Accessing Capital : US Private Firms

The sources analyze the IPO decisions of US private firms by examining which ex-ante characteristics predict whether a firm chooses to go public, explicitly focusing on selection effects—that is, the types of firms that choose to IPO. The main hypothesis investigated is whether private firms with greater needs for external capital are more likely to go public.

The analysis uses several firm characteristics—or ex-ante predictors—to determine the likelihood of a firm going public within the next three years, measured using a linear probability model.

Key Predictor: External Capital Needs (Financing Deficit)

The primary finding supporting the access to capital motive is the predictive power of the financing deficit, which serves as a proxy for the firm's expected external financing needs.

• Positive Relationship: Firms with higher financing deficits—defined as (capex - EBITDA)/assets—are more likely to go public.
• Magnitude: A one standard deviation increase in a firm's Financing Deficit (0.23) is associated with a 73% increase in its likelihood of going public.
• Comparison to Control Firms: On average, IPO firms have a financing deficit close to zero (-0.00), while non-IPO firms have a significantly negative financing deficit (-0.12), indicating that the average firm that stays private internally generates more cash flows than it needs to fund its investment.

Components of the Financing Deficit

When the two components of the financing deficit are analyzed separately, they reveal distinct relationships with the IPO decision:

1. Ex-Ante Investment (Capex/Assets): Investment positively predicts future IPOs.
2. Profitability (EBITDA/Assets): Profitability negatively predicts future IPOs.

The fact that profitability negatively predicts going public is consistent with the idea that more profitable firms have less of a need to go public because internally generated cash flows can fund their investments. This result contrasts with earlier studies on European data.

Furthermore, the relationship between investment needs and going public is stronger for less profitable firms. The analysis finds that the interaction coefficient between Capex/Assets and EBITDA/Assets is negative and statistically significant, suggesting that internally generated cash flows only matter to the extent that firms have substantive investment needs to begin with.

Other Significant Ex-Ante Predictors

The following characteristics are also found to predict the likelihood of an IPO:

• Firm Size (Log(1+Sales)): Larger firms are more likely to go public, consistent with the existence of large fixed costs associated with the IPO process. A 10% increase in sales increases the likelihood of a firm going public by 12% from its base rate of 0.20%.
• Sales Growth: Faster-growing firms are more likely to IPO. A one standard deviation increase in sales growth (0.42) is associated with just over a 100% increase in the likelihood of going public.
• Leverage (Debt/Assets): Firms with higher leverage are more likely to go public. This positive effect becomes more pronounced and statistically significant when industry effects are controlled for.
• Industry Market-to-Book Ratio: The industry-level market-to-book ratio has a positive relationship with the propensity to go public, consistent with firms that have greater investment opportunities being more likely to go public.

Analysis of VC-Backed Firms

When restricting the sample to VC-backed firms, the relationship between high external capital needs and the propensity to go public is even stronger.

• The coefficient estimates for the Financing Deficit are larger for VC-backed firms than in the baseline tests.
• This stronger effect suggests that firms with VC backing might be more subject to asymmetric information and, therefore, find the public market particularly attractive when their external capital needs are high.

The consistent evidence that firms with high external capital needs (high investment/low profitability) are more likely to go public supports the conclusion that improved access to capital is a key motive for US private firms going public.

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The identification of ex-ante predictors is crucial because while subsequent analyses of firm outcomes capture both the causal impact of the IPO (treatment effects) and the pre-existing characteristics of the firms that choose to go public (selection effects), these initial tests specifically isolate the selection effects, revealing which firms find the IPO decision most advantageous due to their need for external financing.

 The sources provide detailed evidence that firms successfully improve their access to capital and increase investment in the four years following an Initial Public Offering (IPO), consistent with the hypothesis that improved access to capital is a key motive for going public.

The analysis of post-IPO outcomes often captures both the causal effect of the IPO (treatment) and the pre-existing traits of the firms that chose to go public (selection). The findings below are generally documented by comparing IPO firms to comparable control firms that remain private over the four-year post-IPO window.

Investment and Asset Growth (4 Years)

Firms dramatically increase their investment and assets relative to their matched private counterparts after going public.

• Investment: Four years following the IPO, firms' capital expenditures (capex) increase by over 40% (specifically, a statistically significant 46%) compared to matched non-IPO control firms.
• Total Assets: This increase in investment translates directly into asset growth. IPO firms' total assets increase 40% more than control firms four years after the IPO.
• Intangible Assets: The growth is observed in both tangible and intangible assets. Four years after the IPO, intangible assets increase 23% more than matched non-IPO firms.

Financing and Debt Structure Dynamics (4 Years)

A crucial finding is how firms finance this post-IPO asset and investment growth. The growth is largely funded by debt, suggesting that the IPO facilitates broader debt market access alongside equity raises.

