other questions), but it has not uncovered a definitive single answer for why firms go public. The contrast of the economic models of M&M and the reality of the

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opening quote about the Netscape IPO demonstrate corner solutions to the question of why firms go public. At least ten other theories fit in between these two endpoints. Like traditional empirical studies, the survey evidence suggests that motives for going public vary far and wide, depending on the entrepreneur and firm. In this chapter I have summarized and organized the extant theories on why firms go public. Depending on the sample, method, intent, and perhaps desire of the researcher, all of the theories have been supported through argument and empirics at least once. Several theories are supported by one study and disputed by another. Within my own research, in fact, within one of my single papers, this has been the case. The researcher (and investor) is left to ask not which theory is correct, but which theories apply to which samples of firms that go public.

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Table 1. Survey of 984 IPO CFOs from 1996-1998 and 2000-2002

Strongly agree or agree/Yes Panel A. General Life-Cycle Theory A benefit of the IPO was that it allowed our company to gain additional financing for immediate growth. A benefit of the IPO was that it allowed our company to gain additional financing for long-term growth. Yes, No, or Don't Know Smaller companies are less likely to go public. Younger companies are less likely to go public. High-tech companies are less likely to go public. Riskier companies are more likely to go public. Panel B. Capital Structure / Cost of Capital A benefit of the IPO was to decrease the total cost of capital. Yes, No, or Don't Know We plan to issue more debt within two years. Our present debt/equity mix is optimal. Panel C. Pecking Order A benefit of the IPO was that it allowed our company to reduce its debt. A benefit of the IPO was to reduce open bank loans. Yes, No, or Don't Know Highly leveraged companies are more likely to go public. Companies with higher interest rates are more likely to go public. Panel D. Change Control A benefit of the IPO was that it allowed our company increase options to change control of company. Panel E. VC Harvest A benefit of the IPO was that it allowed the venture capitalist to sell their interest and move on. 22.20% 44.40% 37.40% 38.20%

Strongly or mildly disagree/ No

82.60% 86.80%

7.90% 4.20%

55.80% 49.50% 1.90% 11.50%

32.40% 37.60% 86.60% 59.80%

34.40%

33.70% 49.50%

38.80% 43.30%

37.70% 43.30%

47.90% 37.30%

21.50% 27.50%

46.70%

16.30%

65.30%

39

Panel F. Optimal Dispersion A benefit of the IPO was that it allowed original owners to diversify their interests. A benefit of the IPO was that it allowed the sale of some of the owners shares. A benefit of the IPO was that it increased liquidity. A benefit of the IPO was that it improved our secondary market. Yes, No, or Don't Know Our company has made a secondary offering since the IPO. Our company plans a secondary offering within two years. Panel G. Control Issues A disadvantage of the IPO was that it reduced control. A benefit of the IPO was that it increased the alliance of shareholders and management. Panel H. Founder Cash-Out A benefit of the IPO was that it allowed for the retirement of the original owner. Panel I. Increased Reputation A benefit of the IPO was that it improved market perception of stock. A benefit of the IPO was prestige of being on an exchange. A benefit of the IPO was the enhancement of media attention. Panel J. Public Scrutiny A disadvantage of the IPO was that it made our company suddenly open to public scrutiny. Panel K. Market Timing Theories A benefit of our IPO was that the market was undervalued when we went public. A benefit of the IPO was that the market was strong at the time of IPO. Yes, No, or Don't Know Companies with higher market to book ratios are more likely to go public. 49.20% 17.00% 36.70% 59.20% 33.20% 25.50% 48.70% 39.60% 28.50% 20.20% 25.00% 33.20% 38.20% 23.30% 25.20% 35.70% 46.00% 30.20% 82.50% 40.30% 38.10% 54.20% 4.90% 17.70%

10.90% 48.30%

88.50% 19.20%

3.80%

82.70%

68.90%

10.90%

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Table 2. A Closer Look at Brau and Fawcett (2006a) Motivation Question for IPOs from 2000-2002
Panel A. How important were/are the following motivations for conducting an IPO? a. To minimize our cost of capital b. Debt is becoming too expensive c. Our company has run out of private equity d. To create public shares for use in future acquisitions e. To allow one or more principals to diversify personal holdings f. To allow venture capitalists (VCs) to cash-out g. To enhance the reputation of our company h. To establish a market price/value for our firm i. To broaden the base of ownership j. To attract analysts' attention Panel B. How important were/are the following motivations for conducting an IPO? d. To create public shares for use in future acquisitions h. To establish a market price/value for our firm g. To enhance the reputation of our company a. To minimize our cost of capital i. To broaden the base of ownership e. To allow one or more principals to diversify personal holdings j. To attract analysts' attention f. To allow venture capitalists (VCs) to cash-out c. Our company has run out of private equity b. Debt is becoming too expensive Not Important 1 2 6% 14% 7% 14% 11% 14% 14% 21% 18% 13% 22% 16% 21% 24% 40% 12% 35% 19% 39% 29% Very Important 5 24% 16% 14% 19% 15% 15% 7% 14% 12% 4% Not Important 1 2 24 35 66 49 59 32 11 24 38 27 68 20 19 23 12 23 31 22 35 40 Very Important 5 Total Reply 32 167 7 168 20 167 41 170 26 170 24 168 24 169 27 170 25 170 11 168

