Direct Listing or IPO? The Anatomy of the Going-Public Market

Abstract

This paper analyzes the impact of direct listing (DL) innovation on firms’ going public decisions and the welfare consequences. I develop and test an adverse-selection model of the DL market. Theory predicts that (1) DL and IPO markets attract different types of firms. DL innovation caters to late-stage firms’ demand for going public without raising capital. (2) DL market is more vulnerable to breakdown. Imposing certification intermediaries is essential in maintaining a well-functioning DL market, which leads to more firm entry into the public market and improved social welfare. (3) DL firms and intermediaries enjoy welfare gains, while public investors may face higher investment risks. These predictions match several empirical patterns in the U.S. and U.K. public markets, including the different characteristics of DL and IPO firms, the low firm participation in the U.S. DL market, and investment banks’ support on the DL market. The analysis implies that better-developed private capital and stock trading markets motivate DL innovation. The paper also highlights the severe informational frictions and the importance of regulation in protecting public investors and preventing market failure in the DL market.

Keywords: Direct Listing, Firm Boundary, Adverse Selection, Certification, Financial Innovation, Regulation

JEL Classification: G24; G32