• Debt Increase: The total amount of debt held by IPO firms increases by about 65% relative to control firms four years after the IPO.
• Leverage Dynamics: Although the influx of IPO equity initially causes leverage ratios to drop significantly (about 4 percentage points) in the first year, subsequent debt issuance results in a reversion of leverage. Consequently, four years after going public, the leverage ratios (Debt/Assets) are not significantly different from those of the matched control firms. This outcome contrasts with findings from older studies on European markets.
• Shift to Market-Based Debt: Firms increase their usage of market-based debt financing, including syndicated loans and public bonds, which is argued to be facilitated by increased transparency following the IPO.
  • Syndicated Loans: The ratio of syndicated debt to total debt increases by about 15 percentage points after the IPO, representing a 167% increase relative to the baseline.
  • Bonds: The proportion of total debt comprised of public bonds increases by almost 8 percentage points by year four, with this increase occurring only after the IPO.

Improved Borrowing Terms and Reduced Asymmetric Information

The improvements in capital access are directly linked to better borrowing terms facilitated by reduced information asymmetry.

• Reduction in Asymmetric Information: A key indicator is the change in the dispersion of banks’ private risk assessments (Probability of Default, PD). Consistent with a reduction in asymmetric information, the dispersion in PD estimates drops significantly after the IPO and persists through the four-year period. By year four, the dispersion is 6 percentage points lower than for control firms, suggesting that banks' beliefs converge due to the increased transparency afforded by the public listing.
• Improved Borrowing Costs: Newly public firms borrow from banks at more favorable terms. After controlling for the underlying risk of the borrower using banks' internal PD and Loss Given Default (LGD) assessments, the analysis finds that firms' borrowing costs drop by 38 basis points (bps) after going public. This 38bp drop represents a 21% reduction in credit spreads relative to the pre-IPO average, suggesting the drop is driven, at least partially, by an improvement in borrowing terms rather than just a reduction in risk.
• Expanded Pool of Lenders: Going public allows firms to borrow from a broader pool of lenders. Four years post-IPO, IPO firms borrow from just under one more bank relative to control firms, starting from a baseline of 2.3 banks.

The sources present strong evidence that the reduction in asymmetric information is a key mechanism through which private US firms gain improved access to capital after deciding to go public. The increased transparency resulting from an IPO helps to mitigate problems like adverse selection and hold-up, allowing firms to raise capital more easily and at a lower cost.

The analysis relies on detailed data, including banks’ private risk assessments of borrowers (Probability of Default or PD, and Loss Given Default or LGD), which is uniquely suited to examine how the degree of asymmetric information changes after the IPO.

Here is a discussion of the specific findings related to the reduction in asymmetric information:

1. Direct Evidence: Decrease in PD Dispersion

The sources utilize a novel measure to proxy for the degree of asymmetric information: the within-firm dispersion in banks’ PD assessments (Probability of Default).

• Rationale: The underlying intuition is that if asymmetric information is reduced, the private beliefs of different banks regarding the firm's risk should converge and more closely coincide. Differences of opinion, such as dispersion in bond ratings and analyst forecasts, are common proxies for asymmetric information in the literature.
• Post-IPO Outcome: Consistent with a reduction in asymmetric information, the cross-sectional standard deviation of PD estimates drops significantly after the IPO. This decline begins immediately after the IPO and persists over the four-year period analyzed.
• Magnitude: Four years after going public, the dispersion in PD estimates for IPO firms is 6 percentage points lower than for matched control firms that remain private, which is close to one standard deviation of the dispersion measure (6.4 percentage points).
• Timing Implication (Selection vs. Treatment): This convergence is observed after the IPO, not before. This timing suggests that the convergence is a direct result of the public listing (a treatment effect), rather than a pre-existing trend that predicts the IPO (selection effect). If firms were simply going public in anticipation of this convergence, it would be expected to occur prior to the IPO.
• Broader Implications: While the observed convergence is among banks' beliefs, the sources suggest that this likely reflects improvements in the broader information environment that benefit the firm's ability to raise capital from all types of investors.

2. Consequence: Improved Borrowing Terms

The reduction in asymmetric information is cited as the mechanism explaining the improvement in bank loan terms and lower borrowing costs.

• Mechanism: The sources argue that the increased transparency following the IPO reduces the amount of information rents informed financiers (such as banks) can extract from the firm. This aligns with theoretical literature suggesting that information asymmetries increase firms' cost of capital due to adverse selection problems.
• Quantified Outcome: After controlling for the underlying risk of the borrower using banks' internal PD and LGD assessments, firms' borrowing costs (interest rates) drop by 38 basis points (bps) after going public. This drop is substantial, representing a 21% reduction in credit spreads relative to the pre-IPO average, and suggests that the improvement in terms is related to factors other than just a reduction in the firm's risk profile.

3. Effect on Debt Composition and Lender Pool

The reduction in information asymmetries facilitates access to a wider range of debt financing options, including market-based debt.

