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583 (Journal of Business, 2003, vol. 76, no. 4) 2003 by The University of Chicago. All rights reserved. 0021-9398/2003/7604-0004$10.00 James C. Brau Brigham Young University Bill Francis University of South Florida Ninon Kohers University of South Florida The Choice of IPO versus Takeover: Empirical Evidence* I. Introduction Recent literature has highlighted a privately held firm’s choice of going public via an initial public of- fering (IPO) or staying private. 1 This literature ad- dresses only two outcomes, staying private or con- ducting an IPO; however, an important, yet unexplored alternative pathway exists for private firms wishing to access public equity markets. Agreeing to a takeover by a publicly traded acquirer is often an attractive opportunity for private firms and presents an alter- native to the IPO route. In this study, we focus on the following four key factors advanced in the current IPO and merger and * We thank Rob Daines, Hal Heaton, Andrew Holmes, Mike Lemmon, Beverly Marshall, Grant McQueen, Bill Megginson, Todd Mitton, Mike Pinegar, Mike Schill, Bernell Stone, Steve Thorley, Keith Vorkink, participants at the BYU and USF finance seminars, participants at the 2000 FMA conference, an anonymous referee, and the editor (Albert Madansky) for helpful comments. All omissions/errors are our responsibility. 1. Examples of literature on IPO vs. staying private include Roell (1996), Brennan and Franks (1997), Bolton and von Thadden (1998), Mello and Parsons (1998), Pagano, Panetta, and Zingales (1998), Pagano and Roell (1998), Stoughton and Zechner (1998), Chemmanur and Fulghieri (1999), Maug (1999), Gomes (2000), and Stoughton, Wong, and Zechner (2001). We examine factors that influence the choice be- tween an initial public offering (IPO) and a takeover by a public ac- quirer. Our results show that the industry concen- tration, high-tech industry affiliation, current cost of debt, relative “hotness” of the IPO market, firm size, and insider owner- ship percentage are all positively related to the probability of an IPO. In contrast, private compa- nies in high market-to- book industries, financial service sectors, highly leveraged industries, and deals involving greater li- quidity for selling insid- ers show a stronger like- lihood for takeovers. Our findings also indicate that a liquidity discount exists in takeovers relative to IPOs.

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583

(Journal of Business, 2003, vol. 76, no. 4)� 2003 by The University of Chicago. All rights reserved.0021-9398/2003/7604-0004$10.00

James C. BrauBrigham Young University

Bill FrancisUniversity of South Florida

Ninon KohersUniversity of South Florida

The Choice of IPO versusTakeover: Empirical Evidence*

I. Introduction

Recent literature has highlighted a privately heldfirm’s choice of going public via an initial public of-fering (IPO) or staying private.1 This literature ad-dresses only two outcomes, staying private or con-ducting an IPO; however, an important, yet unexploredalternative pathway exists for private firms wishing toaccess public equity markets. Agreeing to a takeoverby a publicly traded acquirer is often an attractiveopportunity for private firms and presents an alter-native to the IPO route.

In this study, we focus on the following four keyfactors advanced in the current IPO and merger and

* We thank Rob Daines, Hal Heaton, Andrew Holmes, MikeLemmon, Beverly Marshall, Grant McQueen, Bill Megginson, ToddMitton, Mike Pinegar, Mike Schill, Bernell Stone, Steve Thorley,Keith Vorkink, participants at the BYU and USF finance seminars,participants at the 2000 FMA conference, an anonymous referee,and the editor (Albert Madansky) for helpful comments. Allomissions/errors are our responsibility.

1. Examples of literature on IPO vs. staying private include Roell(1996), Brennan and Franks (1997), Bolton and von Thadden(1998), Mello and Parsons (1998), Pagano, Panetta, and Zingales(1998), Pagano and Roell (1998), Stoughton and Zechner (1998),Chemmanur and Fulghieri (1999), Maug (1999), Gomes (2000),and Stoughton, Wong, and Zechner (2001).

We examine factors thatinfluence the choice be-tween an initial publicoffering (IPO) and atakeover by a public ac-quirer. Our results showthat the industry concen-tration, high-tech industryaffiliation, current cost ofdebt, relative “hotness”of the IPO market, firmsize, and insider owner-ship percentage are allpositively related to theprobability of an IPO. Incontrast, private compa-nies in high market-to-book industries, financialservice sectors, highlyleveraged industries, anddeals involving greater li-quidity for selling insid-ers show a stronger like-lihood for takeovers. Ourfindings also indicate thata liquidity discount existsin takeovers relative toIPOs.

584 Journal of Business

acquisition (M&A) literature that can affect the IPO versus takeover decision:first, industry characteristics (e.g., Mitchell and Mulherin 1996; Pagano et al.1998; Maksimovic and Pichler 2001; Stoughton, Wong, and Zechner 2001);second, the role of market timing (e.g., Ritter 1984; DeLong et al. 1990; Golbeand White 1993; Rajan and Servaes 1997); third, the demand for funds byprivate firms (e.g., Mikkelson, Partch, and Shah 1997; Lowry 2000); andfourth, deal-specific factors such as the size of the firm, insider ownership,and the liquidity effects of the deal. In the extant literature, these four factorsare important separately for IPOs and takeovers. However, to our knowledgeno existing study examines the choice of conducting an IPO or agreeing toa takeover. In this study, we attempt to fill this void by evaluating the impactof industry, market-timing, deal-specific, and fund-demand effects on a privatefirm’s choice of an IPO versus a takeover.

Anecdotal evidence from the financial press indicates that our extension isnot trivial. An increasing number of articles have drawn attention to the choicebetween a takeover or an IPO. For example, a recent Fortune article focuseson the strategic restructuring decisions of serial entrepreneurs. These entre-preneurs create and grow businesses with the express purpose of selling outto large publicly traded firms in lieu of conducting an IPO. Many of thesesame entrepreneurs previously focused on IPOs and have recently changedto the takeover strategy (Gimein 2000). As another example, a recent WallStreet Journal article tells how the insiders at Cerent deviated from theiroriginal IPO plan and sold out to Cisco instead, in a classic example of whathas become known as a “pick-off” (Thurm 2000). Another Wall Street Journalarticle, entitled “Many Firms Take Buyouts after Planning IPOs,” articulatesseveral of the ideas that we formally test in our article (Fitch and Benjamin1998). Specifically, the article discusses the dual paths to equity markets (i.e.,takeover or IPO) and emphasizes how factors such as market and industryconditions affect the choice of a takeover or an IPO. The connection betweenthe takeover and IPO markets is further highlighted by the observation thatsurges in IPO volume have been associated with downturns in takeover activity(“Surfing the IPO Rolls for Targets” 1996, p. 5).

The lack of an academic study on this fundamental restructuring choice aswell as the recognition of this issue in the current financial press and amongpractitioners motivate us to explore which factors determine whether a pri-vately held firm reorganizes via an IPO or a takeover. Although both choicesallow firms to access public equity markets (directly with an IPO and indirectlywith a takeover), we conjecture that different motivations and market con-ditions exist that affect the choice between an IPO and a takeover.

Two important motives for choosing an IPO or a takeover may be the levelof liquidity and ownership insiders require following the completion of thetransaction. The takeover arrangement may make cashing out (or significantlyincreasing liquidity) more efficient than an IPO for the insiders of the firm.Leland and Pyle (1977) argue that insiders who sell large portions of their

IPO versus Takeover 585

firm in the IPO send a signal that the firm is overvalued. Insiders who attemptto liquidate by selling a large amount of personally owned (i.e., secondary)shares in the IPO may depress the price of their firm and decrease both theamount raised in an IPO and the probability of full subscription through thenegative signal they convey. These negative signaling effects are less likelyin takeovers, since acquiring firms might face fewer information asymmetriesrelating to the target firm’s value (see Leland and Pyle 1977). Thus, takeoversoffer selling insiders the ability to divest the entire firm by selling to an existingcompany that may not interpret the exit by insiders as a negative signal.

Closely related to the issue of liquidity is that of ownership and control.Insiders who wish to maintain a controlling ownership in the firm whileobtaining access to capital markets may prefer an IPO. Relative to targetinsiders, IPO insiders do not have an acquiring firm to deal with in mattersof control, and depending on the proportion of primary to secondary shares,may retain effective ownership after the IPO. In our empirical analysis, weexamine the relative importance of insider ownership in the IPO versus take-over decision to ascertain whether, on average, differences in control pref-erences drive private firm owners to choose one type of restructuring routeover the other.

