When Firms Go Private: Signs Are Obvious
Ross School professors can accurately predict which companies will go private—even at the time of the IPO.
ANN ARBOR, Mich.—Many factors that drive public companies to go private are evident throughout their public life—even at their initial public offering (IPO), say researchers at the University of Michigan’s Ross School of Business.
Using data from the time of the IPO to when a firm decides to go private, Ross School finance professors Sreedhar Bharath and Amy Dittmar are able to accurately predict which firms will become private about 83 percent of the time.
"On average, firms that ultimately go private remain in the public market for more than 13 years after their IPO," Dittmar said. "Despite this fact, these
firms are very different and discernable relative to firms that remain public.
"The results at the IPO not only provide evidence of the choice between being private or public, but also indicate that it is possible to determine the relative costs and benefits of being public early in the firm's public life. It seems that at least in part there is something inherent to the firm at the time of the IPO that determines if it will
ultimately go private."
In their study, "Why Do Firms Use Private Equity to Opt out of Public Markets?" Dittmar and Bharath examined 1,451 public U.S. firms that went private between 1980 and 2004, comparing them to 6,640 IPO firms that remained public during that time.
They found that companies that are more likely to go private have less coverage by stock analysts, fewer institutional holdings, greater concentrated ownership and more informed trading at the time of the IPO, compared to firms that remain public. This, they say, shows the importance of information considerations in the choice between being public or private.
In addition, firms that go private are less liquid and have less share turnover—which supports the importance of liquidity issues, they say. These companies also have lower capital expenditures, indicating fewer investments and less need for capital.
Moreover, going-private firms have lower market-to-book ratios, higher return on assets, higher leverage, less cash, more tangible assets and engage in fewer mergers and acquisitions than firms that remain public.
"Assuming the firm's IPO decision was optimal, these results suggest that firms that ultimately go private may be just above this threshold where benefits exceed the costs at the time of the IPO, but reverse the going-public decision once they fall below the threshold," Bharath said. "Alternatively, the results may indicate that these are firms that should not have gone public and, in time, reversed this sub-optimal decision."
Bharath and Dittmar also examined the impact of market and macroeconomic forces on firms' decisions to go private. They found that the likelihood of going private increases significantly in high sentiment and hot private equity markets and decreases in hot IPO markets. Further, supply of debt in the economy and costs of bankruptcy may be influencing factors, as well, they say.
"Since 2000, we have seen a resurgence in going-private transactions, fueled by the development of the private equity market," Dittmar said. "Given the size and growth of this market, it is important to understand the economic forces that determine these decisions.
"Our analysis shows that we are able to predict which firms will go private, on average, 13 years before they make this decision. It is not so much the path that the firm takes but factors inherent and observable to the firm at the time of going public that determines if it will eventually go private."
Their paper, "Why do firms use private equity to opt out of public markets?" won the LECG Best Paper in Corporate Finance and Governance award at last month's European Finance Association conference.
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