Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 174: The Stock Market as a Screening Device and the Decision to Go Public

Tore Ellingsen () and Kristian Rydqvist
Additional contact information
Tore Ellingsen: Department of Economics, Postal: Stockholm School of Economics, Box 6501, 113 83 Stockholm, Sweden
Kristian Rydqvist: Norwegian School of Management

Abstract: We argue that many firms become publicly traded on a stock exchange as the first stage of a longer term divestment plan. Making a direct sale of unlisted stock may be associated with great adverse selection costs. The publicly listed stock price reduces adverse selection by aggregating the information of several investors, and this market valuation, rather than the cash infusion, could be the main benefit of an initial public offering. This theory provides a unified treatment of a whole range of empirical observations, in particular why initial owners frequently exit completely subsequent to an initial public offering (IPO) and why the number of stock market introductions increases with the stock price level. The model also reformulates the ”sweet taste” explanation of IPO underpricing in a way which is consistent with recent evidence. Finally, we argue that the number of firms which go public is inefficiently large.

Keywords: IPOs; going public; seasoned offers; underpricing; adverse selection

JEL-codes: G32; G14

30 pages, May 1997

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