In addition to examining the liquidity and ownership effects of the IPOversus takeover decision, we investigate external factors that can influencethe relative attractiveness of IPOs and takeovers for private firms. Specifically,we argue that certain macroeconomic, stock market and industry factors areimportant determinants in a private firm’s restructuring decision.2 Our inves-tigation of these external influences shows that the degree of concentrationof the private firm’s industry, the high-tech industry affiliation of the firm,the “hotness” of the IPO market relative to the takeover market, and the currentcost of debt are positively related to the probability that a firm will conductan IPO. Also, an analysis of the influence of certain deal-related factors onthe IPO versus takeover decision reveals that larger private firms are morelikely to choose IPOs, and the level of postdeal insider ownership tends tobe higher for IPOs than for takeovers. In contrast, our results indicate thatprivate companies in high market-to-book industries, in financial service in-dustries, and in high debt industries show a stronger likelihood for takeovers.

2. In our analysis, we focus on broad external influences, and not on firm-specific factors, fortwo primary reasons. First, we wish to capture those industry and market-timing factors that areable to explain market-wide tendencies for private firms to take one restructuring route insteadof the other. As previously discussed, recent observations reported in the financial press suggestthat market-related environmental factors play a role in determining broad trends in takeover vs.IPO activity. Additionally, and perhaps more importantly, Mitchell and Mulherin (1996), Paganoet al. (1998), Stoughton et al. (1999), and Maksimovic and Pichler (1999), among others, findthat market and industry factors significantly affect IPOs and takeovers independently. To capturethese broad tendencies, we examine larger numbers of private firms that make the IPO vs. takeoverdecision. Whereas an examination of firm-specific factors is certainly of interest, the severe lackof available data on private firms would significantly reduce our sample and compromise theability to identify the external factors that are thought to influence this choice.

586 Journal of Business

Further, examination of the liquidity versus ownership implications of thesetwo types of transactions indicates that the level of postdeal insider liquidity(ownership) tends to be higher (lower) for takeovers than for IPOs.

In a separate comparison of premiums earned by insiders of IPOs versusinsiders of takeovers, we find that in the aggregate sample, target insidersreceive a takeover payoff that equals approximately 78% of an IPO payoff.Regression analysis suggests that takeover insiders are willing to accept this22% discount due to the greater liquidity they obtain.

The remainder of this article proceeds as follows. Section II contains adiscussion of the theoretical underpinnings for our empirical tests. In SectionIII, we present the data and difference testing between samples consisting oftakeover and IPO firms. Section IV contains multivariate tests of the hypoth-eses, and Section V contains an analysis of the premiums received by issuersin an IPO and sellers in a takeover. We summarize and conclude in SectionVI.

II. Factors Influencing the Relative Attractiveness of IPOsversus Takeovers

In examining the IPO versus private target takeover decision, we focus oncertain industry-related characteristics, market-timing factors, deal-specificfactors, and fund-demand determinants that can influence the relative attrac-tiveness of one restructuring route versus the other. We discuss the possibleimpact of these factors in the following subsections. Most of the variableswe examine are broad market and industry-related factors, and, thus, a cleartheoretical prediction for each factor’s influence on the IPO versus takeoverdecision is not always available. For variables with no clear prediction, weanalyze both sides of the issue by presenting the opposing arguments thatpredict how each factor can influence the decision to choose an IPO or atakeover. After discussing the potential effect of each factor, we test theseempirical issues by examining the relative importance of each variable on theIPO versus takeover choice. For convenience, table 1 provides a succinctsummary of this section. The first column of table 1 lists the variables inquestion. The second column provides the arguments in favor of an IPO, whilethe third column provides the arguments in support of a takeover.

A. Industry-Related Factors

Panel A of table 1 lists the industry-related factors that are likely to determinethe choice of an IPO or takeover. First, the level of concentration within anindustry may influence whether privately held firms conduct IPOs or insteadagree to acquisitions. The likelihood of a takeover, as opposed to that of anIPO, can be smaller in relatively high concentration industries because highconcentration industry environments would have less potential for furtherconsolidation. Further, antitrust concerns and government scrutiny would be

IPO versus Takeover 587

more prevalent in high concentration industries, leading to greater difficultiesin implementing takeovers. Thus, mergers, as opposed to IPOs, would bemore likely to occur in low concentration (fragmented) industries.

However, industries with lower concentration may not be inclined towardincreased concentration if the technological dynamics and demand character-istics of the industry make concentration unattractive as an industrial strategy.3

Further, firm survival can be more difficult in industries that are highly con-centrated, making the takeover route an attractive strategy for smaller, lesscompetitive private firms (see Audretsch 1995; Sharma and Kesner 1996).Thus, given these two counterarguments, the role of industry concentrationin influencing the relative attractiveness of IPOs versus takeovers becomesan empirical issue. Similar to Pagano et al. (1998) and others, we employ theHerfindahl index as a measure of the degree of competition within an industry.4

In essence, this index represents the sum of squared market shares of allmembers of a particular industry and is a measure of the degree of concen-tration within an industry. Higher index values indicate higher industry con-centration. The Herfindahl index is calculated using sales data obtained fromCompustat.

In addition to examining the importance of the degree of concentrationwithin industries, we also test for the influence of distinct types of industriesthrough the use of industry dummy variables. Investor enthusiasm towardnewly public firms operating in high-tech industries in recent years illustratesthe popularity of these new, emerging fields and technologies among investorssearching for the next super growth IPO (see Mandel 1997, p. 58). For ex-ample, the notoriously lofty valuations of many Internet companies that areoften not expected to produce positive earnings in the near future have pro-vided some indication of the favorable perception of firms involved in certainhigh-tech pursuits and emerging industries (Maksimovic and Pichler 2001).Given the popularity of high-tech IPOs among investors over the time periodexamined, privately held high-tech firms may be more likely to capitalize onthis enthusiasm by choosing an IPO instead of agreeing to a takeover (Allenand Gale 1999). Further, a firm’s decision to go public provides a signal tocustomers and investors that the company is willing to provide the periodicalSecurity and Exchange Commission reporting documents and undergo thescrutiny of outside analysts. This aspect of going public can be of particularimportance to firms in high-tech industries where there is a significant amountof uncertainty about the quality of its product(s) and where competitive dy-

3. Different industries would not necessarily have a tendency to move toward the same levelof industry concentration since increased concentration may not provide the same efficiencyeffects across all industries. Thus, in equilibrium, a low concentration industry may have nostrong inclination to become more concentrated in the long run. We appreciate this point providedby our referee.

4. In addition to its common use in the finance and economic literature as a measure of industryconcentration, the Herfindahl index is also utilized by the Justice Department in assessing marketpower for antitrust analysis.

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ofB

usiness

TABLE 1 Summary of Factors in the IPO and Takeover Decisions

VariableDependent Variable p 0Theories Predicting IPO

Dependent Variable p 1Theories Predicting Takeover

A. Industry-related factors:Herfindahl index for private/issue firm

industryHigh concentration industries are less condu-

cive to corporate combinations; antitrustconcerns make takeovers more difficult

Firm survival may be more difficult in highlyconcentrated industries (Audretsch 1995;Sharma and Kesner 1996)

High-tech indicator Investors’ attraction to high-tech IPOs may en-courage IPO activity (Allen and Gale 1999;Maksimovic and Pichler 2001)

High-tech targets tend to receive relatively at-tractive premiums (Kohers and Kohers2000); ability to maintain confidentiality(Yosha 1995)

Financial services indicator Deregulation may motivate private firms to doIPOs to allow for stock payment in futureacquisitions or to raise cash for futureacquisitions

Deregulation of fragmented industry makesconsolidation more feasible (Berger, Dem-setz, and Strahan 1999)

Industry average debt ratio High leverage firms have already undergonethe scrutiny of lenders, leading to lower in-vestigation costs for investors (Harris andRaviv 1990)

Higher leverage firms may opt for the moreconservative restructuring path, i.e., atakeover

Industry average market/book High industry M/B provides favorable environ-ment for IPOs (Pagano et al. 1998)

Target valuation may be based on industryM/B, leading to attractive premiums (Golbeand White 1993)