• Expanded Pool of Lenders: Reduced information asymmetries lessen the adverse selection problem, enabling firms to borrow from a broader pool of banks. Four years after the IPO, public firms borrow from just under one more bank relative to control firms, starting from a baseline average of 2.3 banks.
• Market-Based Debt Access: Reduced information asymmetries also facilitate the use of market-based debt financing, such as public bonds and syndicated loans.
  • Firms' use of syndicated loans increases dramatically after the IPO, rising by about 15 percentage points relative to peers that remain private, representing a 167% increase from the baseline. This is consistent with the idea that syndicated loans are utilized more often when borrower information is more transparent.
  • The proportion of total debt comprised of public bonds increases by almost 8 percentage points by year four, and this increase occurs only after the IPO.

In summary, the sources attribute the overall improved access to capital experienced by newly public US firms to the increase in transparency inherent in the IPO process, which directly leads to a measurable reduction in information asymmetry among lenders. This reduction in asymmetric information, in turn, allows firms to secure better borrowing terms and expand their sources of financing.

The sources emphasize that the robustness of their findings regarding the IPO decision of US private firms stems directly from the detailed and unique nature of the data utilized, which in turn allows the paper to make several significant contributions to the finance literature.

Data Used for Analysis

The core of the analysis relies on the Federal Reserve Y-14Q data, which is uniquely suited to examine the "access to capital motive" for going public.

1. Coverage and Granularity of Private Firm Financials:

• The Y-14Q data includes all corporate loans over one million dollars extended by large US bank holding companies (BHCs) from 2012 onward.
• These BHCs account for 85.9% of all assets in the US banking sector as of 2018:Q4.
• The data contains extensive financial information on private firms in the US, including balance sheet and income statement information.
• The constructed firm/quarterly panel includes over one million firm/quarter observations covering just over 100,000 unique private firms.
• This data is considered the most detailed data on US private firms in the literature. In contrast, many comparable studies rely on data like the Census Longitudinal Business Database (LBD), which often contains incomplete income statement and balance sheet information and no information on firms’ borrowing terms.

2. Unique Loan-Level Risk Assessments:

• Crucially, the Y-14Q data includes banks’ internal risk assessments of borrowers. Specifically, it provides information on the Probability of Default (PD) and the Loss Given Default (LGD) for each loan.
• The availability of these private risk assessments allows the authors to examine how both firms’ cost of capital and the degree of asymmetric information change after the IPO.
• The authors confirm that these risk assessments strongly predict future loan performance, suggesting they are sufficient statistics for the underlying risk of the borrower.

3. IPO Sample and Matching:

• IPO data from SDC Platinum (2012–2023) is merged with the Y-14 data, identifying 423 unique IPOs.
• The matched IPO sample tends to be representative of larger IPOs, accounting for 61% of the aggregate IPO proceeds.
• The final sample of IPO firms are relatively larger private firms that borrow from large banks, a selection factor that the authors suggest likely works against the access to capital mechanism they explore.
• The Y-14 data is supplemented with VC financing data from the Preqin VC funding database and public bond data from the Mergent FISD dataset.

Research Contribution

The paper makes several specific contributions to the literature examining the determinants and outcomes of firms’ IPO decisions.

1. Providing Direct Evidence on the Access to Capital Mechanism:

• The study provides evidence from many different angles that ex-ante investment needs predict IPOs and that access to capital improves after the IPO, linking this improvement to reductions in asymmetric information. This directly supports the motive that improved access to capital is a key driver for US private firms going public, challenging mixed empirical support in the past.

2. Novel Findings Enabled by Risk Assessment Data:

• The sources claim this paper is the first to use banks’ private risk assessments in the IPO literature.
• It is the first to use this data to demonstrate that firms’ borrowing costs drop conditional on the risk of the borrower after going public.
• It is the first to show that this drop in borrowing costs coincides with a measurable decrease in the dispersion in banks’ private credit assessments (PD dispersion), thereby providing direct evidence for a reduction in asymmetric information as a potential mechanism for the improvement in borrowing terms.

3. New Evidence on Ex-Ante Predictors:

• The findings that ex-ante profitability negatively predicts going public and that this effect is stronger when ex-ante investment is high are new. This stands in contrast to studies using European data (e.g., Pagano, Panetta, and Zingales (1998)), which found that more profitable firms were more likely to go public.

4. New Insights on Post-IPO Financing Structure:

• The paper is the first to show that, due to large increases in debt, newly public firms' leverage levels revert to their pre-IPO levels within four years of the IPO. This also contrasts with earlier findings of permanent leverage reductions in European data.
• It is the first to show that firms increase their use of market-based debt financing (specifically syndicated loans and public bonds) after going public, relative to a set of control firms that remain private.

5. Distinction from Treatment Effect Literature:

• While acknowledging the importance of isolating causal treatment effects (as pursued by literature using withdrawn IPO filings, e.g., Bernstein (2015)), the authors note that their results capture both treatment and selection effects. However, they argue that certain findings, such as the post-IPO convergence in bank risk assessments and the improvement in borrowing terms, are difficult to explain through selection alone.

The detailed nature of the Y-14Q data, particularly the inclusion of banks' internal risk metrics, is thus fundamental to the paper's ability to isolate and confirm the reduction in asymmetric information as the driving force behind improved access to capital post-IPO.