IPO Waves, Product Market Competition, and the Going Public Decision: Theory and Evidence

Thomas J. Chemmanur Jie He

Abstract

We develop a new rationale for IPO waves based on product market considerations, and empirically test the implications of our theory. We model an industry with two competing firms, one of which has higher productivity of capital compared to the other. The two firms assess a significant probability of a positive productivity shock affecting their industry in the near future. Going public, though costly, not only allows each firm to raise external capital at a lower cost compared to a private firm, but also allows it to grab market share from its competitor if the latter remains private. In the above setting, we solve for the decision of each firm whether to go public or remain private, and if it chooses to go public, the optimal timing of going public. We show that, in equilibrium, even firms with sufficient internal capital to optimally fund their investment may go public, driven by the possibility of their product market competitors going public. We also show that IPO waves may arise in equilibrium even in industries which do not experience a positive productivity shock. Our model develops several testable predictions for IPO waves and post-IPO profitability, two of which are as follows. First, firms going public during an IPO wave will have lower post-IPO profitability than those going public off the wave. Second, firms going public earlier in an IPO wave will have higher post-IPO profitability than those going public later in the wave. We empirically test these and other predictions of our model and find supporting evidence.