IPO

versusT

akeover589

B. Market-timing variables:Relative volume of IPOs to mergers Hot issue periods have been found for IPOs

(Ritter 1984; Hoffmann-Burchardi 1999)Clustering of merger activity has been docu-

mented (Mitchell and Mulherin 1996)Market return (MKT) IPOs may be strategically timed during favora-

ble market environments (Lowry 2000)Favorable markets can also encourage bidder

activity (Golbe and White 1993)C. Deal-specific factors:

Total assets and scaled transaction value High fixed cost component of the IPO processmay deter smaller private firms from IPOs(Ritter 1987; Holmstrom and Tirole 1993)

Insider ownership after offer Owners who wish to maintain control preferIPOs (Bebchuk and Zingales 1999)

Target owners can structure takeovers viastock purchases to retain varying levels ofcontrol

Liquidity IPO insiders may sell secondary shares for li-quidity needs (Dhillon, Raman, and Ramirez2000)

Takeovers may be an effective cash-out strat-egy (Brown, Ditmar, and Servaes 2000);IPO insiders selling large personal sharesmay devalue firm (Leland and Pyle 1977)

D. Demand for fund factors:HML Private firms’ need for funds leads to IPOs

(Mikkelson et al. 1997; Lowry and Schwert2000)

A takeover by a public acquirer can provideprivate firms with needed financing as well

SMB Similar to HML, used as a proxy for demandfor funds (Lowry 2000)

Like HML, a proxy for demand for funds

3-month T-bill rate High cost of debt makes IPOs more attractivevia the pecking order (Myers and Majluf1984); high cost of debt makes takeoversharder to fund (Golbe and White 1993)

High cost of debt may decrease the value ofan IPO firm when using discounted cashflows or considering future growthopportunities

590 Journal of Business

namics are an important consideration for the firm’s longevity (Stoughton etal. 2001).

In contrast, Yosha (1995) and Maksimovic and Pichler (2001) argue thatthe potential loss of confidentiality can deter high-tech firms from choosingan IPO. Additionally, in recent years high-tech firms have been attractivetakeover targets for acquiring firms in search of enhanced growth opportu-nities. In examining this high-tech attraction, Kohers and Kohers (2000) findthat the premiums paid for high-tech targets during the late 1980s throughthe mid-1990s were significantly larger than those paid for non-high-techtargets. In our empirical analysis, we examine which of the predictions ismore important in explaining the tendency of private high-tech firms to choosean IPO or to agree to a takeover. High-tech industry identifications are basedon classifications made by Securities Data Company (SDC) and include areasin biotechnology, chemicals, computers, defense, electronics, communications,medical, and pharmaceuticals, among others.

In addition to isolating high-tech industries, we test for effects associatedwith private firms operating in financial service industries. The deregulationoccurring in financial services, in conjunction with the relatively high degreeof fragmentation within these industries, has created an environment that isconducive toward acquisitions and widespread consolidation. Berger, Kashyap,and Scalise (1995) and Berger, Demsetz, and Strahan (1999) present evidencethat supports the consolidation hypothesis. Specifically, they show that con-solidation-promoting bank policy that lifts geographic restrictions (e.g., theRiegle-Neal Interstate Banking and Branching Efficiency Act of 1994) leadsto mergers. Institutions that merge often benefit from economies of scale thatallow income to grow faster than expenses. Further, although the firms weexamine are privately held companies, public information is often availablefor financial firms. As a result, the information acquisition role for conductingan IPO becomes less important (Shah and Thakor 1988; Holmstrom and Tirole1993; van Bommel 1997; Maug 1999; Stoughton et al. 2001). Based on theconsolidation and information acquisition arguments, financial service firmswould be more likely to agree to a takeover rather than to choose an IPO.

However, the consolidation occurring in financial services’ areas might alsopromote IPO activity. Because bidders’ stock is often used as a method ofpayment in these types of mergers, potential acquirers that are privately heldcould be constrained from engaging in merger activity because of their limitedfinancial options. Conducting an IPO would provide the firm with a publiclytraded stock that could be used as a payment method in future acquisitions.This enhanced ability to undertake acquisitions and adapt to changing industryconditions could, in turn, increase the firm’s competitiveness within the in-dustry. In a similar view, even if stock is not needed for acquisitions, the cashraised from public equity sales allows financial service firms to take advantageof the deregulatory environment.

Our next industry-related factor captures the capital structure characteristicsof the private firm’s industry. Following Pagano et al. (1998), we use the

IPO versus Takeover 591

firm’s debt level as a proxy for financial risk. Because leverage ratios are notavailable for many of the private firms in our sample, we assume an equilib-rium capital structure in industries and proxy for firm leverage with the in-dustry leverage ratio (measured as debt/assets). Given the data constraints,this proxy seems reasonable since previous studies such as Bradley, Jarrell,and Kim (1984) have documented strong intra-industry similarities in indi-vidual firm leverage ratios. When evaluating privately held firms, investorsmay perceive high debt levels as a potential risk factor, especially since theseinvestors do not have wide access to other sources of reliable information thatwould be useful in evaluating these companies. Thus, private firms from highlylevered industries may be viewed with an extra degree of caution. As such,all else constant, these firms would be more severely underpriced in an IPOtransaction, thereby leaving a significant amount of money on the table. Con-sequently, the more conservative takeover route may be the more appealingrestructuring path for private firms belonging to highly leveraged industries.

However, an alternative is that highly leveraged firms are generally requiredto undergo close scrutiny and monitoring by creditors, making the investi-gation costs lower for these firms (see Harris and Raviv 1990, 1991). If thesefirms have already passed the hurdles of lenders, potential shareholders mayfree ride on prior bondholder and bank scrutiny and view more highly leveredfirms as attractive IPO candidates. These observations suggest that firms inhighly leveraged industries are likely to use IPOs as their restructuring choice.Overall, in view of these competing arguments, the effect of the industry’sleverage ratio on the choice of IPO versus takeover is an issue to be resolvedthrough empirical testing.

We also employ the market-to-book ratio of the private firm’s industry tocapture the potential influence of industry valuations on the IPO versus take-over choice. In their examination of the going public decision, Pagano et al.(1998) note that high market-to-book ratios in an industry may create anenvironment conducive to IPOs. Alternatively, takeovers may be attractivefor private firms in high market-to-book industries since these multiples canserve as a basis in the target valuation process (Golbe and White 1993). Ourempirical analysis is designed to reveal the relative importance of industryvaluations, as proxied by the market-to-book ratio, for the IPO and privatetarget takeover decision.

B. Market-Timing Factors

Panel B of table 1 lists the market-timing variables that are hypothesized toinfluence the choice between an IPO and a takeover. Ritter (1984) and Ib-botson, Sindelar, and Ritter (1994), among others, document the existence of“hot issue” periods in the IPO market. DeLong et al. (1990), Lerner (1994),Loughran, Ritter, and Rydqvist (1994), Rajan and Servaes (1997), and Pagano,Panetta, and Zingales (1998), among others, also provide evidence of market-timing behavior by managers and underwriters in the IPO market. One ex-

592 Journal of Business

planation for hot issue periods is time variation in adverse selection costs thatleads to periods of favorable market environments, or windows of opportu-nities for issuing equity. This literature contends that during periods charac-terized by high information asymmetry, adverse selection costs are high, and,as a result, fewer firms choose to issue equity. Lowry (2000) and Lowry andSchwert (2000) provide evidence of the impact of adverse selection costs onthe volume of IPOs, while Choe, Masulis, and Nanda (1993) and Bayless andChaplinsky (1996) also find that adverse selection costs influence the timingof seasoned equity offerings.

Another important aspect of the IPO timing hypothesis is that of investorsentiment. The investor sentiment hypothesis argues that periods exist wheninvestors are overly optimistic and are willing to overpay for IPOs. Thus,during these periods, managers and underwriters are more likely to bring IPOsto the market. Lee, Shleifer, and Thaler (1991), Helwege and Liang (1996),Rajan and Servaes (1997), and more recently, Lowry (2000) present evidenceof a positive relationship between IPO volume and investor sentiment in theU.S. market. Pagano et al. (1998) present similar evidence for the Italianmarket. We use two proxies to capture the level of investor sentiment. Thefirst is the return on the stock market (Lowry 2000). The second is a laggedrelative volume variable that measures the quarterly volume of IPOs occurringin a particular industry in the prior quarter, divided by the quarterly volumeof private target takeovers occurring in that industry over the same time frame.This variable is motivated by the fact that both the theoretical literature (Hoff-mann-Burchardi 1999; Maksimovic and Pichler 2001) and empirical evidence(Ritter 1984; Lowry 2000) show that the clustering of IPOs is predominantlyan industry phenomenon.

