Market Liquidity

Market Liquidity, Banking & growth

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TI 2006-011/2
Tinbergen Institute Discussion Paper
Market Liquidity, Investor
Participation and Managerial
Autonomy:
Why do Firms go Private?
Arnoud W.A. Boot
1
Radhakrishnan Gopalan
2
Anjan V. Thakor
3
1 University of Amsterdam, Tinbergen Institute, and CEPR;
2
Stephen M. Ross School of Business, University of Michigan;
3
Olin School of Business, Washington University in St Louis.
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MARKETLIQUIDITY,INVESTOR
PARTICIPATIONANDMANAGERIAL
AUTONOMY:WHYDOFIRMSGOPRIVATE?
by
ArnoudW.A.Boot,RadhakrishnanGopalanandAnjanV.Thakor
December29,2005
BootisfromtheUniversityofAmsterdamandCEPR,a.w.a.boot@uva.nl,GopalanisfromtheStephenM.
RossSchoolofBusinessattheUniversityofMichigan,gopalanr@umich.eduandThakoristheJohnE.Simon
ProfessorofFinance,OlinSchoolofBusiness,WashingtonUniversityinSt.Louis,thakor@wustl.edu.We
thankYhakovAmihud,PatrickBolton,KoseJohn,RafaelRepullo,seminarparticipantsatthe2005ACLE/JFI
Conferenceon“TheOwnershipoftheModernCorporation:EconomicandLegalPerspectivesonPrivateversus
Publicly-listedCorporations”,andseminarparticipantsatAmsterdam,BIOslo,Frankfurt,Georgetown,and
NYUforusefulcomments.
ABSTRACT
Weanalyzeapublicly-tradedfirm’sdecisiontostaypublicorgoprivatewhenmanagerial
autonomyfromshareholderinterventionaectsthesupplyofproductiveinputsbymanage-
ment.Weshowthatboththeadvantageandthedisadvantageofpublicownershiprelativeto
privateownershiplieintheliquidityofpublicownership.Whiletheliquidityofpublicowner-
shipletsshareholderstradeeasilyandsupplycapitalatalowercost,theliquidity-engendered
tradingalsoresultsinstochasticshockstoafirm’sshareholderbase.Thisexposesmanagement
touncertaintyregardingtheidentityoffutureshareholdersandtheirextentofintervention
inmanagementdecisionsandinturncurtailsmanagerialincentives.Bycontrast,becauseof
itsilliquidity,privateownershipprovidesastableshareholderbaseandimprovestheseinput-
provisionincentivesbutresultsinahighercostofcapital.Thus,capitalmarketliquidity,
whilebeingaprincipaladvantageofpublicownership,alsohasasurprising“darkside”that
discouragespublicownership.Ourmodeltakesseriouslyakeydierencebetweenprivateand
publicequitymarketsinthat,unliketheprivatemarket,thefirm’sshareholderbase,namely
theextentofinvestorparticipation,isstochasticinthepublicmarket.Thisallowsustoextract
predictionsabouttheeectsofinvestorparticipationonthestockpricelevelandvolatility
andonthepublicfirm’sincentivestogoprivate,therebyprovidingalinkbetweeninvestor
participationandfirmparticipationinpublicmarkets.Lesserinvestorparticipationinduces
lowerandmorevolatilestockprices,encouragingpublicfirmstogoprivate,whereasgreater
investorparticipationencouragesyoungerfirmstogopublic.Moreover,IPOunderpricingis
optimalbecauseitisshowntoleadtoahigherandlessvolatilepost-IPOstockprice,greater
autonomyforthemanagerandahighersupplyofprivately-costlymanagerialinputs.
MARKETLIQUIDITY,INVESTOR
PARTICIPATIONANDMANAGERIAL
AUTONOMY:WHYDOFIRMSGOPRIVATE?
“Thepublicbedamned”
WottVanderbilt,ReplytoReporter,1883
1INTRODUCTION
Whenshouldapublicly-tradedfirmdecidetogoprivate?Thisquestion,whichweaddressin
thispaper,isofcentralimportanceinthetheoryofthefirm,andhasbeenbroughtintosharper
focusbyrecentevents.Duringthe1990s,scoresofcompanieswentpublic,manyquiteyoung,
withinitialpublicoerings(IPOs)soldatunprecedentedprice-earningsmultiples.However,
sincetheprecipitousdeclineofthestockmarket,the“going-public”waveappearstohave
beenreplacedbyadelistingsurge.ThenumberofU.S.companiesdelistingwas35in1999,66
in2000and86in2003.Continuingthistrend,200companiesappliedfordelistingin2004.
1
Manyhaveconjecturedthatthedeclineinstockpricesafter2000hasinducedfirmstogo
private,asortofflipsideoftheobservationthatIPOsarelargelyabull-marketphenomenon
(e.g.RitterandWelch(2002)).Butwhyshouldprivately-heldfirmsgopublicwhenstock
pricesarehighandpublicly-tradedfirmsgoprivatewhenstockpricesarelow?
Anadditionaldevelopmentthathasbeensuggestedasafactoristherecentsetofchanges
inthecorporategovernanceofpublicly-tradedfirms.IntheU.S.,thisinvolvedthepassage
oftheSarbanes-OxleyAct.ThisAct,passedinthewakeofaccountingscandalsandother
corporateabusesathighly-visiblepublicly-tradedfirms,isintendedinparttorestoreinvestor
confidenceinthepublicstockmarketandensurecontinuedinvestorparticipation.Butit
hasbeensuggestedthatthismayincreasethecostsofbeingpublicanddiscouragepublic
ownership.
2
Thereis,however,noformaltheorythatprovidesanylinkbetweenafirm’s
decisiontogoprivate,investorparticipationinpubliccapitalmarkets,thelevelofitsstock
price,andthestringencyofitscorporategovernance.
1
AsimilartrendhasbeenobservedinEurope,wherethenumberoffirmsgoingprivatewentfrom32in1998
to50in2003,peakingduringthisperiodat75in1999.
2
Forexample,Deutsch(2005)reportsintheNewYorkTimes:“ThesharesofFidelityBancorphavealways
beenthinlytraded,anditsexecutiveswonderedwhyitbotheredtobeapubliccompanyatall.Still,they
neverreallyconsidereddelistingthestockuntilCongresspassedtheSarbanes-OxleyAct,withitsmyriadnew
reportingrequirements,in2002.
InNovember,thebankannouncedthatitwas“goingdark”-delistingitsstockfromtheNasdaqmarket.”
1
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