Valuation Risk, Control and the Public Financing of Entrepreneurial Firms

52 Pages Posted: 10 Sep 2008 Last revised: 9 Mar 2010

Hadiye Aslan

Georgia State University - Department of Finance

Praveen Kumar

University of Houston - Department of Finance

Date Written: May 7, 2008

Abstract

Entrepreneurial firms seeking public financing are typically intrinsically difficult to value, and investors are subject to valuation risk. Public firms, motivated by profitable acquisition opportunities, compete with stock markets (i.e., IPOs) in evaluating and financing such firms. We theoretically and empirically analyze the allocation of going-public firms between IPOs and acquisitions when there is valuation risk and costly information generation by investors. Owners of private firms trade off the loss of control from sellouts against IPO price discounts due to valuation risk. We empirically test the predictions from this framework on the universe of private firms (i.e., including those that choose not go public) in the UK during 1996-2006. Consistent with the theoretical predictions, but in contrast to the recent literature on merger and acquisition activity between publicly traded firms, stock market overvaluation and higher expected capital productivity have a negative influence on acquisitions of private firms, especially for family-owned and concentrated-ownership private firms. Moreover, other things held fixed, high valuation-risk firms are more likely to be acquired by public firms than do IPOs because public firms have greater incentives for increasing information investment for such firms compared with the dispersed owners in the stock market.

Keywords: Valuation Risk, Control Benefits, Overvaluation, Initial Public Offers; Acquisitions

JEL Classification: G32, D23

Suggested Citation

Aslan, Hadiye and Kumar, Praveen, Valuation Risk, Control and the Public Financing of Entrepreneurial Firms (May 7, 2008). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1266356 or http://dx.doi.org/10.2139/ssrn.1266356

Hadiye Aslan

Georgia State University - Department of Finance ( email )

35 Broad Street
Atlanta, GA 30303-3083
United States

Praveen Kumar (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

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