Mitchell and Mulherin (1996), among others, provide evidence on markettiming in merger activity by revealing clustering of mergers over time. Theyshow an increase in merger activity during industry or economic contractions,periods when information asymmetry tends to be relatively high. Althoughnot strictly comparable because they focus on mergers and acquisitions in-volving publicly held firms, this observed tendency may also be evident inthe private takeover market. The anecdotal evidence cited earlier suggests thatIPOs and takeovers occur in waves that are negatively correlated. If the cyclesare actually simultaneous, then the relative volume of IPOs to takeovers maynot have an effect on the choice between conducting an IPO or a takeover.

C. Deal-Specific Factors

Panel C of table 1 reports the four deal-specific factors and how they mayinfluence the choice between an IPO and a takeover. Perhaps the most definingfirm-level characteristic is firm size. Firm size can provide some indicationof the private firm’s ability to successfully compete as an independent publiclytraded firm. Holmstrom and Tirole (1993) and Pagano and Roell (1998), toname a few, argue that IPOs involve high explicit fixed costs. Evidence pro-

IPO versus Takeover 593

vided by Ritter (1987) is consistent with this argument. Thus, for relativelysmall private firms, conducting an IPO can be quite costly, and the potentialfor success as an independent public company may be limited. Whereas smallfirms may not be equipped to successfully operate as stand-alone public com-panies, they can provide value for acquiring firms who could share their ownresources and skills with the target firm. Similar to Pagano et al. (1998), weuse the total assets of the firm as well as the scaled transaction value as proxiesfor size and as measures of the potential for independent survival. Based onour preceding arguments, we predict a positive relation between the size ofthe firm and the choice of an IPO (and thus a negative relation with the choiceof a takeover).

The level of insider ownership after the reorganization varies when com-paring takeovers and IPOs. The typical IPO allows for gradual changes inownership for insiders wishing to relinquish control of their firm slowly overtime (see Rydqvist and Hogholm 1995; Zingales 1995; Mello and Parsons1998; Bebchuk and Zingales 1999). In a takeover, the controlling stake in theprivate firm changes hands at the time of the transaction. However, the targetowners can maintain a noncontrolling stake in the merged firm, dependingon the method of payment used. For example, the acquisition of a privatefirm through a stock offer enables its owners to retain some stake, albeitindirectly, in their firm after a merger. At the other extreme, cash takeoversprovide the most dramatic change in ownership structure, enabling owners todivest completely and thereby relinquish their stakes in the firm. Since ownerscan tailor the design of either an IPO or a takeover to result in various levelsof control, the degree of insider ownership may not be a critical factor in theIPO versus takeover decision. The ownership issue is thus an empirical one.We measure insider ownership in IPOs as the percentage of the firm not offeredin the IPO (i.e., one minus the ratio of the number of shares offered in theIPO divided by the total number of shares outstanding after the offer). Formergers, insider ownership is the percentage of the stake that target insidershave in the newly combined firm (i.e., the ratio of the target firm value tothe combined firm value, all times the proportion of the takeover paid instock).

Closely related to the level of insider ownership is the issue of insiderliquidity. Private firm owners may seek a particular level of liquidity, whichcan be achieved, to varying degrees, through either an IPO or a private targettakeover. For smaller liquidity needs, the owners may decide on a partial saleof the firm via an IPO, or for maximum liquidity, the private firm ownerscan completely cash out by agreeing to acquisition via a cash offer (Brown,Ditmar, and Servaes 2000; Dhillon, Raman, and Ramirez 2000). However,similar to the insider ownership issue, the proper design of a transaction,whether an IPO or a takeover, could allow the initial owner to achieve thedesired level of liquidity and is, thus, an empirical matter.5 For takeovers, we

5. We thank the referee for highlighting this point.

594 Journal of Business

measure liquidity as the percentage of the offer that is in cash. The metric isbounded above by one (for total cash-outs) and below by zero (for total stockdeals). For IPOs, liquidity equals the ratio of secondary shares offered to totalshares (also bounded by zero and one). Proceeds from secondary shares soldin the IPO go directly to selling insiders as cash payments.

D. Funding Demand Factors

Panel D of table 1 lists three demand for fund factors and their potentialinfluence on the choice between an IPO and takeover. Mikkelson et al. (1997)and Lowry and Schwert (2000) present evidence that one of the most importantreasons for going public is to raise funds for new investments. Since infor-mation on the demand for capital by private companies is not available, weuse as proxies certain variables that have been shown to be good indicatorsof future investment opportunities. Specifically, we use the return on a portfoliothat is long on high book-to-market stocks and short on low book-to-marketstocks (HML), and the return on a portfolio that is long on small capitalizationstocks and short on large capitalization stocks (SMB). The choice of thesevariables as proxies for the demand for funds is based on evidence providedby Liew and Vassalou (2000). They find that HML and SMB, shown byLowry and Schwert (2000) to be good proxies for private firm fund demand,also reliably predict future gross domestic product. In comparing IPOs totakeovers, the preferable restructuring decision for private firms wishing toincrease their access to financing is not clear. As pointed out earlier, an IPOis one path to enhanced financing choices; yet a takeover by a publicly tradedacquirer also provides the private target with access to public capital markets,via the acquiring firm. Thus, our tests are constructed to reveal whether ornot the demand for funds plays a stronger role in either type of transaction.

In addition to HML and SMB, the 3-month T-bill rate is used as a proxyfor borrowing costs at the time of the transaction. Since many acquirers usedebt to finance acquisitions, periods of higher interest rates can result in lessattractive takeover environments (Golbe and White 1993). The pecking orderhypothesis of Myers and Majluf (1984) contends that, for firms that requireexternal financing, the use of debt is attractive only up to a certain level, afterwhich it gets prohibitively costly and external equity becomes the chosenalternative. Thus, for firms that are highly leveraged, equity issues may rep-resent an important source of financing during periods of high interest rates.Taken together, these arguments suggest that, as interest rates increase, thelikelihood of IPOs relative to takeovers increases. Conversely, a higher interestrate may indicate lower firm value in IPO pricing.6 Additionally higher interestrates may also indicate lower future growth opportunities for IPOs. In thiscase, high interest rate environments may decrease activity in the IPO marketrelative to takeovers. Once again, we are left with an empirical issue.

6. The IPO pricing argument relies on a larger discount rate in a discounted cash flow model.We thank Mike Pinegar for this point.

IPO versus Takeover 595

III. Data Description and Difference Tests between IPOsand Takeovers

In this section, we describe the sample used in the subsequent empirical tests.Additionally, we perform difference tests between IPO firms and takeoverfirms as initial tests of our hypotheses outlined in the preceding section.

A. Data

Our aggregate sample consists of two subsamples—an IPO sample and atakeover sample. The IPO sample is obtained from the SDC Global NewIssues database. The initial sample consists of 7,716 firms that conducted afirm commitment IPO from 1984 to 1998. We exclude unit issues (1,025),closed-end funds (505), limited partnerships (85), spinoffs (719), previousleveraged buyouts (283), and foreign issuers (384) from this original SDCdownload to obtain a preliminary group of 4,715 firms. Next we eliminatefirms if there are missing data for the high-tech indicator, financial servicesindicator, industry market-to-book ratio, transaction value, or the Herfindahlindex, resulting in a sample of 4,683 firms. We use the 4,683 firms for themajority of our univariate difference tests.7 Also, we require that IPO firmshave sufficient data available for the regression models used to examine theinfluence of the previously discussed factors. Because some firms have missingvariables, the IPO sample size for the subsequent regressions is 3,147 firms.

Similarly, the takeover sample is drawn from the SDC Mergers and Ac-quisitions database and utilizes all completed deals involving 100% acqui-sitions of U.S. private targets by U.S public acquirers. Using these screeningcriteria, our initial sample consists of 19,908 firms. Excluding limited part-nerships (198) and leveraged buyouts (9,261) results in a sample of 10,449.Again we eliminate firms if there are missing data for the high-tech indicator,financial services indicator, industry market-to-book ratio, transaction value,or the Herfindahl index, resulting in a sample of 4,927 firms. We use all 4,927takeovers for the majority of the univariate tests.8 The data requirements forthe multivariate model lead to a regression sample of 2,691 privately heldtarget firms.

