Using a hand-collected data set of private firm acquisitions and IPOs, this paper develops the first empirical analysis in the literature of the “IPO valuation premium puzzle,” which refers to a situation where many private firms choose to be acquired rather than to go public at higher valuations. We also test several new hypotheses regarding a private firm's choice between IPOs and acquisitions. Our analysis of private firm valuations in IPOs and acquisitions indicates that IPO valuation premia disappear for larger VC backed firms after controlling for various observable factors affecting a firm's propensity to choose IPOs over acquisitions. Further, after controlling for the long-run component of the expected payoff to firm insiders from an IPO exit, we find that the IPO valuation premium vanishes even for larger non-VC backed firms and shrinks substantially for smaller firms as well. Our Heckman-style treatment effects regression analysis demonstrates that the above results are robust to controlling for the selection of exit mechanism by firm insiders based on unobservables. Our findings on private firms' choice between IPOs and acquisitions can be summarized as follows. First, firms operating in industries characterized by the absence of a dominant market player (and therefore more viable against product market competition) are more likely to go public rather than to be acquired. Second, more capital intensive firms, those operating in industries characterized by greater private benefits of control, and those which are harder to value by IPO market investors are more likely to go public rather than to be acquired. Third, the likelihood of an IPO over an acquisition is greater for venture backed firms and those characterized by higher pre-exit sales growth.

We analyze a private firm’s choice of exit mechanism between initial public offerings (IPOs) and acquisitions, and we provide a resolution to the “IPO valuation premium puzzle.” The private firm is run by an entrepreneur and a venture capitalist (VC) (insiders) who desire to exit partially from the firm. A crucial factor driving their exit choice is competition in the product market: While a stand-alone firm has to fend for itself after going public, an acquirer is able to provide considerable support to the firm in product market competition. A second factor is the difference in information asymmetry characterizing the two exit mechanisms. Finally, the private benefits of control accruing to the entrepreneur post-exit and the bargaining power of outside investors versus firm insiders are also different across the two mechanisms. We analyze two situations: the first, where the entrepreneur can make the exit choice alone (independent of the VC), and the second, where the entrepreneur can make the exit choice only with the concurrence of the VC. We derive a number of testable implications regarding insiders’ exit choice between IPOs and acquisitions and about the IPO valuation premium puzzle.

We analyze a firm’s choice between dividends and stock repurchases under heterogeneous beliefs. Firm insiders, owning a certain fraction of equity, choose between paying out cash available through a dividend payment or a stock repurchase, and simultaneously choose the scale of the firm’s project. Outsiders have heterogeneous beliefs about project success and may disagree with insiders. In equilibrium, the firm distributes value through dividends alone, through a repurchase alone, or through a combination of both. In some situations, the firm may raise external financing to fund its payout. We also develop results for long-run stock returns following dividends and repurchases. (JEL G32, G35) Received June 2, 2020; editorial decision November 3, 2020 by Editor Andrew Ellul.

We study an environment with short-sale constraints and heterogeneous beliefs among outsiders and between insiders and outsiders. Firm insiders choose between equity, debt, and convertible debt to raise external financing. We analyze two settings: one in which heterogeneous beliefs is the only market imperfection and another in which there are significant security issue and financial distress costs. Our model generates a pecking order of external financing different from asymmetric information models, and new predictions for capital structure, sequential tranching of securities, the price impact of security issues, and long-run stock returns. We also provide a new rationale for convertible debt issuance.

We develop a theoretical model providing a new rationale for venture capitalist (VC) syndicate formation and empirically test our model predictions. An entrepreneur obtains financing and two different value-adding inputs from a single VC or from two different VCs, each operating in his area of expertise. We characterize the entrepreneur’s equilibrium choice between contracting with a single VC, individually with multiple VCs, or with a VC syndicate. We show that syndicates mitigate VCs’ moral hazard problem in value addition. We also analyze the dynamics of VC syndicate composition. The results of our empirical analysis are consistent with our model’s predictions.

We develop a theory of new-project financing and equity carve-outs under heterogeneous beliefs. In our model, an employee of a firm generates an idea for a new project that can be financed either by issuing equity against the cash flows of the entire firm (“integration”), or by undertaking an equity carve-out of the new project alone (“non-integration”). While the patent underlying the new project is owned by the firm, the employee generating the idea needs to be motivated to exert optimal effort for the project to be successful. The firm's choice between integration and non-integration is driven primarily by heterogeneity in beliefs among outside investors (each of whom has limited wealth to invest in the equity market) and between firm insiders and outsiders: if the marginal outsider financing the new project is more optimistic about the prospects of the project than firm insiders, and this incremental optimism of the marginal outsider over firm insiders is greater regarding new-project cash flows than that about assets-in-place cash flows, then the firm will implement the project under non-integration rather than integration. Two other ingredients driving the firm's financing choice are the cost of motivating the employee to exert optimal effort, and the potential synergies between the new project and assets in place. We derive a number of testable predictions regarding a firm's equilibrium choice between integration and non-integration. We also provide a rationale for the “negative stub values” documented in the equity carve-outs of certain firms (e.g., the carve-out of Palm from 3Com) and develop predictions for the magnitude of these stub values.

We analyze PIPE (Private Investments in Public Equity) transactions in which the issuer experienced class action lawsuits. We explain the associated information effects measured by the announcement wealth effects and the discounts. Using a comprehensive, hand-gathered dataset, we show that the more severely litigated PIPEs are associated with higher announcement wealth effects and higher levels of discounts. We find that the issuer's voluntary disclosure positively influences PIPE information effects particularly when coupled with auditor changes. We report that certain mitigation actions affect the pricing of PIPEs along with their associated wealth effects while facing ongoing litigation. We posit that confidentiality in privately negotiated securities is the key in litigated transactions as issuers efficiently share the operational details of mitigation efforts. PIPE transactions are not necessarily costlier funding venues even when securities class action lawsuits are ongoing compared to the PIPE transactions that did not experience any prior litigation action.