Reaching for Yield in the Going-Public Market: Evidence from SPACs

Abstract

This paper provides a unified explanation for the existence, time-series variation, and recent boom of the Special Purpose Acquisition Company (SPAC). We develop a theoretical framework in which SPAC and IPO markets serve different types of production firms and public investors. SPAC managers act as non-bank certification intermediaries and match yield-seeking investors with value-creating but risky production firms. Reaching for yield in the going-public market contributes to the rise of SPACs. Our model jointly explains several empirical patterns regarding the U.S. SPAC market: (1) Compared to IPO firms, SPAC firms are ex-ante smaller, riskier, but grow at higher or similar rates after going public. (2) SPAC issuance boomed in 2007 prior to the Global Financial Crisis and accelerated from 2015 to 2020. (3) The market share of SPACs is strongly positively correlated with equity market sentiment. Our model implies that a well-functioning SPAC market improves social welfare and stimulates economic growth by allowing creative, risk-taking firms to go public, increasing innovative activity ex-ante. Finally, we highlight the importance of aligning SPAC managers with long-term investors and provide recommendations for an improved SPAC structure.

Keywords: SPAC, IPO, Going-Public, Reaching-for-Yield, Non-Bank Intermediaries, Adverse Selection, Innovation

JEL Classification: G24, G32