Other databases employed in this study include Compustat (to constructthe Herfindahl industry index) and the Federal Reserve Economic Data(FRED) provided by the Federal Reserve Bank of St. Louis (for the 3-monthT-bill rates and the consumer price index). To control for inflation effects, weadjust all dollar values to 1998 dollars using the consumer price index.

The distribution of takeovers and IPOs in our sample is shown over time

7. Variables with fewer than 4,683 observations include industry leverage ratio (4,417), relativevolume of IPOs to takeovers (3,450), MKT (4,610), total assets (4,187), HML (4,610), and SMB(4,610).

8. Variables with fewer than 4,927 observations include industry leverage ratio (3,451), relativevolume of IPOs to takeovers (4,095), MKT (4,264), total assets (834), ownership (2,647), HML(4,264), and SMB (4,264).

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Fig. 1.—Volume of IPOs and takeovers of private firms from 1984 to 1998. Thevolume of IPOs ( ) and the volume of takeovers of private firms (n p 4,715 n p

) are shown for the firms in the sample from 1984 to 1998.10,449

in figure 1, based on the available observations in SDC. We construct figure1 prior to eliminating observations with missing independent variables tocapture the overall trend of IPOs and takeovers, which results in a samplesize of 15,164 firms (i.e., 4,715 IPOs and 10,449 takeovers). In earlier years,IPOs occurred more frequently than takeovers, while in more recent years,takeovers have clearly gained prominence. Figure 2, which reports the fre-quency distribution for the IPO and takeover samples after firms with missingindependent variables are omitted (resulting in 4,683 IPOs and 4,927 take-overs), provides further evidence of these trends. The bars in the graph rep-resent the ratio of the number of firms in a specific year divided by the totalnumber of firms over all years for a particular subsample. For example, in1984, 4.9% of the IPO sample occurred (i.e., 229/4,683). For each year from1984 to 1995, we observe a larger percentage of IPOs relative to takeovers.This trend reverses from 1996 to 1998, with takeovers representing a largerpercentage. The largest disparities are in 1997 (8.9% IPO vs. 30.5% takeovers)and 1998 (5.7% IPOs vs. 30.0% takeovers). In our subsequent tests, thisintertemporal pattern is controlled for by using constant 1998 dollars, byperforming subperiod tests for the pre- and post-1996 samples, and by in-cluding year dummy variables in the regressions.

In figure 3 we report the industry classification breakdown used in figure2 (4,683 IPOs and 4,927 takeovers). Each column represents the percentageof the specific sample (i.e., IPO or takeover) that is in the particular industrygrouping. Our industry classifications are taken from Kahle and Walkling

IPO

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akeover597

Fig. 2.—Distribution of IPO and takeover sample by year, 1984–98. The volume of IPOs and the volume of private target takeovers for the firmsin the sample are shown over time. The dark (light) bar represents the proportion of IPOs (takeovers) for that year relative to the entire sample ofIPOs (takeovers). The total sample contains 4,683 IPOs and 4,927 takeovers.

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Fig. 3.—Distribution of IPO and takeover sample by industry, 1984–98. Each barrepresents the proportion of either IPOs ( ) or takeovers ( ) for thatn p 4,683 n p 4,927industry relative to the entire sample. A p Agriculture, Forestry, and Fishing, 01–09;B p Mining, 10–14; C p Construction, 15–17; D p Manufacturing, 20–39; E pTransportation, Communications, Electric, Gas, and Sanitary Services, 40–49; F pWholesale Trade, 50–51; G p Retail Trade, 52–59; H p Finance, Insurance, andReal Estate, 60–67; I p Services, 70–89; J p Public Administration, 91–97 (thereare no public adminstration firms in our sample).

(1996). Based upon the two-digit SIC classifications, takeovers are relativelymore prevalent in the manufacturing and retail trade sectors, with IPOs rel-atively higher in the other sectors.

B. Difference Testing between IPO and Takeover Samples

Table 2 reports the results of difference tests between the IPO sample and theprivate target takeover sample. To test for differences in means and differencesin medians, we conduct t-tests and Wilcoxon rank difference tests, respectively.Initial inspection of table 2 shows that the mean and median for each of theindustry, market-timing, and deal-specific variables are significantly differentbetween the IPO and takeover samples (i.e., all the corresponding p-valuesare below 1%). In the remainder of this section, we examine the relationshipsbetween these factors and the IPO versus takeover decision.

As discussed earlier, if takeovers are less likely to occur in industries thatare already highly concentrated, then the Herfindahl index for the takeoversample would tend to be less than that for the IPO sample. Panel A of table2 reveals that the IPO sample mean for the Herfindahl index is significantlygreater than the takeover sample mean ( ). This finding suggests thatp ! .0001takeovers are less prevalent in higher concentration industries, where the po-tential for further consolidation may be limited. The results also provideevidence that high-tech firms, with an IPO sample mean of 24% versus only11% for takeovers, are more likely to go public via an IPO. The soaringpopularity of high-tech IPOs with investors over the time period examinedmay help explain this result. Table 2 also shows that owners of financial

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akeover599

TABLE 2 Difference Tests between IPO and Takeover Sample Occurring from 1984 to 1998

IPO Sample Mean Takeover Sample Mean Difference in Means Parametric p-Value Wilcoxon p-Value

A. Industry-related factors:Herfindahl index for private/issue firm industry .09 .07 .02 !.0001 !.0001High-tech indicator .24 .11 .12 !.0001 !.0001Financial services indicator .17 .21 �.04 !.0001 !.0001Average debt ratio for private firm industry .47 .52 �.05 !.0001 !.0001Average market/book for private firm industry 1.48 1.67 �.20 !.0001 !.0001

B. Market-timing variables:Relative volume of IPOs to mergers 3.15 .45 2.70 !.0001 !.0001Market return (MKT)t 1.44 1.97 �.53 !.0001 !.0001MKTt�1 1.55 1.88 �.33 !.0001 !.0001MKTt�2 1.65 2.10 �.45 !.0001 !.0001MKTt�3 1.54 2.15 �.61 !.0001 !.0001MKTt�4 1.65 2.18 �.53 !.0001 !.0001

C. Deal-specific factors:Total assets ($ million) 267.76 111.38 156.38 .0008 !.0001Transaction value/stake of firm sold ($ million) 138.18 48.25 89.93 !.0001 !.0001Insider ownership after deal (%) 63.73 4.60 59.13 !.0001 !.0001Liquidity of deal (%) 10.77 60.40 �49.63 !.0001 !.0001

D. Demand for fund factors:HMLt�1 .20 .28 �.08 .1068 .0639HMLt�2 .19 .16 .03 .5395 .5593HMLt�3 .25 .19 .05 .2768 .3011HMLt�4 .25 .09 .17 .0011 .0013SMBt�1 �.17 �.25 .09 .1314 .0004SMBt�2 .08 �.16 .24 !.0001 !.0001SMBt�3 .02 �.18 .20 .0006 !.0001SMBt�4 �.07 �.06 �.02 .7925 .0022

3-month T-bill rate 5.34 5.00 .34 !.0001 !.0001

Note.—The mean values for selected variables are shown for a sample of IPOs ( ) and a sample of takeovers involving private targets ( ). Differences in the meann p 4,683 n p 4,927values for the two samples are also provided, along with significance levels for parametric t-tests and nonparametric Wilcoxon rank tests.

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service firms are more likely to agree to be acquired rather than to go publicvia an IPO. This finding supports the argument that the deregulation occurringin financial service industries has helped create an environment more con-ducive to consolidation within these industries.

The findings in panel A of table 2 indicate that the IPO sample mean foreach firm’s industry leverage ratio is significantly less than that for the takeoversample. If higher financial leverage serves as a proxy for risk, then privatefirms from riskier industries have a tendency to take the more conservativerestructuring path, that is, a takeover. Similarly, an examination of the averageindustry market-to-book for the two samples reveals a higher ratio for thetakeover sample than for the IPO sample. Since this ratio can serve as a basisfor the valuation of private targets in takeover transactions, privately heldfirms may find it advantageous to agree to takeovers when these industryvaluations are relatively high.

