Incentives to Innovate and the Decision to Go Public or Private

55 Pages Posted: 29 Mar 2010

See all articles by Daniel Ferreira

Daniel Ferreira

London School of Economics - Department of Finance; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Gustavo Manso

University of California, Berkeley - Haas School of Business

Andre C. Silva

Nova School of Business and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: March 2010

Abstract

We model the impact of public and private ownership structures on firms' incentives to choose innovative projects. Innovation requires the exploration of new ideas with potential advantages but unknown probability of success. We show that it is optimal to go public when firms wish to exploit the current technology and to go private when firms wish to explore new ideas. This result follows from the fact that privately-held firms are less transparent to outside investors than publicly-held firms. In private firms, insiders can time the market by choosing an early exit strategy when they learn bad news. This option makes insiders more tolerant of failures and thus more inclined to choose innovative projects. In public firms, an early exit strategy is less valuable because there is less information asymmetry about cash flows. In such firms, prices of publicly-traded securities react quickly to good news, providing insiders with incentives to choose conventional but safer projects in order to cash in early when good news arrive. Extensions to the model allow us to incorporate other drivers of the decision to go public or private, such as liquidity and cost of capital. Our model rationalizes recent evidence linking private equity to innovation and creative destruction and also generates new predictions concerning the determinants of going public and going private decisions.

Keywords: going public, innovation, private equity

JEL Classification: G2, G3, O3

Suggested Citation

Ferreira, Daniel and Manso, Gustavo and Silva, Andre C., Incentives to Innovate and the Decision to Go Public or Private (March 2010). CEPR Discussion Paper No. DP7750, Available at SSRN: https://ssrn.com/abstract=1578080

Daniel Ferreira (Contact Author)

London School of Economics - Department of Finance ( email )

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(+44) 20 7955 7544 (Phone)

HOME PAGE: http://personal.lse.ac.uk/FERREIRD/

European Corporate Governance Institute (ECGI)

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Belgium

HOME PAGE: http://www.ecgi.org

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Gustavo Manso

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Andre C. Silva

Nova School of Business and Economics ( email )

Campus de Carcavelos
Carcavelos, 2775-405
Portugal

HOME PAGE: http://sites.google.com/view/andredecastrosilva

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