3 37 29 30 34 30 26 44 48 39 43

4 39 17 26 60 49 30 59 60 53 39

3 20% 28% 26% 22% 23% 18% 26% 15% 18% 17%

4 35% 35% 35% 23% 31% 29% 23% 18% 16% 10%

Mean 3.56 3.39 3.27 3.12 3.11 2.99 2.71 2.54 2.50 2.11

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Panel C. Withdrawn IPOs How important were/are the following motivations for conducting an IPO? d. To create public shares for use in future acquisitions g. To enhance the reputation of our company h. To establish a market price/value for our firm a. To minimize our cost of capital i. To broaden the base of ownership j. To attract analysts' attention f. To allow venture capitalists (VCs) to cash-out e. To allow one or more principals to diversify personal holdings c. Our company has run out of private equity b. Debt is becoming too expensive Panel D. Successful IPOs How important were/are the following motivations for conducting an IPO? f. To allow venture capitalists (VCs) to cash-out a. To minimize our cost of capital j. To attract analysts' attention c. Our company has run out of private equity d. To create public shares for use in future acquisitions i. To broaden the base of ownership b. Debt is becoming too expensive g. To enhance the reputation of our company e. To allow one or more principals to diversify personal holdings h. To establish a market price/value for our firm Not Important 1 2 7% 8% 9% 15% 9% 12% 17% 9% 21% 18% 22% 21% 16% 25% 32% 19% 35% 16% 40% 31% Very Important 5 22% 26% 20% 17% 21% 15% 9% 14% 14% 5% Not Important 1 2 0% 11% 5% 11% 3% 11% 11% 19% 14% 14% 16% 11% 30% 8% 32% 14% 43% 14% 51% 24% Very Important 5 32% 16% 19% 22% 19% 5% 16% 11% 14% 0%

3 11% 16% 35% 22% 35% 38% 19% 24% 16% 11%

4 46% 51% 32% 27% 19% 30% 27% 19% 14% 14%

Mean 4.00 3.62 3.54 3.30 3.16 2.97 2.92 2.62 2.41 1.86

3 28% 21% 24% 20% 19% 17% 21% 19% 19% 15%

4 36% 29% 35% 37% 20% 25% 28% 15% 15% 9%

Mean 3.57 3.48 3.44 3.28 3.02 2.91 2.89 2.61 2.56 2.08

42

Panel E. Never Tried Not Important 1 2 15% 9% 7% 15% 4% 28% 11% 26% 24% 20% 20% 20% 35% 24% 28% 30% 59% 7% 33% 33% Very Important 5 20% 13% 13% 2% 7% 2% 7% 7% 13% 2%

How important were/are the following motivations for conducting an IPO? i. To broaden the base of ownership a. To minimize our cost of capital d. To create public shares for use in future acquisitions f. To allow venture capitalists (VCs) to cash-out c. Our company has run out of private equity j. To attract analysts' attention g. To enhance the reputation of our company h. To establish a market price/value for our firm e. To allow one or more principals to diversify personal holdings b. Debt is becoming too expensive Panel F. No VC-Backing

3 13% 26% 28% 24% 20% 37% 17% 26% 7% 24%

4 43% 39% 26% 37% 30% 22% 17% 9% 15% 9%

Mean 3.43 3.37 3.15 2.93 2.76 2.67 2.37 2.35 2.17 2.15

How important were/are the following motivations for conducting an IPO? d. To create public shares for use in future acquisitions h. To establish a market price/value for our firm a. To minimize our cost of capital g. To enhance the reputation of our company i. To broaden the base of ownership e. To allow one or more principals to diversify personal holdings j. To attract analysts' attention b. Debt is becoming too expensive c. Our company has run out of private equity f. To allow venture capitalists (VCs) to cash-out

Not Important 1 2 12% 12% 10% 10% 21% 15% 17% 15% 27% 8% 24% 24% 30% 19% 33% 25% 38% 21% 60% 9%

3 16% 29% 13% 21% 20% 12% 17% 19% 17% 17%

4 35% 27% 23% 27% 31% 20% 23% 15% 11% 11%

Very Important 5 24% 24% 28% 21% 14% 18% 11% 8% 13% 4%

Mean 3.47 3.45 3.21 3.21 2.98 2.84 2.66 2.40 2.38 1.91

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Panel G. VC-Backing Not Important 1 2 3% 13% 1% 10% 3% 7% 10% 13% 17% 17% 14% 20% 9% 21% 26% 14% 32% 14% 51% 30% Very Important 5 33% 17% 17% 19% 21% 19% 7% 10% 16% 0%

How important were/are the following motivations for conducting an IPO? d. To create public shares for use in future acquisitions g. To enhance the reputation of our company h. To establish a market price/value for our firm i. To broaden the base of ownership f. To allow venture capitalists (VCs) to cash-out a. To minimize our cost of capital j. To attract analysts' attention e. To allow one or more principals to diversify personal holdings c. Our company has run out of private equity b. Debt is becoming too expensive

3 20% 24% 33% 27% 21% 26% 31% 24% 20% 10%

4 31% 47% 40% 31% 23% 20% 31% 26% 17% 9%

Mean 3.79 3.69 3.61 3.36 3.14 3.09 3.07 2.80 2.71 1.77

44