Panel B reports the market-timing variables. The relative volume of IPOsto mergers indicates that during heavy periods of IPO activity, takeover activitytends to be relatively low and vice versa. This observed clustering of IPOsand takeovers supports the work of Loughran, Ritter, and Rydqvist (1994)and Mitchell and Mulherin (1996), who analyze IPOs and takeovers separately.Furthermore, takeovers of privately held firms tend to occur during periodsof relatively high stock market returns, as evidenced by the higher marketreturn variables for the takeover sample than for the IPO sample. This resultsuggests that favorable market environments encourage bidder activity relativeto IPO activity.

In examining deal-specific factors, panel C indicates that larger firms (mea-sured by total assets) are more likely to undertake an IPO rather than beacquired by a public company. Specifically, IPO firms tend to have about 2.5times the assets of takeover targets ($268 million for IPOs vs. $111 millionfor private targets). Consistent with this finding, our second proxy for size,the average transaction value (i.e., the total amount paid to the private firmowners scaled by the percentage of the firm sold) is significantly larger forIPOs ($138.18 million) than for takeovers ($48.25 million). An examinationof the insider ownership and liquidity characteristics of IPOs and takeoversprovides some preliminary evidence on the ownership versus liquidity trade-off in these two types of transactions. Specifically, insider ownership afterthe deal is more pronounced in IPOs, where insiders retain an average 64%of the firm. In contrast, in mergers, target firm owners average only about5% ownership in the combined firm. The liquidity effects of mergers showthat, on average, private firm owners receive about 60% of the deal’s valuein cash. On the other hand, the liquidity effects of IPOs tend to be significantlymore modest, providing only about 11% liquidity for insiders. Both the own-ership and liquidity findings are consistent with the Leland and Pyle (1977)framework discussed earlier. In Section V, we examine the relationship be-tween liquidity and the premiums paid in takeovers versus IPOs.

IPO versus Takeover 601

Finally, panel D provides mixed results for the explanatory power of thedemand for fund factors in the choice of IPOs versus takeovers. The HMLand SMB factors tend to be larger for IPOs, but this is not the case for allthe lagged coefficients. In a univariate setting, HML and SMB are difficultto interpret because, without adequate controls for competing effects, thesevariables possibly serve as proxies for multiple economic factors. We thereforedefer the interpretation of HML and SMB to the subsequent multivariatesetting. The last demand for fund factor, the 3-month T-bill variable, indicatesthat takeovers tend to occur during times of lower interest rates than IPOs.Since acquirers often use debt to finance acquisitions, they may time theirtakeovers to correspond with cheaper debt markets.

This section has provided, in a univariate setting, initial empirical evidenceon the determinants of the choice between a takeover or an IPO. In an attemptto provide more rigorous tests, we estimate several multivariate models in thefollowing section.

IV. Logistic Regression Results

A. Full Sample Model with the Choice of Either an IPO or Takeover asthe Binomial Choice Dependent Variable

The sample under examination includes firms that choose either an IPO orfirms that choose to be acquired by a publicly traded bidder. Firms that remainprivate or choose any route other than (a) conducting an IPO or (b) beingacquired by a publicly traded firm are omitted from the sample. By focusingon this specific sample we are able to examine how different factors influencethe relative attractiveness of IPOs versus takeovers of private firms. We modelthe dependent variable as a binomial choice variable of either (a) going publicvia an IPO (in which case the dependent variable equals zero) or (b) agreeingto a takeover by a publicly traded company (in which case the dependentvariable equals one). As a result of the bivariate nature of the dependentvariable, we employ a logistic regression methodology and estimate the fol-lowing model:

[0 if IPO or 1 if Takeover]

p a � b industry-related factors�i iip1,5

� b market-timing factors (1)� iip6,11

� b deal-related factors� iip12,13

� b demand for fund factors � � ,� i iip14,22

where the dependent variable equals zero when the transaction is an IPO and

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TABLE 3 Logistic Regressions on Full Sample to Predict a Takeover versus an IPO

VariableWald

EstimateStandard

Error x2 p-Value

Intercept .71 .27 7.04 .0080Herfindahl index �2.25 .51 19.55 !.0001High-tech indicator �.07 .09 .67 .4124Financial services indicator .85 .11 56.78 !.0001Average debt ratio for private

firm industry .37 .17 4.73 .0296Average market/book for private

firm industry .48 .08 35.13 !.0001Relative volume of IPOs to

mergers �.60 .04 283.51 !.0001Market return (MKT)t .01 .01 1.29 .2556MKTt�1 .03 .01 2.91 .0880MKTt�2 �.01 .01 1.02 .3114MKTt�3 .00 .01 .08 .7744MKTt�4 .03 .01 5.42 .0199Log of transaction value �.46 .03 226.88 !.0001Liquidity .04 .00 892.64 !.0001HMLt�1 .02 .02 .53 .4653HMLt�2 �.05 .02 5.47 .0194HMLt�3 �.02 .02 .84 .3585HMLt�4 �.01 .02 .12 .7287SMBt�1 �.01 .02 .34 .5597SMBt�2 �.03 .02 4.58 .0323SMBt�3 �.02 .02 1.40 .2366SMBt�4 .05 .02 10.68 .00113-month T-bill rate �.17 .04 20.23 !.0001�2 log likelihood 4,646.8 !.0001

Note.—The dependent variable is a binary variable equal to 1 for private firms taken over by publiclytraded companies and equal to 0 for private firms conducting an IPO. Each of the lagged factors (SMB, HML,and the market return, MKT) is shown with the corresponding number of lags. The sample consists of 3,147IPOs and 2,691 takeovers.

one when it is a takeover.9 The specific independent variables discussed inSection II are listed in the first column of table 3. The results show that fourof the five industry-related factors have coefficients significantly different thanzero. In addition, the sign of each variable is consistent with the univariatefindings in table 2, indicating that industry effects play a prominent role inthe choice of an IPO or takeover. These results are consistent with the the-oretical arguments of Mitchell and Mulherin (1996), Hoffmann-Burchardi(1999), Maksimovic and Pichler (2001), and Stoughton et al. (2001) thatemphasize the importance of industry factors when testing for the determinantsof IPOs and mergers independently.

The market-timing variable, an extension of the hot issue theories in theIPO and merger literature, predicts a negative coefficient for the relative vol-ume of IPOs to mergers. The result in table 3 provides support for thisprediction, with a negative coefficient that is different from zero beyond the

9. In the subsequent robustness tests, we estimate a multinomial logit and a multinomial generalestimation equation. These specifications relax the binomial assumption of the dependent variable.

IPO versus Takeover 603

1% level. The significance of the relative volume variable suggests that privatefirms tend to time, or herd, when they go public via either an IPO or a takeover.The relative influence of the market return variables, however, is not as clear.Specifically, the coefficients for MKT and its corresponding lags are insig-nificant, except at the first and fourth lags where they are positive and sig-nificant at the 10% and 5% levels, respectively.

Turning to the deal-specific factors, the size proxy (the log of transactionvalue) shows that larger transactions are more likely to be IPOs. The sizevariable result supports the use of size as an indication of the private firm’sability to stand alone as an independent company. In addition, the negativecoefficient for size supports the conjecture that flotation costs can deter smallerprivate firms from conducting IPOs. Furthermore, an examination of the li-quidity effects of the two types of transactions confirms the earlier findingsof table 1. Private firm owners who agree to a takeover experience significantlylarger liquidity as a result of the transaction, as shown by the positive signof the liquidity coefficient, that is significant at the 1% level.10

Similar to the market-return results, the proxies for the demand for fundsalso provide mixed results. The HML factor is negative and significant at lag2. The SMB factor is also negative and significant at lag 2, but positive andsignificant at lag 4. The instability of signs across both HML and SMB andthe lack of significance on the first lags suggest that HML and SMB are notsignificant determinants in the choice of IPO versus takeover. Finally, the 3-month T-bill rate is inversely related to the probability of a takeover, whichsupports the prediction that acquiring firms are more likely to undertake ac-quisitions when debt is cheaper.

B. Method of Merger Payment Models

In this section, we test the robustness of our full model results by examiningthe influence of the method of payment on the decision to conduct a takeoveror an IPO. Similar to the previous analysis, in this section, the sample consistsof firms that were either bought by a publicly traded firm or went public viaan IPO. The dependent variable for each of the first three models in table 4is a binomial choice indicator variable that takes a value of one when thefirm is taken over with either a 100% cash offer (model 1), a mixed offer(model 2), or a 100% stock offer (model 3). When the private firm conductsan IPO, the dependent variable is zero in all three models. Model 4 in table4 reports the results of an ordered multinomial logit regression where thedependent variable is 0 for firms conducting IPOs, 1 for 100% stock takeovers,

10. Given the trade-off between liquidity and ownership for private firm owners, the inverserelationship between these two factors, and the lack of ownership data for takeovers, we includeonly the liquidity variable in the reported regression analysis. In a separate regression incor-porating the ownership variable, the findings showed a negative sign for this factor, which wassignificant beyond the 1% level. Thus, consistent with the findings of table 2, the level of insiderownership is positively associated with the IPO choice.

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TABLE 4 Logistic Regressions: IPOs versus Takeovers by Payment Method

Variable

Dependent Variable

1 if CASH, 0 if IPO(1)

1 if MIXED, 0 if IPO(2)

1 if STOCK, 0 if IPO(3)

3 if CASH, 2 if MIXED,1 if STOCK, 0 if IPO

(4)

EstimatedCoefficient p-Value

EstimatedCoefficient p-Value

EstimatedCoefficient p-Value

EstimatedCoefficient p-Value

Intercept .77 .0135 1.02 .0079 .78 .0138 2 of 3 significantHerfindahl index �.10 .8390 �.98 .1269 �3.39 !.0001 �.47 .1814High-tech indicator �.66 !.0001 �.65 !.0001 .13 .1996 �.42 !.0001Financial services indicator .92 !.0001 .09 .6004 .85 !.0001 .59 !.0001Industry average debt ratio .36 .0457 .64 .0012 .17 .387 .27 .0136Industry average market/book ratio .18 .0423 .07 .5271 .42 !.0001 .04 .5075Relative volume of IPOs to mergers �.99 !.0001 �.99 !.0001 �.65 !.0001 �.73 !.0001Market return (MKT)t .03 .0461 .05 .0072 .00 .9758 .03 .0014MKTt�1 .04 .0113 .07 .0007 .03 .1570 .04 .0003MKTt�2 .01 .5451 .01 .7390 .00 .7962 .01 .2393MKTt�3 .02 .3021 .00 .9709 .01 .4455 .01 .2343MKTt�4 .03 .0453 .04 .0734 .05 .0134 .03 .0052Log of transaction value �.53 !.0001 �.47 !.0001 �.43 !.0001 �.32 !.0001HMLt�1 .02 .5149 .08 .0174 .02 .5782 .03 .1270HMLt�2 �.01 .6644 �.02 .6257 �.05 .0482 �.01 .7321HMLt�3 .00 .8966 �.01 .6779 �.01 .8073 .00 .8283HMLt�4 .03 .2725 �.03 .3536 .01 .7604 .02 .1912SMBt�1 .00 .9564 .02 .2378 �.02 .3367 .00 .9365SMBt�2 �.01 .6517 .00 .966 �.03 .1086 .00 .9081SMBt�3 .02 .2224 .01 .6725 �.03 .0924 .01 .2510SMBt�4 .07 .0001 .09 !.0001 .07 .0001 .05 !.00013-month T-bill rate .00 .9331 �.17 .0035 �.17 .0004 �.07 .0301�2 log likelihood 3,640.30 !.0001 2,520.77 !.0001 3,442.01 !.0001 11,865.09 !.0001

Note.—The dependent variable differs for each model and is indicated at the top of the result columns. Models 1–3 are binomial logit models; model 4 is an ordered multinomial logitmodel. Each of the lagged factors (SMB, HML, and the market return, MKT) is shown with the corresponding number of lags. The cash takeover sample consists of 1,194 firms, the mixedtakeover sample consists of 595 firms, and the stock takeover sample consists of 902 firms. The IPO sample contains 3,185 firms.

IPO versus Takeover 605

2 for mixed takeovers, and 3 for 100% cash takeovers.11 The table 4 analysisis undertaken, in part, because numerous studies have shown that the methodof payment in mergers is an important variable in the value effects of takeoveractivities (e.g., Travlos 1987; Amihud, Lev, and Travlos 1990; Martin 1996;Ang and Kohers 2001). Also, as previously discussed, private firm ownerscompletely relinquish their ownership of the firm in cash offers, while theystill retain some ownership in stock offers. Thus, from the standpoint ofownership, IPOs and stock offers may be more comparable than IPOs andcash takeovers.12

Overall, the results of the method of payment subsample analysis are largelyconsistent with those found for the full sample of takeovers and IPOs in table3. There are nevertheless certain distinctions in the relative influence of thefactors on the IPO versus cash offer (model 1), mixed offer (model 2), andstock offer (model 3) decisions. To avoid redundancy, we focus on the keydifferences in results between the models. The degree of industry concentra-tion, as measured by the Herfindahl index, plays a significant role in influ-encing the IPO versus stock offer decision in model 3, but this factor doesnot have a distinct impact on the other decisions captured in models 1, 2, and4. Also, the high-tech indicator is insignificant in the IPO versus stock takeoverspecification of model 3, suggesting that high-tech sellers tend not to have apreference over IPOs or stock takeovers. In contrast, the high-tech indicatoris negative and significant in models 1, 2, and 4, indicating an increase in thelikelihood of an IPO relative to the types of takeovers captured by thesemodels. This finding suggests that high-tech firm owners, who often providea valuable source of human capital in their firms, are more likely to retainpartial ownership in their firm through an IPO instead of completely cashingout via a cash offer.

Finally, another difference in the method of payment models involves therole of the T-bill variable, the proxy for the cost of debt. In particular, thisfactor is negative and significant in models 2, 3, and 4, indicating that takeoversare more likely than IPOs when the T-bill rate is lower. In contrast, the T-billfactor loses its significance in model 1, which captures the IPO versus cashoffer choice. Since private target takeovers paid fully with cash tend to berelatively smaller transactions, acquirers often do not require significantamounts of debt financing and, thus, may not be particularly sensitive to thecost of debt. In sum, while the overall results in table 4 are similar to those

11. We take the format of our table 4 from Martin’s (1996) table 2. The number of cashtakeovers (model 1) is 1,194; the number of mixed takeovers (model 2) is 595; the number ofstock takeovers (model 3) is 902. The number of IPOs in each model is 3,185 firms. Model 4contains all of the observations from models 1–3. Table 4 contains 38 more IPOs than table 3because the liquidity variable is not required for table 4 and 38 IPO firms have missing data forliquidity.

12. We do include the method of payment as a dummy variable in eq. (1) because it appliesonly to takeovers. The nature of the binomial dependent variable creates a quasi-separation thatcannot converge when only one of the dependent variable choices has a variable with observations.We overcome this obstacle with the analysis reported in table 4.

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reported for the full samples in table 3, this method of payment subsampleanalysis provides additional insights on the relative influence of the factorson the choice between IPOs and different types of takeovers.

C. Further Robustness Tests

Lowry and Schwert (2000) find that IPO volume fluctuates substantially overtime. Figure 1 supports this finding and indicates that the volume of privatetakeovers also fluctuates over time. To control for time period differences, weemployed yearly dummy variables and reestimated the modified equation (1).Estimation results (not reported) showed significant coefficients for the 1997and 1998 periods. However, the findings for the previously discussed variableswere not qualitatively different. In further robustness tests, an alternativemeasure for firm size, total assets, was employed. With the exception of theaverage market-to-book of the firm industry and the 3-month T-bill rate, allof the results were robust to this specification. Because the availability of totalasset figures for privately held firms is more limited than transaction sizeinformation, using this measure would decrease the sample size and hencethe power of our tests. We therefore choose to report the transaction sizespecifications.

Another robustness check further addresses the issue of ownership. Aspreviously discussed, in contrast to IPOs, insiders of a takeover often losesubstantial, if not entire, ownership of the firm. In a subsample analysis, wereestimated equation (1) with all of the takeovers in our sample, but onlythose IPOs where the insiders lose majority stake control of the firm (i.e.,they own less than 50% of the firm after the IPO). Thus, we focused on theset of firms that had chosen either an IPO or a takeover and, at the sametime, had agreed to give up majority ownership of their firms. The results ofthe subsample analysis were consistent with the previous logistic regressionanalyses and, thus, are not shown.

An additional robustness test involved reestimating equation (1) to capturepossible time period shifts in the IPO versus takeover decision. As previouslyreported in figure 1, the frequency of takeovers grew significantly in the periodfrom 1996 through 1998. Thus, the first model was estimated for deals oc-curring between 1984 and 1995, and the second model covers deals between1996 and 1998. In both periods, our results are qualitatively robust, indicatingthat time period effects do not drive our findings.

A final robustness test treats for possible industry clustering in the multi-variate logit model (table 4, model 4). Moulton (1986) provides evidence thatadjusting for the cross-correlation of the error terms in a regression if clusteringexists can increase efficiency of estimators. Using an adaptation of Diggle,Liang, and Zeger’s (1994) method, we construct a generalized estimatingequation that controls for clustering by two-digit SIC code. The results of this

IPO versus Takeover 607

TABLE 5 Various Premiums Associated with Takeovers and IPOs

IPO Takeover Difference Tests

Mean Median Mean MedianParametric

p-ValueNonparametric

p-Value

Complete sample 13.3 7.1 10.9 4.7 .0018 !.0001High-tech sample 13.7 7.9 13.0 7.6 .7455 .2178Non-high-tech sample 13.2 6.6 10.7 4.5 .0025 !.0001Stock only merger sample 13.3 7.1 13.0 4.6 .8597 .0060Cash only merger sample 13.3 7.1 9.5 4.2 .0044 !.0001Stock only high-tech sample 13.7 7.9 18.9 12.0 .1651 .1170Stock only non-high-tech

sample 13.2 6.6 11.8 3.4 .3606 .0008Cash only high-tech sample 13.7 7.9 4.6 3.2 !.0001 .0019Cash only non-high-tech

sample 13.2 6.6 9.9 4.4 .0216 !.0001

Note.—The mean and median values are for the ratio of offer price per share to book value of equity pershare for each respective sample. P-values for tests of differences in the mean and median values for the twosamples are provided, parametric t-tests first with nonparametric Wilcoxon rank tests second. The completesample consists of 4,683 IPOs and 4,927 takeovers.

model are nearly identical to the results of model 4 reported in table 4.13

Overall, these alternative tests and different model specifications providestrong validation of the robustness of the previously examined factors andtheir role in the IPO versus takeover choice for privately held firms.

V. Seller Premiums to Insiders in IPOs and Takeovers

Thus far, we have not specifically examined the premiums received by sellinginsiders. In this section, we explore the pay-offs that selling insiders receivethrough either the takeover or the IPO.

Using the argument of Leland and Pyle (1977), insiders who retain a largerstake of a risky firm issue a costly, and therefore credible, signal of the qualityof the firm. This signal of quality would allow them to obtain a better pricefor the stake they sell. However, if a controlling stake affords the firm’s newowners the ability to extract some private benefits of control from the company,then a controlling stake may command a premium (Zingales 1994). In anattempt to test this issue we analyze the ratio of offer price per share to bookvalue of equity per share for each firm. By using a measure on a per sharebasis, we are able to capture the premium for the portion of the firm sold inthe transaction (either IPO or takeover).

Table 5 reports the results of parametric t-tests (and Wilcoxon rank tests)between the mean (and median) of the IPO and takeover samples. The firstcolumn of the table reports subsamples based on the conditioning variablesof method of payment and high-tech industry status.

13. We thank Rob Daines for pointing out the potential problem of cross correlation of theerror terms and the remedy.

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The complete sample difference tests indicate that the premiums for IPOsare significantly greater on average than the takeover premiums (13.3 vs. 10.9mean, 7.1 vs. 4.7 median, both ). Thus, insiders who choosep-values ! .01the IPO route tend to earn a greater premium (22% larger, on average; i.e.,(13.3–10.9)/10.9]) than insiders who sell out to acquirers. One potential reasonfor the IPO premium may be the existence of a liquidity discount that privatetarget owners experience in takeovers. We documented earlier that takeoversprovide greater liquidity on average than IPOs for selling insiders. This greaterliquidity in takeovers may result in a liquidity discount, as target firm insidersare generally not willing to bear the nonliquidity risk that is associated morewith IPOs. The next two rows of table 5 indicate that this relationship holdsfor non-high-tech firms, but it does not hold statistically for high-tech firms.The finding that high-tech takeover premiums are not significantly smallerthan IPO premiums extends the work of Kohers and Kohers (2000), whoshow that high-tech takeover targets generally receive higher premiums thannon-high-tech targets.

The remaining six rows consider the method of payment and compare IPOswith cash and stock offers, respectively. The premiums paid to IPO insidersare greater than takeover insider premiums in all scenarios except the stockonly high-tech sample. Consistent with the high-tech indicator result in model3, table 4, the IPO and stock offer high-tech takeover premiums are notsignificantly different, supporting the notion that liquidity may be the drivingforce behind the premiums. Focusing on the takeover columns, the stocktakeover sample average 13.0 is greater than the cash takeover sample average9.5 ( , not reported in the table). The significant differencep-value p .0542between the cash and stock takeover samples also supports the liquidity dis-count hypothesis advanced in the paragraph above.

We have suggested that the disparity in premiums reported in table 5 maybe due to varying levels of liquidity between the choice of IPO or takeover.To formally test this conjecture, we estimate the following tobit regressionmodel:

Offer/book value p 13.87 � 0.04 LIQUIDITY � 0.45 TAKEOVER,(! 0.0001) (! 0.0001) (! 0.6124)

(2)

where the dependent variable is the premium paid to selling insiders (i.e., theoffer price per share to book value of equity per share), LIQUIDITY is thepercentage of the takeover or IPO transaction value received in cash by sellers,and TAKEOVER is an indicator variable that equals one when the firm is atakeover and zero when the firm is an IPO.14 Estimated coefficients are reportedin equation (2), and p-values for each are reported beneath in parentheses.The regression results confirm our intuition that the disparity in premiums

14. We use tobit methodology because the dependent variable (offer price to book value) iscensored on the left tail of the distribution at zero.

IPO versus Takeover 609

reported in table 5 is driven by the liquidity associated with the deal. Addi-tionally, the negative coefficient on TAKEOVER suggests that mergers receivea smaller premium than IPOs; however, it is not statistically significant.15 Theresults of equation (2) indicate that insiders in takeovers experience a dis-counted payoff relative to IPOs due mainly to the greater average liquidityassociated with takeovers.

VI. Summary and Conclusions

A fundamental decision facing privately held firms interested in reachingpublic equity markets is the choice between an IPO and a takeover by apublicly traded acquirer. Whereas previous studies have recently highlightedthe importance of industry and market-timing factors in the decision to gopublic via an IPO versus staying private, none of this research has addressedalternative corporate strategies for private firms to access public equity mar-kets. Additionally, the large numbers of privately held companies undertakingIPOs and takeovers make the identification of economic factors that influencefirms to choose one route versus the other inherently interesting.

Using a sample of over 9,500 U.S. privately held firms, we address thisissue by examining the determinants of the IPO choice versus the decisionto be acquired by a publicly traded firm. Our results show that four factors—industry, market-timing, deal-specific, and to a lesser degree demand forfunds—play a role in the IPO versus takeover choice. Specifically, the con-centration of the industry, the high-tech industry status of the private firm,the “hotness” of the IPO market relative to the private target takeover market,the current cost of debt, the percentage of insider ownership maintained inthe firm, and the size of the firm are all positively related to the probabilitythat a firm will conduct an IPO. In contrast, firms in high market-to-bookindustries, financial service firms, firms in high debt industries, and dealsinvolving greater liquidity for selling insiders show a stronger likelihood fortakeovers. Finally, a quantitative analysis of the liquidity effects of the IPOversus takeover decision provides evidence that a liquidity discount of ap-proximately 22% exists in takeovers. Overall, in addressing the IPO versustakeover choice, our study sheds new light on a previously unexplored di-mension of the going public decision for privately held companies and iden-tifies key determinants that influence this fundamental restructuring choicefor private firms.

15. We do not include offer to book value as an independent variable in the full model (i.e.,table 3) because we lose a large portion of the merger sample when we do. In unreported testing,we include offer to book value along with all of the other variables listed in table 3. The coefficienton the offer to book variable is not statistically different from zero in the regression.

610 Journal of Business

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